Banking Briefs 2008

1Banking Briefs (For internal circulation only)


Today, availability of information is not scarce; but what is often lacking is theavailability of right information at the right time and at the right place. This isparticularly an issue for today’s bankers who are so engrossed in their daily routinethat they find it difficult to find time to scan the environment around them.‘Banking Briefs’, brought out by the State Bank Staff College, is an attempt toaddress this issue.

‘Banking Briefs’ was first published in 1995. This is its tenth edition, which coversa wide spectrum of topics in banking, economy, finance, law, institutions, IT, etc.The topics included in the publication are contemporary and of relevance toBanking Professionals. We in the College track the events that occur during a yearand try to present these, with their implications, in a comprehensive and lucidway.

While a lot of efforts has gone into bringing out this edition, there could still begaps particularly from a reader’s point of view. Your feedback in the form annexedwould, therefore, be always welcome.

‘Banking Briefs’ is available on SBITimes. I extend my compliments to all Facultymembers and Research Officers who have contributed papers to this edition. Iappreciate the efforts put in by Shri M.R. Das, AGM (Economist) and Shri KshitijMohan, Chief Manager (Research) for compiling the book. I compliment Shri S.T.Rajasundaram, Shri K.B. Bakthavathsal and Shri L. Mahapatra, all Dy. GeneralManager & Senior Faculty, for their active involvement in bringing out the book.

Our efforts will be amply rewarded if it is found useful by our colleagues.

I wish you an intellectually enriching reading.

FOREWORD

P. BHASHYAMChief General Manager & Principal

State Bank Staff College,HyderabadDecember 20, 2007


BANKING

BRIEFSA Compendium of Readings of Relevance to Bankers

STATE BANK STAFF COLLEGEDISTANCE LEARNING DEPARTMENT

JANUARY 2008

(For Internal Circulation Only)

(Tenth Revised & Enlarged Edition)

Compiled by

M.R. Das Kshitij MohanAGM (Economist) Chief Manager (Research)

Satbir Singh C.S. ShajiChief Manager (Research) Deputy Manager (Research)

HYDERABAD


1. Vibrant SBI ..... 1

2. Transfer of Reserve Bank’s Share Holding inState Bank of India to Government of India ..... 7

3. Personal Financial Planning: An Overview ..... 8

4. Credit Cards With Special Reference toConsumer Protection ..... 12

5. Deposit Insurance in India ..... 14

6. Islamic Banking ..... 17

7. Implementation of Basel II: Present Status ..... 27

8. Scheme of Prompt Corrective Action ..... 31

9. Disclosure and Transparency in Banks’Balance Sheets ..... 33

10. Compliance Function in Banks ..... 3511. Revised Guidelines on Priority Sector Lending ..... 3712. Micro, Small and Medium Enterprises ..... 3813. Outsourcing ..... 40

14. Prevention of Money Laundering (PML) Act ..... 41

15. SARFAESI Act: An Update ..... 44

16. Technological Development in Indian Banks ..... 57

17. E-learning ..... 59

18. E-Purse ..... 62

19. Mobile Banking ..... 64

20. Biometrics Authentication Technology ..... 66

21. Payment Systems: An Update ..... 68

22. Centralized Funds Management System (CFMS) ..... 71

23. Technology-Based Solutions for Rural Banking Business ..... 73

24. Tech Terms in Vogue ..... 75

25. Reverse Mortgage ..... 78

26. Credit Derivatives: Risk Transfer Instrument ..... 8627. Overheating of the Economy ..... 12228. Rupee Appreciation ..... 12329. Inclusive Growth ..... 12530. Economic Survey 2006-07 ..... 12831. Some Budget Concepts ..... 13332. Union Budget 2007- 08 ..... 13633. Railway Budget 2007-08 ..... 14334. Mid-Term Review of Annual Policy for 2007-08 ..... 146

71 NEW TOPICS ADDED IN THIS EDITION


35. Special Economic Zones (SEZs) ..... 15336. Legislative Amendments for Conduct of Monetary Policy ..... 15537. Government Securities Act, 2006 ..... 15638. Credit Information Companies (Regulation) Act, 2005 -

Rules and Regulations ..... 15739. Investment in Indian Companies by FIIs/NRIs/PIOs ..... 15940. Micro, Small and Medium Enterprises Development

(MSMED) Act, 2006 ..... 16041. RTI Act: Implications for Banks ..... 16242. Banking Codes and Standards Board of India:

Banks' Commitments to Customers ..... 16843. Pension Fund Regulatory and Development Authority (PFRDA)..... 17144. Money Market ..... 18945. Government Securities Market ..... 19246. Corporate Debt Market ..... 19647. Foreign Exchange Market ..... 19848. Non-Deliverable Forward Market ..... 20149. Hedge Funds ..... 20250. Private Equity ..... 20551. Participatory Notes ..... 20652. Carbon Credits and Emission Trading ..... 20853. The Sub-prime Crisis ..... 22654. Impact of Hike in Oil Price ..... 22855. China’s Banking Sector ..... 23056. External Sector: An Overview ..... 23357. Management of Mounting Forex Reserves ..... 23658. External Commercial Borrowings: The Current Status ..... 23959. UCP 600: ICC’s New Rules on Letters of Credit ..... 24660. SAARCFINANCE: Network of SAARC Country Central Banks ..... 24961. Money Laundering Menace: An International Perspective ..... 25062. Strokes ..... 25563. Burnout ..... 25764. Values and Ethics ..... 26065. IT Governance ..... 27866. Committee on Fuller Capital Account Convertibility ..... 31167. Technical Group to Review the Legislations on Money Lending ..... 31368. National Commission on Farmers ..... 31469. National Development Council: Resolution on Agriculture ..... 31670. Sadasivan Working Group on Reasonable

Service Charges by Banks to Customers ..... 31871. Committee on Financial Sector Assessment ..... 319


A. BANKING

I. STATE BANK OF INDIA

1. Vibrant SBI ..... 1

2. Transfer of Reserve Bank’s Share Holding inState Bank of India to Government of India ..... 7

II. GENERAL3. Personal Financial Planning: An Overview ..... 8

4. Credit Cards With Special Reference toConsumer Protection ..... 12

5. Deposit Insurance in India ..... 14

6. Islamic Banking ..... 17

7. Banking Industry: Vision 2010 ..... 21

8. Retail Banking - Opportunities and Challenges ..... 23

III. POLICIES AND ACTS

9. Implementation of Basel II: Present Status ..... 27

10. Scheme of Prompt Corrective Action ..... 31

11. Disclosure and Transparency in Banks’Balance Sheets ..... 33

12. Compliance Function in Banks ..... 35

13. Revised Guidelines on Priority Sector Lending ..... 37

14. Micro, Small and Medium Enterprises ..... 38

15. Outsourcing ..... 40

16. Prevention of Money Laundering (PML) Act ..... 41

17. SARFAESI Act: An Update ..... 44

18. Guidelines on Purchase/Sale of Non-PerformingFinancial Assets ..... 47

19. Know Your Customer (KYC) Guidelines ..... 49

20. CAMELS Ratings for Banks ..... 52

21. Banking Ombudsman Scheme ..... 54

22. Road Map for Presence of Foreign Banks ..... 56

CONTENTS


IV. TECHNOLOGY

23. Technological Development in Indian Banks ..... 57

24. E-learning ..... 59

25. E-Purse ..... 62

26. Mobile Banking ..... 64

27. Biometrics Authentication Technology ..... 66

28. Payment Systems: An Update ..... 68

29. Centralized Funds Management System (CFMS) ..... 71

30. Technology-Based Solutions forRural Banking Business ..... 73

31. Tech Terms in Vogue ..... 75

V. CREDIT AND DERIVATIVE PRODUCTS32. Reverse Mortgage ..... 78

33. Credit Derivatives: Risk Transfer Instrument ..... 86

34. Infrastructure Financing ..... 88

35. Securitisation ..... 90

36. Factoring ..... 92

37. Forfaiting ..... 93

38. Commercial Paper ..... 94

39. Currency Swaps ..... 96

40. Currency Options ..... 97

41. Currency Futures ..... 98

42. Interest Rate Swaps ..... 99

VI. MANAGEMENT OF ASSETS AND LIABILITIES43. Risk Based Supervision of Banks ..... 100

44. Risk Management Systems in Banks ..... 103

45. Asset-Liability Management ..... 105

46. Credit Risk Management ..... 107

47. Treasury Management in Banks ..... 110

48. Portfolio Management ..... 113

49. Operational Risk in Banks ..... 115

50. Essentials of Liquidity Risk Management ..... 117

51. Value at Risk (VaR) ..... 120


B. ECONOMY AND FINANCEI. POLICIES AND ACTS

52. Overheating of the Economy ..... 12253. Rupee Appreciation ..... 12354. Inclusive Growth ..... 12555. Economic Survey 2006-07 ..... 12856. Some Budget Concepts ..... 13357. Union Budget 2007- 08 ..... 13658. Railway Budget 2007-08 ..... 14359. Mid-Term Review of Annual Policy for 2007-08 ..... 14660. Special Economic Zones (SEZs) ..... 15361. Legislative Amendments for Conduct of Monetary Policy ..... 15562. Government Securities Act, 2006 ..... 15663. Credit Information Companies (Regulation) Act, 2005 -

Rules and Regulations ..... 15764. Investment in Indian Companies by FIIs/NRIs/PIOs ..... 15965. Micro, Small and Medium Enterprises Development

(MSMED) Act, 2006 ..... 16066. RTI Act: Implications for Banks ..... 16267. Micro Finance ..... 165

II. INSTITUTIONS68. Banking Codes and Standards Board of India:

Banks' Commitments to Customers ..... 16869. Pension Fund Regulatory and Development

Authority (PFRDA) ..... 17170. Credit Information Bureau (India) Limited (CIBIL) ..... 17271. SME Rating Agency of India Limited (SMERA) ..... 17472. The Institute for Development and Research in

Banking Technology (IDRBT) ..... 17573. Clearing Corporation of India Ltd. (CCIL) ..... 17874. Asset Reconstruction Company (India) Limited ..... 18075. Multi Commodity Exchange of India

(MCX, NCDEX, NMCIL) ..... 183

76. Non-Banking Finance Companies (NBFCs) ..... 185

III. FINANCIAL MARKETS77. Money Market ..... 189

78. Government Securities Market ..... 192


79. Corporate Debt Market ..... 196

80. Foreign Exchange Market ..... 198

81. Non-Deliverable Forward Market ..... 201

82. Hedge Funds ..... 202

83. Private Equity ..... 205

84. Participatory Notes ..... 206

85. Carbon Credits and Emission Trading ..... 208

86. Exchange Traded Funds ..... 211

87. Gold Demat ..... 212

88. Book Building ..... 214

89. Buy Back ..... 215

90. Stock Index Futures ..... 217

91. Employees Stock Option Plans (ESOPS) ..... 219

92. Margin Trading ..... 221

93. Internet Trading ..... 222

94. Venture Capital in India: Growth and Challenges ..... 223

IV. EXTERNAL SECTOR95. The Sub-prime Crisis ..... 226

96. Impact of Hike in Oil Price ..... 228

97. China’s Banking Sector ..... 230

98. External Sector: An Overview ..... 233

99. Management of Mounting Forex Reserves ..... 236

100. External Commercial Borrowings: The Current Status ..... 239

101. UCP 600: ICC’s New Rules on Letters of Credit ..... 246

102. SAARCFINANCE: Network of SAARC CountryCentral Banks ..... 249

103. Money Laundering Menace: An International Perspective ..... 250

104. National Foreign Trade Policy 2004-09 ..... 252

C. MANAGEMENT105. Strokes ..... 255

106. Burnout ..... 257

107. Values and Ethics ..... 260

108. Corporate Governance ..... 262

109. Balanced Score Card ..... 266


110. Transformational Leadership ..... 268111. Learning Organization ..... 270112. Intellectual Capital ..... 273113. Knowledge Management ..... 275114. IT Governance ..... 278115. Assessment Centre ..... 279116. Competency Mapping ..... 280117. Organisation Culture ..... 282118. Mentoring ..... 284119. 360–Degree Technique ..... 286120. Emotional Intelligence ..... 288121. Stress Management ..... 290122. Empowerment ..... 292123. Service Quality Management ..... 293124. Niche Market ..... 296125. Six Sigma: For Quality ..... 297126. Total Quality Management (TQM) ..... 299127. Benchmarking ..... 301128. ISO 9001 ..... 303129. ISO 14000 ..... 304130. Quality Circles ..... 305131. Financial Engineering ..... 306132. Economic Value Added (EVA) ..... 307133. Market Value Added (MVA) ..... 308134. Emerging Trends in Banking and Finance:

Role of New Generation Managers ..... 309

D. COMMITTEES135. Committee on Fuller Capital Account Convertibility ..... 311136. Technical Group to Review the Legislations on

Money Lending ..... 313137. National Commission on Farmers ..... 314138. National Development Council: Resolution

on Agriculture ..... 316139. Sadasivan Working Group on Reasonable

Service Charges by Banks to Customers ..... 318140. Committee on Financial Sector Assessment ..... 319141. Narasimham Committee - I ..... 321142. Narasimham Committee - II ..... 324


Table 1: Consolidated Balance Sheet of Scheduled Commercial Banks ..... 327

Table 2: Important Financial Indicators of Scheduled Commercial Banks ..... 328

Table 3: Financial Performance of State Bank Group ..... 329

Table 4: Lending to the Sensitive Sector by Scheduled Commercial Banks ..... 330

Table 5: Cost of Funds and Return on Funds – Bank Group-wise ..... 330

Table 6: Capital Adequacy Ratio – Bank Group-wise ..... 331

Table 7: Computerisation in Public Sector Banks ..... 331

Table 8: Branches and ATMs of Scheduled Commercial Banks ..... 331

Table 9: Gross and Net NPAs of Scheduled Commercial Banks –Bank Group-wise ..... 332

Table 10: Share Prices and Price/Earning Ratios of Bank Stocks at BSE ..... 333

Table 11: Share of Top Hundred Centres in Aggregate Deposits andGross Bank Credit ..... 334

Table 12: Overseas Operations of Indian Banks ..... 334

Table 13: List of Foreign Banks Operating in India – Country-wise ..... 335

Table 14: Return on Assets of Indian Banks vis-à-vis Select Countries ..... 336

Table 15: Ratio of Gross Non-performing Loans to Gross Advancesof Indian Banks ..... 337

Table 16: Capital Adequacy Ratio- Indian Banks vis-a-vis Select Countries ..... 338

Table 17: Distribution of Commercial Bank Branches in India –Bank Group and Population Group-wise ..... 339

Table 18: Off-Balance Sheet Exposure of ScheduledCommercial Banks in India ..... 340

STATISTICAL PROFILE


BANKINGSTATE BANK OF INDIA


VIBRANT SBI

State Bank of India is the largest commercialbank in India in terms of assets, deposits,profits, branches and employees. At the endof 2006-07 (April’06-March07), the Bank hadtotal assets of Rs.5,66,565.23 crore (US$130.33 billion), total deposits of Rs.43,552.08crore (US $100.19 billion) and recorded anet profit of Rs.4,541 crore (US $1.04 billion).The Bank has a vast domestic network of 9,517branches and staff strength of 1,85,388.

The State Bank is the only Indian bank to rankamong the top 100 banks in the world and isalso among the top 20 banks in Asiaaccording to The Banker (UK) annual survey.SBI is the sixth Indian company to feature inthe Fortune Global 500 companies.

The State Bank Group, consisting of theBank and its subsidiaries, has anoverwhelming presence in the Indian financialsector commanding a market share of aboutone-fourth of deposits and loans of allscheduled commercial banks in the country.Total assets of the State Bank Group as at end-March 2007 were Rs.8,15,174 crore (US$187.53 billion). The net profit of the Groupworked out to Rs.6,620 crore (US $1.52billion). The Group, through its varioussubsidiaries, provides a whole range offinancial services which include life insurance,merchant banking, mutual funds, credit card,factoring, security trading and primarydealership in the money market.

Structure and Organisation

The Bank’s Top Management consists of theChairman, two Managing Directors (Group

� The State Bank of India has been in the forefront of all areas of banking and has,over the years, richly merited its status as the flagship of Indian banking.

� In several fields, the Bank has pioneered innovative measures and contributedsignificantly to the growth of the Indian economy, while improving its ownprofitability over the years.

Executives) for National Banking Group andCorporate Banking Group and DeputyManaging Directors. New senior positionsrecently created are i.e. Deputy ManagingDirector & Group Executive (Rural & Agri.Business), Deputy Managing Director & GroupExecutive (Treasury & Markets), DeputyManaging Director (Corporate Strategy & NewBusiness), Deputy Managing Director(Wholesale Banking Group), General Manager(Corporate Communication & Change) andGeneral Manager (Super Circle Excellence), aspart of new initiatives for focusing on marketsegments that need ongoing monitoring of thegrowth in business.

Capital and Shareholding Pattern

SBI was the first public sector bank to accessthe domestic capital market in 1994 to shore upits capital base. In fiscal year 1994, the Bankraised Rs.2,210 crore (US $644 million) throughthe issuance of shares and Rs.1000 crore(US $291 million) through the issue ofunsecured redeemable subordinated floatingrate bonds. In October 1996, the Banksuccessfully floated the first GDR issue by anycommercial bank in the country and raised US$369 million, including the greenshoe option. The“World Equity” journal adjudged the SBI GDRissue as the “Asian Equity Issue of the Year” forits being a “well-planned, well–priced and well-executed issue that continued to perform wellfor the investors”.

SBI’s shares are listed for trading on all themajor Indian stock exchanges, viz., MumbaiStock Exchange and stock exchanges at NewDelhi, Kolkata, Chennai and Ahmedabad and at


the National Stock Exchange (NSE). The bondsare listed only on the NSE. The Bank’s GDRsare listed on the London Stock Exchange.The total number of shareholders as on 31stMarch 2007 was 5,26,782 with the followingownership pattern:

Shareholders % of shares held

Reserve Bank of India 59.73

Non-residents (FIIs/OCBs/NRIs/GDRs) 19.83

Financial Institutions including InsuranceCompanies/Banks 5.28

Mutual Funds/GovernmentCompanies/UTI 6.92

Domestic Companies/Trusts 2.28

Others including Resident Individuals 5.96

In its biggest ever cash purchase, theGovernment of India in June 2007 acquired theentire Reserve Bank of India (RBI) shareholdingin State Bank of India consisting of over 314million equity shares at a total amount of overRs.35500 crore.

Indian Associates and Subsidiaries

A network of eight Indian banking subsidiariesof the Bank, comprising seven AssociateBanks and SBI Commercial and InternationalBank Ltd. (SBICI), are engaged in the businessof commercial banking in the country. Branchesof the seven Associates are located at variousregions of the country while SBICI has its officesin Mumbai. The SBI Board has approved themerger of one of the Associates, viz., State Bankof Saurashtra with the parent SBI.

The Bank has six domestic non-bankingsubsidiaries providing various financialservices like merchant banking, fundsmanagement, factoring services, securitiestrading, credit cards and insurance. The Bankalso has seven foreign subsidiaries/jointventures/associates. The Bank is a co-promoterof Credit Information Bureau of India Ltd. AndClearing Corporation of India Ltd. The Bank hasset up Asset Reconstruction Company (India)

Ltd. under SARFAESI Act, 2002 jointlywith seven other commercial banks. TheBank has promoted a new technologycompany, C-Edge Technologies Ltd., as a jointventure with Tata Consultancy Services Ltd.

Domestic Branch Network

At the core of the Bank’s commercial bankingbusiness is its nationwide network of 9,517branches as on March 31, 2007, by far the largestbranch network of any bank in India. The Bank’sdomestic branches represent approximately14% of all bank branches in India. In additionto Bank’s own branches and 4,820 branchesof seven associate banks, Bank has a networkof Regional Rural Banks (RRBs). The financialyear 2006-07 was a year of consolidation ofRRBs. There was Bank-specific amalgamationof each State-level RRBs. Resultantly, Bankhas got 16 RRBs post-amalgamation witha network of 2,334 branches spread over104 districts in the country. The aggregatedeposits and advances of the sponsoredRRBs stood at Rs.12,990 crore and Rs.7,902crore respectively as on 31st March 2007.

National Banking Group (NBG)

The Bank’s National Banking Group consists ofthree business groups viz., Personal Banking,Small & Medium Enterprises (SME) andGovernment Banking.

Personal Banking Business Unit (PBBU)

The Bank accords high priority to personalbanking in the retail banking segment. TheBank’s Personal Banking Branches are well-equipped with state-of-the-art technology andoffer a wide range of services to high net worthindividuals covering the entire range ofpersonal segment products. The Bank’sretail banking activities are widespread andcover, among others, housing finance, autoloans, consumer finance, education loan andcustomer-group-specific products.

SME Business Unit (SMEBU)

SMEs include Small Scale Industries, SmallBusiness Finance and other entities


(Commercial & Institutional with annualturnover of less than Rs.25 crore ). A separateSMEBU was created in the Bank which startedfunctioning in October 2004 to address, in afocused manner, the market dynamics/customer preferences of this segment. TheSME Business Unit is implementing variousstrategies to maintain the Bank’s leadership inthe SME financing.

Government Business Unit (GBU)

The Bank has created the Government BusinessUnit as a distinct Strategic Business Unit withthe objective of focusing exclusively on thebusiness emanating from this segment. TheBank launched SBI e-Tax, an online tax paymentfacility. In addition, e-freight, a facility forpayment of railway freight has been extendedto large corporates on a pilot basis.Centralised Pension Processing Centres havealso been established at all 14 LHO Centres toprovide excellent customer service topensioners.

Rural & Agri Business Group

In 2006-07, a new business group, viz., Ruraland Agri Business Group, was created asstrategic initiative for maximum exploitationof the emerging rural banking opportunity andthe Bank’s initiatives in agriculture cover,among others, financial inclusion, ATM linkedKisan Credit Cards, contract farming andagri clinics, financing farmers in AgriculturalExport Zones, value chain financing, besidesfocusing on development of infrastructure likewarehouses and cold storage chains. Specialagricultural officers have been recruited togive a thrust to the Bank’s agricultural lending.SBI has been very active in Self Help Group(SHG) - Bank Credit Linkage Programme formicro finance and has contributed to theeconomic upliftment, social transformation andempowerment of women through extension ofthe SHG movement. The Bank’s flagshipprogramme for financial inclusion, SBI Tiny,was introduced last year and pilots for theSBI Tiny smart card project have beenlaunched in 3 States with proposed nationwide

rollout during the current year.

International Banking Group (IBG)

With the opening up of 5 new offices andtakeover of a Bank in Indonesia during 2007, theBank now has 83 offices in 32 countriesspanning all time zones. The Bank’s foreignoffices include full-fledged branches at centres,such as London, New York, Frankfurt, Paris,Hong Kong, Tokyo, Cape Town, Chittagongand Sydney. At Moscow, a full-fledged bank,namely, Commercial Bank of India LLC in a60:40 equity participation with Canara Bankhas been established. For expanding NRIbusiness, the Bank has a strategic alliancewith RAK Bank, UAE. The Bank has offshorebanking units in India at SEEPZ, Mumbaiand Kochi, Kerala. It also has representativeoffices, subsidiaries and other arrangementsfor conducting business and servicing theinternational needs of the Bank’s foreigncustomers as well as conducting some retailbanking.

Corporate Banking Group

The Corporate Banking Group emerged inresponse to the urgent need to provide topcorporate clients a wider and moresophisticated product range, greater skills andspeedy delivery platforms. The Groupconsists of five Strategic Business Units(SBUs), i.e., Corporate Accounts Group(CAG), Leasing Group, Project FinanceGroup, Mid-Corporate Group and StressedAssets Management Group (SAMG).

The Corporate Accounts Group is anexclusive unit for top corporates and ischaracterised by relationship banking and adelayered credit process for speedy decisionmaking. A new group – Institutional AccountsGroup has been formed for focusing on Banksand Financial Institutions, providing them withvarious banking products/services and forforming strategic alliances in the areas ofmutual interest. The CAG innovate productsto suit customer requirements and providesa one-stop shop to clients. It has dedicated


delivery platforms at Mumbai, Delhi, Kolkataand Chennai.

The Project Finance SBU focuses on fundingcore projects like power, telecom, roads, ports,airports, SEZ and others. It also handles non-infrastructure projects with minimum projectcosts of Rs.2 billion.

The Leasing SBU offers all types of financialleases tailored to suit the leasingrequirements of the Bank’s corporatecustomers.

The Mid-Corporate Group was created in July2004 with 7 MCG Regional Offices controlling28 branches with high concentration of Mid-Corporate business. The mid-corporatebusiness at all other branches at certainidentified centres was also brought under thecontrol of MCG under the off-site model. Thefocus of the MCG was to increase marketshare of the Bank in the emerging mid-corporate segment through relationshipmanagement and quicker credit processing.

The Stressed Assets Management Group(SAMG) was initially set up to take over all NPAswith outstanding of Rs.5 crore and above,for ensuring focused efforts in resolution ofNPAs. Now the policy has been modified tobring all NPAs of Rs.1 crore and above underthe purview of SAMG.

Project Uptech

Project Uptech is a unique initiative of the Bankdesigned to catalyze entrepreneurial thoughtsand action for technology up gradation/modernisation which is vital for the survival ofSMEs. Focused on the Small and MediumEnterprises (SME) sector, projects areundertaken in location specific and activityspecific industry clusters. So far the Bank hastaken up 30 projects for modernization underProject Uptech.

Global Link Services

The Global Link Services (GLS) was set upin 1997 to provide international correspondentbanking services to the Bank’s branches as well

as to other banks. It aims to provide anefficient system for realizing the proceedsof clean and documentary collections drawnon overseas centres. The operations of GLSin the area of export payments and otheroverseas collections have significantlyimproved the profitability of the Bank’sforex operations and reduced dependenceon foreign banks in the related businessprocess. The GLS offers correspondent bankingproducts on matching terms with similarproducts of foreign banks.

Technology Orientation

The State Bank Group is fully computerized. TheBank is pursuing an aggressive IT policy as astrategic initiative to meet the growingcompetition for business and market share,achieve efficiency in internal operations,and meet customer expectations. With thisend in view, several initiatives wereundertaken, viz., ATM Project, where ATMs arenow also enabled to pay utility bills and collegefees, accept donations, etc. Further,bilateral sharing of ATMs was extended tothirteen banks, covering 15,700 ATMs and anMOU has been signed with the Indian Railwaysfor installing ATMs at 682 Railway Stations.Core Banking Solution (CBS) presently covers72 million accounts, and more than 85% ofthe Bank’s business. Finacle Project forTreasury and Core Banking Solution has beenimplemented at 73 foreign offices in 22countries, along with Internet Banking at allforeign offices. Further, Internet Banking hasbeen implemented at 4,841 domesticbranches, and used by retail banking customersfor utility bill payment and booking of Rail and Airtickets and transfer of funds between banksthrough NEFT/RTGS. IT Policy and IS SecurityPolicy have been implemented after beingbenchmarked against best global practices. TheBank’s Central Data Centre and DisasterRecovery Centres have been certified asISO/IEC 27001:2005 Compliant, which is thenew International Standard for InformationSecurity Management Systems. SBI Connect,the Wide Area Networking (WAN) project of


the Bank, is capable of carrying data, voiceand video. At present, 5,794 branches of SBI and4,995 branches of Associate Banks are beingnetworked under the SBI Connect Project.

The Bank has provided helplines at all its 14LHOs with toll free numbers to enable thecustomers to have their grievances redressedspeedily, besides obtaining completeinformation on the Bank’s products andservices.

Risk Management & Internal Controls:Risk Governance Structure

An independent Risk Governance structure, inline with international best practices, has beenput in place in the Bank. This is in thecontext of separation of duties/independenceof risk measurement, monitoring and controlfunctions of the Bank. An independent positionof ‘Chief Risk Officer’ has been created andis currently headed by a Managing Director to

ensure integrated risk management for credit,market and operational risks. A new RiskManagement structure with new positions willenable the Bank to comply with the firstphase of implementation of Basel-II.

The State Bank of India has been in the forefrontof all areas of banking and has, over the years,richly merited its status as the flagship ofIndian banking. In the recent Customer LoyaltySurvey 2006-07 conducted by Business World,the Bank has been ranked number one in allthe parameters of Customer Satisfaction,Service Orientation, Customer Care/Call Centre,Customer Loyalty and Home Loans. In 2006 theBank won the AWAAZ Consumer Award for 2006as (i) the Most Preferred Bank and (ii) the MostPreferred Housing Loan provider. In severalfields, the Bank has pioneered innovativemeasures and contributed significantly to thegrowth of the Indian economy, while improvingits own profitability over the years.

STATE BANK OF INDIA (Source: SBI Website)FINANCIAL HIGHLIGHTS-2002-2007 (Rs. in Billion)

FY2002 FY2003 FY2004 FY2005 FY 2006 FY2007

Deposits 2705.6 2961.24 3186.19 3670.48 3800.46 4355.21

Advances 1208.06 1377.58 1579.34 2023.74 2618.01 3373.36

Investments 1451.42 1723.48 1856.76 1970.98 1625.34 1491.49

Total Assets 3482.28 3758.76 4078.15 4598.83 4940.29 5665.65

Interest Income 298.10 310.87 304.60 324.28 359.80 394.91

Interest Expenses 207.29 211.09 192.74 184.83 203.90 234.37

Net Interest Income 90.81 99.78 111.86 139.45 155.89 160.54

Non-Interest Income 41.74 57.40 76.12 71.20 74.35 57.69

Total Operating Income 132.55 157.18 187.98 210.65 230.24 218.23

Staff Expenses 51.53 56.89 64.48 69.07 81.23 79.33

Overhead Expenses 20.58 22.53 27.97 31.67 36.02 38.91

Total Operating Expenses 72.11 79.42 92.45 100.74 117.25 118.24

Operating Profit 60.44 77.76 95.53 109.91 112.99 100.00

Total Provisions 36.14 46.70 58.72 66.86 68.93 54.59

Net Profit 24.30 31.06 36.81 43.05 44.07 45.41


FY2002 FY2003 FY2004 FY2005 FY2006 FY2007

ROA (%) 0.73 0.86 0.94 0.99 0.89 0.84ROE (%) 15.97 18.05 18.19 18.10 15.47 14.24EPS(Rs.) 46.20 59.00 69.94 81.79 83.73 86.29BVS(Rs.) 289.00 327.00 384.00 450.00 525.00 606.00Dividend Pay out Ratio (%) 12.98 14.40 15.73 15.29 16.72 16.22Cost/Income Ratio (%) 54.40 50.53 49.18 47.83 58.70 54.18Capital Adequacy Ratio (%) 13.35 13.50 13.53 12.45 11.88 12.34Cost of Deposits (%) 7.60 7.11 6.02 5.11 4.77 4.79Yield on Advances (%) 9.66 8.97 8.17 7.68 7.78 8.67Yield on Resources Deployed (%) 10.06 9.53 8.62 7.94 7.10 6.88Net Interest Margin (%) 2.91 2.95 3.04 3.39 3.40 3.31Gross NPA Ratio (%) 11.95 9.33 7.75 5.96 3.61 2.92Net NPA Ratio (%) 5.63 4.50 3.48 2.65 1.88 1.56Provision Coverage (%) 56.00 54.00 57.00 57.00 49.00 47.00

SUMMARY OF BALANCE SHEET (Rs. in billion)

MARCH MARCH MARCH MARCH MARCH MARCH2002 2003 2004 2005 2006 2007

CAPITAL & LIABILITIESCapital 5.26 5.26 5.26 5.26 5.26 5.26Reserves & Surplus 146.98 166.77 197.05 235.46 271.18 307.72Deposits 2705.60 2961.23 3186.19 3670.48 3800.46 4355.21Borrowings 93.24 93.04 134.31 191.84 306.41 397.03Other Liabilities & Provisions 531.20 532.46 555.34 495.79 556.98 600.42Total 3482.28 3758.76 4078.15 4598.83 4940.29 5665.65ASSETSCash & balances withReserve Bank of India 218.73 127.38 190.41 168.10 216.53 290.76Balances with banks andmoney at call & short notice 430.58 324.43 245.25 225.12 229.07 228.92Investments 1451.42 1723.48 1856.76 1970.98 1625.34 1491.49Advances 1208.06 1377.58 1579.34 2023.74 2618.01 3373.36Fixed Assets 24.15 23.89 26.45 26.98 27.53 28.19Other Assets 149.34 182.01 179.94 183.91 223.81 252.92Total 3482.28 3758.77 4078.15 4598.83 4940.29 5665.65Contingent Liabilities 1022.13 1061.06 1118.92 1593.97 2288.51 3065.90Bills for Collection 101.77 75.71 101.94 167.77 205.93 233.68

MARKET RELATED RATIOS

MAR 03 MAR 04 MAR 05 MAR 06 MAR 07

Market Price (Rs)(as on last dayof the year/quarter) 270 606 657 968 993Price to Book Ratio (%) 0.83 1.58 1.44 1.84 1.64Market Capitalization(Rs in Billion) 142.05 318.78 345.75 509.48 522.56Earning Per Share( Rs) 59.00 69.94 81.79 83.73 86.29P/E Ratio (%) 4.58 8.66 8.03 10.40 11.51

KEY FINANCIAL INDICATORS


TRANSFER OF RESERVE BANK’S SHARE HOLDING INSTATE BANK OF INDIA TO GOVERNMENT OF INDIA

� An ordinance was promulgated on June 21, 2007 for certain amendments in the SBIAct to enable the transfer of shares from RBI to Government.

� Accordingly 31,43,39,200 shares of SBI which were held by the Reserve Bank weresold on June 29, 2007 to Government of India at the rate of Rs.1,130.35 per share.

� The total consideration of Rs.355,31,33,14,720 was received in cash fromGovernment.

� As a result of the RBI's divestment, the majority ownership of SBI lies with theGovernment of India.

The State Bank of India (SBI) was establishedby an Act of Parliament passed on April 30, 1955on the basis of the recommendations made bythe Rural Credit Survey Committee, 1952 tobring the Imperial Bank of India under publicownership and to entrust it with the responsibilityof spreading the banking facilities to the remoteregions of the country. Accordingly, theCommittee recommended the formation of anew bank, to be called State Bank of India byamalgamating the Imperial Bank of India with 10major banks associated with the former princelystates with a view to having effective state control.Even though the Survey Committee was infavour of majority ownership for the Governmentof India by issuing additional capital withoutdisturbing the ownership of the existing sharecapital, it was thought prudent that Reserve Bankholds the majority of the shares. Accordingly, theReserve Bank held the majority of SBI’s shares.As at end-March 2007 the Reserve Bank’s stakein the SBI was 31,43,39,200 equity shares ofRs.10 (face value) per share aggregating to59.73 per cent of the SBI’s paid-up share capital.

Based on the recommendations of theNarasimham Committee II that the ReserveBank should not own the institutions it regulates,

an internal Group was set up by the ReserveBank in 2001 to finalise the modalities of transferof its investment in SBI, NABARD and NHB andthe Group’s Report was forwarded toGovernment for necessary action. Governmentannounced in the Union Budget 2007-08 theirproposal for acquisition of Reserve Bank’sholdings in SBI and an amount of Rs.40,000crore was provided in the Budget. An ordinancewas promulgated on June 21, 2007 for certainamendments in the SBI Act to enable the transferof shares from Reserve Bank to Government.Accordingly 31,43,39,200 shares of SBI whichwere held by the Reserve Bank were sold onJune 29, 2007 to Government of India at the rateof Rs.1,130.35 per share. The sale price wasarrived at in accordance with the SEBI(Substantial Acquisitions of Shares and TakeoverRegulations, 1997) using National StockExchange (NSE) prices for the 26 weekspreceding the date of public announcement. Thetotal consideration of Rs.355,31,33,14,720 wasreceived in cash from Government. The ReserveBank booked a profit on sale of investment tothe extent of Rs.343,08,60,37,320. As a resultof the Reserve Bank’s divestment, the majorityownership of SBI lies with the Government ofIndia.


BANKINGTECHNOLOGY


PERSONAL FINANCIAL PLANNING: AN OVERVIEW

� “Plan your future before. That’s whereyou are going to spend the rest of yourlife.” —— Mark Twain

� ‘If you can’t predict the future, at leastyou can plan for it’

WHAT IS PERSONAL FINANCIALPLANNING?

Personal Financial Planning is planning for thefinancial well-being of a person enabling him toachieve his financial goals in life. It is a processof identifying financial goals, evaluating existingresources and designing financial strategies thathelp achieve those goals. In short it is a processof meeting your life’s goals, through prudentmanagement of finances.

The process helps a person work out

Where he is today- Evaluate current FinancialHealth

What he may need in future- Define FinancialGoals in life

How to meet those goals - Develop a Financialplan to fund the gap between current resourcesand future goals

THE FINANCIAL PLANNING PROCESS —OBJECTIVE

Products by themselves are not as importantas what they can do for us in terms of makingmoney available when needed. We all need‘finance’ at different stages of our life for meetingdifferent goals like education / marriage ofchildren, purchase of house, building a corpusfor retirement etc. The objective of the financial

� Financial planning is a process of meeting your life’s goals, through prudent managementof finances.

� Goals should be ‘SMART’ – Specific – Measurable – Achievable – Realistic – Timebound.

� Financial planning takes into account the comprehensive needs of the individual as wellas the family. It follows the “big picture” approach – to include savings, budgeting, goalsetting, debt management, apart from insurance, investment, retirement, tax and estateplanning.

planning process is to ensure that the rightamount of money is available in the right handsat the right time in future to achieve one’sfinancial goals.

IMPORTANT ASPECTS OF FINANCIALPLANNING

Most of us spend more than half our livesworking and saving because money is crucial.However, most of us spend almost no timeplanning to make that hard-earned money workmore effectively for us. What are you saving for?

Define Your Financial Goals

Financial goals refer to all goals and needs whichhave a monetary aspect to them.

These are best defined when the amount, thepurpose and the timeframe are clearly statedi.e in terms of how much money will be needed,for what purpose and when.

Goals should be ‘SMART’ – Specific –Measurable – Achievable – Realistic – Timebound:

Identify specific goals of what you want,categorise them into long term and short termgoals and prioritise – given your financial andlife situation

Quantify them into monetary terms- Attach a costto each goal and adjust it for inflation – a ‘big’house, or a ‘comfortable’ retired life are vagueand not well defined.

Are the goals achievable given what you haveand want?


Are the expectations realistic? – don’t expectchanges overnight!

Set a time frame for when the money is neededto accomplish the goal

Evaluate your current situation

Planning for your financial life begins withevaluating your current financial health i.eassessing your overall financial profile. This canbe done through preparation of personalfinancial statements like –

a. Personal balance sheet, the financialPolaroid, which helps in assessing your networth and measuring your wealth. Assets[financial & physical assets] - Liabilities [Highcost / low cost debt & short term / long term] =Net Worth. Creating a personal balance sheetwill help in tracking your wealth through increase/ decrease in net worth over a period of time.

b. Income and Expense statement and cashflow statement, help you track your money i.ewhere your money comes from (all sources)and where it goes (fixed / variable expenses).They form the financial motion picture, helpingyou understand current spending patterns andin formulating a budget. Budgeting is a processof tracking, planning and controlling the inflowand outflow of income. The most importantreason for not knowing whether we have enougheven after working for years is that we do notbudget for the family. The Finance Minister hasan annual Budget, the Bank has one too, butthe most important budget - family budget is,unfortunately, the most ignored aspect of ourfinancial life.

Draw up a savings plan

Investible surplus can be increased throughsystematic savings. Income - Expenditure =Savings. This equation cannot be left to chance.So record all expenses, review spending andsaving habits and make a savings plan. ‘Savingscreate wealth, not income’

Contingency Plan: Put aside money foremergenciesDeploy some money in short-term investments that can be encashed ondemand to help you tide over unforeseen needsand emergencies.

Insurance Planning — First Protect and thenbuild:

Insurance Planning is the foundation for thefinancial plan edifice. Insurance will protect yourfamily’s current lifestyle from adverse events andexpenses. The aim of financial planning is to helpyou/ your family realize future goals. A financialplan can go awry due to occurrence ofunforeseen events which will erode existingwealth and prevent further wealth accumulation.Insure your life, health and assets adequatelyas a hedge against various risks such as death,illness, disability or damage / loss of property.Insurance needs change according to your lifestage, financial commitments and long termneeds.

Investment Planning – is an important pillar inthe structure of a financial plan. The GuidingPrinciples:

When to invest? Start investing early toharness the power of compounding. Investwhenever you have the money, be it big or smallamounts, because it gives money more time togrow. Those who invest small amounts earlyand for long term often tend to do better thanthose who delay until later in life - because everyday that you are invested, is a day your moneyis working harder for you.

How to invest? Invest regularly. Timing themarket is risky. A more successful strategy is toadopt the rupee cost averaging method whereyou invest a fixed amount regularly, regardlessof what direction the market is moving. This canbring down the average cost of investments andmaximize returns.

Where to invest? Diversify. Have a suitableasset allocation plan (right mix of investments)based on your risk tolerance, time horizon andneeds and goals.

Match investment options to liquidity needs atdifferent points of time in the future, taking intoaccount inflation and taxation.

Retirement planning is a key element in afinancial plan and is a process which runsthrough different stages of our working life,accumulating funds which are required to builda retirement corpus. This corpus is to be


planned and managed in such a way that it laststhroughout the retirement years. ‘We planenough for a 30 day vacation but not enough fora 30 year retirement’

Tax planning and Estate planning

Look for post tax yields. Tax free returns arebetter than taxable returns. ‘It is not what youmake that matters but what you keep.’

Make nominations, create a will so that yourestate passes on to your intended beneficiariesas smoothly as possible.

Implement:

With the plan in place, along with strategies forinsurance, investment, retirement, tax andestate planning, the next step is to implementthe action plan to achieve financial goals.

Monitor - the action plan. Review progress,reevaluate and revise your plan at periodicintervals to ensure you are on course.Rebalance the asset allocation if need be. If thefuture always went according to plan, financialplanning would be a one-time exercise. But lifethrows a few curves now and then.

THE PROFESSIONAL FINANCIAL PLANNER:

A person can do his own financial planning ortake the help of professional financial planners.In general, financial planners use a six –stepprocess, which involves gathering relevantfinancial data, setting life goals, examining thecurrent financial status and formulating an actionplan for meeting the goals given the currentsituation and future plans, implementing andmonitoring the plan.

The CFP Board of Standards (USA) haspromoted the following six step process forprofessional financial planners:

1. Establishing and defining the client-planner relationship.

Financial planning is a two way interactionbetween client and planner. The planner shouldclearly explain or document the services to beprovided and define both his and yourresponsibilities. He should explain fully how hewill be paid and by whom. You and the planner

should agree on how long the professionalrelationship should last and on how decisionswill be made.

2. Gathering client data, including goals.

The planner should ask for information aboutyour financial situation. You and the plannershould mutually define your personal andfinancial goals, understand your time frame forresults and discuss, if relevant, how you feelabout risk. He should gather all the necessarydocuments at this stage.

3. Analyzing and evaluating your financialstatus.

The planner should analyze the information toassess your current situation vis-a –vis yourfuture goals. Depending on what services youhave asked for, this could include analyzing yourassets, liabilities and cash flow, debtmanagement, current insurance coverage,investments or tax strategies.

4. Developing and presenting financialplanning recommendations and/oralternatives.

The planner should offer financial planningrecommendations that address your goals,based on the information you provide. Theplanner should go over the recommendationswith you to help you understand them so thatyou can make informed decisions. The plannershould also listen to your concerns and revisethe recommendations as appropriate.

5. Implementing the financial planningrecommendations.

You and the planner should agree on how therecommendations will be carried out. Theplanner may carry out the recommendations orserve as your “coach,” coordinating the wholeprocess with you and other professionals suchas attorneys or stockbrokers.

6. Monitoring the financial planningrecommendations.

You and the planner should agree on who willmonitor your progress towards your goals. If theplanner is in charge of the process, he shouldreport to you periodically to review your situation


and adjust the recommendations, if needed, asyour life changes.

THE BENEFITS OF FINANCIAL PLANNING:

Financial planning follows the “big picture”approach– to include savings, budgeting, goalsetting, debt management, apart from insurance,investment, retirement, tax and estate planning.It takes into account the comprehensive needsof the individual as well as the family.

It provides direction and meaning to our financialdecisions. It helps us understand how eachfinancial decision made affects other areas ofour finances. By viewing each financial decisionas part of a whole, you can consider its shortand long-term effects on your life goals.

‘Those who do not work for their own goalswork for other’s goals’

“Money can’t buy happiness; lack of moneywill certainly buy you misery”


Based on the recommendations of the WorkingGroup on Regulatory Mechanism for Cards setup by RBI, comprehensive guidelines on creditcard operations of banks were framed inNovember 2005 for implementation by the creditcard issuing banks. These guidelines wereupdated in July 2007 and inter alia, cover areaslike transparency in interest rates and othercharges, wrongful billing, use of direct marketingagents (DMAs)/direct selling agents (DSAs) andother agents, protection of customer rights,redressal of grievances, etc. Banks wereadvised that credit card dues are in the natureof non-priority sector personal loans and assuch banks are free to determine the rate ofinterest on credit card dues without referenceto their BPLR and regardless of the size.Customer’s rights in relation to credit cardoperations primarily relate to personal privacy,customer confidentiality and fair practices in debtcollection. The areas of consumer protectiontaken care of in the guidelines are as under:

(i) Banks should be transparent in fixing theirinterest rate/service charge on credit carddues and include the above in the‘Welcome Kit’ and the monthly statements.

(ii) Banks should have a well documentedpolicy and a Fair Practices Code for creditcard operations and should adopt the FairPractices Code for credit card operationsof banks released by IBA.

(iii) The card issuing bank should ensure thatwrong bills are not raised and issued tocustomers. In case, a customer protestsany bill, the bank should provide

CREDIT CARDS WITH SPECIAL REFERENCE TOCONSUMER PROTECTION

� Based on the recommendations of the Working Group on Regulatory Mechanism forCards set up by RBI, comprehensive guidelines on credit card operations of bankswere framed in November 2005 for implementation by the credit card issuing banks.

� These guidelines were updated in July 2007 and inter alia, cover areas liketransparency in interest rates and other charges, wrongful billing, use of directmarketing agents/direct selling agents and other agents, protection of customer rights,redressal of grievances, etc.

explanation and, if necessary,documentary evidence to the customerwithin a maximum period of sixty days. Thecredit card issuing bank may considerproviding bills and statements of accountsonline, with suitable security built for thatpurpose.

(iv) While outsourcing the various credit cardoperations banks have to take care thatthe quality of the customer service and thebank’s ability to manage credit, liquidityand operational risks is not compromised.In the choice of the service provider, bankshave to be guided by the need to ensureconfidentiality of the customer’s records,respect customer privacy, and adhere tofair practices in debt collection.

(v) The Code of Conduct for Direct SalesAgents (DSAs) formulated by the IndianBanks’ Association could be used bybanks in formulating their own codes forthe purpose. The bank should ensure thatthe DSAs engaged by them for marketingtheir credit card products scrupulouslyadhere to the bank’s own Code of Conductfor credit card operations which should bedisplayed on the bank’s website and beavailable easily to any credit card holder.

(vi) Unsolicited cards should not be issuedand unsolicited loans or other credit facilityshould not be offered.

(vii) The card issuing bank should notunilaterally upgrade credit cards andenhance credit limits. Prior consent of thecardholder should invariably be taken


whenever there are any change/s in termsand conditions.

(viii) The card issuing bank should not revealany information relating to customers toany other person/organisation withoutobtaining their specific consent. In caseof providing information relating to credithistory/repayment record of the cardholder to a credit information company(specifically authorised by the ReserveBank), the bank may explicitly bring to thenotice of the customer that suchinformation is being provided in terms ofthe Credit Information Companies(Regulation) Act, 2005. A similar priornotice may be given to the cardholderbefore reporting default status to the CreditInformation Bureau of India Ltd. (CIBIL) orany other credit information Companyauthorised by the Reserve Bank.

(ix) In the matter of recovery of dues, banksshould ensure that they, as also theiragents, adhere to the extant instructionson Fair Practice Code for lenders issuedby the Reserve Bank as also IBA’s Codefor Collection of dues and repossessionof security. In case banks have their owncode for collection of dues it should, at theminimum, incorporate all the terms of IBA’sCode. In particular, in regard toappointment of third party agencies fordebt collection, it is essential that suchagents refrain from action that coulddamage the integrity and reputation of thebank and that they observe strict customerconfidentiality.

(x) Banks/their agents should not resort tointimidation or harassment of any kind,either verbal or physical, against anyperson in their debt collection efforts,including acts intended to humiliatepublicly or intrude the privacy of the creditcard holders’ family members, refereesand friends, making threatening andanonymous calls or making false andmisleading representations.

(xi) Generally, a time limit of sixty days maybe given to the customers for preferringtheir complaints/grievances. The cardissuing bank should constitute grievanceredressal machinery within the bank. Thename and contact number of designatedgrievance redressal officer of the bankshould be mentioned on the credit cardbills/displayed on the website. The bankshould have a system of acknowledgingcustomers’ complaints for follow-up suchas complaint number/docket number evenif the complaints are received on phone.

(xii) Option to approach of the Office of theBanking Ombudsman for redressal ofgrievances relating to Credit Cards hasalso been provided in the guidelines.

(xiii) The Reserve Bank reserves the right toimpose penalty on banks under theprovisions of the Banking Regulation Act,1949 for violation of any of the credit cardguidelines.


The concept of insuring deposits kept with banksreceived attention for the first time in the year1948 after the banking crises in Bengal. Thequestion came up for reconsideration in the year1949, but it was decided to hold it in abeyancetill RBI ensured adequate arrangements forinspection of banks. Subsequently, in the year1950, the Rural Banking Enquiry Committee alsosupported the concept. Serious thought to theconcept was, however, given by RBI and theCentral Government after the crash of the PalaiCentral Bank Ltd., and the Laxmi Bank Ltd. in1960. The Deposit Insurance Corporation (DIC)Bill was introduced in the Parliament on August21, 1961. After it was passed by the Parliament,the Bill got the assent of the President onDecember 7, 1961 and the Deposit InsuranceAct, 1961 came into force on January 1, 1962.

In July 1978, DIC assumed also the function ofcredit guarantee and hence was named DepositInsurance Corporation & Credit GuaranteeCorporation (DICGC). The Bank was a memberunder the Credit Guarantee Scheme until itwithdrew in early nineties.

All commercial banks including branches offoreign banks functioning in India, local areabanks and regional rural banks are insured byDICGC. All State, Central and Primarycooperative banks, also called urban cooperativebanks, functioning in States/Union Territories

DEPOSIT INSURANCE IN INDIA

� DICGC was set up in 1962 to restore public confidence in the banking system in theaftermath of successive bank failures in the ‘60s. In fact, India, as it happened, wasonly the second country in the world after the US in 1933, to provide insurance coverto bank deposits.

� All commercial banks including branches of foreign banks functioning in India, localarea banks and regional rural banks are insured by DICGC.

� Each depositor in a bank is insured up to a maximum of Rs.1,00,000/- for both principaland interest amount held by him in the same right and same capacity.

� Deposit insurance premium is borne entirely by the insured bank. The current premiumrate is Rs.0.10 per assessable deposit of Rs.100/-.

� The deposit insurance scheme is compulsory and no bank can withdraw from it.

which have amended the local CooperativeSocieties Act empowering RBI to order theRegistrar of Cooperative Societies of the State/Union Territory to wind up a cooperative bank orto supersede its committee of management andrequiring the Registrar not to take any actionregarding winding up, amalgamation orreconstruction of a co-operative bank withoutprior sanction in writing from RBI are coveredunder the Deposit Insurance Scheme. Atpresent, all co-operative banks other than thosefrom the State of Meghalaya and the UnionTerritories of Chandigarh, Lakshadweep, andDadra and Nagar Haveli are covered by DICGC.Primary cooperative societies are not insuredby DICGC.

DICGC insures all deposits such as savings,fixed, current, recurring, etc., deposits except(i) Deposits of foreign Governments, (ii) Depositsof Central/State Governments, (iii) Inter-bankdeposits, (iv) Deposits of the State LandDevelopment Banks with the State co-operativebank, (v) Any amount due on account of anddeposit received outside India and (vi) Anyamount, which has been specifically exemptedby the Corporation with the previous approval ofRBI.

Each depositor in a bank is insured up to amaximum of Rs.1,00,000 (Rupees One Lakh)for both principal and interest amount held by


him in the same right and same capacity as onthe date of liquidation/cancellation of bank’slicence or the date on which the scheme ofamalgamation/merger/reconstruction comesinto force. The rule of same right and capacityhas been recently relaxed (w.e.f. April 26, 2007)in the case of joint accounts. Earlier, DICGCused to settle the claims of all joint accounts in“the same capacity and the same right” up toRs.1 lakh, for all combinations of the same setof depositors. This meant that joint accounts of“A” and “B” and “B” and “A” in the same bankwere treated as one account and the claimswere settled for only up to Rs.1 lakh aggregatingthe balance in both accounts together. As perthe revised policy the deposits held in twoseparate joint accounts in combination of say,“A” and “B” and “B” and “A”; will now be treatedas two separate accounts, and each categoryof the joint account will be eligible for a claim upto Rs.1 lakh.

The deposits kept in different branches of a bankare aggregated for the purpose of insurancecover and a maximum amount up to Rs.1 lakhis paid. If the funds are deposited into separatebanks they would then be separately insured.

DICGC insures principal and interest up to amaximum amount of Rs.1 lakh. For example, ifan individual had an account with a principalamount of Rs.95,000 plus accrued interest ofRs.4,000, the total amount insured by DICGCwould be Rs.99,000. If, however, the principalamount in that account was Rs.1 lakh, theaccrued interest would not be insured, notbecause it was interest but because that wasthe amount over the insurance limit.

Banks have the right to set off their dues fromthe amount of deposits. The deposit insuranceis available after netting of such dues.

Deposit insurance premium is borne entirely bythe insured bank. The current premium rate isRs.0.10 per assessable deposit of Rs.100/-.

If a bank goes into liquidation DICGC is liable topay to each depositor through the liquidator, theamount of his deposit up to Rs.1 lakh within twomonths from the date of receipt of claim list from

the liquidator. If a bank is reconstructed oramalgamated/merged with another bank DICGCpays the bank concerned, the difference betweenthe full amount of deposit or the limit of insurancecover in force at the time, whichever is less andthe amount received by him under thereconstruction/amalgamation scheme withintwo months from the date of receipt of claim listfrom the transferee bank/Chief Executive Officerof the insured bank/transferee bank as the casemay be.

DICGC does not directly deal with the depositorsof failed banks. In the event of a bank’sliquidation, the liquidator prepares depositor-wise claim list and sends it to DICGC for scrutinyand payment. DICGC pays the money to theliquidator who is liable to pay to the depositors.In the case of amalgamation/merger of banks,the amount due to each depositor is paid to thetransferee bank.

The deposit insurance scheme is compulsoryand no bank can withdraw from it. However, theCorporation may cancel the registration of aninsured bank if it fails to pay the premium forthree consecutive periods. In the event of theDICGC withdrawing its coverage from any bankfor default in the payment of premium the publicwill be notified through newspapers. Registrationof an insured bank stands cancelled if the bankis prohibited from receiving fresh deposits; orits licence is cancelled or a licence is refused toit by RBI; or it is wound up either voluntarily orcompulsorily; or it ceases to be a bankingcompany or a co-operative bank within themeaning of Section 36A(2) of the BankingRegulation Act, 1949; or it has transferred all itsdeposit liabilities to any other institution; or it isamalgamated with any other bank or a schemeof compromise or arrangement or ofreconstruction has been sanctioned by acompetent authority and the said scheme doesnot permit acceptance of fresh deposits. In theevent of the cancellation of registration of a bank,deposits of the bank remain covered by theinsurance till the date of the cancellation.

The Corporation has deposit insurance liabilityon liquidation, etc., of “Insured banks”, i.e., banks


which have been de-registered (a) on accountof prohibition on receiving fresh deposits or (b)on cancellation of licence or it is found thatlicence cannot be granted. The liability of theCorporation in these cases is limited to theextent of deposits as on the date of cancellationof registration of bank as an insured bank. Onliquidation, etc., of other de-registered banks, i.e.,banks which have been de-registered on othergrounds such as non-payment of premium ortheir ceasing to be eligible co-operative banksunder section 2(gg) of the DICGC Act, 1961, theCorporation will have no liability.

DICGC was set up in 1962 to restore publicconfidence in the banking system in theaftermath of successive bank failures in the ‘60s.In fact, India, as it happened, was only thesecond country in the world after the US in 1933,to provide insurance cover to bank deposits.DICGC has, over time, succeeded in increasingpublic confidence in the banking system andpromoted savings. Since 1991, several reformshave swept the financial sector in general andbanking sector in particular. To remaincontinually safe and sound amidst fast changingand globally integrating environment has

emerged as the biggest challenge before theIndian banking sector today. The NarasimhamCommittee Report on the Banking SectorReforms (1998), while focussing on thestructural issues recommended for revampingthe deposit insurance system too. Following this,RBI constituted in April 1999 an Advisory Groupand a Working Group under Shri Jagdish Capoor,the then Deputy Governor of RBI to look into thisissue. The Groups made variousrecommendations on the basis of which the thenFinance Minister in his Budget Speech for theyear 2002-03 announced the setting up of aBank Deposits Insurance Corporation (BDIC) onthe lines of the globally-acclaimed FederalDeposit Insurance Corporation (FDIC) model.Therefore, with a view to closely studying thefunctioning of the FDIC system and evolving aframework for adapting the US system in Indiaa joint team of the Ministry of Finance (BankingDivision), RBI and DICGC had visited the US inJune 2002. The team had discussions with FDICand other US banking regulatory and supervisoryagencies. The team submitted its report titledModelling Bank Deposits Insurance Corporationin January 2003 to the Union Government. TheUnion Government is yet to take a view on that.


ISLAMIC BANKING

� Islamic Banking does not involve payment and charging of interest.

� It is based on profit and loss (PLS) sharing concept.

� Services like remittances, foreign exchange transactions are provided on chargebasis.

Introduction

Modern banking system was introduced into theMuslim countries at a time when they werepolitically and economically at a low ebb, in thelate 19th century. The main banks in the homecountries of the imperial powers establishedlocal branches in the capitals of the subjectcountries and they catered mainly to the importexport requirements of the foreign businesses.The banks were generally confined to the capitalcities and the local population remained largelyuntouched by the banking system. The localtrading community avoided the “foreign” banksboth for nationalistic as well as religious reasons.However, as time went on it became difficult toengage in trade and other activities withoutmaking use of commercial banks. Even thenmany confined their involvement to transactionactivities such as current accounts and moneytransfers. Borrowing from the banks anddepositing their savings with the bank werestrictly avoided in order to keep away from dealingin interest which is prohibited by religion.

With the passage of time, however, and othersocio-economic forces demanding moreinvolvement in national economic and financialactivities, avoiding the interaction with the banksbecame impossible. Local banks wereestablished on the same lines as the interest-based foreign banks for want of another systemand they began to expand within the countrybringing the banking system to more localpeople. As countries became independent theneed to engage in banking activities becameunavoidable and urgent. Governments,businesses and individuals began to transactbusiness with the banks, with or without liking it.This state of affairs drew the attention and

concern of Muslim intellectuals. The story ofinterest-free or Islamic banking begins here. Inthe following paragraphs we will trace this storyto date and examine how far and howsuccessfully their concerns have beenaddressed.

Interest-free banking as an idea

Interest-free banking seems to be of very recentorigin. Proponents of Islamic Banking haverecognised the need for commercial banks andthe evil of interest in that enterprise, and haveproposed a banking system based on theconcept of Mudarabha - profit and loss sharing.

The coming into being of interest-free banks

The first private interest-free bank, the DubaiIslamic Bank, was also set up in 1975 by agroup of Muslim businessmen from severalcountries. Two more private banks were foundedin 1977 under the name of Faisal Islamic Bankin Egypt and the Sudan. In the same year theKuwaiti government set up the Kuwait FinanceHouse.

However, small scale limited scope interest-freebanks have been tried before.

In the ten years since the establishment of thefirst private commercial bank in Dubai, morethan 50 interest-free banks have come intobeing. Though nearly all of them are in Muslimcountries, there are some in Western Europeas well: in Denmark, Luxembourg , Switzerlandand the UK.

In most countries the interest-free banking havebeen established through private initiative andwere confined to that bank.


Current practices

Generally speaking, all interest-free banks agreeon the basic principles. However, individualbanks differ in their application. Thesedifferences are due to several reasons includingthe laws of the country, objectives of the differentbanks, individual bank’s circumstances andexperiences, the need to interact with otherinterest-based banks, etc. In the followingparagraphs, we will describe the salient featurescommon to all banks.

All the Islamic banks have three kinds of depositaccounts: current, savings and investment.

Current or demand deposit accounts are virtuallythe same as in all conventional banks. Depositis guaranteed.

Savings deposit accounts operate in differentways. In some banks, the depositors allow thebanks to use their money but they obtain aguarantee of getting the full amount back fromthe bank. Banks adopt several methods ofinducing their clients to deposit with them, butno profit is promised. In others, savingsaccounts are treated as investment accountsbut with less stringent conditions as towithdrawals and minimum balance. Capital isnot guaranteed but the banks take care to investmoney from such accounts in relatively risk-freeshort-term projects. As such lower profit ratesare expected and that too only on a portion ofthe average minimum balance on the groundthat a high level of reserves needs to be kept atall times to meet withdrawal demands.

Investment deposits are accepted for a fixed orunlimited period of time and the investors agreein advance to share the profit (or loss) in a givenproportion with the bank. Capital is notguaranteed.

Modes of financing

Banks adopt several modes of acquiring assetsor financing projects. But they can be broadlycategorised into three areas: investment, tradeand lending.

Investment financing

This is done in three main ways: a) Musharakawhere a bank may join another entity to set up ajoint venture, both parties participating in the

various aspects of the project in varying degrees.Profit and loss are shared in a pre-arrangedfashion. This is not very different from the jointventure concept. The venture is an independentlegal entity and the bank may withdraw graduallyafter an initial period. b) Mudarabha where thebank contributes the finance and the clientprovides the expertise, management and labour.Profits are shared by both the partners in a pre-arranged proportion, but when a loss occurs thetotal loss is borne by the bank. c) Financing onthe basis of an estimated rate of return. Underthis scheme, the bank estimates the expectedrate of return on the specific project it is askedto finance and provides financing on theunderstanding that at least that rate is payableto the bank. (Perhaps this rate is negotiable.) Ifthe project ends up in a profit more than theestimated rate the excess goes to the client. Ifthe profit is less than the estimate the bank willaccept the lower rate. In case a loss is sufferedthe bank will take a share in it.

Trade financing

This is also done in several ways. The main onesare: a) Mark-up where the bank buys an itemfor a client and the client agrees to repay thebank the price and an agreed profit later on.b) Leasing where the bank buys an item for aclient and leases it to him for an agreed periodand at the end of that period the lessee pays thebalance on the price agreed at the beginning anbecomes the owner of the item. c) Hire-purchase where the bank buys an item for theclient and hires it to him for an agreed rent andperiod, and at the end of that period the clientautomatically becomes the owner of the item.d) Sell-and-buy-back where a client sells oneof his properties to the bank for an agreed pricepayable now on condition that he will buy theproperty back after certain time for an agreedprice. e) Letters of credit where the bankguarantees the import of an item using its ownfunds for a client, on the basis of sharing theprofit from the sale of this item or on a mark-upbasis.

Lending

Main forms of Lending are:


1. Loans with a service charge where the banklends money without interest but they cover theirexpenses by levying a service charge. Thischarge may be subject to a maximum set bythe authorities.

2) No-cost loans where each bank is expectedto set aside a part of their funds to grant no-costloans to needy persons such as small farmers,entrepreneurs, producers, etc. and to needyconsumers.

3) Overdrafts also are to be provided, subjectto a certain maximum, free of charge.

Services

Other banking services such as moneytransfers, bill collections, trade in foreigncurrencies at spot rate etc. where the bank’sown money is not involved are provided on acommission or charges basis.

Shortcomings in current practices

In the previous section we listed the currentpractices under three categories: deposits,modes of financing (or acquiring assets) andservices. There seems to be no problems asfar as banking services are concerned. Islamicbanks are able to provide nearly all the servicesthat are available in the conventional banks. Theonly exception seems to be in the case of lettersof credit where there is a possibility for interestinvolvement. However some solutions havebeen found for this problem mainly by havingexcess liquidity with the foreign bank. On thedeposit side, judging by the volume of depositsboth in the countries where both systems areavailable and in countries where law prohibitsany dealing in interest, the non-payment ofinterest on deposit accounts seems to be noserious problem. Customers still seem todeposit their money with interest-free banks.

The main problem, both for the banks and forthe customers, is in the area of financing. Banklending is still practised but that is limited to eitherno-cost loans (mainly consumer loans)including overdrafts, or loans with servicecharges only. Both these types of loans bringno income to the banks and therefore naturallythey are not that keen to engage in this activity

much. That leaves us with investment financingand trade financing. Islamic banks are expectedto engage in these activities only on a profit andloss sharing (PLS) basis. This is where thebanks’ main income is to come from and this isalso from where the investment account holdersare expected to derive their profits from. And thelatter is supposed to be the incentive for peopleto deposit their money with the Islamic banks.And it is precisely in this PLS scheme that themain problems of the Islamic banks lie. Thereforewe will look at this system more carefully in thefollowing section.

Problems in implementing the PLS scheme

Several writers have attempted to show, withvarying degrees of success, that IslamicBanking based on the concept of profit and losssharing (PLS) is theoretically superior toconventional banking from different angles. See,for example, Khan and Mirakhor (1987).However from the practical point of view thingsdo not seem that rosy. Our concern here is thislatter aspect. In the over half-a-decade of full-scale experience in implementing the PLSscheme the problems have begun to show up.If one goes by the experience of Pakistan asportrayed in the papers presented at theconference held in Islamabad in 1992, thesituation is very serious and no satisfactoryremedy seems to emerge. In the followingparagraphs we will try to set down some of themajor difficulties.

Suggestions

Banks too are enterprises; they cater to peoples’needs connected with money safe-keeping,acquiring capital, transferring funds etc. The factthat they existed for centuries and continue toexist and prosper is proof that their methods aregood and they fulfill the customers’ needs andexpectations. Conventional commercial bankingsystem as it operates today is accepted in allcountries except the Islamic world where it isreceived with some reservation. The reservationis on account of the fact that the bankingoperations involve dealing in interest which isprohibited in Islam. Conventional banks haveignored this concern on the part of their Muslim


clientele. Muslims patronised the conventionalbanks out of necessity and, when anotherentrepreneur the Islamic banker offered toaddress their concern many Muslims turned tohim. The question is: has the new entrepreneursuccessfully met their concerns, needs andexpectations? If not he may have to put up hisshutters!

Broadly speaking, banks have three types ofdifferent customers: depositors, borrowers and

seekers of bank’s other services such asmoney transfer. Since services do not generallyinvolve dealing in interest Muslims have noproblem transacting such businesses withconventional banks; neither do Islamic banksexperience any problems in providing theseservices. Among the depositors there are currentaccount holders who too, similarly, have noproblems. It is the savings account holders andthe borrowers who have reservations in dealingwith the conventional banks.


BANKING INDUSTRY: VISION 2010

� The total assets of all scheduled commercial banks by end March 2010 is esti-mated at Rs.40,90,000 crore.

� Opening up of the financial sector from 2005, under WTO, would see a number ofglobal banks taking large stakes and control over banking entities in the country.

� Some of the Indian banks may also emerge as global players.

S.C. Gupta committee appointed by IBAobserved the following in its report on BankingIndustry: Vision 2010.

Cost Control

In the future, as domestic and internationalcompetition hots up, banks may have to shift theirfocus to ‘cost’ which will be determined byrevenue minus profit. In others words, cost-control in tandem with efficient use of resourcesand increase in productivity will determine thewinners and laggards in the future.

Qualitative Growth

The growth of banking in the coming years islikely to be more qualitative than quantitative,according to the report. Based on the projectionsmade in the “India Vision 2020” prepared by thePlanning Commission and the Draft 10th Plan,the report forecasts that the pace of expansionin the balance-sheets of banks is likely todecelerate.

The total assets of all scheduled commercialbanks by end March 2010 is estimated atRs.40,90,000 crore. That will form about 65 percent of GDP at current market prices ascompared to 67 per cent in 2002-03.

Banks assets are expected to grow at an annualcomposite rate of growth of 13.4 per cent duringthe rest of the decade against 16.7 per centbetween 1994-95 and 2002-03.

On the liability side, there is likely to be largeadditions to capital base and reserves. As thereliance on borrowed funds increases, the paceof deposit growth may slow down.

On the asset side, the pace of growth in bothadvances and investments is forecast toweaken.

Consolidation

On the growing influence of globalisation on theIndian banking industry, the financial sector wouldbe opened up for greater internationalcompetition under WTO. Opening up of thefinancial sector from 2005, under WTO, wouldsee a number of global banks taking large stakesand control over banking entities in the country.

Multi National Banks would bring with themcapital, technology, and management skillswhich would increase the competitive spirit inthe system leading to greater efficiency.

The pressure on banks to gear up to meetstringent prudential capital adequacy normsunder Basel II and the various Free TradeAgreements that India is entering into with othercountries, such as Singapore, will also impactglobalisation of Indian banking.

Some of the Indian banks may also emerge asglobal players. As globalisation opens upopportunities for Indian corporate entities toexpand their business overseas, banks in Indiawanting to increase their international presencecould naturally be expected to follow thesecorporate entities and other trade flows out ofIndia.

Alongside, the growing pressure on capitalstructure of banks is expected to trigger a phaseof consolidation in the banking industry. In thepast, mergers were initiated by regulators toprotect the interests of depositors of weak banks.


In recent years, there have been a number ofmarket-led mergers between private banks.

This process is expected to gain momentum inthe coming years. Mergers between publicsector banks or public sector banks and privatebanks could be the next logical development.Consolidation could also take place throughstrategic alliances or partnerships coveringspecific areas of business such as credit cards,insurance, etc.

Risk and Reward

The ability to gauge the risks and take appropriateposition will be the key to successful banking inthe emerging scenario. Risk-takers will survive,effective risk mangers will prosper and risk-averse are likely to perish.

Risk management has to trickle down from thecorporate office to branches.

As audit and supervision shifts to a risk-basedapproach rather than transaction oriented, therisk awareness levels of line functionaries alsowill have to increase.

The report also talks of the need for banks todeal with issues relating to ‘reputational risk’ tomaintain a high degree of public confidence forraising capital and other resources.

Technology

Technological developments would render flowof information and data faster leading to fasterappraisal and decision-making. This wouldenable banks to make credit management moreeffective, besides leading to an appreciablereduction in transaction cost.

To reduce investment costs in technology, banksare likely to resort more and more to sharingfacilities such as ATM networks. Banks andfinancial institutions will join together to sharefacilities in the areas of payment and settlement,back-office processing, date warehousing, andso on.

The advent of new technologies could see theemergence of new players doing financialintermediation. For example, we could see utility

service providers offering, say, bill paymentservices or supermarkets or retailers doing basiclending operations. The conventional definitionof banking might undergo changes.

Social Banking

All these developments need not mean bankswill neglect social banking. Rather than beingseen as directed lending such lending would bebusiness-driven. Rural market comprises 74 percent of the population, 41 per cent of the middle-class, and 58 per cent of disposable income.Going Rural would be the new mantra of banks.

Consumer growth is taking place at a fast pacein 17,000-odd villages each with a population ofmore than 5,000. Of these, more than 50 percent are concentrated in just seven states. Small-scale industries would remain important forbanks.

However, instead of the narrow definition of SSIbased on the investment in fixed assets, thefocus may shift to small and medium enterprises(SMEs) as a group. Changes could be expectedin the delivery channel for small borrowers,agriculturists and unorganised sectors also.

Regulation

The expected integration of variousintermediaries in the financial system wouldrequire a strong regulatory framework. It wouldalso require a number of legislative changes toenable the banking system to remaincontemporary and competitive. Underscoringthat there would be an increased need for self-regulation, development of best practices whichwould evolve better through self-regulation ratherthan based on regulatory prescriptions.

For instance, to enlist the confidence of the globalinvestors and international market players, thebanks will have to adopt the best global practicesof financial accounting and reporting. It isexpected that banks would migrate to globalaccounting standards smoothly, although itwould mean greater disclosure and tighternorms.


RETAIL BANKING: OPPORTUNITIES ANDCHALLENGES

� Retail Banking constituted almost a quarter of ASCBs' gross bank credit as at theend of Mar 2007.

� Key Growth drivers of Retail Banking: Growth in Economy, more than 70% ofpopulation below 35 years, technological growth and innovation, falling treasuryincome, attractive interest rate and the willingness to borrow

� Challenges: Customer retention, rising indebtedness, maintaining the uptime oftechnology infrastructure, KYC and money laundering,

Across the globe, retail lending has been aspectacular innovation in the commercialbanking sector in recent years. The growth ofretail lending, especially, in emerging economics,is attributable to the rapid advances ininformation technology, the evolvingmacoreconomic environment, financial marketreform, and several micro-level demand andsupply side factors.

India too experienced a surge in retail banking.The retail loan market has decisively gottransformed from a sellers’ market to a buyers’market.

In recent past, retail lending has turned out to bea key profit driver for banks with retail portfolioconstituting 25.8 per cent of ASCBs' total creditas at March-end 2007. The overall impairmentof the retail loan portfolio worked out much lessthen the Gross NPA ratio for the entire loanportfolio. Within the retail segment, the housingloans had the least gross asset impairment. Infact, retailing make ample business sense in thebanking sector.

While new generation private sector banks havebeen able to create a niche in this regard, thepublic sector banks have not lagged behind.Leveraging their vast branch network andoutreach, public sector banks have aggressivelyforayed to garner a larger slice of the retail pie.By international standards, however, there is stillmuch scope for retail banking in India. After all,retail loans constitute less than 7% of GDP inIndia vis-a-vis about 35% for other Asianeconomics - South Korea (55%), Taiwan (52%),Malaysia (33%) and Thailand (18%).

Drivers of Retail Business in India

• First, economic prosperity and theconsequent increase in purchasing powerhas given a fillip to a consumer boom. Duringthe 10 years after 1992, India’s economygrew at an average rate of 6.8 per cent andcontinues to grow even higher - not manycountries in the world match thisperformance. In the recent years, the annualgrowth rate has been 8 to above 9%.

• Second, changing consumer demographicsindicate vast potential for growth inconsumption both qualitatively andquantitatively. India is one of the countrieshaving highest proportion (70%) of thepopulation below 35 years of age (youngpopulation). The BRIC report of the Goldman-Sachs, which predicted a bright future ofBrazil, Russia, India and China, mentionedIndian demographic advantage as animportant positive factor for India.

• Third, technological factors played a majorrole. Technological innovations relating toincreasing use of credit/debit cards, ATMs,direct debits and internet and phone bankinghave contributed to the growth of retailbanking in India.

• Fourth, the Treasury income of the banks,which had strengthened the bottom lines ofbanks for the past few years, has been onthe decline during the last two years. In sucha scenario, retail business provides a goodvehicle of profit maximisation. Considering


the fact that retail’s share in impaired assetsis far lower than the overall bank loans andadvances, retail loans have putcomparatively less provisioning burden onbanks apart from diversifying their incomestreams.

• Fifth, decline in interest rates has alsocontributed to the growth of retail credit bygenerating the demand for such credit.

Opportunities

Retail banking has immense opportunities in agrowing economy like India. As the growth storygets unfolded in India, retail banking is going toemerge as a major driver. A. T. Kearney, a globalmanagement consulting firm, recently identifiedIndia as the “second most attractive retaildestination” of 30 emergent markets.

The rise of the Indian middle class is an importantcontributory factor in this regard. The percentageof middle to high income Indian households isexpected to continue rising. The youngerpopulation wields increasing purchasing powerand as far as acquiring personal debt isconcerned, they are perhaps more comfortablethan previous generations. Improving consumerpurchasing power, coupled with more liberalattitudes toward personal debt, is contributingto growth in India’s retail banking segment.

The combination of the above factors promisessubstantial growth in the retail sector. Due tobundling of services and delivery channels, theareas of potential conflicts of interest tend toincrease in universal banks and financialconglomerates. Some of the key policy issuesrelevant to the retail banking sector areresponsible lending, access to finance, long-term savings, financial capability, consumerprotection, regulation and financial crimeprevention. Let us look at some of the challenges.

Challenges

• First, retention of customers is going to be amajor challenge. According to a research byReichheld and Sasser in the HarvardBusiness Review, 5 per cent increase incustomer retention can increase profitabilityby 35 per cent in banking business, 50 per

cent in insurance and brokerage, and 125per cent in the consumer credit card market.Thus, banks need to emphasise retainingcustomers and increasing market share.

• Second, rising indebtedness could turn outto be a cause for concern in the future. India’sposition, of course, is not comparable to thatof the developed world where household debtas a proportion of disposable income is muchhigher. Such a scenario creates highuncertainty. Exprersing concerns about thehigh growth witnessed in the consumer creditsegments the Reserve Bank has, as atemporary measure, put in place riskcontainment measures and increased therisk weight from 100 per cent to 125 percentin the case of consumer credit includingpersonal loans and credit cards (Mid-termReview of Annual Policy, 2004-05).

• Third, information technology poses bothopportunities and challenges. Even with ATMmachines and Internet Banking, manyconsumers still prefer the personal touch oftheir neighbourhood branch bank.Technology has made it possible to deliverservices throughout the branch bank network,providing instant updates to checkingaccounts and rapid movement of money forstock transfers. However, this dependencyon the network has brought IT departmentsadditional responsibilities and challenges inmanaging, maintaining and optimizing theperformance of retail banking networks.Illustratively, ensuring that all bank productsand services are available, at all times, andacross the entire organization is essential fortoday’s retails banks to generate revenuesand remain competitive. Besides, there arenetwork management challenges, wherebykeeping these complex, distributed networksand applications operating properly in supportof business objectives becomes essential.Specific challenges include ensuring thataccount transaction applications runefficiently between the branch officers anddata centres.

• Fourth, KYC issues and money launderingrisks in retail banking are also important.Retail lending is often regarded as a low riskarea for money laundering because of the


preception of the sums involved. However,competition for clients may also lead to KYCprocedures being waived in the bid for newbusiness. Banks must also considerseriously the type of identification documentsthey will accept and other processes to becompleted.

Way Forward

How do we see the future of retail banking?

• First, customer service should be the be-alland end-all of retail banking.

• Second, sharing of information about thecredit history of households is extremelyimportant as far as retail banking isconcerned. Perhaps due to the confidentialnature of customers, banks have a traditionalresistance to share credit information on theclient, not only with one another, but alsoacross sectors. Globally, Credit informationBureaus have, therefore, been set up tofunction as a repository of credit information-both current and historical data on existingand potential borrowers. The databasemaintained by these institutions can beaccessed by the lending institutions.

• Third, outsourcing has become an importantissue in the recent past. With the increasingmarket orientation of the financial system andto cope with the competition as also tobenefit from the technological innovationssuch as banking, the banks are makingincreasing use of “outsourcing” as a meansof both reducing costs and achieving betterefficiency. While outsourcing does havevarious cost advantages, it has the potentialto transfer risk, management and

compliance to third parties who may not beregulated. A BIS Report on “Outsourcing inFinancial Services” developed some high-level principles. A basic requirement in thiscontext is that a regulated entity seeking tooutsource activities should have in place acomprehensive policy on outsourcingincluding a comprehensive outsourcing riskmanagement programme to address theoutsourced activities and the relationshipwith the service provider.

Conclusion

There is a need of constaint innovation in retailbanking. In bracing for tomorrow, a paradigm shiftin bank financing through innovative producs andmechanisms involving constant upgradation andrevalidation of the bank’s internal systems andprocess is called for. Banks now need to useretail as a growth trigger. This requires productdevelopment and differentiation, innovation andbusiness process reengineering, micro-planning, marketing, prudent pricing,customisation, technological upgradation, home/electronic/mobile banking, cost reduction andcross-selling.

While retail banking offers phenomenalopportunities for growth, the challenges areequally daunting. How far the retail banking isable to lead growth of the banking industry infuture would depend upon the capacity buildingof the banks to meet the challenges and makeuse of the opportunities profitably. However, thekind of technology used and the efficiency ofoperations would provide the much neededcompetitive edge for success in retail bankingbusiness. Furthermore, in all these, customers’interest is of paramount importance.


Retail Loan Portfolio of Banks

(Amount in Rs. crore)

Item Outstanding as at Percentageend-March Variation

2006 2007 2005-06 2006-07

1 2 3 4 5

1. Housing Loans 1,79,060 2,24,481 33.4 25.42. Consumer Durables 4,469 7,296 17.3 63.33. Credit Card Receivables 12,434 18,317 47.9 47.34. Auto Loans 61,369 82,562 75.1 34.55. Other Personal Loans 1,18,351 1,55,204 39.1 31.1

Total Retail Loans (1+2+3+4+5) 3,75,683 4,87,860 40.9 29.9(25.5) (25.8)

Total Loans and Advances of SCBs 14,73,723 18,93,775 31.0 28.5

Note: Figures within brackets represent percentage share in total loans andadvances.

Source: RBI Report on Trend and Progress of Banking in India, 2006-07.

Retail Business of SBI(Rs. Crore)

Item O/s as at end-March % Change

2006 2007Total Deposits (ex.Inter-bank) 3,15,540 3,67,511 16.5Out of whichRetail Deposits 1,98,362 2,40,816 21.4

(62.9%) (65.5%)

Total NF Credit 1,53,040 1,95,534 27.8Out of whichRetail Credit 85,320 1,03,047 20.8

(55.8%) (52.7%)

Note: Retail Sector includes SIB and Personal segment.Figures in brackets give % to respective totals.

Source: SBI Annual Report, 2006-07.


BANKINGPOLICIES AND ACTS


The Basel II

The attempts at harmonising the capitaladequacy standards internationally date back to1988, when the “Basle Committee on BankingRegulations and Supervisory Practices”, as itwas then named, released a capital adequacyframework, now known as Basel I. This initiativeset out the first internationally acceptedframework for measuring capital adequacy anda minimum ratio to be achieved by the banks.This norm was widely adopted in over 100countries, and in India, it was implemented in1992. Over the years, however, the Basel Iframework was found to have several limitationssuch as its broad-brush approach to credit risk,its narrow coverage confined to only credit andmarket risks, and non-recognition of credit riskmitigants, which encouraged capital arbitragethrough structured transactions. Moreover, therapid advances in risk management, informationtechnology, banking markets and products, andbanks’ internal processes, during the lastdecade, had far outpaced the simple approachof Basel I to measuring capital. A need was,therefore, felt to replace this Accord with a morerisk-sensitive framework, which would addressthese shortcomings.

Accordingly, after a wide-ranging globalconsultative process, the Basel Committee onBanking Supervision (BCBS) released on June26, 2004 the document “InternationalConvergence of Capital Measurement and

Capital Standards: A Revised Framework”,which was supplemented in November 2005 byan update of the Market Risk Amendment. Thisdocument, popularly known as “Basel IIFramework”, offers a new set of internationalstandards for establishing minimum capitalrequirements for the banking organisations. Itcapitalises on the modern risk managementtechniques and seeks to establish a more risk-responsive linkage between the banks’operations and their capital requirements. It alsoprovides a strong incentive to banks forimproving their risk management systems. Therisk sensitiveness is sought to be achievedthrough the now-familiar three mutuallyreinforcing Pillars.

The Pillar 1 stipulates the minimum capital ratioand requires allocation of regulatory capital notonly for credit risk and market risk butadditionally, for operational risk as well, whichwas not covered in the previous Accord. ThePillar 1, unlike the previous Accord, provides amenu of approaches, from the simplified to theadvanced ones, for determining the capitalcharge for each of the three categories of risks.The credit risk mitigants used by the banks havebeen specifically recognised to provideappropriate capital relief.

The Pillar 2 of the framework deals with the‘Supervisory Review Process’ (SRP), and isprobably not that well understood as the othertwo Pillars. In fact, this is the element which

IMPLEMENTATION OF BASEL II: PRESENT STATUS

� Basel II Framework offers a new set of international standards for establishingminimum capital requirements for the banking organisations.

� The Pillar 1 stipulates the minimum capital ratio.� The Pillar 2 of the framework deals with the ‘Supervisory Review Process’.� The Pillar 3 of the framework, Market Discipline, focuses on the effective public

disclosures to be made by the banks.� Foreign banks operating in India and Indian banks having operational presence

outside India should adopt the Revised Framework with effect from March 31, 2008.� All other commercial banks (excluding Local Area Banks and Regional Rural Banks)

are encouraged to migrate to the Revised Framework in alignment with them, but inany case not later than March 31, 2009.


makes the revised framework verycomprehensive in its sweep by addressing theentire risk domain of the banks. It requires thebanks to develop an Internal Capital AdequacyAssessment Process (ICAAP) which shouldencompass their whole risk universe – byaddressing all those risks which are either notfully captured or not at all captured under theother two Pillars – and assign an appropriateamount of capital, internally, for all such risks,commensurate with their risk profile and controlenvironment. Under the Supervisory Review, thesupervisors would conduct a detailedexamination of the ICAAP of the banks, and ifwarranted, could prescribe a higher capitalrequirement, over and above the minimumcapital ratio envisaged in Pillar 1.

The Pillar 3 of the framework, Market Discipline,focuses on the effective public disclosures tobe made by the banks, and is a criticalcomplement to the other two Pillars. Itrecognises the fact that apart from theregulators, the banks are also monitored by themarkets and that the discipline exerted by themarkets can be as powerful as the sanctionsimposed by the regulator. It is premised on thebasic principle that the markets would be quiteresponsive to the disclosures made and thebanks would be duly rewarded or penalised, intune with the nature of disclosures, by the marketforces.

Preparatory Measures for Basel IIImplementation

Though the Indian banks became fully compliantwith Basel I Accord in March 2005, RBI hadinitiated preparatory measures even prior to that.In August 2004, soon after the new frameworkwas released by the BCBS, the banks wereadvised to conduct a self-assessment of theirrisk management systems and to initiateremedial measures, as needed, keeping in viewthe requirements of the Basel II framework.Further, to secure a consultative and participativeapproach for a non-disruptive migration to BaselII, a Steering Committee was constituted inOctober 2004, comprising senior officials from14 select banks (a mix of public sector, privatesector and foreign banks). It formed several sub-

groups to address specific issues under BaselII and made its recommendations to RBI. Basedon these inputs, in February, 2005, RBI issuedthe draft guidelines, for public comments, onimplementation of Pillar 1 and Pillar 3requirements of the Basel II framework. In thelight of the feedback received from a widespectrum of banks and other stake holders, thedraft guidelines were revised and again placedin public domain on March 20, 2007 for a secondround of consultations. Keeping in view theadditional feedback received, the guidelines werefinalised and issued on April 27, 2007. As regardsthe Pillar 2, the banks have been asked to put inplace the requisite Internal Capital AdequacyAssessment Process (ICAAP) with the approvalof their Boards.

Even before the final guidelines were issued,RBI had asked the banks in May 2006 to beginconducting parallel runs, as per the draftguidelines, so as to familiarise them with therequirements of the new framework. During theperiod of parallel run, the banks are required tocompute, parallely, on an ongoing basis, theircapital adequacy ratio – both under Basel Inorms, currently applicable, as well as the BaselII guidelines to be applicable in future. Thisanalysis, along with several other prescribedassessments, is to be placed before the Boardsof the banks every quarter and is also transmittedto RBI. These reports received in the RBIindicate that implementation of Basel II in thebanks is in the process of getting stabilised.

Basel II: Implementation of the New CapitalAdequacy Framework by Banks in India:Salient Features

• Banks in India shall adopt the StandardisedApproach for credit risk, and the BasicIndicator Approach for operational risk forcomputing their capital requirements underthe Revised Framework. Banks shallcontinue to apply the Standardised DurationApproach for computing capital requirementfor market risk.

• Foreign banks operating in India and Indianbanks having operational presence outsideIndia should adopt the Revised Framework


with effect from March 31, 2008. All othercommercial banks (excluding Local AreaBanks and Regional Rural Banks) areencouraged to migrate to the RevisedFramework in alignment with them, but inany case not later than March 31, 2009.

• Banks are required to maintain a minimumcapital to risk weighted assets ratio (CRAR)of 9 per cent on an ongoing basis. However,taking into account the relevant risk factorand internal capital adequacy assessmentsof each bank, the Reserve Bank mayprescribe a higher level of minimum capitalratio to ensure that the capital held by a bankis commensurate with its overall risk profile.

• Banks are required to maintain, at both soloand consolidated level, a minimum Tier I ratioof at least 6 per cent. Banks below this levelmust achieve this ratio on or before March31, 2010.

• The minimum capital maintained by bankson implementation of Basel II norms shallbe subject to a prudential floor computedwith reference to the requirement as perBasel I framework for credit and marketrisks. The floor has been fixed at 100 percent, 90 per cent and 80 per cent for theposition as at end-March for the first threeyears of implementation of the RevisedFramework.

• Banks may use the credit ratings awardedby the following four credit rating agenciesfor assigning risk weights for credit risk forcapital adequacy purposes: Credit Analysisand Research Ltd., CRISIL Ltd., Fitch India,and ICRA Ltd. Banks are also allowed to usethe credit ratings of following threeinternational rating agencies: Fitch, Moody’sand Standard & Poor’s.

• Claims on domestic sovereigns (Central andState Governments) will attract a zero riskweight while those guaranteed by StateGovernments will attract 20 per cent riskweight.

• Risk weights for claims on banks will belinked to the capital adequacy position of the

counter party bank. Scheduled and otherbanks will receive a differential treatment.

• Claims on corporates will be risk weightedas per the ratings awarded by the chosenrating agencies. Unrated claims oncorporates will attract a risk weight of 100per cent. However, unrated claims aboveRs.50 crore sanctioned/renewed on or afterApril 1, 2008 will attract a higher risk weightof 150 per cent; this threshold will belowered to Rs.10 crore with effect from April1, 2009.

• Claims eligible for inclusion as regulatoryretail portfolio, specified claims secured bymortgage of residential property, loans andadvances to banks’ own staff meeting thespecified conditions, and consumptionloans up to Rs.1 lakh against gold and silverornaments shall attract a preferential riskweight ranging between 20 per cent and 75per cent.

• Claims in respect of a few specifiedcategories such as venture capital funds,commercial real estate, consumer creditincluding personal loans and credit cardreceivables, capital market exposures, andclaims on non-deposit taking systemicallyimportant NBFCs will attract risk weights of125 per cent or 150 per cent.

• A portion of unutilised limits will attract capitalcharge.

• A set of collaterals has been specified whichis eligible for asset netting. That is, reductionin capital adquacy requirements will beavailable to the extent of such collateral held.

• Where the benefit of such collateral is takenfor asset netting, the value of the collateralswill be subject a "Haircut" - that is themarket value will be reduced by a certainpercentage given by RBI.

• If the exposure is in one currency and thecollateral is in another currency, the amountof the exposure deemed to be protected willbe reduced by the application of a haircut -HFx. That is, the collateral availablility willbe reduced to provide for currencyfluctuations.


• If the residual maturity of a collateral is lessthan that of the underlying exposure, thenthe collateral cannot be recognised in fulland has to be calculated pro-rata to providefor the maturity mismatch.

• Capital requirements for operational riskunder the Basic Indicator Approach will bethe average of a fixed percentage (now 15%)of positive annual gross income of theprevious three completed financial years.

• A set of disclosure requirements has beenprescribed to encourage market discipline.

• Banks are required to obtain prior approvalof RBI to migrate to the advancedapproaches such as the Internal RatingBased Approach for credit risk and theStandardised Approach or the AdvancedMeasurement Approach for operational riskfor computing capital requirements. The pre-requisites and procedure for approachingRBI for seeking such approval will be issuedin due course.


RBI will initiate certain Structured Actions inrespect of the banks which have hit the TriggerPoints in terms of CRAR, Net NPA and ROA.RBI, at its discretion, will resort to additionalactions (Discretionary Actions) as indicatedunder each of the Trigger Points. The TriggerPoints, as well as Structured and DiscretionaryActions are indicated below:

1. Trigger Points

CRAR

(i) CRAR less than 9%, but equal or morethan 6%

(ii) CRAR less than 6%, but equal or morethan 3%

(iii) CRAR less than 3%

NPAs

(i) Net NPAs over 10% but less than 15%

(ii) Net NPAs 15% and above

ROA below 0.25%

2. Structured and Discretionary Actions

CRAR less than 9%, but equal or more than6%

Structured Actions

• Submission and implementation ofcapital restoration plan by the bank

• Bank will restrict expansion of its risk-weighted assets

• Bank will not enter into new lines ofbusiness

• Bank will not access/renew costlydeposits and CDs

• Bank will reduce/skip dividend payments

Discretionary Actions

• RBI will order recapitalisation

SCHEME OF PROMPT CORRECTIVE ACTION

� RBI will initiate certain Structured Actions in respect of the banks which have hit the TriggerPoints in terms of CRAR, Net NPA and ROA.

• Bank will not increase its stake insubsidiaries

• Bank will reduce its exposure to sensitivesectors like capital market, real estateor investment in non-SLR securities

• RBI will impose restrictions on the bankon borrowings from inter-bank market

• Bank will revise its credit/investmentstrategy and controls

CRAR less than 6%, but equal or more than 3%

Structured Actions

• All Structured actions as in earlier zone

• Discussion by RBI with the bank’s Boardon corrective plan of action

• RBI will order recapitalisation


• Bank will revise its credit/investmentstrategy and controls


• Bank/ Govt. to take steps to bring in newManagement / Board

• Bank will appoint consultants forbusiness/organisational restructuring

• Bank/Govt. to take steps to changepromoters / to change ownership

• RBI/Govt. will take steps to merge thebank if it fails to submit / implementrecapitalization plan or fails torecapitalise pursuant to an order, withinsuch period as RBI may stipulate

CRAR less than 3%

Structured Actions



• RBI will observe the functioning of thebank more closely

• RBI/Govt. will take steps to merge/amalgamate/liquidate the bank orimpose moratorium on the bank if itsCRAR does not improve beyond 3%within one year or within such extendedperiod as agreed to.

Actions based on Net NPAs

Net NPAs over 10% but less than 15%

Structured Actions

• Bank to undertake special drive toreduce the stock of NPAs and containgeneration of fresh NPAs

• Bank will review its loan policy

• Bank will take steps to upgrade creditappraisal skills and systems

• Bank will strengthen follow-up ofadvances including loan reviewmechanism for large loans

• Bank will follow-up suit filed/decreeddebts effectively

• Bank will put in place proper credit-riskmanagement polices/process/procedures /prudential limits

• Bank will reduce loan concentration -individual, group, sector, industry, etc.





Net NPAs 15% and above

Structured Actions


• Discussion by RBI with the bank’s Boardon corrective plan of action




ROA less than 0.25%

Structured Actions

• Bank will not access/renew costlydeposits and CDs

• Bank will take steps to Increase fee-based income

• Bank will take steps to containadministrative expenses

• Bank will launch special drive to reducethe stock of NPAs and containgeneration of fresh NPAs



• RBI will impose restrictions on the bankon borrowings from inter-bank market


• Bank will not incur any capitalexpenditure other than for technologicalupgradation and for such emergentreplacements within Board approvedlimits

• Bank will not expand its staff/fill upvacancies

3. Any other action

Notwithstanding anything contained in the PCAframework, RBI reserves the right to direct abank to take any other action or implement anyother direction, in the interest of the concernedbank or in the interest of its depositors.


Disclosures and transparency in financialstatements have become more important, asbanks’ activities have become more complexand dynamic. Banks are special. Banks arefinancial intermediaries critical for mobilisingsavings, deploying the same taking into accountsafety of funds and decent return to the savers.Banks thus have fiduciary role and responsibility.They are crucial for operation of the paymentsystem. The sustained, stable and continuingoperations of banks depend on the publicconfidence in individual bank and the bankingsystem. Full disclosure of the financial positionof banks and financial institutions is consideredessential for an objective assessment of thestability of the banking system. The level oftransparency of the annual accounts of banksand financial institutions, has therefore, receivedconsiderable attention from internationalorganisations, rating agencies and other marketparticipants. Effective public disclosureenhances market discipline. Market disciplineand improved public scrutiny can provide strongincentives to banks to conduct their business ina safe, sound and efficient manner; to conformto stated business objectives; and to maintainsound risk management practices and internalcontrols. Market discipline which is achievedthrough better disclosures have been given dueimportance under Basel II by recognising it asone of its three Pillars.

In pursuance of the financial sector reformsintroduced since 1991, RBI has initiated a

DISCLOSURE AND TRANSPARENCY IN BANKS'BALANCE SHEETS

� Disclosures and transparency in financial statements have become more important, asbanks’ activities have become more complex and dynamic.

� In pursuance of the financial sector reforms introduced since 1991, the Reserve Bankhas initiated a number of measures for bringing about greater or full disclosure in thepublished accounts of banks having regard to the need for disclosure, public accountabilityof banks, maintenance of confidentiality between banker and customer and the requirementof maintaining the reputation of creditworthiness of banks.

� In the interest of full and complete disclosure, some very useful information is betterprovided, or can only be provided, by way of notes to the financial statements.

number of measures for bringing about greateror full disclosure in the published accounts ofbanks having regard to the need for disclosure,public accountability of banks, maintenance ofconfidentiality between banker and customer andthe requirement of maintaining the reputation ofcreditworthiness of banks. The Formats ofBalance Sheet and Profit and Loss Accounts ofbanks were amended in 1991 having regard to(i) the need for greater or full disclosure, (ii)expansion of banking operations both area-wiseand sector-wise over the period and (iii) the needfor improving the presentation of accounts. Thethrust of the amendment was to bring the truefinancial position of banks to pointed focus andto enable the user of financial statements tostudy and have a meaningful comparison of theirpositions. Banks were required to disclose theaccounting policies regarding key area ofoperations in one place along with Notes onAccounts in their Financial Statements for theAccounting Year.

In the interest of full and complete disclosure,some very useful information is better provided,or can only be provided, by way of notes to thefinancial statements. The use of notes andsupplementary information provides the meansto explain and document certain items, whichare either presented in the financial statementor otherwise affect the financial position andperformance of the reporting enterprise. RBI hasrecognised the need for improving the disclosurerequirements prescribed for banks. Keeping in


view factors like computerisation and the levelof MIS in banks, development of the market, etc.,it has been agreed that the level of transparencyneeds to be brought on par with international bestpractices. In line with the above approach, thedisclosure standards of banks have graduallybeen enhanced. In addition to the 16 detailedschedules to their Balance Sheet, banks arerequired to furnish in the “Notes to Account”details such as:

� Capital Adequacy Ratio; Tier I capital; Tier IIcapital;

� Percentage of share holding of theGovernment of India in the nationalisedbanks;

� Amount of subordinated debt raised asTier-II capital;

� The gross value of investments separatelyon investments in India and outside Indiaand the net value of investments in Indiaand outside India;

� Percentage of net NPAs to net advances;

� Provisions made towards depreciation inthe value of investments and the movementof such provisions;

� Percentage of net NPAs to net advances.Provisions made towards NPAs and themovement of such provisions;

� Details of loan assets subjected torestructuring; restructuring under CDR;details of financial assets sold to an SC/RC for Asset Reconstruction; details ofnonperforming asset purchased/sold;

� Details of ‘Provisions and Contingencies’;provisions made during the year towardsincome-tax, standard asset, floatingprovisions, etc.

� Disclosures of business ratios such asinterest income as a percentage of workingfunds; operating profit as a percentage toworking funds; return on assets; business(deposits plus advances) per employee,and profit per employee;

� Asset Liability Management - maturitypattern of loans and advances; investmentsecurities; deposits; borrowings; andforeign currency assets and liabilities;

� Lending to sensitive sectors, which aresensitive to asset price fluctuations. Theseshould include advances to sectors suchas capital market, real estate, etc., andsuch other sectors to be defined assensitive by RBI from time to time;

� Exposure to country risk;

� Details of single borrower/group borrowerlimit exceeded by the bank;

� Disclosures relating to repo transactions;non-SLR investment portfolio; forward rateagreement/interest rate swaps; exchangetraded interest rate derivatives; and riskexposure in derivatives.

Banks are required to comply with the disclosurenorms stipulated under the various AccountingStandards issued by the Institute of CharteredAccountants of India.


Compliance function in banks is perceived asone of the key elements in their corporategovernance structure. Based on therecommendations of the Ghosh Committee,banks in India have already put in placecompliance processes. However, the processesand the organisational structures have not keptpace with the increased complexities andsophistication in the banking business. In a largenumber of banks, the compliance function is yetto reckon the ‘compliance risk’ and thereputational risk arising out of compliancefailures causing huge economic costs. The needfor the management of the compliance risk bybanks as one of the key facets of integrated riskmanagement or enterprise-wide riskmanagement framework at banks wasrecognised. Accordingly, the Annual PolicyStatement for the year 2006-07 stressed theneed for strong compliance standards in banks.A Working Group set up by the Reserve Bankwith participation from the banking industry toreview the present system of compliancemachinery in banks recommended a numberof measures for strengthening the compliancefunction. Based on the recommendations,guidelines on compliance function of the bankswere issued on April 20, 2007. The guidelinessought to introduce certain principles, standardsand procedures relating to compliance functionconsistent with the high level paper on‘Compliance and the Compliance Function inBanks’ issued by the Basel Committee ofBanking Supervision as also the operatingenvironment in India. The guidelines articulateRBI's view that the compliance function is an

COMPLIANCE FUNCTION IN BANKS

� Based on the recommendations of the Ghosh Committee, banks in India have alreadyput in place compliance processes.

� A Working Group set up by RBI with participation from the banking industry to reviewthe present system of compliance machinery in banks recommended a number ofmeasures for strengthening the compliance function.

� Based on the recommendations, guidelines on compliance function of the bankswere issued on April 20, 2007.

integral part of governance, along with the internalcontrol and risk management process. Theguidelines are also intended to guide the bank-led financial conglomerates in managing their‘group-wide compliance risk’. The salientfeatures of the guidelines are as under:

• Each bank will put in place a formal compliancefunction and designate a compliance officer forits bank. It will be the responsibility of the bank’scompliance officer to assist the top managementin managing effectively the compliance risksfaced by the bank.

• A robust compliance system in a bank shouldinclude a well-documented compliance policy,outlining the philosophy of the bank, role and set-up of the compliance department, compositionof its staff and their specific responsibilities. Thepolicy should be reviewed annually by the bank’sboard. Depending on its branch network, sizeand complexity of the business operations,sophistication of products and services offered,every bank should decide on the organisationalstructure and composition of its compliance unit.The structure may, however, be laid down withinthe overall framework of these guidelines andshould avoid all potential conflicts of interest.

• The compliance department at the Head Officeshould play the central role in the area ofidentifying the level of compliance risk in eachbusiness line, products and process and issueinstructions to operational functionaries andformulate proposals to mitigate such risk. Itshould periodically circulate the instances of


compliance failures among staff along with thepreventive instructions.

• The responsibilities of the compliance functionshould be carried out under a complianceprogramme that sets out its planned activities.The compliance programme should be risk-based and subject to oversight by the head ofcompliance to ensure appropriate coverageacross businesses and co-ordination amongrisk management functions. The compliancefunction should advise and assist the seniormanagement on compliance laws, rules andstandards. It should also put up to the seniormanagement information on developments byestablishing written guidance to staff on theappropriate implementation of compliance laws,rules and standards through policies and

procedures and other documents such ascompliance manuals, internal codes of conductand practice guidelines.

• Banks may choose to carry on business invarious jurisdictions for a variety of legitimatereasons. In such cases, it should be ensuredthat they comply with the applicable laws andregulations in all such jurisdictions and that theorganisation and structure of the compliancefunction and its responsibilities are consistentwith local legal and regulatory requirements. Itis for local businesses to ensure that complianceresponsibilities specific to each jurisdiction arecarried out by individuals with the appropriatelocal knowledge and expertise, with oversightfrom the head of compliance in co-operation withthe bank’s other risk management functions.


The revised guidelines on lending to the prioritysector, effective April 30, 2007 seek to enlargethe base of the priority sector lending. The targetsand sub-targets for the priority sector lendingwould henceforth be linked to adjusted net bankcredit (ANBC) (net bank credit plus investmentsmade by banks in non-SLR bonds held in HTMcategory) or credit equivalent amount of off-balance sheet exposures (OBE), whichever ishigher, as on March 31 of the previousaccounting year. The outstanding FCNR (B) andNRNR deposits balances will no longer bededucted for computation of ANBC for prioritysector lending purposes. The broad categoriesof the priority sector for all scheduledcommercial banks will be as under:

(i) Agriculture (Direct and Indirect Finance):Direct finance to agriculture shall includeshort-, medium- and long-term loans given foragriculture and allied activities (such as dairy,fishery, piggery, poultry, beekeeping) directly toindividual farmers, self-help groups (SHGs) orjoint liability groups (JLGs) of individual farmerswithout limit and to others (such as corporates,partnership firms and institutions) up to thespecified limits for taking up agriculture/alliedactivities. Indirect finance to agriculture shallinclude loans given for specified entities in theareas of agriculture and allied activities.

(ii) Small Enterprises (Direct and IndirectFinance): Direct finance to small enterprisesshall include all loans given to micro and smallenterprises, engaged in both manufacturing(production, processing or preservation ofgoods) and services activities, and whoseinvestment in plant and machinery and

REVISED GUIDELINES ON PRIORITY SECTOR LENDING

� The revised guidelines on lending to the priority sector, effective April 30, 2007 seekto enlarge the base of the priority sector lending.

� The targets and sub-targets for the priority sector lending would henceforth be linkedto adjusted net bank credit (ANBC) (net bank credit plus investments made by banksin non-SLR bonds held in HTM category) or credit equivalent amount of off-balancesheet exposures (OBE), whichever is higher, as on March 31 of the previousaccounting year.

� The outstanding FCNR (B) and NRNR deposits balances will no longer be deductedfor computation of ANBC for priority sector lending purposes.

equipment does not exceed the specifiedamounts. The micro and small (service)enterprises will include small road and watertransport operators, small business,professional and self-employed persons, andcertain other service enterprises. Indirect financeto small enterprises shall include finance to anyperson providing inputs to or marketing the outputof artisans, village and cottage industries,handlooms and to cooperatives of producers inthis sector.

(iii) Retail Trade shall include retail traders/private retail traders dealing in essentialcommodities (fair price shops), and consumerco-operative stores.

(iv) Micro Credit shall include provision of creditand other financial services and products of verysmall amounts not exceeding Rs.50,000 perborrower, either directly or indirectly through aSHG/JLG mechanism or to NBFC/MFI for on-lending up to Rs.50,000 per borrower.

(v) Education Loans shall include loans andadvances granted to individuals (but not toinstitutions) up to Rs.10 lakh for studies in Indiaand Rs.20 lakh for studies abroad.

(vi) Housing Loans shall include loans up toRs.20 lakh to individuals for purchase/construction of one dwelling unit per family(excluding loans granted by banks to their ownemployees) and loans given for repairs to thedamaged dwelling units of families up to Rs.1lakh in rural and semi-urban areas and up toRs.2 lakh in urban and metropolitan areas.


MICRO, SMALL AND MEDIUM ENTERPRISES

� The micro and small & medium enterprises (MSMEs) constitute an important segment ofthe Indian economy.

� The process of economic liberalization and market reforms, while exposing the IndianMSMEs to increasing levels of domestic and global competition, has also opened upattractive possibilities of access to larger markets and of stronger and deeper linkages ofMSMEs with larger enterprises.

� The performance of the MSME sector can be enhanced by addressing the issues whichcan create an enabling environment for the MSMEs to flourish in the current highlycompetitive and complex market conditions.

The micro and small & medium enterprises(MSMEs) constitute an important segment of theIndian economy, contributing around 39 percentof the country’s manufacturing output and 34 percent of its exports in 2004-05. It providesemployment to around 29.5 million people in therural and urban areas of the country.

The process of economic liberalization andmarket reforms, while exposing the IndianMSMEs to increasing levels of domestic andglobal competition, has also opened up attractivepossibilities of access to larger markets and ofstronger and deeper linkages of MSMEs withlarger enterprises. Improved manufacturingtechniques and management processes can besourced and adopted with greater ease. Arobust and vibrant MSME segment can derivethe benefits of these new opportunities providedappropriate enabling policies are put in place andmeasures for capacity building in public privatemode are also initiated. In this environment ofcompetition and rapid technological changes,the segment can then achieve higher sustainedgrowth by enhancing its technologicalcapabilities, improving its product and servicequality to global standards and seeking ways ofinnovation.

Initiatives and measures taken by theGovernment during the year to enable MSMEsenhance their competitive strength, address thechallenges of competition and avail of thebenefits of the global market include:

� Enactment of the Micro, Small and MediumEnterprises Development (MSMED) Act,2006.

� Amendment to the Khadi and VillageIndustries Commission Act, 1956introducing several new features to facilitateprofessionalism in the operations of theCommission as well as field-level formal andstructured consultations with all segmentsof stakeholders. The new Commission hasbeen constituted.

� A Package for Promotion of Micro & Smalland Medium Enterprises has been approvedrecently to address most of the concernsin the areas such as credit, cluster-baseddevelopment, infrastructure, technology andmarketing. Capacity building of MSMEAssociations and support to womenentrepreneurs are the other importantfeatures of this package.

� An empowered group of Ministers (EgoM)under the Chairmanship of the ExternalAffairs Minister has been set up to lay downa comprehensive policy for cluster-development and oversee itsimplementation.

� Under the Credit Guarantee Scheme, lifeinsurance cover for chief promoters of unitsprovided guarantee cover by the CreditGuarantee Fund Trust for Small Industries(CGTSI) has been introduced. Further, the


one-time guarantee fee under the schemehas been reduced from 2.5 per cent to 1.5per cent with effect from April 1, 2006.

� After due consultation with the stakeholders,180 items reserved for exclusivemanufacture in micro and small enterpriseshave been de-reserved on May 16, 2006 and87 such items have been dereserved onJanuary 22, 2007.

The logic of reserving items for domesticproduction exclusively in the small scale sector,particularly when such products can be freelyimported from large-scale production unitsabroad and when such a policy prevents the‘small’ from growing and benefiting from theeconomies of scale, has progressively comeunder serious questioning. However, thequestion that needs to be addressed is whetherthe reservation in the small scale sector is basedon any objective policy parameter. The processof reservation of items for production exclusivelyby the small-scale sector started in 1967 andreached its peak in 1984. There has been a

gradual relaxation of the reservation policy overtime, and the number of items reserved for thesmall-scale sector was 239 on January 22,2007.

The performance of the MSME sector can beenhanced by addressing the issues which cancreate an enabling environment for the MSMEsto flourish in the current highly competitive andcomplex market conditions. MSME developmenttypically requires cross – cutting strategies thattouch upon areas such as conducive policies,simplified legal and regulatory systems, goodgovernance norms, readily accessible andadequate finance from the institutions,supportive infrastructure, entrepreneur skilldevelopment, capacity building, etc. A consciouspolicy needs to be evolved as to what share ofthe economy of the emerging markets shouldbe through MSMEs which require a certainamount of protection from the market forces.The benefits of continued promotion of theMSME sector with the apparently conflictinginterests of the globalization process have to beweighed and policies evolved accordingly.


OUTSOURCING

� In the face of rapid technological developments, the reliance on outsourcing hasincreased due to its various positive gains.

� At the same time, there can be potential and significant threats arising out ofoutsourcing. Outsourcing is not a trouble free solution; it is only that the nature andtypes of problems change.

The Indian banking sector has been undergoingradical transformation in view of the ongoinginnovations, modernisation and large-scaleadoption of newer technology. In the face of rapidtechnological developments, the reliance onoutsourcing has increased due to a variety offactors.

� First, due to the fast pace of technologicaladvancements, IT infrastructure and in-house expertise get obliterated, unlesssubjected to continuous upgradation. Thecosts associated with regular upgradationof infrastructure and skills in a highlydynamic environment tend to be high andthus outsourcing, which provides for latesttechnology based solutions, is a preferredoption.

� Second, internal expertise can be inwardlooking, with focus on established andexisting processes; outsourcing increasesthe scope for fresh reviews resulting inimproved processes and services.

� Finally, the benefit of experience from otherinstitutions is not generally available forinternal experts; this is available foroutsourced solutions. It is possible to fix highperformance yardsticks/uptime and

functional levels for outsourced projects -even up to 99.9 per cent, which may bedifficult in the case of an internal solution.

At the same time, there can be potential andsignificant threats arising out of outsourcing.Outsourcing is not a trouble free solution; it isonly that the nature and types of problemschange. Outsourcing requires that thenecessary skills to outsource projects are firstavailable in-house. Such skill sets include

� management of the outsourcing process;

� managing vendors and, most often, multiplevendors for the same processes/systems;

� managing the conflicting interests ofdifferent vendors such as between ahardware vendor and an applicationsoftware vendor using the same resources;

� knowledge of trends and developments intechnology to keep pace with therequirements expected out of the vendors;and

� capability to evaluate the charging patternof vendors to ensure that the organisationis not at the mercy of the vendor.


Money laundering is called what it is becausethat perfectly describes what takes place-illegal,or dirty money is put through a cycle oftransactions, or washed, so that it comes out atthe other end as legal, or clean, money. In otherwords, the source of illegally obtained funds isobscured through a succession of transfers anddeals in order that those same funds caneventually be made to reappear as legitimateincome.

Common Factors

There are four factors common to all moneylaundering operations. To begin with, the trueownership and the real source of the money isconcealed. Next, the form it takes is changed.The launderers change the form of the proceedsin order to shrink the huge volume of cashgenerated by the initial unlawful activity. Thirdly,the trail left by the process is obscured so as tomake it difficult to follow the money frombeginning to end. And finally, constant control ismaintained over the money.

Three Stages of the Process

The money laundering process can be dividedinto three stages. The placement stage is thefirst introduction of dirty money into thelegitimate world. It is done, at the simplest levelby placing the illicit funds to purchase goods andservices for the criminal. More sophisticatedplacement involves using the banking andfinancial system but this will involve disguise oftrue depositor. ‘Smurfing’ is one way ofminimising the risk of getting caught and thisoccurs when the sum to be laundered is brokenup into smaller amounts and introduced into thelegitimate system in this way.

PREVENTION OF MONEY LAUNDERING (PML) ACT

� As the term implies, money laundering is a process of converting (or cleaning) dirty/illegal money into clean/legal money.

� This is done by using various channels to hide the source of income.

� Under/Over invoicing, investment by offshore companies and trusts, large transactionsin cash, opening of benami accounts are some examples.

� Money Laundering Act 2002 seeks to contain the menace.

The next is the layering or agitation stage. Theobject of this stage is to prevent the tracing ofillegal proceeds by disrupting any paper trail thatmay have been started at the placement stage.Some methods used are under and over-invoicing and investments by offshorecompanies and trusts in the internationalmarkets.

The last stage of making, the dirty money cleanis generally referred to as integration and thisoccurs when placement and layering have beensuccessfully achieved. It is the means by whichthe criminal enjoys the proceeds of his crimes.To do this, the integration process achieves theappearance of total legitimacy for the funds,thereby ensuring safety from enquiry as to theirtrue source. At the end of this stage, the moneywill appear to have been acquired utterly lawfully.

The facilitators of money laundering are oftenlawyers, accountants, financial advisors andbankers.

Some Methods

As already stated, there is no one method oflaundering money. The British Banker ’sAssociation has made an attempt to list out themost basic ways by which money may belaundered. Some of the basic kinds ofsuspicious transactions are:

� Frequent exchange of cash into othercurrencies.

� Customers transferring large sums ofmoney to or from overseas locations withinstructions for payment in cash.

� Large cash withdrawals from previouslydormant or inactive account, or from an


account which has just received anunexpected large credit from abroad.

� Use of letters of credit and other methods oftrade finance to move money betweencountries where such trade is not consistentwith the usual business of the customer.

� Building up of large balances not consistentwith the known turnover of the business ofthe customer, and subsequent transfer toaccounts held overseas.

� Frequent paying in of travellers cheques orforeign currency drafts particularly iforiginating from overseas.

� Any apparently unnecessary use of anintermediary in the transaction.

� Customers who deposit cash by means ofnumerous credit slips so that the total of eachdeposit is unremarkable but the total of allthe credits is significant.

� Customers who seek to exchange largequantities of low denomination notes forthose of higher denomination.

� Customers who appear to have accountswith several banks within the same locality.

� Large number of individuals makingpayments into the same account without anadequate explanation.

How Banks Can Prevent It

In order to arrest money laundering, where banksare mostly used in the process, it is imperativethat banks should know its customers, moreparticularly those dealing with foreign exchange.Banks should make reasonable efforts todetermine the customer’s true identity and haveeffective procedure for verifying the bonafidesof new customers.

Government Initiative

The prevention of Money Laundering Act 2002has the following provisions:

The Bill aims at prevention and punishment ofoffences relating to money laundering andconnected activities, confiscation of proceedsof crime, disclosure of such transactions byfinancial institutions, setting up agencies andmechanisms for co-ordinating measures

necessary for controlling money laundering andthe like.

Offence of money-laundering has been definedin an exhaustive manner in the bill. Whoeveracquires, owns, possesses or transfers anyproceeds of crime; or knowingly enters into anytransaction which is related to proceeds of crimeeither directly or indirectly; or conceals or aidsin the concealment of the proceeds of crime willbe treated as committing the offence of money-laundering. Strict punishment for offence ofmoney-laundering has been proposed, viz.,rigorous imprisonment for a period of not lessthan 3 years and not more than 7 years and fineup to Rs. 5 lakh. In certain cases even higherrigorous punishment has been proposed.

Responsibilities of Banks

Banks have been advised to put in place a policyframework and to be fully compliant with theprovisions of the Money Laundering Act to ensurethat systems and procedures were put in placeand instructions had percolated to the operationallevels. Banks have also been advised to appointa Principal officer and put in place a system ofinternal reporting of suspicious transactions andcash transactions of Rs.10 lakh and above.

Maintenance of records of transactions

Banks should introduce a system of maintainingproper record of transactions, as mentionedbelow:

(i) all cash transactions of the value of morethan Rs.10 lakh or its equivalent in foreigncurrency;

(ii) all series of cash transactions integrallyconnected to each other which have beenvalued below Rs.10 lakh or its equivalent inforeign currency where such series oftransactions have taken place within a monthand the aggregate value of such transactionsexceeds Rs.10 lakh;

(iii) all cash transactions where forged orcounterfeit currency notes or bank noteshave been used as genuine and where anyforgery of a valuable security has takenplace;


(iv) all suspicious transactions whether or notmade in cash and by way of as mentionedin the Rules.

Information to be preserved

Banks are required to maintain the followinginformation in respect of the followingtransactions:

(i) the nature of the transactions;

(ii) the amount of the transaction and thecurrency in which it was denominated;

(iii) the date on which the transaction wasconducted; and

(iv) the parties to the transaction.

Maintenance and preservation of records

Banks should take appropriate steps to evolvea system for proper maintenance andpreservation of account information in a mannerthat allows data to be retrieved easily and quicklywhenever required or when requested by thecompetent authorities. Further, banks shouldmaintain for at least ten years from the date ofcessation of transaction between the bank andthe client, all necessary records of transactions,both domestic or international, which will permitreconstruction of individual transactions(including the amounts and types of currencyinvolved if any) so as to provide, if necessary,evidence for prosecution of persons involved incriminal activity.

Banks should ensure that records pertaining tothe identification of the customer and his address(e.g., copies of documents like passports,identity cards, driving licences, PAN and utilitybills) obtained while opening the account and

during the course of business relationship, areproperly preserved for at least ten years afterthe business relationship is ended. Theidentification records and transaction datashould be made available to the competentauthorities upon request.

Reporting to Financial Intelligence Unit-India

Banks are required to report information relatingto cash and suspicious transactions to theFinancial Intelligence Unit-India, Government ofIndia. The banks should ensure electronic filingof Cash Transaction Report (CTR). TheSuspicious Transaction Report (STR) should befurnished within 7 days of arriving at a conclusionthat any transaction, whether cash or non-cash,or a series of transactions integrally connectedare of suspicious nature. Banks may not put anyrestrictions on operations in the accounts wherean STR has been made and ensure that thereis no tipping off to the customer at any level.

An indicative list of suspicious activities:

1) Transactions involving large amount ofcash.

2) Transactions which do not have anyeconomic sense.

3) Activities not consistent with the customer'sbusiness.

4) Attempts to avoid reporting/record keepingrequirements.

5) Unusual activities.

6) Customer who provides insufficient orsuspicious information.

7) Certain suspicious funds transfer activities.

8) Certain bank employees arousingsuspicion.


SARFAESI ACT: AN UPDATE

� Enacted in 2002, the Act is intended to strengthen Banks and FIs to recover NPAsfaster.

� The Act empowers banks and FIs to seize changed assets without Court’s interventionand sell them off.

� The Act does not cover loans up to Rs.1 lakh, security interest created on Agriculturallands and where the amount due is less than 20% of the principal and interest.

� The Act was amended in 2004 to relax certain provisions in the interest of borrowers.

One of the problems faced by the bankingindustry in India is Non-Performing Assets(NPAs). The high level of NPAs has led to lowerinterest income and loan loss provisioningrequirements which reduced the profitability ofthe banks. Besides, the recycling of funds isrestricted, thus leading to serious asset liabilitymismatches. The supply of credit to potentialborrowers has been blocked which is having aharmful effect on capital formation andhampering economic activities of the country.So the NPA problem is an issue of public debateand of national priority.

Background of the Act

In 1993, Recovery of Debts Due to Banks andFinancial Institutions Act was enacted with aview to recover huge amount of NPAs at a fasterpace than through the Civil Courts. The DebtRecovery Tribunals (DRTs) were set up underthis Act and the banking institutions filed casesagainst the borrowers in these tribunals. But thisAct could not live upto its high expectations. So,the banking sector wanted to recover their NPAson their own without taking the lengthy judicialroute. This led to the enactment of TheSecuritization and Reconstruction of FinancialAssets and Enforcement of Security Interest Act,2002 (SARFAESI Act).

Purpose of the Act

This Act empowers banks and financialinstitutions (FIs) to seize the assets charged tobanks without intervention of the courts and sellthem off to realize their loans, which have

become NPAs. But the option of approachingthe DRT, in case the banks or financialinstitutions do not recover the dues bythemselves will always remain open.

Salient Features of the Act

1. In case borrower of an NPA account fails topay the dues of the bank within 60 days fromthe date of the notice sent by the bank, thebank can exercise any of the following rightsunder sub-section 13(4) to recover hissecured debt.

(a) Take possession of the secured assetsof the borrower and transfer the same byway of lease, assignment or sale forreleasing the dues without intervention ofthe DRT/Court.

(b) Takeover the management of theborrower's concern.

(c) Appoint any person as a Manager tomanage the secured assets.

(d) Send notice to a third person who hasacquired the assets from the borrowerwithout the consent of the bank to paythe dues of the bank which are related tothe assets acquired by him. Such apayment is a valid discharge to the saidborrower.

2. In case NPA account is a consortiumaccount or under multiple finance, the rightto enforce securities can be exercised bythe Banks/ FIs, only when secured creditorsrepresenting not less than three-fourth in


value on the amount outstanding areagreeable as laid down in sub-section 13(9).

3. After acquiring the possession of the assetscharged to the bank and selling the sameand appropriation of sale proceeds towardsthe dues of the bank, then the bank canapproach DRT for recovering the balanceamount, if any, from the borrower/guarantoras laid down in sub-section 13(10).

4. If the bank feels that there can be resistancefor acquiring the assets charged to the bankfrom the borrower, in such cases the bankcan approach the concerned ChiefMetropolitan Magistrate or the DistrictMagistrate by filing a written request fortaking possession of the said assets. Onreceipt of such a request, the said magistrateshall take necessary steps to takepossession of the assets and other relateddocuments and same would be handed overto the bank (Section 14).

5. After issuance of 60 days notice by the bankto the borrower, the borrower shall not dealwith the assets which are charged to thebank. However, dealing with the said assetsin the ordinary course of business of theborrower is permitted.

6. The provisions of the Act are not applicableto the following transactions:

(a) Any security interest created forrepayment of financial assets notexceeding Rs.1 lakh.

(b) Any security interest created overagricultural lands.

(c) Any case in which the amount due is lessthan 20 per cent of the principal amountand interest therein.

(d) Pledge of movable assets within themeaning of section 172 of the IndianContract Act, 1872.

(e) Any conditional sale, hire purchase orlease, or any other contract, in which nosecurity interest has been created.

(f) Security created in any aircraft under theAircraft Act, 1934.

(g) Security created in a vessel underMerchant Shipping Act.

(h) Any rights of unpaid seller under Section47 of the Sale of Goods Act, 1930.

(i) Any proper ties exempted fromattachment under Section 60 of CPC.

7. This Act has permitted establishment ofasset reconstruction companies which willpurchase the NPA accounts from the banksat a discounted price. They will also takeover the assets charged to the bank for theparticular account for necessary recoveryaction through reconstruction of the assetsor otherwise.

8. Under section 17, any person including theborrower may approach DRT by filing anappeal before the DRT within 45 days fromthe date on which steps have been taken bythe bank. But such an appeal shall not beentertained by the DRT unless a specifiedamount of the outstanding dues of the bankis deposited in the DRT. The right to appealbefore DRAT (Debts Recovery AppellateTribunal) within 30 days is given underSection 18 to any person aggrieved by theorder of DRT. The Act ousts the jurisdictionof the Civil Courts and declares that noinjunction shall be granted in respect of anyexercise of rights conferred by this Act.

After the publication of this Act, severalborrowers filed writ petitions in the SupremeCourt of India, challenging the validity of theAct. In the landmark case of MardiaChemicals Ltd. & Others vs. Union of India& Others (2004) 120 Comp. Cas 373 (SC),the Supreme Court has upheld the validityof the Act.

Some of the salient features of the judgementare:

(a) The Court directed that the banks shouldevolve appropriate internal mechanism tothoroughly resolve the contentions raised


by the borrower. The bank should applyits mind to the objections andcommunicate its reasons to the borrower.This will be an act of fairness on the partof the bank.

(b) The Court held that banks and financialinstitutions have been provided withguidelines by RBI laying down the terms,conditions and circumstances in whichthe debt is to be classified as non-performing assets. Hence, there is noarbitrary powers vested in the bank.

(c) The Court has held that under Section17(2), the provision for deposit of duesbefore appeal is bad which will render theremedy illusory. It is also unreasonableand violative of Article 14 of theConstitution.

(d) Section 34 of the Act lays down that CivilCourts have no jurisdiction to entertainany suit in respect of any matter whichDRT or DRAT (Debts RecoveryAppellate Tribunal) is empowerned to dealwith. The Court has upheld the validityof this provision.

Accordingly, the Supreme Court upheldthe whole of the Act excluding Section17 (2).

Limitations of the Act

1. In case of enforcement of claim inconsortium advances the creditors canenforce only on the consent of the othercreditors having minimum 75 per cent sharein the loan whereas enforcement of claimthrough DRT/Civil Court can be initiated bya single creditor by impleading the othercreditors as respondents in the case.

2. In case of sale of seized assets, the sellerand the beneficiary will be the same. The

sale of secured assets by banks at a valueenough to cover their dues would beadequate for them, but it may be unfair to theother stakeholders.

SERFAESI (Amendment) Ordinance - 2004

In the light of the Supreme Court judgement inthe Mardia Chemicals vs. ICICI Bank Ltd., theGovernment promulgated the Ordinance toamend certain sections of the Act, which hasbeen passed by Parliament in December, 2004.

Highlights of the changes are as under:

(a) Amendment in Section 13: On receipt of thenotice if the borrower makes anyrepresentation or raises any objection, thesecured creditor shall consider suchrepresentation or objection and shallcommunicate within one week of receipt ofsuch representation to the borrower.

(b) Amendment in Section 17: The borrowermay make an application to the DRT if thesecured creditor has not accepted hisrepresentation or objection.

Any application made by the borrower shallbe dealt with by DRT, as expeditiously aspossible and to be disposed of within 60 daysfrom the date of such application. If theapplication is not disposed of by DRT withinthe period of 4 months, any party to theapplicant may make an application to theDRAT for directing the DRT for expeditiousdisposal of the application.

(c) Amendment in Section 18: No appeal shallbe entertained by DRAT unless the borrowerhas deposited with it 50 per cent of the amountof debt due from him, as claimed by thesecured creditor or determined by the DRT,whichever is less. DRAT may reduce theamount upto 25 per cent of the debt.


The guidelines are applicable to banks, FIs andNBFCs purchasing/selling non-performingfinancial assets, from/to other banks/FIs/NBFCs(excluding securitisation companies/reconstruction companies).

Financial assets, including assets undermultiple/consortium banking arrangements,would be eligible for purchase/sale in terms ofthese guidelines if it is a non-performing asset/non performing investment in the books of theselling bank.

Procedure for Purchase/Sale of Non-Performing Financial Assets, includingValuation and Pricing Aspects

i. A bank which is purchasing/ selling non-performing financial assets should ensurethat the purchase/ sale is conducted inaccordance with a policy approved by theBoard. The Board shall lay down policies andguidelines covering, inter alia,

a) Non performing financial assets that maybe purchased/sold;

b) Norms and procedure for purchase/saleof such financial assets;

c) Valuation procedure to be followed toensure that the economic value offinancial assets is reasonably estimatedbased on the estimated cash flowsarising out of repayments and recoveryprospects;

d) Delegation of powers of variousfunctionaries for taking decision on thepurchase/sale of the financial assets, etc.

e) Accounting policy

GUIDELINES ON PURCHASE/SALE OFNON-PERFORMING FINANCIAL ASSETS

� NPAs may be purchased/sold only on cash basis.

� Valuation procedure to ensure that the economic value of financial assets is reasonablyestimated based on the estimated cash flows arising out of repayments and recoveryprospects.

� Delegation of powers of various functionaries for taking decision on the purchase/sale of the financial assets to be defined.

ii. The estimated cash flows are normallyexpected to be realised within a period ofthree years. Ten per cent of the estimatedcash flows are to be realised in the first yearand not less than 5% of the estimated cashflows should be realized in each subsequenthalf year.

iii. A bank may purchase/sell non-performingfinancial assets from/to other banks only on‘without recourse’ basis.

iv. Each bank will make its own assessment ofthe value offered by the purchasing bank forthe financial asset and decide whether toaccept or reject the offer.

v. A non-performing asset in the books of abank shall be eligible for sale to other banksonly if it has remained a non-performingasset for at least two years in the books ofthe selling bank.

vi. Banks shall sell non-performing financialassets to other banks only on cash basis.

vii. A non-performing financial asset should beheld by the purchasing bank in its books atleast for a period of 15 months before it issold to other banks. Banks should not sellsuch assets back to the bank, which hadsold the NPFA.

viii. Banks are also permitted to sell/buyhomogeneous pool within retail non-performing financial assets, on a portfoliobasis provided each of the non-performingfinancial assets of the pool has remained asnon-performing financial asset for at least2 years in the books of the selling bank. The


pool of assets would be treated as a singleasset in the books of the purchasing bank.

ix. The selling bank shall pursue the staffaccountability aspects as per the existinginstructions in respect of the non-performingassets sold to other banks.

Prudential Norms for Banks for thePurchase/Sale transactions

(A) Asset classification norms

(i) The non-performing financial assetpurchased, may be classified as ‘standard’in the books of the purchasing bank for aperiod of 90 days from the date of purchase.Thereafter, the asset classification status ofthe financial asset purchased, shall bedetermined by the record of recovery in thebooks of the purchasing bank with referenceto cash flows estimated while purchasing theasset which should be in compliance withrequirements in Para 5 (iii).

(ii) The asset classification status of an existingexposure (other than purchased financialasset) to the same obligor in the books ofthe purchasing bank will continue to begoverned by the record of recovery of thatexposure and hence may be different.

(iii) Where the purchase/sale does not satisfyany of the prudential requirementsprescribed in these guidelines the assetclassification status of the financial asset inthe books of the purchasing bank at the timeof purchase shall be the same as in thebooks of the selling bank. Thereafter, theasset classification status will continue to bedetermined with reference to the date of NPAin the selling bank.

(iv) Any restructure/reschedule/rephase of therepayment schedule or the estimated cashflow of the non-performing financial asset bythe purchasing bank shall render theaccount as a non-performing asset.

(B) Provisioning norms

Books of selling bank

i) When a bank sells its non-performingfinancial assets to other banks, the samewill be removed from its books on transfer.

ii) If the sale is at a price below the net bookvalue (NBV) (i.e., book value less provisionsheld), the shortfall should be debited to theprofit and loss account of that year.

iii) If the sale is for a value higher than the NBV,the excess provision shall not be reversedbut will be utilised to meet the shortfall/losson account of sale of other non-performingfinancial assets.

Books of purchasing bank

The asset shall attract provisioning requirementappropriate to its asset classification status inthe books of the purchasing bank.

(C) Accounting of recoveries

Any recovery in respect of a non-performingasset purchased from other banks should firstbe adjusted against its acquisition cost.Recoveries in excess of the acquisition cost canbe recognised as profit.

(D) Capital adequacy

For the purpose of capital adequacy, banksshould assign 100% risk weights to the non-performing financial assets purchased fromother banks. In case the non-performing assetpurchased is an investment, then it would attractcapital charge for market risks also. For NBFCsthe relevant instructions on capital adequacywould be applicable.

(E) Exposure norms

The purchasing bank will reckon exposure onthe obligor of the specific financial asset. Hencethese banks should ensure compliance with theprudential credit exposure ceilings (both singleand group) after reckoning the exposures to theobligors arising on account of the purchase. ForNBFCs the relevant instructions on exposurenorms would be applicable.

Disclosure Requirements

Banks which purchase non-performing financialassets from other banks shall be required tomake disclosures in the Notes on Accounts totheir Balance sheets on details of non-performingfinancial assets purchased and details of non-performing financial assets sold.

The purchasing bank shall also furnish allrelevant reports to RBI, CIBIL, etc., in respectof the non-performing financial assetspurchased by it.


The Governors of supervising bodies of G 10countries, at a meeting held in Basel, Switzerlandevolved a set of principles to effectively curbmoney laundering so that banks can protectthemselves against it.

Besides money laundering, financial frauds arecommitted with frightening regularity using avariety of means and more often banks end uplosing heavily in the process.

‘Know Your Customer’ Standards

The objective of KYC guidelines is to preventbanks from being used, intentionally orunintentionally, by criminal elements for moneylaundering activities. KYC procedures alsoenable banks to know/understand theircustomers and their financial dealings betterwhich in turn help them manage their risksprudently. KYC, the principal means of identifyingthe customer, is the platform on which bankingsystem operates to control financial frauds,identify money laundering and suspiciousactivities, and for scrutiny and monitoring of largevalue transactions. The guidelines are alsoapplicable to foreign currency accounts/transactions.

Banks should frame their KYC policiesincorporating the following four key elements:

i. Customer Acceptance Policy;

ii. Customer Identification Procedures;

iii. Monitoring of Transactions; and

iv. Risk management.

KNOW YOUR CUSTOMER (KYC) GUIDELINES

� Issued by RBI in August 2002 to protect banks against financial frauds and moneylaundering

� Objective: To properly identify individuals/corporates; to monitor high-valuetransactions and transactions of suspicious nature; and establish procedure for duediligence and reporting of such transactions.

� Key provisions: Open account with proper identification and address verification,monitor cash transactions above Rs.10 lakh; route all remittances aboveRs.50,000/- through account (and not cash); watch transactions of suspicious nature.

Objectives

� To establish procedures to verify the bonafideidentification of individuals/corporatesopening an account.

� To establish processes and procedures tomonitor high value transactions andtransactions of suspicious nature inaccounts

� To establish systems for conducting duediligence and reporting of such transactions.

KYC Policy

(i) “Know Your Customer” (KYC) procedureshould be the key principle for identificationof an individual/corporate opening anaccount. The customer identification shouldentail verification through an introductoryreference from an existing account holder/aperson known to the bank or on the basis ofdocuments provided by the customer.

(ii) The Board of Directors of the banks shouldhave in place adequate policies that establishprocedures to verify the bonafide identificationof individual/corporates opening an account.The Board should also have in place policiesthat establish processes and procedures tomonitor transactions of suspicious nature inaccounts and have systems of conductingdue diligence and reporting of suchtransactions.

1. “Know Your Customer” Procedures forExisting Customers

Banks are expected to have adopted duediligence and appropriate KYC norms at the time


of opening of accounts in respect of existingcustomers in terms of extant instructions.However, in case of any omission, the requisiteKYC procedures for customer identificationshould be got completed at the earliest.

2. Ceiling and Monitoring of CashTransactions

� The banks are required to keep a close watchof cash withdrawals and deposits for Rs.10lakh and above in deposit, cash credit oroverdraft accounts and keep record of detailsof these large cash transactions in aseparate register.

� Issuance of travellers cheques, demanddrafts and telegraphic transfers forRs.50,000 and above only by debit tocustomers’ accounts or against cheques andnot against cash. The applicants for thesetransactions for amount exceedingRs.50,000 should affix their PAN on theapplication forms.

� Repayment of deposits of Rs.20,000 andabove should be through the accounts orcrossed DD/cheques.

� In case of foreign organizations, among otherdocuments, a certificate to the effect that theorganization is registered with the GOI toadhere to Foreign Contributions RegulationAct (FCRA, 1976) has to be obtained at thetime of opening of accounts.

� RBI have now further simplified KYCprocedure for opening small accounts.Branches need to seek only a photograph ofthe account holder and self-certification ofaddress. Balances in these accounts at anytime will be limited to Rs.50,000 and totaltransactions to Rs.2,00,000 in a year. As andwhen the balances or total transactionsexceed these limits, branches should treatthem like regular accounts and follow thenormal procedure of KYC.

� While opening accounts as described above,the customer should be made aware that ifat any point of time, the balances in all his/her accounts with the bank (taken together)

exceeds Rupees Fifty thousand (Rs.50,000)or total transactions in the account exceedsRupees Two lakh (Rs.2,00,000), no furthertransactions will be permitted until the fullKYC procedure is completed. In order not toinconvenience the customer, the bank mustnotify the customer when the balancereaches Rupees Fifty thousand (Rs.50,000)or the total transactions in a year reachesRupees Two lakh (Rs.2,00,000) thatappropriate documents for conducting theKYC must be submitted otherwise theoperations in the account will be stoppedwhen the total balance in all the accountstaken together exceeds Rupees Fiftythousand (Rs.50,000) or the totaltransactions in the accounts exceedsRupees Two lakh (Rs.2,00,000) in a year.

3. Transactions of Suspicious Nature andReporting

Branches of banks are required to report all cashtransactions of Rs.10 lakh and above as well astransactions of suspicious nature with full detailsin fortnightly statements to their controllingoffices. Besides, controlling offices are alsorequired to appraise their Head Offices regardingtransactions of suspicious nature.

The guidelines apart from laying emphasis onrecord keeping, training of staff and managementfor strict adherence to KYC norms also stipulatesbanks to lay down a policy for adherence to theabove requirements comprising:

a. Internal Control Systems

b. Terrorism Finance

c. Internal Audit/Inspection

d. Identification and Reporting of SuspiciousTransactions

e. Adherence to Foreign ContributionRegulation Act (FCRA), 1976

4. Threshold Limit

At the time of opening the account based oncustomer ’s profile, a threshold limit oftransactions is to be determined. As it is


proposed to report all the transactions of Rs.10lakh and above to the controlling authorities,under no circumstances, the threshold limitshould exceed the limit of Rs.10 lakh. Thethreshold limit should be 25% of the annualincome in case of individuals and one monthsturnover in the case of business enterprise.

5. Record Keeping

All financial records, which have been reportedto the controlling authorities under suspicioustransactions list, should be retained for at least10 years after the date of transaction.

6. Internal Control System

� Ensure to train all the staff of KYC norms

� Strengthening the internal audit system

� Controllers should periodically monitor theimplementation levels of KYC norms.

7. Conclusion

The KYC guidelines impose greater responsibilityon different functionaries in the bank. Moneylaundering done through bank would not onlyaffect its image but also the officials who wereused as instruments in the process. Properlyfollowed, KYC guidelines would provide sufficientprotection to banks against financial frauds andmoney laundering. However, we need to ensureadherence to KYC guidelines withoutinconveniencing the customer and by convincingthem that these are well intended in their long-term interests.


During the normal course of conducting itsbusiness, banks assume risks — notably creditand liquidity risks. If the risks are controlledproperly, banks create economic value byattracting savings to finance investment. In casesof mismanagement and misallocation of theirresources, banks fail. III effects of bank failuresare rapidly transferred through the entire financialsystem of the economy.

At present, banks are subjected to AnnualFinancial Inspections (AFI) by RBI with mainaccent on the assessment of the bank’s financialposition and senior officials of the RBI’sDepartment of Supervision (DoS) to look into thenon-financial aspects, i.e., management andsystems.

The system of inspection of banks by RBI wasreviewed in 1991 by a Working Group chairedby Shri S. Padmanabhan, former Chairman ofIndian Overseas Bank. The Padmanabhancommittee suggested that banks be placed inthe following two categories, for the purpose ofexamination, depending on the known andreported condition of the banks in financial,operational and management and complianceterms:

1) those that need to be examined on an annualcycle and

2) those that may be examined on a wider timescale say within two years from the date oflast examination.

In other words, the committee suggested thatsupervisory examinations should be

CAMELS RATINGS FOR BANKS

� Recommended by Padmanabhan Committee.

� Deals with supervision of banks by RBI.

� Banks to be classified into two: One, that needs annual supervision; other, on a largertime scale.

� Classification based on key parameters: Capital adequacy, Asset quality,Management, Earnings performance, Liquidity and Systems (For foreign banks it isCACS- second “C” stands for Compliance with regulatory guidelines).

� Ratings on a scale of A to E .

discriminating as between banks, based ondefined parameters of soundness — financial,managerial and operational (related mainly to riskmanagement and internal control systems)systems. It was recommended that intervalsbetween examinations in respect of bankswithout known or reported problems be widened,while the weaker banks may be subjected tofrequent examinations by lessening the intervalsbetween two examinations.

For evaluation and rating of Indian banks, thecommittee suggested six key parameters, viz.,Capital Adequacy, Asset Quality, Management,Earnings performance, Liquidity and Systems(CAMELS — Acronym). This is on the lines ofrating model (CAMEL) employed by theSupervisory Authorities in U.S.A. Consideringgrowing supervisory concerns on the need foradequate systems of risk management andoperational controls in banks operating in India,especially with the increase of market risk in bankportfolios, an additional parameter of “systems”was added to the CAMEL in India.

With regard to foreign banks operating in Indiathe committee considered that some parameterslike management, earnings, liquidity are not ofmuch significance and are clearly of lesserconcern in regard to branch operations from theviewpoint of a host country supervision andexcluded these factors for the evaluationpurpose. On the other hand, keeping in mind theserious aberrations that surfaced in theoperations of some foreign banks in the recentpast, the committee, recommended to include“compliance (Regulatory compliance)” factor for


inclusion for evaluation. Therefore, for foreignbanks operating in India the factors forexamination would be:

1) Capital Adequacy 2) Asset Quality 3)Compliance and 4) Systems (CACS-Acronym).

Component Ratings

Each of the six components in CAMELS (forIndian banks) or four components in CACS (forforeign banks operating in India) are assigned arating on a scale of 1 to 5 in order ofperformance.

Composite Ratings

Once the component ratings are determined, acomposite (CAMELS or CACS) rating isassigned as a summary and is used by thesupervisors as the prime indicator of bankcondition. Composite rating is not determinedby calculating an average of the separatecomponents but rather based on an independentjudgement of the overall condition of the bank.

Composite ratings are assigned on a scale of Ato E. Composite rating of A indicates that aninstitution is of least supervisory concern whilecomposite rating of E indicates an institution tobe a most supervisory concern.


The scheme, which came into effect from June14, 1995 and amended in 2006 provides thepublic, a system of redressal of grievancesagainst banks and to approach BankingOmbudsman for grievances against a bankwhich are not resolved within a period of twomonths provided their complaints pertain to anyof the matters specified in the scheme. TheScheme sought to establish a system ofexpeditious and inexpensive resolution ofcustomer complaints. The Scheme is inoperation since 1995, and was revised duringthe year 2006. The Scheme is being executedby Banking Ombudsmen appointed by RBI at15 centres covering the entire country. Thescheme covers all scheduled commercialbanks, Regional Rural Banks and all ScheduledPrimary Co-operative Banks having a place ofbusiness in India whether incorporated in Indiaor outside India. The scheme is not asubstitution for Consumer Protection Act but anadditional grievance settlement mechanismavailable to the banks’ consumers.

Powers of the Banking Ombudsman

Banking Ombudsmen have been authorized tolook into complaints concerning (a) deficiencyin banking or other service (b) sanction of loansand advances as they relate to non-observanceof RBI directives on interest rates, delay insanction or non-observance of prescribed timeschedule for disposal of loan applications or non-observance of any other directions orinstructions of RBI.

His authority also includes matters referring toall complaints concerning,

i) non-payment/inordinate delay in the paymentor collection of cheques.

BANKING OMBUDSMAN SCHEME

� Scheme effective from June 1995 and amended in 2006.

� Covers scheduled commercial banks, RRBs and co-operative banks.

� Deals with: Deficiiency in banking services, delayed collection of cheques, non-issueof drafts, interest rate disputes, failure to honour LC/guarantee commitments, delayin disposal of loan application

� It promotes settlement through conciliation

ii) non-acceptance, without sufficient cause, ofsmall denomination notes tendered for anypurpose.

iii) non-issue of drafts to customers and othersand non-adherence to prescribed workinghours.

iv) failure to honour guarantee/letter of creditcommitments by banks.

v) complaints pertaining to operations in SB/CA/NRI accounts and interest rates.

vi) non-observance of RBI instructionsregarding time schedule for disposal of loanapplications.

vii) Delays, non-credits to parties' accounts,non-payment of deposit.

viii)Credit card operations.

Procedure for Redressal

The complaint has to be in writing duly signedby the complainant or his authorisedrepresentative containing name and address ofthe complainant and name and address of thebank against which the complaint is made. Itshould also contain facts giving rise to thecomplaint supported by documents wherenecessary. Finally, it should also mention aboutthe relief sought from the Ombudsman.

Settlement of Complaints by Agreement

Banking Ombudsman will send a copy of thecomplaint to the branch or office of the banknamed in the complaint under advice to nodalofficer and endeavour to promote a settlementof the complaint by Agreement between theComplainant and the bank through conciliationor mediation.


For the purpose of promoting a settlement, theBanking Ombudsman may follow procedurewhich he may consider just and proper and heshall not be bound by any rules of evidence.

Award by Banking Ombudsman

If a complaint is not settled by agreement withina period of one month from the date of receiptof the complaint or such further period as BOmay allow the parties, he may, after affordingthe parties a reasonable opportunity to presenttheir case, pass an Award or reject thecomplaint.

A copy of Award will be sent to the complainantand the bank. The Award shall not be binding onthe bank unless complainant furnishes letter ofacceptance to the bank withing 15 days fromthe date of receipt of the copy of Award.

BO may grant another 15 days time to thecomplainant for submitting letter of acceptanceand thereafter the Award shll lapse and be of noeffect.

The bank within one month from the date ofreceipt of letter of acceptance will intimate

compliance to the BO. BO may grant another15 days time to comply with the Award andsubmission of compliance.

BO may reject a claim at any stage if afterconsideration of the complaint and evidenceproduced before him the BO is of the opinionthat the proceedings are not appropriate foradjudication of complaint. The decision of BOis final and binding on all parties.

Appeal before the Appellate Authority (AA)

Any person agrieved by the Award may, within45 days of the date of receipt of the Award, preferan appeal against the AA (Deputy Governor incharge of the department of BankingOmbudsman at RBI). AA may, if he is satisfied,allow a further period not exceeding 30 days.

Appeal may be filed by the bank only with theprevious sanction of the Chairman or in hisabsence, the Managing Director of the ExecutiveDirector or the Chief Executive Officer or anyother Officer of equal rank.

The order of the AA shall have the same effectas the Award passed by BO.


ROAD MAP FOR PRESENCE OF FOREIGN BANKS

Under the road map, during the first phase

between March 2005 and March 2009, foreign

banks satisfying the eligibility criteria prescribed

by RBI will be permitted to establish presence

by way of setting up a wholly owned banking

subsidiary (WOS) or converting the existing

branches into a WOS, which should have a

minimum capital of Rs.300 crore and sound

corporate governance. The WOS will be treated

on par with the existing branches of foreign banks

for branch expansion with flexibility to go beyond

the existing WTO Commitments of 12 branches

in a year and preference for branch expansion

in under banked areas. RBI would also prescribe

market access and national treatment limitation

consistent with WTO commitments as also

other appropriate limitations consistent with

international practices and the country’s

requirements. Permission for acquisition of

shareholding in India of private sector banks by

eligible foreign banks will be limited to banks

identified by the Reserve Bank for restructuring.

The Reserve Bank would consider permitting

such acquisition if it is satisfied that such

investment by the foreign bank concerned will

be in the long term interest of all the stakeholders

in the investee bank. Where such acquisition is

by a foreign bank having presence in India., a

maximum period of six months will be given for

conforming to the ‘one form of presence’

concept.

The second phase will commence in April 2009

after a review of the experience gained and after

due consultation with all the stakeholders in the

banking sector. Extension of national treatment

to WOS, dilution of stake and permitting

mergers / acquisitions of any private sector

banks in India by a foreign bank would be

considered., subject to the overal investment

limit of 74 per cent.

� The first phase of the policy is for the period March 2005 to March 2009.� Foreign banks can establish Wholly Owned Subsidiary with minimum capital of

Rs. 300 crore� Wholly owned subsidiaries will be given preference for branch expansion in under-

banked areas� Foreign banks with the permission of RBI can acquire those banks which qualify for

restructuring.� Second phase of the policy will commence from April 2009 based on experience

gained.


BANKINGTECHNOLOGY


Technological developments have vastlyaltered the banking landscape in India withsignificant improvement in processes andprocedures leading to higher productivity, rapidproduct development through alternative deliverychannels, and reduction in the transaction cost.In particular, the technology is being leveragedincreasingly to expand the banking outreach,especially in the rural areas .

The process of computerisation, which wasthe starting point of all technological initiativeshas reached a stage of maturity. The cumulativeamount spent during September 1999 to March2007 aggregated to Rs.12,826 crore

The cumulative proportion of branches providing‘core banking solutions’ (CBS) increased rapidlyto 44.4% at end-March 2007 from 28.9% at endof March 2006. All seven Associate Banks ofState Bank of India and Corporation Bank havefully implemented the core banking solutions.Additionally, eight more public sector banks,viz., State Bank of India, Andhra Bank, Bankof Baroda, Bank of India, Bank ofMaharashtra, Punjab National Bank and VijayaBank have achieved full computerizationalthough implementation of CBS is still underprogress. Allahabad bank, Canara Bank, CentralBank of India, Dena Bank, Indian Bank havecomputerized 70% to 90% of their branches.UCO Bank with 37.2%, Union Bank of India(42.7%), United Bank of India (28.2%) andPunjab and Sind Bank ( 10.1%) have laggedbehind. The overall computerization in public

TECHNOLOGICAL DEVELOPMENTS IN INDIAN BANKS

� Technological developments have vastly altered the banking landscape in India

� The cumulative proportion of branches of various providing ‘core banking solutions’(CBS) has increased rapidly to 44.4%

� The total number of ATMs installed by the Banks were 27,088 at end-March 2007

� The volume of electronic transactions increased by 32.9 per cent during2006-07

sector banks including SBI was as under:

(%)

2006 2007

Branches under CBS 28.9 44.4

Branches fully computerizedother than CBS 48.5 41.2

Total 77.5 85.6

Source: RBI Report on Trend and Progress of Banking

in India, 2006-07

The total number of ATMs installed by the Bankswere 27,088 at end-March 2007 as comparedwith 20,267 at end-March 2006.

ATMs installed by foreign banks and new privatesector banks were more than three times thenumber of their branches. The ATM to branchratio was much lower for public sector (32.9 %)and old private sector banks (34.9%) . It was47.5% for SBI. ATMs in the case of twopublic sector banks (Corporation Bank andIDBI Ltd.) were more than the number of theirbranches. At individual bank level, the numberof ATMs exceeded branches in respectof all new private sector banks except YesBank Ltd. Of all the ATMs installed in the countryat end-March 2007, new private sector bankshad the largest share in off- site ATMs.


ATMs (As on 31st March 2007)

Total Number of Total Number of ATMs as % of Offsite ATMs asBranches ATMs branches % of Total ATMs

SBI @ 9270 4407 47.5 48.1

SBI Group 14030 6441 45.9 43.3

Nationalised Banks 35636 9888 27.7 27.4

Old Pvt Sector Banks 4606 1607 34.9 31.3

New Pvt Sector Banks 2497 8192 328.10 61.5

Foreign Banks 273 960 351.6 74.1

Total 57042 27088 47.5 42.3

@ Not included in Total as also included in figures of SBI Group

Source: RBI Report on Trend and Progress of Banking in India, 2006-07

Reflecting the increased application of technology, the use of electronic payments, both retail andcard-based, has increased in recent years. The volume of electronic transactions increasedby 32.9 per cent during 2006-07 as compared with 24.5 per cent in the previous year. In termsof value, the growth was as high as 61.0 per cent as compared with 34.6 per cent.

Volume of Transactions Value of Transactions (in ‘000) (Rs. crore)

2005-06 2006-07 Growth % 2005-06 2006-07 Growth %

ECS- Credit 44216 69019 56.10 32324 83273 157.60

ECS-Debit 35958 75202 109.1 12986 25441 95.90

EFT/NEFT 3067 4776 55.70 61288 77446 26.40

Credit Cards 156086 169536 8.60 33886 41361 22.10

Debit Cards 45686 60177 31.70 5897 8172 38.60

Total 285013 378710 32.90 146381 235693 61.00

Source: RBI Report on Trend and Progress of Banking in India, 2006-07


Electronic learning or E-learning is a generalterm used to refer to computer-enhancedlearning. It is used interchangeably in so manycontexts. In many respects, it is commonlyassociated with the field of advanced learningtechnology (ALT), which deals with both thetechnologies and associated methodologies inlearning using computers, networks and/ormultimedia technologies.

E-learning is a broad term. It is generally usedto refer to the use of technology in learning in amuch broader sense than the computer-basedtraining or computer aided instruction. It is alsobroader than the terms on-line learning or onlineeducation which generally refer to purely web-based learning. E-learning is naturally suited todistance learning and flexible learning, but canalso be used in conjunction with face-to-faceteaching, commonly called ‘blended learning’.

E-Learning also refers to educational web sitessuch as those offering learning scenarios,worksheets and interactive exercises forchildren. The term is also used extensively inthe business sector where it generally refers tocost-effective online training.

The worldwide E-learning industry is estimatedto be worth over 40 billion US dollars accordingto conservative estimates. Developments ininternet and multimedia technologies are thebasic enabler of E-learning, with content,technologies and services being identified as thethree key sectors of the E-learning industry.

E-LEARNING

� E-learning is a broad term generally used to refer to the use of technology in learningin a much broader sense than the computer-based training or computer aidedinstruction.

� Developments in internet and multimedia technologies are the basic enabler of E-learning.

� The success of e-Learning depends on three important aspects: availability ofinfrastructure, technology and support for sustainability.

� E-learning initiative in State Bank of India.

Many higher education courses now offer on-line classes. Many technologies can be, and are,used in e-Learning, including: screencasts, web-based teaching materials, MP3 Players withmultimedia capabilities, educational animation,computer aided assessment, discussionboards, learning management software,simulations, virtual classrooms Most E-learningsituations use combination of the abovetechniques.

The advantages of E-learning are that thereceiver can access it from anywhere, anytimeand at his convenience. It is independent ofdistance.

The success of e-Learning depends on threeimportant aspects: availability of infrastructure,technology and support for sustainability.

• e-Infrastructure– Connectivity– Resources Availability– Empowerment of e-Skills

• Technology– Content Development, Standards– Interoperable Learning Systems

• Sustainability– Quality Assurance Systems– Large number and varied training

programmes


The Learning tools are:• Learning Management Systems

– A Learning Management System (orLMS) is a software package thatenables the management and deliveryof online content to learners

• Learning and Content ManagementSystems– An LCMS provides tools for authoring

content as well as virtual spaces forlearner interaction (such as discussionforums and live chat rooms)

• Content Management Systems– CMS facilitates the organization, control,

and publication of a large body ofdocuments and other content, such asimages and multimedia resources.

Implementation of E-Learning in the Bank

State Bank of India has undertaken todevelopment of e-courses for the followingreasons:

� Providing widespread availability andaccessibility to information and knowledge

� Development of appropriate courses foraligning training to business strategy

� Putting in place a suitable model forpromoting a learning organization

� Moving towards creating a virtual campusfor the State Bank Group

� Migrate functional programmes to E-learning to free SBLCS/ATIs for high-endprogrammes

E-learning project would help develop a reservoirof knowledge within the organisation. Initially itwould supplement the existing training systembut eventually most knowledge and skill basedtraining would be imparted through this medium.More importantly for a Bank of our size with morethan 2 lacs employees , the e-courses will beavailable at the door-step of the employee to beaccessed as per his need , convenience. Thiswill go a long way in extending training facilitiesto each employee.

E-learning initiative in State Bank of India

� To touch all employees on a continuousbasis to avoid Knowledge/skillsobsolescence.

� First attempt was made in 2003 using LMSfrom ORACLE with 1000 concurrent userlicence.

� Not so successful at that time due to lowpenetration of computer/ Internet, few e-courses etc. Only 6 e-Courses wereavailable at that time.

� A Committee was setup for studying theBank’s initiative on E-learning andrecommend initiatives.

� Based on the recommendations of theCommittee the present initiative waslaunched on the 28th September, 2007.Important initiatives are :

o Learning Management Software as apart of Human Resources ManagementSoftware package obtained from SAP.It will help us in recording achievementsof the employees and implementReward and Recognition schemes.

o An Asst General Manager (E-leaning)has been posted at the College to driveand coordinate the Bank’s E-learninginitiative.

o It was decided that all Functional(Knowledge/ skill based) inputs wouldbe disseminated through E-learning.

o E-courses are available both on Internetand Intranet.

o More than 50 e-Courses have beendeveloped so far in-house by the ApexTraining Institutions.

o DGMs and Heads of various disciplinesat the SBSC/SBA/SBIICM and SBIRDare in-charge of development of e-courses. They have been designated asCourse Directors. The CourseDirectors nominate a Faculty asSubject Matter Expert (SME) for eachcourse who develops the courses in


technical collaboration with outsidevendor (s) hired by the Bank.

o 28 members of Faculty from variousApex Training Institutes and SBLCshave been trained as e-Faculty andgiven exposure to various concepts andtools related to E-Learning so that moreeffective contents can be developed

o E-courses would also be procured off-the-shelf, to address needs of all thecategories of employees/Roles.

o Bank is in the process devising ascheme for completing e-courses andpassing online tests.


E-PURSE

� An e -purse is a stored value or prepaid product in which a record of the funds orvalue is stored on an electronic device.

� E-purse uses both smart card and computer networks.

� In Europe and America one can load up to 200 US Dollar or Euro onto the chip andpay the exact amount at approximately millions of vending machines.

� Future of e-purse in India.

The Committee on Payment and SettlementSystem (CPSS) defines electronic money as,‘monetary value as represented by a claim onthe issuer which is: (i) stored on an electronicdevice; (ii) issued on receipt of funds of anamount not less in value than the monetary valueissued; and (iii) accepted as means of paymentby undertakings other than the issuer’. Thisdefinition includes both prepaid cards(sometimes called electronic purse) and prepaidsoftware products that use computer networks(sometimes called digital cash). An electronicpurse or e -purse is a stored value or prepaidproduct in which a record of the funds or valueis stored on an electronic device which is inthe consumer’s possession and is availableto the consumer for multipurpose use. Theloading of value onto the device is akin to thewithdrawal of cash from an ATM. Most of the e-purses relate to use of reloadable cards.

Banks in Europe and America gave theelectronic purse a try in the 1990s, but largelyabandoned their efforts when the products failedto gain any real traction in the marketplace. Manycompanies Mondex, VisaCash, GeldKarte andDanmont tried but then abandoned. Clearly,banks thought, people did not want pre-paid orstored-value payment cards for low valuetransactions. But new technology means thatthe e-purse is back again with more potentialfor success. Pre-paid cards are being used forpaying for public transport, parking, postalstamps, public phones, laundromats, gamingcentres, eateries The majority of digital mobilephones are pre-paid. The gift card market

continues to grow around the world. In the US,gift cards were sold in their millions over theholiday period and account for more than 8% ofretail transaction value. One can load up to 200US Dollar or Euro onto the chip and pay theexact amount due conveniently at approximatelymillions of vending machines as well as on theInternet

The growth in ‘open’ prepaid cards (ie, cardsthat can be spent on the Visa, MasterCard andDiscover networks) is also substantial witharound $3.5 billion loaded last year. Visa USAestimate the pre-paid market at around $2 trillion,spread across consumer (eg, gift cards),business (payroll cards) and government (eg,benefit cards)

E-purse has gone through an electronic cycle.Banks tried to introduce the e-purse and it didnot work. They then thought that there was nomarket for pre-paid cards for small transactions.Meanwhile, other people (who understoodmarketing and brand) launched pre-paid cardsand turned them into a successful product. Nowbanks are going back into the business.

In India, quite a few banks have started issuingprepaid cards. Now a number of non-banksin collaboration with banks/without collaborationof banks are issuing both, limited ormultipurpose prepaid cards. Broad categoriesunder which cards have been issued by banksin India are- co -branded pre -paid travel card/foreign travel cards, co - branded pre -paidannuity cards, co -branded pre -paid payrollcards, etc. These cards, apart from being used


at ATMs, can also be used at point of sale (POS)terminals for making payments. The paymentcould also be made for transactions done oninternet. Slowly, but steadily, usage of thesemode of payment is on an increase. Themoney is loaded on cards by transfer of balancesfrom bank accounts through ATMs or in somecases through the telephone or internet, onreceipt of equivalent monetary value. These canbe used for making payment for purchaseswhich are generally of low value.

E-purse uses the smart card technology. Asmart card is a card which is similar to acredit/debit ATM card. The distinguishing featurelies in the presence of a chip in the card whichcan store information. Unlike in the case ofmagnetic- stripe based cards, the storedinformation in the chip could either be permanentin nature, or may be subject to change. Forinstance, the passwords can be changed at anyfrequency by the cardholder. Because of itsadditional feature, smart cards find usage notonly for financial transaction processing but in anumber of other areas as well.

One of the greatest advantages of the smart cardtechnology is its ability to consolidate multipleapplications in a single, dynamic card. These

cards simplify life for end-users, often replacingup to three other cards for payment and othertransactions. Thus, there can be a singlecard which can function as an identity card, asa driving licence, as a health card and also forother funds related purposes. Because thesecards deliver such highly personalisedapplications, their perceived value among end-users is much higher and helps to build strongerthan average customer loyalty.

With Indian banking having embraced IT in alarge way, the potential for usage of multi-application smart cards is high. Smart-card-based electronic purse systems, in which valueis stored on the card chip and not in an externallyrecorded account so that machines acceptingthe card need no network connectivity. Thus,the multi-application cards are beneficial forissuers as well, especially because they providethe prospect to create unique marketingopportunities. They are particularly suitablefor financial inclusion in remote parts of thecountry. For the banks introducing smart cards,another quantifiable benefit is the ability toforecast a reduction in fraud.


MOBILE BANKING

� The term ‘mobile banking’ or M-banking in the contemporary context denotes bankingtransactions done through mobile phones by way of SMS.

� Account related queries, real-time transaction alerts and investment services arecurrently possible through M-banking and the scope is widening day by day.

� M-banking is being used very successfully for micro payments in countries likePhilippines, Africa, etc., and now increasingly looked upon as a tool for financialinclusion rather than mere convenience enhancer.

The term ‘mobile banking’ or M-banking in thecontemporary context denotes bankingtransactions done through mobile phones byway of SMS. These transactions, when enabledby the bank and the mobile phone serviceprovider, can give the customer the convenienceof virtual 24x7, anywhere banking in respect ofspecific sets of transactions. This specific setincludes balance checking, mini-statement,stop-payment, cheque book requests, billpayments and funds transfer from one accountto another (domestic and international). Anotherset of services keeps the customer updated inreal-time about the transactions taking place inhis account like debit and credit over specifiedlimit, balance, bouncing of cheques, etc. M-banking scope is widening day by day andmutual fund investments, insuranceinvestments, real time stock quotes andcustomised price alerts are also have becomea part of it.

Mobile internet enhances the scope and easeof M-banking. However it is more of an extendedform of internet-banking rather than the kind ofM-banking discussed above.

M-banking provides a low-cost delivery channelfor banking services and hence currently banksare offering mobile banking free of charge.

Emerging Trends

With the explosive growth in mobile phonesubscription, the mobile phone owners havealready outnumbered bank account holders inmany developing countries. M-banking is nowincreasingly looked upon as a tool for financialinclusion rather than mere convenienceenhancer. M-banking is very successfully being

used for micro payments in countries likePhilippines. It caters to millions of rural peoplewho otherwise have no access to conventionalfinancial institutions like banks. Bankers thinkthem as not bankable because of negligibly lowlevels of balances in their account and in turnthe rural poor either feel intimidated by thebanking procedures or feel inconvenient to keeptheir meagre savings with banks. M-bankingsteps in to address such major gaps neglectedby the banks but critical to rural poor and a pre-paid connection becomes anytime money forthem. Using their mobile they can lend or borrowmoney from one another and receive domesticand international remittances in real time. Insome of the African countries bankers areexperiencing exponential growth in M-bankingcustomers compared to the growth in internet-banking customers. In many Latin Americancountries hardly 10% of the beneficiaries ofinternational remittances have a bank account,at present they depend on agencies likeWestern Union who charge upto 15% andrequire the recipient to travel to such offices. M-banking will save them the trip and bring downthe cost of remittance.

M-banking in future will enable customers tomake payments at the point of sale like using aconventional credit or debit card but in muchmore faster and safer, contactless paymentmode. Service providers like Obopay have ineffect converted the mobile phone into a wallet.

Challenges

Security of financial transaction is the biggestchallenge in M-banking.

Physical security of the hand set, the strengthof the software application and secure


transmission of data are of vital importance.Another major challenge in mobile banking isironically the technology itself. Many protocolslike HTML (Hyper Text Mark-up Language), XML(Extensible Mark-up Language), WAP (WirelessApplication Protocol) are used by different mobileoperators. Interoperability of banks’ softwarewith various protocols used by the mobileoperators is necessary for providing M-banking.However, there is a set of software solutionscalled ‘middleware’ which can mediate between

various types of mobile phones and banks’computer networks is now available and canaddress the kind of technology challengenarrated above.

Another issue is new types of disputes that thebanks and service providers will be facing.Problems due to inadvertent errors fromcustomers’ side, non-completion of transactionat either end due to technological orgeographical reasons, etc., can give rise tocomplicated disputes.


In USA, there are nearly 1,300 ATMs per millionpeople. In Mexico, this figure is about 200. Thehighest density of ATMs is in South Korea, whereit is about 1,600 ATMs per million. At 55 ATMsper million, China’s tally is almost double that ofIndia with only 28 ATMs per million people.Despite rapid growth, India has a long way to gocompared to other markets. For example, Chinahas about 80,000 ATMs, and the US, more than4,00,000 ATMs.

To reach the rural masses, banks are going allout in providing a user-friendly bankingexperience. ATMs with biometric devices are thelatest solution in the ongoing effort to offerbanking services to the rural masses.

Credit and debit card fraud is a major problemwithin the UK, going up to £74.6 millionwithdrawn from Automated Teller Machines in2004. Top Japanese financial institutions areusing fingerprint scanning in addition to PIN codeto ensure safer banking.

Banks are also trying biometric enabledtechnologies in their micro finance initiatives.Establishing the identity of a depositor throughbiometrics makes it possible for illiterate orbarely literate folks to become part of the bankinguser community. With an increasing need forsecurity, in view of incidences of password theft,etc., a need is felt for a technology that cancreate a unique identification for each individual.Its use is no more limited to identification bypolice, investigating agencies. In view of therapidly increasing applications, the scope ofvarious biometrics techniques is increasing, beit identification via face, voice, retina, iris,fingerprint, hand geometry, face, odour, retinalpattern, or a behavioural trait like voice pattern,handwriting or acoustic sign. Fingerprinting,

BIOMETRICS AUTHENTICATION TECHNOLOGY

� Biometrics technology is solution to the problem of increasing frauds throughimpersonation.

� It can be easily used to bring rural masses in the fold of technology enabled bankingchannels.

� There are a number of biometric technologies, but those suitable for specific requirementsshould be adopted.

however, has the advantage of being a familiarconcept worldwide.

In the retail payments arena, biometrictechnology has already made its way in the formof self service devices including AutomatedTeller Machines (ATMs) and Point of Sale (POS)machines. Some of the new generation POSterminals are biometric enabled with smart cardreaders, allowing thumb-print basedauthentication. Some Indian banks have startedimplementing biometric applications in retailbranch applications for officer authentication.However, in India most of such initiatives are stillin the trial run phase.

Across the globe efforts are on to enablepayments through kiosks based on fingerprints.ATM enhancements with biometric supportenvisaged by vendors eliminate the need for PINentry, and authenticate customer transactionsby thumb-impressions. A simplified menu onATMs coupled with possible audio guidance inlocal language enable easy use for ruralmasses. So far bank ATMs are dependent onPIN verification. The biometric technologyenabled methods of identification are notdependent on password.

Benefits of Biometrics AuthenticationTechnology

• Provides strong authentication, biometricfeatures of an individual is always differentfrom the rest of the world population.

• Can be used instead of a PIN, which hasproblems of impersonation, difficulty in useby semi-literate and illiterate, with increaseduse of password based technologyremembering passwords is difficult for manyliterate people also.


• Hidden costs of ATM card management likecard personalization, delivery, management,re-issuance, PIN generation, helpdesk.

• Ideal for rural masses all over the world.

How It Works

With ATMs supported by biometric solutions,banks having a presence across the country canleverage this technology. ATMs are so prevalentand today so many people use ATMs that itbecomes easy to use biometrics as areplacement for an ATM PIN. The typical ATMhas two input devices (a card reader andkeypad) and four output devices (display screen,cash dispenser, receipt printer, and speaker).There is also a communication mechanism thatlinks the ATM directly to an ATM host network.The ATM functions much like a PC, it comeswith an operating system and applicationsoftware for the user interface andcommunications. To identify account holdersATMs use magnetic strip cards and personalidentification numbers or smart cards withfingerprint validation. ATM forwards informationread from the client’s card and the client’srequest to a host processor, which routes therequest to the concerned financial institution. Ifthe cardholder is requesting cash, the hostprocessor signals for an electronic fundstransfer from the customer’s bank account tothe host processor’s account. Once the fundshave been transferred, the ATM receives anapproval code authorizing it to dispense cash.

Biometric Authentication Techniques

Biometrics is statistical study of biologicalphenomena. Some of the techniques used are:

Iris recognition: It works on a high resolutionpicture of a subject’s eye and comparing it to adata set. The blood vessels in an Iris havecomplete uniqueness across the population, asthey are determined randomly during gestation.

Finger-print recognition: The epidermis offingers and palms are unique to an individual,

the hand is placed upon a sensory pad, whichreads the ridges of the epidermis for use as thefeatures. However, it has been observed thatover a period of time, especially in case oflabourers, the finger prints undergo a change.

DNA fingerprinting: DNA fingerprinting involvescomparison of the DNA makeup of an individual.

Gait recognition: Gait is based on identifying anindividual by the way he/she walks.

Face recognition: This is the most popularmodern form of biometric identification. In thistechnique identification is carried out based onthe facial features.

Voice recognition: Automated voice recognitionuses the features of a person’s voice. However,this technique is highly vulnerable to noise.

Adverse Features of the BiometricTechniques

Digital Spoofing: if a biometric identification chipcontained information related to a subject’sfinger relief, then the perpetrator could create amodel of the relief for his hand and thenimpersonate the subject where the use of onlythat fingerprint is needed.

Physical Spoofing: Physical spoofing is theprocess of modifying any biometric data on areal document, to match that of the imposingindividual. As the false biometric data verifies theimposter’s identity, he can pass through thevarious security systems unhindered.

Privacy: Some people regard having biometricdata being kept on them as a violation of personalprivacy. In techniques such as odourrecognition, it becomes quite apparent as aninvasion of a person’s privacy. For the populationto accept biometric systems, the features usedneed to be very carefully selected to minimiseany antagonistic effects.

Cost: Biometric systems are quite expensive.


Smooth functioning of the payment andsettlement systems is a pre-requisite for stabilityof the financial system. Any malfunctioning ofthe system could seriously impair the flow ofgoods and services and financial assets in theeconomy. This could have serious implicationsfor financial stability and the transmissionmechanism of monetary policy.

Board for regulation and supervision of Paymentand Settlement Systems (BPSS) is the apexbody for giving policy direction in the area ofpayment and settlement systems. The mainthrust of the BPSS was on electronification ofthe payment systems by way of encouragementand information dissemination.

The Reserve Bank has also taken keen interestin developing robust payment and settlementsystems, both retail and large value. TheReserve Bank has taken a number of measuresfor improving efficiency of both large value andretail payments systems.

The payment systems comprise paper-basedclearing and electronic clearing systems, viz.,national electronic funds transfer (NEFT),electronic clearing service (ECS), cardpayments, e-payment, internet and mobilepayments. The broad structure and features areas under:

Paper-based Clearing - Extension of MICRand Implementation of Magnetic MediaBased Clearing System (MMBCS)

The paper-based cheque is still thepredominant mode of payment. The volumeof transactions settled through this mode makesit imperative that the system operates smoothly.The standardization of cheque in MICR formathas been achieved. However, at quite a largenumber of clearing houses, the processing

PAYMENT SYSTEMS: AN UPDATE

� The main thrust of RBI and BPSS is on electronification of the payment systems.

� ECS is now available at all bank branches at 67 centres.

� 30,000 branches of various banks are providing remittance through NEFT/RTGS.

� NFS comprises of 27 banks and 16891 ATMs.

was manual. Thus, on completing the settingup of MICR Cheque Processing Centres(CPCs) at the 59 identified centres, RBI feltthe need to computerise the settlementoperations at the clearing houses where thesetting up of a MICR CPC was not a viableoption due to lower volumes. A plan was drawnfor computerisation of the clearing operationsusing the Magnetic Media Based ClearingSystem (MMBCS). In Phase I (clearing housewith more than 25 banks) - 41 clearing housewere identified and computerised. During PhaseII (clearing houses with 15 or more memberbanks), 180 clearing houses were identifiedfor computerisation. Of these, 176 clearinghouses were computerised. In addition, another313 clearing houses were also computerisedeven though they had less than 15 memberbanks. The MMBCS provides for clearing andsettlement based on the MICR code information.MICR code information system has been inoperation for more than 15 years. It coverspresentation clearing, return clearing, highvalue/high value return clearings and inter-bank clearing, but does not cover inter- cityclearing. The system was initially implementedat the four MICR CPCs operated by the ReserveBank. The same was subsequentlyimplemented at all the clearing houses managedby the Reserve Bank. The member bankspresent their claims in the form of an electronicfile which gets processed on the computer. As aresult, the settlement figures are arrived at within15 minutes compared to 3 or 4 hours under themanual system.

Cheque Truncation System (CTS)

The cheque truncation system (CTS) was alsotaken up to improve efficiency of the paper-based payment system. On operationalisationof the CTS, the paper instruments would not


travel beyond the presenting bank. Banks wouldtake a business decision at the point of truncatingthe cheque – branch level or service branch orgateway level. A pilot project for chequetruncation has been set up to cover the NationalCapital Region of Delhi. RBI has suggested thatsmaller banks, which may find it unviable toset up this infrastructure, could come togetherand utilise the services of service bureaus setup for providing this service. A few large bankswould set up service bureaus for smaller banksfor this purpose.

Electronic Clearing Service

Electronic clearing service (ECS) is a retailpayment system that can be used to make bulkpayments/receipts of a similar nature,especially where each individual payment is ofa repetitive nature and of relatively small amount.It has two variants - one for direct credit and theother for direct debit. Under ECS (credit)one entity/company makes payments from itsbank account to a number of recipients by directcredit to their bank accounts. The direct creditfacility enables companies and Governmentdepartments to make large volumes of paymentssuch as salary and pension. With the ECS(debit), the organisations such as utilitycompanies (electricity and telecom) andinsurance companies collect their bills,insurance premia and equated monthlyinstalment payments of loans directly fromthe bank account of their customers. ECS isnow available at all bank branches at 67centres.

NEFT/RTGS

In order to broad-base the facilities ofelectronic funds transfer to centers wherethe Reserve Bank does not have its officesand to implement public key Infrastructure (PKI)- based security system, a variant of the EFTcalled the national electronic fund transfer (NEFT)system was introduced in November 2005.The NEFT system has become a criticalpayment system for retail electronic paymentsafter the (Real time gross settlement (RTGS)was made a system for large value payments.The settlement of NEFT takes place on a ‘net’basis; there are 6 settlements on week days(9.30 a.m., 10.30 a.m., 12.00 noon, 1.00 p.m.,

3.00 p.m. and 4.00 p.m.) and 3 settlements(9.30 a.m., 10.30 a.m. and 12.00 noon) onSaturdays. The increase in the number ofsettlements of the NEFT system, which is adeferred net settlement, has made it close to areal time system. There are now 74 banksoffering the facility at over 30,000 branches.RTGS/NEFT is now available onwww.onlinesbi.com.

The large value payment systems comprise theRTGS which includes Government securitiesclearing and forex clearing. The RTGS wasoperationalised in March 2004. At present, 100participants (banks), primary dealers and theReserve Bank are members of the RTGSsystem. The RTGS system facilitates customertransactions, apart from inter- bank fundstransfer

From January 2007, the system has been madea purely high value system and transactionsabove Rs.1 lakh only can now be put throughthis system. Integration of the RTGS with theintegrated accounting system (IAS) andcentralised funds management system (CFMS)has facilitated better funds management bybanks and seamless transfer of funds acrosstheir accounts with the Reserve Bank. Integrationof the RTGS- IAS with the securities settlementsystem (SSS) has facilitated automatic intra-dayliquidity (IDL) availability based on the eligibilityconditions.

The RTGS has the facility of multilateral netsettlement batch (MNSB) mode of settlement,which has been implemented for the settlementsat Mumbai covering cheque clearing settlements(including high value clearing), ECS and EFT/NEFT. The Clearing Corporation of India Limited(CCIL) settlement is also being done in RTGS.The reach and utilisation of the RTGS is on therise. At present, 32,768 branches are providingthis facility to their customers.

e-payment: Internet and Mobile Payment

The rapid growth of e-commerce and the use ofthe internet have led to the development of newpayment mechanisms capable of exploitingthe internet’s unique potential for speed andconvenience. Similarly, the broader usage ofmobile phones has encouraged banks and


non- banks to develop new payment servicesfor their customers. Internet payments andmobile payments are defined by the channelthrough which the payment instruction is enteredinto the payment system.

CFMS

The Reserve Bank has implemented theCentralised Funds Management System(CFMS) which enables banks to transferfunds across their accounts with the variousoffices of the Reserve Bank. At present, thesystem of funds transfer is available ateleven centres – Ahmedabad, Bangalore,Chandigarh, Chennai, Guwahati, Hyderabad,Kolkata, Mumbai, Nagpur, New Delhi and Patna.

We have carried complete details on CFMS ina separate article.

National Financial Switch

National financial switch (NFS) was establishedby the Institute for Development and Researchin Banking Technology (IDRBT) to facilitateapex level connectivity among all banks’ ATMswitches. NFS was set up in 2004 and

comprises of 27 banks including ICICI Bank,HDFC Bank, Axis Bank, Bank of Baroda andPunjab National Bank. SBI and Associate Banksare not part of NFS. NFS covers 16,891 ATMsat present. This will facilitate ATM connectivityamong banks across the country. The switchaims to integrate ATM switches of all banks inthe country and simplify interbank transactions.The CCIL has been designated as the settlementagency for all transactions routed through theNFS. The net settlement obligations of individualmembers are sent to CCIL by IDRBT. This fileis submitted to the Reserve Bank by CCIL forsettlement.

The Payment and Settlement Systems Bill hasbeen cleared by the Cabinet. Once the Bill isenacted as an Act, the Reserve Bank wouldbe empowered to regulate and supervise allpayment and settlement systems in thecountry. The Act will also provide legalrecognition to multilateral netting and settlementfinality, which are the basic tenets of thedeferred net settlement (DNS) systems – themode of settlement of all payment systems inthe country.


Centralised Funds Management System(CFMS) is set up, operated and maintained byRBI to enable operations on current accountsmaintained at various offices of the bank,through standard message formats in a securemanner. CFMS gives a global view of thebalances to the entities maintaining account withRBI to query/transfer funds in its account at thevarious Deposit Accounts Departments (DADs)of RBI. Using CFMS, banks maintainingaccounts with RBI at its various offices are in aposition to know their balances at each location.

The CFMS comprises two components:Centralised Funds Enquiry System (CFES) andCentralised Funds Transfer System (CFTS).These have been made available through thefollowing sub-systems :

i) Apex Level Server (ALS)

ii) Local Funds Management System (LFMS)

iii) Bank Level Funds Management System(BLFMS)

iv) Local Banks Funds Management System(LBFMS)

ALS is the software which resides in themainframe computer systems currently housedin Mumbai, while the LFMS is the softwarecomponent which functions from the serversystems at the Regional Offices of RBI wherethe Deposit Accounts Department is existent.The BLFMS is the software provided by RBI tothe members of the CFMS and would be usedby the Treasury Department/Central AccountsDepartment, while the LBFMS is the softwarecomponent which would be given by RBI to theCFMS members for accessing the facilities ateach local DAD.

Time stamps, affixed by the ALS on thetransactions and events, will be deemed to bethe applicable time stamp in all cases and in allmatters.

CENTRALISED FUNDS MANAGEMENT SYSTEM(CFMS)

� CFMS is managed by RBI.

� Helps banks in managing their funds with RBI.

Each entity, which maintains a current accountwith RBI and is a member of INFINET, will beeligible for membership to the CFMS.

The following of facilities shall be availablethrough CFMS:

� Enquiries relating to the operation of itscurrent account/s maintained with any of theDADs

� Funds transfers between accounts of thesame account holder at different DADs.

All communication will be duly authenticated onthe basis of security infrastructure requirementsas may be decided by RBI from time to timeand would incorporate features such as PKI anddigital signatures.

All funds transfer messages received by thecentral system for debiting of any currentaccount should be digitally signed by theauthorised signatories only. If the users operatingon current accounts are those who have beenotherwise authorised to operate on the currentaccounts while opening the current account orsubsequently, then no separate authorization isrequired for CFMS. RBI has no responsibility, inso far the authority of the individual originatingthe transaction, with regards to the messagesreceived by the central system. The accountholders will ensure that the messagesemanating from their LFMS are orignated onlyby authorized personnel.

Each message would be identified by a uniqueidentifier which shall form the basis for itstracking at a future point of time. The CFMSwould provide for Confirmation Numbers whichwould be used for processing of the contents. Ifany message is received twice, then themessage with the communication numberwhich has been received in the first would beprocessed and the subsequent message wouldnot be processed.


Every message, received by the CFMS from theBLFMS/LBFMS/LFMS, will be acknowledged bythe CFMS, after subjecting the message to aset of security, format and operationalvalidations. A positive CFMS acknowledgementwill be sent updating the flag at the BLFMS/LBFMS originating the message indicating thatthe message has been accepted for furtherprocessing. A rejected CFMS acknowledgementwill be sent by changing the status to ‘R’ formessages which fail the tests. In case themessage cannot be accepted for furtherprocessing, an appropriate reason codeindicating the reason for the failure ofacceptance by the CFMS will be specified in theacknowledgement. A positive CFMSacknowledgement does not, in any manner,indicate that the transaction has been processed.The message will not be taken up automaticallyfor further processing, unless the furtherauthentications/validations/controls are passedfor the respective message.

A negative CFMS acknowledgement, whichindicates a potential security breach, may result

in the CFMS/BLFMS/LBFMS link being logicallysevered after a control message is sent,indicating the reason for the link severance. Thereasons, among others, include:

� Failure of signature authentication;

� Receipt of a message with the sameConfirmation Number;

� Receipt of a message with a sequencenumber, which is not the same as the nextexpected sequence number; and

� Receipt of a message with a sequencenumber, which is the same as in the caseof a previously received message, but witha different message content.

On the successful completion of a transaction,the status of completion would be reported bythe CFMS to the originator of the message,through the member’s BLFMS/LBFMS.


Banks are using technology-based solutions forincreasing financial inclusion. Credit delivery inrural areas has often been expensive with largenumber of small loan accounts to be serviced.Information Technology (IT) enabled methodsare being looked into as the best alternativefor rural credit delivery that can increase thereach and reduce cost of delivery.

In the Annual Policy for the year 2007-08, RBIurged banks to scale up IT initiatives forfinancial inclusion while ensuring that solutionsare highly secure, amenable to audit, andfollow widely accepted open standards

RBI’s permission to banks to appoint businesscorrespondents (BCs) has opened possibilitiesof wider reach which were not available earlier.The use of appropriate technology by the BCshas the potential of reducing operationalcosts and building up a powerful managementinformation system (MIS). The use oftechnology combined with an effective use ofBCs has the potential of creating a bankingoutpost in every village.

The technology application model is premisedon providing financial services in the rural areasthrough the BC model using low cost and simpleIT based solutions. A central system, whichcould be a shared, provides for economies ofscale and consequential cost benefits. A fieldsystem which enables access to the centralcomputer by the BCs are essentialcomponents of the model. BCs use hand heldcomputer devices which connect to remoteservers using fixed line connectivity or mobiletechnology. Finger print method is being widelyused for uniquely identifying customers for

TECHNOLOGY-BASED SOLUTIONS FOR RURALBANKING BUSINESS

� Banks are using technology-based solutions for increasing financial inclusion.

� Banks are appointing business correspondents (BCs) for wider reach.

� SBI has also announced a scheme for Financial Inclusion by extension of BankingServices through Business Facilitators and Business Correspondents model.

� Banks are providing financial services in the rural areas through low cost and simpleIT based solutions.

extending financial services. It has beenobserved that bio-metric identification for KYCpurposes is emerging as the most popularmethod. Transactions in the accounts suchas cash deposits and withdrawals can becarried out by customers at ATMs / BCswithout having to go to the bank branch. Thecustomers are issued hard copy of transactiondetails facilitated by a tiny printer.

Several models have emerged in the last coupleof years to enable technology driven rural reachby banks. Nearly all of them converge on thefollowing essential components; i) a customerwith a multi application smart card ii)business correspondent with a simputer/handheld terminal/mobile phone enabling bankingservices, iii) a central processor unit, i v) acentralised card management for each of theabove systems.

An IT enabled model for banking outreachis basically implemented as under:

� Information regarding potential customer iscollected by business facilitators andpassed on to the bank in a prescribedformat.

� Banks carry out KYC scrutiny and arrangefor opening a savings bank account forthe customer, after relevant information iscaptured, such as his photograph,fingerprints and signature (optional). Thisinformation is encrypted in the smart card.

� While handing over the card to thecustomer, the BC activates the card forthe customer by fingerprint identification.


At the time of activation, the balanceavailable in the bank account is recorded onthe smart card.

� A customer can withdraw and depositmoney using his smart card at the terminalof the BC. Every time a transaction ismade, a print out is provided to thecustomer. Transactions cannot beundertaken unless a biometric verificationof the cardholder is done.

� Banking transactions are freed from branchtimings and can be done at the ATM orwhenever the BC is available with a capturedevice. Banks are installing Biometric ATMsto facilitate transactions through finger printidentification in rural areas

� If a BC does not have requisite moneyto pay the customer, a print out willbe given to him stating that no cash isavailable at the customer’s end. Thisinformation will be passed on to the bankthrough the central processor to facilitateimmediate replenishment of cash.Incidentally, this also acts as a check toprevent business correspondents fromdenying service to customers.

� The terminal with the BC is operatedwith a rechargeable battery and notdependant on steady supply of electricity.

� An added facility that can be enabled is thatthe customer can use the smart card asa debit card at merchant establishments.

� A central processor unit integrates villagelevel terminals and identified merchantestablishments with the bank.

� The technology seamlessly integrates intocore banking solutions of the banksconcerned and supports various types ofdeposits and loan accounts.

Each hand held model can be used to service500 to 1000 accounts by a BC; the device whenseen in the context of its servicing capabilitiesand range is very cost effective. Such modelshave already been adopted by some privatesector and public sector banks.

State Bank of India has also adopted the businesscorrespondent model. Bank has announced ascheme for Financial Inclusion by extension ofBanking Services through Business Facilitatorsand Business Correspondents model. Selectionof Business Correspondents will be done at theCircle level while selection of BusinessFacilitators will be done at the Region level. Theycan undertake activities like opening of depositaccounts, collection and payment of small valuedeposits and withdrawals (not exceedingRs.10,000/- in each case), disbursal of smallvalue loans (not exceeding Rs.10,000/-) afterobtaining prescribed documents, recovery ofprincipal / collection of interest, furnishing of miniaccount statements and account information,selling insurance / mutual fund products /pension products / any other third party product,receipt and delivery of small value remittances /other payment instruments (not exceedingRs.10,000/-), payment / receipt in respect of e-governance activities, railway ticketing and anyother service on behalf of the Bank.


Phising

Phishing is a notorious security scam that usese-mail and pop-ups to trick users into divulgingimportant information. Onlinesbi.com warns that“Phishing is a common form of Internet piracy.It is deployed to steal users personal andconfidential information like bank accountnumbers, net banking passwords, credit cardnumbers, personal identity details etc. Later theperpetrators may use the information forsiphoning money from the victim’s account orrun up bills on victim’s credit cards. In the worstcase one could also become the victim of identitytheft. A few customers of some other Indianbanks have been affected by the attempt ofphishing in early 2006".

The fraud works this way: Scam artists delivera hyperlink by email or launch a fake pop-upwindow. To make the pop-up window look moreconvincing, it may be displayed over a windowone trusts. Users who follow this link are takento a Web site that looks similar to the originalsite. This page captures their accountinformation. The fraudulent site also sets acookie on the victim’s computer, which preventsthe phishing attack from being displayed on anysubsequent visits.

Such e-mail messages or pop-ups often includeofficial-looking logos from real organizations andother identifying information taken directly fromlegitimate Web sites. To make these phishing

TECH TERMS IN VOGUE

� Phishing is a security scam that trick users into divulging important information.

� GPRS is a wireless communication service that enables continuous connection tothe Internet for mobile phone and computer users.

� Bluetooth is a small, cheap radio chip designed to replace cables by taking theinformation normally carried by the cables.

� Freeware is copyrighted computer software which is made available for use free ofcharge for an unlimited time.

� Middleware serves to “glue together” or mediate between two separate and oftenalready existing programs.

e-mail messages look even more legitimate, thescam artists may place a link in them thatappears to go to the legitimate Web site , but itactually takes one to a phony scam site orpossibly a pop-up window that looks exactly likethe official site.

These copycat sites are also called “spoofed”Web sites. Once one is at one of these spoofedsites, one might unwittingly send personalinformation to the con artists.

Reputed organizations do not ask forpasswords, login names, PAN numbers andother personal information through e-mail. If onereceives an e-mail from any organisation askingone to update credit card / other personalinformation, one should not respond to thisphishing scam.

Latest e-mail software with spam and anti-phishing capabilities like Outlook 2003, WindowsLive Hotmail or others help identify and warnabout suspicious e-mails. Microsoft PhishingFilter using Internet Explorer 7 or Windows LiveToolbar filter also protect from Web fraud andthe risks of personal data theft by warning orblocking from reported phishing Web sites.

GPRS

General Packet Radio Services (GPRS) is apacket-based wireless communication servicethat promises data rates from 56 up to 114 Kbpsand continuous connection to the Internet for


mobile phone and computer users. The higherdata rates allow users to take part in videoconferences and interact with multimedia Websites and similar applications using mobilehandheld devices as well as notebookcomputers. GPRS is based on Global Systemfor Mobile (GSM) communication andcomplements existing services such circuit-switched cellular phone connections and theShort Message Service (SMS).

GPRS packet-based services cost users lessthan circuit-switched services sincecommunication channels are being used on ashared-use, as-packets-are-on-needed basisrather than dedicated to only one user at a time.It is also easier to make applications availableto mobile users because the faster data ratemeans that middleware currently needed toadapt applications to the slower speed ofwireless systems are no longer needed. AsGPRS has become more widely available, alongwith other 2.5G and 3G services, mobile usersof virtual private networks (VPNs) have beenable to access the private network continuouslyover wireless rather than through a rooted dial-up connection

GPRS also complements Bluetooth, a standardfor replacing wired connections between deviceswith wireless radio connections. GPRS is anessential feature for unleashing the power ofmobile banking. M-banking customers withoutGPRS can subscribe only to sms basedservices.

BlueTooth

Conceived initially by Ericsson, before beingadopted by a myriad of other companies,Bluetooth is a small , cheap radio chip to beplugged into computers, printers, mobilephones, etc. A Bluetooth chip is designed toreplace cables by taking the information normallycarried by the cable, and transmitting it at aspecial frequency to a receiver Bluetooth chip,which will then give the information received tothe computer or the phone. The Bluetooth nameoriginally came from, a Danish King, HaraldBlåtand (translated as Bluetooth in English),who lived in the latter part of the 10th century.Harald Blåtand united and controlled Denmarkand Norway- hence the inspiration on the name-

uniting devices through Bluetooth.That was theoriginal idea, but the originators of the originalidea soon realised that a lot more was possible.If one can transmit information between acomputer and a printer, why not transmit datafrom a mobile phone to a printer, or even a printerto a printer?. The low cost of a Bluetooth chipand its low power consumption, means onecould literally place one anywhere.

The utility in Bluetooth is soaring, lots of newideas. Many are practical and feasible e.g.:Bluetooth chips in freight containers to identifycargo when a lorry drives into a storage depot,or a headset that communicates with a mobilephone in pocket, or even in the other room. Otherideas not so feasible are also being explored:Refrigerator communicating with Bluetooth-enabled computer, informing it that food supplyis low, and to inform the retailer or the ownerover the internet.

Freeware

Freeware is copyrighted computer softwarewhich is made available for use free of chargefor an unlimited time. It could be noted thatalthough free software is sometimes used asynonym for freeware, it is not the same as freesoftware. Free software is software that canbe used studied and modified without restrictionand which can be copied and redistributed inmodified or unmodified form either withoutrestriction or with restrictions only to ensure thatfurther recipients can also do these things.Authors of freeware share the software, but alsowant to retain control of any future developmentof the software. The term freeware was coinedby Andrew Fluegelam when he wanted to sell acommunications programme named PC-Talkthat he had created but which did not wish touse traditional methods of distribution becauseof their cost. The only criterion for being classifiedas “ freeware” is that the software must be madeavailable for an unlimited time at no cost. Thesoftware license may impose one or more otherrestrictions on the type of use including personaluse, individual use, non profit use, noncommercial use, academic use, commercialuse or any combination of these. For instance,the license may “free for personal , noncommercial use” Everything created with the


freeware programs can be distributed at no cost.Eg of freewares are free spyware detectors etc.

Middle ware

Middleware is a general term for anyprogramming that serves to “glue together” ormediate between two separate and often alreadyexisting programmes. A common application ofmiddleware is to allow programmes written foraccess to a particular database to access otherdatabases.

Typically middleware programmes providemessaging services so that differentapplications can communicate. The systematictying together of disparate applications, oftenthrough the use of middleware is known asenterprise application integration. Middleware isa relatively a new addition to the computinglandscape. It gained popularity in 1980s as asolution to the problem of how to link applicationsto older legacy systems, although the term hasbeen in use since 1968. It also facilitateddistributed processing- the connection of

multiple applications to create a largerapplication, usually over a network.

Middleware services provide a more functionalset of application programming interface to allowan application to

� Locate transparently across the networkthus providing interaction with anotherservice or application

� Be independent from network services

� Be reliable and available always

IBM and BEA are the most important vendors inthe middleware software.

Middle ware addresses one of the majorchallenges in mobile banking. It acts as themediator between various protocols like HTML,XML, WAP, etc., used by various mobileoperators and various software platforms usedby various banks.


BANKINGCREDIT AND DERIVATIVE

PRODUCTS


REVERSE MORTGAGE

� Reverse Mortgage (RM) is a new bank product that allows senior citizens to earnincome, like pension, on a residential property.

� This product is well-suited for senior citizens who are rather poor in retirementplanning.

� RM is not only known for social cause but also for commercial gains.

� Considering the growing number of senior citizens in the country, the product has lotof business potential.

Background

A new financial product is just launched in Indiathat allows senior citizens to make a residentialproperty earn for them while they continue tolive. That is possible through a reverse mortgage(RM) whereby a bank or housing financecompany provides a fixed sum to the owner ofthe housing property for certain period.Appreciating a need for such product, the UnionBudget – 2007-08, under ’Social Sector’,mentions about RM for the first time whichserves as an old age pension for a substantialportion of population of India consisting of seniorcitizens who are rather poor in retirementplanning. With changing demographic profile andincreasing life expectancy, the RM becomesmore relevant. Further, urbanization, coupledwith increasing nuclear families on one hand,and the changing psychology of the seniorcitizens to be less dependent on children at leasteconomically, has created demand for the RMproduct. Hence, National Housing Bank (NHB)has taken initiative to popularize the RM productand provide refinance to banks and housingfinance companies. The RM product has a lotof business potential. This provides old agesecurity to persons who are ‘house-rich andcash–poor'.

Features of the Scheme

• Reverse Mortgage is a mortgage loan forSenior Citizens (over 62 years) who today,generally, are not eligible for any form ofmortgage loan.

• In a Reverse Mortgage

o The lender makes periodic payments(including lump sum payments) to theborrower, i.e., the payment stream is“reversed”, as compared to a conventionalmortgage.

o The loan is not required to be serviced, i.e.,payment of instalment or interest, as longas the borrower is alive and in occupationof the property.

o The loan will be repaid on the death of theborrower and the spouse (usually a co-obligant) or on permanent movementthrough sale of property.

o After adjusting the principal amount of theloan and accumulated interest, surplus willgo the estate of the deceased.

o The loan can be prepaid together withaccumulated interest at any point in timewithout any prepayment charges.

o Maximum period of loan – 15 years.

♦ Borrower does not require an income toqualify for reverse mortgage loan

♦ Loan amount depends on:

- Borrower’s age

- Value of borrower’s House Property

- Prevailing interest rates of lendinginstitutions

♦ Loan amount to the assessed value of thehouse is determined as per actuarialcalculation. It will be reassessed in periodicintervals of say, five years.


♦ Property has to be unencumbered andmortgageable.

♦ Flexibility to the borrower in availing the loan,i.e., loan will be disbursed in periodicinstalments or lump sum or as a line of creditto be drawn in times of need. However, theaggregate cannot exceed the total amountof loan assessed. Loan amount can beused by the borrower for renovating/repairing house, as also for personal uses.

♦ Borrower will remain owner of propertythroughout the period of the loan.

♦ Borrower will be responsible for payingproperty tax, house insurance premium, etc.

♦ Loan shall become due and payable onlywhen the last surviving borrower dies, sellsthe home, or permanently moves out of thehome.

♦ In cases where the borrower lives longerthan 15 years, the maximum period of theloan, payments will not be made by thelender. However, the borrower can continueto occupy.

♦ NHB seeks to refinance banks/HFCs toextend reverse mortgage loan to seniorcitizens. NHB also seeks to guarantee tothe senior citizen borrowers, the obligationsof banks/HFCs to make regular paymentsover the period. NHB, as a RBI subsidiary,may be expected to provide comfort tosenior citizens, who are mortgaging theirhouses upfront to receive payments overtime.

Benefits

♦ Enables senior/elderly citizens owning ahouse but having inadequate income tomeet their needs.

♦ Enables senior citizens to meet unexpectedlump sum expenditure needs such asrenovation/repairs to house, hospitalization,etc.

♦ Borrower owns and occupies the home tilldemise or change in residence. Even afterdemise, the spouse can continue to stayuntil demise. If spouse is co-borrower, he/she will continue to receive payment (up to15 years from grant of loan).

♦ Payment received from a Reverse Mortgageis considered as ‘loan’ and not ‘income’ fromtax angle in many countries.

♦ Reverse Mortgage can be a partial substitutefor a Social Security Scheme for HomeOwning Senior Citizens. This will beparticularly useful to Senior Citizens whohave no/unwilling family to support them.

Difference between Conventional Mortgage(CM) and Reverse Mortgage(RM)

In CM, a borrower receives a lump sum paymentand repays over a period of time. But in RM, thepayment stream is reversed, i.e., the lenderlends in instalments and recovers in lump sum.Further, in CM, a person is to mortgage his/herhouse to the bank or housing finance company.But in RM, the bank or housing finance companydoes evaluation and on that basis, pays EMIregularly to the individual till his/her death. Uponthe death (or as per contract), the housebecomes the property of the bank or housingfinance company. Lastly, the CM is meant for allwhereas the RM is specially designed for seniorcitizens who are less dependent on their childrenat least economically.

Conclusion

The RM product is in great demand due to itsunique features. Banks, housing financecompanies, regulator and government have animportant role to play to make this a grandsuccess. It calls for openness on the part of thecredit institutions to be more senior citizensfriendly. In order to attract the attention of thelarge number of senior citizens, a wide publicityis called for. Initially, there is likely to be somereluctance on the part of senior citizens to jointhe scheme, since it is new to India. Hence,education to this segment is very much felt.Officers in credit institutions have also to undergotraining to observe due diligence in regard to NHBguidelines. To cover the risk under the scheme,suitable arrangements have to be made. Moreimportantly, these organisations have to be moresympathetic towards senior citizens who aremore sensitive due to the advanced age. Theregulator, NHB, should be more vigilant to checkunhealthy developments, if any. Thus, it shouldbe a collective effort to make this unique productmore customer friendly, economically viable andrisk free. Towards this end, we have yet to go along way.


SBI's Reverse Mortgage SchemeSBI launched its Reverse Mortgage Loan Scheme for the welfare of senior citizens of India witheffect from 12th October 2007. The scheme is as under:

S.No. Parameter Details

To provide a source of additional income for seniorcitizens of India who own self-acquired and self-occupied house property in India.

Single or jointly with spouse in case of a living spouse.

Above 60 years

Should not be more than one. Borrowers will have togive an undertaking that they will not remarry duringthe currency of the loan. If the borrowers choose toremarry, the loan will be foreclosed.

Above 58 years

• Borrower should be staying at self-acquired andself owned house /flat against which loan is beingraised, as his permanent primary residence.

• Mobile/Telephone/Credit Card bills/ Certificate fromthe Housing Society where the borrower is staying/Affidavit made before the Executive Magistratemay be accepted as proof of residence.

• Borrowers will be required to inform the Bank whenthey cease to use this residence as theirpermanent residence.

Borrowers should have a clear and transferable title intheir names. Title verification and search report for aperiod of 30 years will be required to be obtained fromthe Bank’s empanelled advocate at borrowers’ cost.

Case – Title in single name and loan availed jointlywith spouse.

Title holder should make a Registered Will in favour ofthe other spouse. The Will should confirm that this isthe last Will and that it supercedes all earlier Wills, ifany. The borrower to undertake that no fresh Will shallbe made during the currency of the loan.

The property should be free from any encumbrances.However in case of property purchased by availingHome Loan from SBI and mortgaged to SBI, it will beconsidered for RML, subject to closure of the HomeLoan account out of the proceeds of RML.

(1) Objective ofthe scheme

(2) Eligibility

a. No. of borrowers

b. Age of first borrower

c. No. of survivingspouses on the date ofsanction of loan

d. Age of spouse

e. Residence

f. Title of the Property

g. Title of the propertyand number ofborrowers

h. Encumbrances



Residual Lifeof property

Security

Tenor

Disbursement

Periodicity ofavailing loan

Quantum of loan

Should be at least 20 years in case of single borrowerand 25 years in case of spouse being below 60 yearsof age.Certificate from empanelled engineer/architect will berequired to be obtained for this purpose, in addition tovaluation of property.

The RML shall be secured by way of equitablemortgage of residential property.

Age of the younger of the borrowersbetween 58 and upto 68 years : 15 years

Age of the younger of the borrowersabove 68 years : 10 years

OR till death of the borrower(s), whichever is earlier.

By credit to an SB account in the joint names of theborrowers operated by E or S.

1. Monthly/quarterly payments2. Lumpsum payment

The loan amount would be 90% of the value of property.Loan amount would include interest till maturity. Theloan installments payable to the borrower(s) would beas under for a loan amount of Rs.1 lac (at interest rateof 10.75% p.a.):

Loan Tenor 10 11 12 13 14 15(years)

Monthly 468 399 343 297 258 225instalments(Rs.)

Quarterly 1,423 1,215 1,045 905 787 687instalments(Rs.)

Lumpsum 36,022 32,525 29,368 26,517 23,944 21,619payment(Rs.)

The maximum loan amount is proposed to be kept atRs.1 crore (monthly payment Rs.22,500/- for 15 years)and minimum Rs.3 lakh (monthly payment Rs.675/-for 15 years).Example of arriving at the monthly instalments:Property value: Rs.10 lakhQualifying loan amount(90% of property value): Rs.9 lakhTenor: 15 yearsMonthly instalment : Rs. 225 x 9 = Rs.2,025/-



(8) Purpose of Loan

(9) Repayment/Settlement

(10) Foreclosure

Supplementing income, any personal expenses, houserepairs, etc. Loan amount should not be used forspeculative, trading and business purposes.

• The loan shall become due and payable only whenthe last surviving borrower dies or opts to sell thehome, or permanently moves out of the home toan institution or to relatives. Typically, a “permanentmove” may generally mean that neither theborrower nor any other co-borrower has lived inthe house continuously for one year or do not intendto live continuously. Bank may obtain suchdocumentary evidence as may be deemedappropriate for the purpose.

• Settlement of loan along with accumulated interestis to be met by the proceeds received out of saleof residential property or prepayment by borrowersand his next of kin.

• The borrower(s) or his/her/their legal heirs/estateshall be provided with the first right to settle theloan along with accumulated interest, without saleof property.

• A reasonable amount of time, say up to 6 months,may be provided when RML repayment istriggered, for house to be sold.

• The balance surplus (if any), remaining aftersettlement of the loan with accrued interest andexpenses, shall be passed on to the borrower orthe estate of the borrower/legal heirs.

• Borrowers will be required to submit annual lifecertificates in the month of November every year.This certificate will also include clauses regardingmarital status, and permanent residence of theborrowers, in addition to the balance confirmationas on 31st October of that year.

• List of legal heirs will be obtained at the time ofsanction of loan. With a view to avoiding disputesat the time of settlement of loan amount by legalheirs, specific instructions about inheritance of theproperty and payment of balance amount, if any,of the sale proceeds after settling the Bank’s dues,will be required to be part of the borrowers’ Will.

The loan shall be liable for foreclosure due tooccurrence of the following events of default.



o If the borrower(s) has/have not stayed in theproperty for a continuous period of one year

o If the borrower(s) fail(s) to pay property taxes ormaintain and repair the residential property or fail(s)to keep the home insured, the Bank reserves theright to insist on repayment of loan by bringing theresidential property to sale and utilizing the saleproceeds to meet the outstanding balance ofprincipal and interest.

o If borrower(s) declare himself/herself/themselvesbankrupt.

o If the residential property so mortgaged to the Bankis donated or abandoned by the borrower(s).

o If the borrower(s) effect changes in the residentialproperty that affect the security of the loan for thelender. For example: renting out part or all of thehouse by creating a tenancy right; adding a newowner to the house’s title; changing the house’szoning classification; or creating furtherencumbrance on the property either by way oftaking out new debt against the residential propertyor alienating the interest by way of a gift or will.

o Due to perpetration of fraud or misrepresentationby the borrower(s).

o If the government under statutory provisions, seeksto acquire the residential property for public use.

o If the government condemns the residentialproperty (for example, for health or safety reasons).

o Any other event such as re-marriage of theborrower(s), etc., which shall have an adverseimpact on the loan settlement prospects.

o Borrowers do not accept the revised terms onrevaluation of property and interest reset at the endof every 5 years from sanction.

o Any violation of the terms and conditions of RML.

• The borrower(s) will have option to prepay the loanat any time during the loan tenor.

• There will be no prepayment penalty.

• After the initial valuation to determine the loanamount, subsequent revaluations will be done atintervals of 5 years.

• The Bank shall have the option to revise the periodic/

(11) Pre-payment of loan

(12) Valuation/Revaluationof property and optionfor the Bank to adjustpayments



lump-sum amount every 5 years along withrevaluation. In the scenario of fall in propertyprices, the Bank may decide to revise the amountat any time earlier than 5 years. At every stage ofrevision, it should be ensured that the Loan toValue ratio does not exceed 90% at maturity.

• If the Borrower does not accept the revised terms,no further payments will be effected by the Bank.Interest at the rate agreed before the review willcontinue to accrue on the outstanding amount ofthe loan. The accumulated principal and interestshall become due and payable as mentioned inclauses 9 and 10.

Public - 10.75% p.a. (Fixed) subject to reset every 5years.SBI Pensioners -Concessional interest rate of 1%below the card rate applicable to public.

0.50% of the loan amount, minimum Rs.500/- andmaximum of Rs.10,000/-

As a customer-friendly gesture and in keeping withinternational best practices, after the documents havebeen executed and loan transaction finalized,borrowers will have right of rescission up to sevendays to cancel the transaction. If the loan amount hasbeen disbursed, the entire loan amount will need tobe repaid by the borrower within this period. However,interest for the period may be waived. Processing feeshall not be refunded in such cases.

• The house property will be insured by the borrowerat his cost against fire, earthquake and othercalamities.

• The borrower shall ensure to pay all taxes,charges, etc.

• Bank reserves the right to pay insurance premium,taxes, charges, etc. by reducing the loan amountto that extent.

• The borrower shall maintain the property in goodcondition.

Non-renewable Overdraft without ledger folio charges.No cheque book/debit card will be linked to thisaccount.

(13) Interest Rate

(14) Processing fee

(15) Right of Rescission

(16) Insurance andmaintenance ofhouse property

(17) Operational issues:

a Type of facility



The loan will be treated as standard asset as long asrepayment does not become due as per the prevailingnorms. Interest applied will be booked as income aslong as the loan remains a standard asset.

Same as for Home Loan sanction.

Looking at the nature of the utilization of the loan, theseloans may be treated as Personal Loans againstmortgage of immoveable properties.

All branches.

50 33

60 50 20 11

b Income Recognitionand AssetClassification

c Discretionary powersfor loan sanction

d Classification inperformancereports

e Loans to be madeavailable at

f CIS Product code

g CBS Product code


Credit derivatives are instruments traded on thefinancial markets by means of which the creditrisk inherent in loans, bonds or other risk assetsor market risk positions are transferred to thirdparties acting as so-called protection sellers.The original credit relationships of the so-calledprotection buyers – say a bank which has madea loan or a financial organization that has notmade the loan but wants to buy the creditderivative to make a profit by trading in it – thatis to say the parties transferring the credit risk -are neither changed nor newly established bythis process. Thus credit derivatives can bedefined as arrangements that allow one party(protection buyer or originator) to transfercredit risk of a reference asset, which it may ormay not own, to one or more other parties (theprotection sellers).

Credit derivatives differ from other traditionalforms of credit risk transfer, such as guaranteesor providing collateral security, in that these, asderivatives, are normally

� concluded under standardised masteragreements,

� subject to an ongoing market valuation,

� subject to special risk controlling andmanagement.

An additional difference is that the drawing onthe credit derivative does not directly constitutea claim on the debtor of the underlying positionfor the protection seller.

Types of Credit Derivatives:

Basically, three types of products can bedistinguished, depending on the kind of risktransferred by the credit derivative:

(i) total return swaps

(ii) credit default swaps

CREDIT DERIVATIVES:RISK TRANSFER INSTRUMENTS

� As the term indicates, it is a financial contract derived from the performance ofunderlying securities.

� It is a hedging mechanism.� It helps in risk management.� Swaps, options and notes are some of the methods in derivative trade.

(iii) credit linked notes

The easiest and the most traditional form of acredit derivative is a guarantee. Financialguarantees have existed for thousands of years.However, the present day concept of creditderivatives has travelled much farther than asimple bank guarantee. The credit derivativescurrently being available in the market can bebroadly classified into the following:

(i) Total Return Swap

In the case of a total return swap, the protectionbuyer swaps the returns on a reference asset(e.g., a bond) and increases in its valueperiodically with the protection seller inexchange for payment of a variable or fixedreference interest and compensation of lossesin the value of the reference asset.

Thus, the protection seller assumes from theprotection buyer the overall market risk as wellas the credit risk from the reference asset forthe term of the transaction.

Total-rate-of-return swaps have a “total-returnpurchaser” who pays a periodic fee to the “total-return seller” in return for the total net paymentsof some underlying asset. In this case if theunderlying asset increases in value the “total-return purchaser” receives this higher return butif the underlying asset depreciates then the“total-return purchaser” pays the value of thisdecrease to the “total-return seller”. In the caseof a default or some other credit event of theunderlying asset the total-rate-of-return swapusually terminates.

As the name implies, a total return swap is aswap of the total return out of a credit assetagainst a contracted prefixed return. The totalreturn out of a credit asset can be affected byvarious factors, some of which may be quite


extraneous to the asset in question, such asinterest rate movements, exchange ratefluctuations, etc. Nevertheless, the protectionseller here guarantees a prefixed return to theoriginator, who, in turn, agrees to pass on theentire collections from the credit asset to theprotection seller. That is to say, the protectionbuyer swaps the total return from a credit assetfor a predetermined, prefixed return.

(ii) Credit Default Swap

Default swaps simply transfer the credit risk ofan asset from one party to another. The holderof an asset, say a bond, would pay a periodicfee to the “risk buyer” and in return would receivesome agreed upon payment in the case of somecredit event, a default, bankruptcy, creditdowngrade, etc., and receives in return a one-off option premium or, if appropriate, anannualised premium in the case of longermaturities.

Credit default swap is a refined form of atraditional financial guarantee, with thedifference that a credit swap need not be limitedto compensation upon an actual default butmight even cover events such as downgrading,apprehended default, etc. Credit default swapcovers only the credit risk inherent in the asset,while risks on account of other factors such asinterest rate movements remain with theoriginator.

(iii) Credit Linked Notes

Credit linked notes are a securitized form ofcredit derivatives. The technology ofsecuritisation here has been borrowed from thecatastrophe bonds or risk securitizationinstruments. Here, the protection buyer issuesnotes. The investor who buys the notes has tosuffer either a delay in repayment or has toforego interest, if a specified credit event, say,default or bankruptcy, takes place. This devicealso transfers merely the credit risk and notother risks involved with the credit asset.

The note is to be redeemed at par value onmaturity only if a pre-defined credit event doesnot occur. If the credit event occurs, the credit-linked note is redeemed within a fixed period oftime, less a compensation amounting, forinstance, to the difference between the par valueand the recovery value of the reference asset.

The credit-linked note constitutes in this respecta combination of a bond and a credit defaultswap. However, in contrast to the credit defaultand the total return swap, the protection sellermakes his payment for the loan in advance. Onthe part of the protection buyer, the collection ofthe proceeds from the issue of the credit-linkednote has the effect of a cash-collateralization ofthe original credit risk.

Banks and other financial institutions can usecredit derivatives to optimize the employmentof their capital by diversifying their portfolio-widecredit risk.


Need for efficient infrastructure services areincreasingly recognised as a sine qua non ofhigh and sustainable economic growth. So far,the provision of infrastructure services in Indiais largely in the Government sector. Budgetaryallocation has been the principal source offinancing capacity additions in infrastructure. Asbudgetary resources to support capacityadditions have become scarce, developmentand financing of infrastructure was opened upto private/foreign participation. The Expert Groupon the Commercialisation of InfrastructureProjects (Chairman: Dr. Rakesh Mohan),submitted its report in June 1996.

The Concession Approach

In the concession approach, the concessionairebuilds the project and is thereafter granted afranchise period during which the costs andreturns can be recovered.

The projects may be executed on principles ofBuild-Own-Operate-Transfer (BOOT), Build-Operate-Transfer (BOT), Build-Own-Lease-and-Transfer (BOLT) and Build-Own-Operate-Share-and-Transfer (BOOST) and other variants. Theprojects could typically be promoted byconsortiums comprising private and publicsector companies, financial institutions andmultinationals.

The brief explanations of various modes offinancing are:

i. BOT- Build, Operate and Transfer: Thisis one of the methods adopted for attractingprivate sector funds for infrastructuredevelopment and is known as build-operate-transfer agreement. Here, the privateinvestor builds, operates and transfers thefacility back to the government at the end of

INFRASTRUCTURE FINANCING

� Infrastructure financing implies lending to sectors such as power and transportation.� India needs more than Rs.14,50,000 crore of infrastructure financing.� Rakesh Mohan Committee recommended measures for commercialization of infrastructure

projects.� Concession options: BOT, BOLT, BOOT, BOO, BOOS� Structure options: non-recourse, limited recourse, escrow, cash flow, subordinated debt

and take-out finance.

a specified period called the ConcessionPeriod.

Build: Set up the facility and infrastructure,staff the development center, and establishknowledge transfer

Operate: Manage the offshore organization:Programme Management, Development,QA, maintenance, enhancements, andproduct support

Transfer: Register a new offshore subsidiaryfor the customer, transfer assets, andhandover operations

ii) BOLT - Build, Operate, Lease andTransfer: Here the private investor builds bytaking the project on lease and after the leaseperiod, transfers it back to the government.

iii) BOO - Build, Own and Operate: Here theprivate sponsor builds, owns and operatesthe infrastructure facility for the entire life ofthe project.

The other variants are:

iv) BOOT - Build, Own, Operate andTransfer

v) BOOS - Build, Own, Operate and Sell:This is better from the viewpoint of riskreduction as well as equitable distribution ofrisks.

vi) BOOST - Build-Own-Operate-Share-andTransfer

Structured Financing Option

Structured Financing Option (SFO) generallyassumes two forms: (a) Non-recourse financingand (b) limited recourse financing.


i) Non-recourse financing: Under this option,the debt instrument is secured by the cash-flows generated by the project or thecollateral value of the specified assetsfinanced by the instrument. In the event ofdefault on the structured instrument, the debtholders’ recourse would be limited to theunderlying assets only and would not extendto general reserves and assets of thecompany. Panvel (Mumbai) By-Pass is thefirst example of SFO in India.

ii) Limited Recourse Financing: Under thisvariant, in addition to project assets, theparent company attaches other assets/revenue-streams for servicing the instrumentto improve its creditworthiness. Thuslenders have limited recourse to the assetsof a company sponsoring the project.

Take-out Financing

Take-out financing structure is essentially amechanism designed to enable banks to avoidasset liability maturity mismatches that mayarise out of extending long term loans toinfrastructure projects. Under the arrangementsbanks financing the infrastructure projects willhave an arrangement with IDFC or any otherfinancial institution for transfering to the latter theoutstandings in their books on a pre-determinedbasis.

Government and Bank Participation

Another way out could be the governmentissuing long-dated bonds at subsidised rates tofund infrastructure. The government mayconsider classifying these securities asapproved securities for the statutory liquidity ratio(SLR) purposes. Banks have been permitted toissue guarantees to loans provided by otherbanks and lending institutions to infrastructureprojects subject to certain conditions. Under therevised norms, a bank would be permitted toissue a guarantee in favour of loans extendedby other banks or financial institutions, providedit also takes a funding share in the project.Further, the amount allowed for guarantee bythe bank should not exceed twice the fundingshare assumed by it.

Cash Flow FinancingIn cash-flow financing, the lenders estimate thecash flows of a project over its lifetime to seewhat kind of debt burdens it can support and atwhat rates. Then, the amount of debt, financingrate and the manner of repayments can betailored to fit the cash flows of the project. Thishelps both the lender and the project promoter.

Escrow Mechanism

The escrow mechanism is suitable, for example,for independent power projects (IPP) which arebuilt by private parites out of private funds andelectricity supplied to state electricity boards(SEBs). Essentially, it ensures that out of therevenues of the SEB, the debt obligations of thefinancing institutions will be paid first. This isdone by having some identified revenues beingpassed through a separate account called theescrow account to which the lenders also havea right to appropriate the funds in case the SEBdefaults in making payments. This gives addedcomfort to the lender and allows the IPP to raisefinancial assistance.

Subordinated Debt Financing

Institutions have also funded infrastructureprojects through quasi-equity instruments orsubordinated debt which may have flexiblematurity and payment terms. Though theseloans will be more expensive than secured debt,they will provide comfort to the other lenders andensure that a project starts up.

Infrastructure projects, being long gestationprojects with considerable risks, requireinnovative financial solutions to tackle them.

Bankability

Some of the main concerns which lenders wishto see adequately catered for are: projectcompletion, assured cash flows, security, step-in rights, termination payments, experience andtechnology. In a nutshell, for a project to bebankable it must be financially viable, structuredso that risk is distributed on an appropriate basisand the documentation provides mechanismsto make the risk distribution work.


Securitisation means “to convert (an asset,specially a loan) into marketable securities,typically for the purpose of raising cash”,according to the Concise Oxford Dictionary.

Securitisation is a process by which the forecastfuture income (the money that is due to comein) of an entity is transformed and sold as debtinstruments, such as bonds, with a fixed rate ofreturn. Securitisation allows the company to getcash upfront which can be put to productive usein the business. Securitisation is done bysuitably ‘repackaging’ the cash flows or the freecash generated by the firm that’s issuing thesebonds. The assets securitized will go out of thebooks of the financial organisation once they aresecuritized and the risk from its books areremoved.

Securitisation has emerged globally as animportant technique of debt financing. Over thelast 20 years, securitisation has become one ofthe largest sources of debt financing in the USand is enjoying very strong growth acrossEurope and Asia. In India, securitisationtransactions have been taking place for sometime now. However, the participation of the banksand financial institutions in the securitisationactivity, but for a few major players, is veryminimal. This activity is however, picking up.

The SARFAESI Act provides the legal basis forsecuritisation.

What can be Securitised?

All assets that generate funds over time can besecuritised. Repayments under car loans, creditcard dues, airline ticket sales, total collectionsfrom roads or bridges, and sales of petroleumbased products from oil refineries are examples.

SECURITISATION

� Securitisation is the process of creating tradable securities backed by future cashinflows and selling these securities in the market.

� It helps in raising immediate funds against anticipated inflows.

� It helps the issuer to reduce its exposure in the intended asset, which is sold

� Securitisation Act provides legal framework to securitisation

Securitisation works well if the securitised asset(say, the pool of car loans) is homogenous (thesame kind) with regard to credit risk (how soundthe borrower is) and maturity. Ideally, thereshould be historical data on the portfolio’sperformance and that of the issuing companywith regard to credit quality and repaymentspeed.

How is it Beneficial to the Issuer?

1. The issuer can raise funds of longermaturities than he would have been able tothrough the conventional routes such asbonds.

2. The process of securitisation allows raisingfunds against future cash flows.Usuallyfunds are raised against existing assets.

3. A conventional loan results in deteriorationof the Debt : Equity ratio. Securitisationresults in improvement of the Debt : Equityratio as the assets are taken out of theissuer's books.

What are the Components of a SecuritisationTransaction?

The entities involved in the securitisationtransaction are the originator or the sellers (theentities raising funds), the issuer (specialpurpose vehicle which issues the securities),the servicer (which manages the portfolio onbehalf of the special purpose vehicle andensures timely payments), the trustee and thecredit rating agency.

Other entities involved are credit enhancementproviders and the investors.


What is the Role of Each of These Players?

The originator is the party which has a pool ofassets which it can offer for securitisation andis in need of immediate cash.

The Special Purpose Vehicle (SPV) is the entitythat will own the assets once they aresecuritised. Usually, this is in the form of a trust.It is necessary that the assets should be heldby the SPV as this would ensure that theinvestors’ interest is secure even if the originatorgoes bankrupt.

The servicer is an entity that will manage theasset portfolio and ensure that payments aremade in time.

The credit enhancer can be any party whichprovides a reassurance to the investors that itwill pay in the event of a default. This could takethe form of a bank guarantee also.

Indian Context

It is a relatively recent phenomenon even in theinternational market and is fraught with risks,which revolve around the definition,ascertainability and quantifiability of securitisablecash flows. Such risks may not be wellunderstood by investors. The need therefore todevelop the requisite competence in analysis ofsuch risks cannot be overemphasized.

Repayment to investors out of future sales coulderode the current assets hypothecated toworking capital bankers or the capacity of theoriginators to service term loans/meet otherpressing obligations.

However, a huge potential exists forsecuritisation in India. Many foreign and privatebanks have securitised there home loan / autoloan profolios. The process of securitisationfrees up capital, particularly in the context ofimplementation of Basel II recommendations inIndia.


The term ‘factor’ has its origin in the Latin word‘Facere’ meaning ‘to make or do’, i.e., to get thingsdone. The International Institute for the Unificationof Private Law in 1988 defined “Factoring meansan arrangement between a Factor and his Clientwhich includes at least two of the followingservices to be provided by the Factor: (1)Finance, (2) Maintenance of Accounts, (3)Collection of Debts and (4) Protection againstCredit Risks”.

Factoring has also been defined “as a continuousrelationship between a financial institution (thefactor) and a business concern selling goodsand/or providing service (the client) to a tradecustomer (customer) on an open account basis,whereby the factor purchases the client’s bookdebts (accounts receivables) with or withoutrecourse to the client — thereby controlling thecredit extended to the customer and alsoundertaking to administer the sales ledgersrelevant to the transaction”.

Factoring refers to management of receivablesof a company by a financial intermediary (factor)for a fee. The need for factoring arose on accountof the inordinate delays faced by suppliers forrealising their bills from their customers.Factoring could be with or without recourse tothe supplier, on whose behalf this service isundertaken. While with recourse factoring is likeour usual bill discounting facility where the moneyis recovered on the return of the bill, in withoutrecourse factoring the factor takes the risk ofnon-payment of bills. Factoring business ischaracterised by low margin and high risk.

A factoring transaction takes place along thefollowing lines:

Upon a sale taking place, the seller (client)forwards invoices on buyer (customer) to factor.The Factor sends copy of invoice and notice ofassignment to buyer (customer) and makes aprepayment of say, 75 to 80 percent of invoice

FACTORING

� Factoring involves purchase of receivables of the company for payment of cash.� In effect, the Company, which sells its goods on credit, gets cash payment immediately

from a third party called ‘ factor’.� Factoring includes other functions such as account maintenance, collection of debt

and risk assumption.

value to the seller and the balance is retained asmargin.

On the due date, the buyer (customer) makespayment to the factor who settles the accountand releases the margin retained by him — afterrecovery of all other charges/out of pocketexpenses.

Factoring is generally used for short-termreceivables of below 90 days.

A factor is thus another financial intermediarybetween the seller and the buyer; but unlike abank, the unique selling proposition of a factorlies in its strength in handling and collectingreceivables — in a more efficient, effective andpurposive manner.

Benefits1) Normally, margin on book debts is high.

Under factoring, such margins could getreduced and availability of funds willincrease.

2) Beneficial to client operating in buyer’smarket.

3) Advantageous to SSI and medium scaleunits - delayed payments by large scaleindustries can be got over and cash flow willimprove.

4) Clients can concentrate on production andselling activities.

5) Time and cost of collection of debts arereduced.

SBI has a subsidiary viz., SBI Factors andCommercial Services Ltd., which wasincorporated in February, 1991. It is jointlypromoted by SBI, State Bank of Indore, StateBank of Saurashtra, SIDBI and Union Bank ofIndia. For the period ended March d a businessturnover of Rs.1601.13 crores. As at March 2005,the number of clientele had increased to 341 andthe company had registered a profit( before taxand provisions) at Rs.9.63 crores.


The term forfaiting has been drawn from Frenchlanguage and means “give up our right”. It is amechanism of financing of exports bydiscounting export receivables evidenced by billsof exchange or promissory note, withoutrecourse to the seller (exporter), on a fixed ratebasis (discount) upto 100 per cent of thecontract value.

Simply put, forfaiting is the non-recoursediscounting of export receivables. In a forfaitingtransaction, the exporter surrenders, withoutrecourse to him, his rights to claim for paymenton goods delivered to an importer, in return forimmediate cash payment from a forfaiter. As aresult, an exporter in India can convert a creditsale into a cash sale, with no recourse to him orto his banker. It helps the exporters toconcentrate on the export front without botheringabout collection of export bills.

In a forfaiting transaction, Bills of exchange orPromissory Notes backed by co-acceptance (or‘avalisation) from the buyer’s bank are endorsedby the exporter, without recourse, in favour ofthe forfaiting agency in exchange for discountedcash proceeds.

The operating mechanism for an Indian Exporterin a forfaiting transaction, is as follows.

1. Indian exporter initiates negotiation with theforeign importer.

2. Exporter approaches Exim Bank to obtainindicative quote from a forfaiting agency.

3. Exim Bank obtains indicative quotes ofdiscount, commitment fees anddocumentation fees, if any, andcommunicates these to the exporter.

4. Exporter finalises the contract with theforeign buyer.

5. Exim Bank is informed of the final contractand the exporter requests the Exim Bank to

FORFAITING

� Forfaiting, similar to factoring, involves discounting of export receivables of medium-term and long-term.

� Unlike factoring, in forfaiting, the forfaiting agency has no recourse to the seller incase of payment default by the buyer.

� It helps in upfront realization of credit sale, perhaps, at a discount.

obtain a firm quote from the forfaiting agency.

6. Exim Bank obtains the firm quote andconveys the terms and conditions of theforfaiting agency and asks for exporter’sacceptance.

7. Contract is finalised with the forfaitingagency.

8. Exporter ships the goods/sends the bills ofexchange.

9. The overseas buyer accepts the bills ofexchange and sends it to exporter.

10. Exporter endorses the avalised bills/Promissory Notes in favour of the forfaitingagency without recourse to him.

11. The forfaiting agency effects the payment ofthe discounted value.

12. On maturity of the Bill of Exchange/Promissory Note, the forfaiting agencypresents the instruments to the aval(Importer’s bank) for payment.

The discount fee, documentation fee, and anyother costs levied by a forfaiter must be passedon to the overseas buyer. Commitment feeshould also be passed on to the overseas buyerto the extent possible.

Forfaiting was introduced in India by EXIM Bankin 1994.

One would think that a large emerging economylike India would hold sizeable potential forforfaiting and factoring – and it does – but thatpotential has not yet been realised. Lack ofawareness, unwillingness on the part ofexporters to pay for risk, reluctance on the partof the banks to promote forfaiting (as it obviatesthe need for postshipment credit) are some ofthe reasons why this method of realisation ofexport proceeds has not picked up in India.


It is an unsecured, short-term debt instrumentissued by a corporation, typically for the financingof accounts receivables, inventoriesand meeting short-term liabilities. Thedebt is usually issued at a discount, reflectingprevailing market interest rates.

It has emerged as a popular instrument forfinancing working capital requirements ofcorporate borrowers of commercial banks.Commercial Paper (CP) is an unsecuredmoney market instrument issued in the form ofa promissory note. This instrument wasintroduced in India in 1990 so as to enable thehighly rated corporate borrowers of commercialbanks to diversify their sources of short-termborrowings. Besides, it was an additionalinstrument for investment provided to theinvesting community.

Commercial paper issued by corporates wasinitially marketed as a privately placedinstrument. Subsequently, the instrumentreceived a wider connotation from the point ofview of both the issuers as well as the investors.The CP market is largely controlled by FIMMDA(Fixed Income Money Market and DerivativesAssociation of India) which has also laid downstandard procedures in this regard inconsonance with the standard best practicesand the RBI guidelines.

One of the main reasons for the growingpopularity of CP as an instrument of financingworking capital requirements is that the rate ofinterest underlying a CP transaction issubstantially lower than the interest charged bycommercial banks against fund based workingcapital limits provided by them. The differenceis substantial and many of the large corporateswith a good credit rating take advantage of thissituation.

COMMERCIAL PAPER

� CP is an instrument issued by companies to borrow short-term finance from the market.

� It can be issued for period ranging from 7 days to one year.

� It is transferable by endorsement and delivery.

� Generally blue chip companies are major players.

A company is eligible to issue commercial paperif it satisfies the following conditions:

� The Tangible Net Worth of the company, asper the latest audited balance sheet, is notless than Rs.4 crore. (TNW is the aggregateof Capital & Free Reserves less intangibleassets, if any).

� The company has been sanctioned workingcapital limit by commercial banks/financialinstitutions.

� The borrowal account of the company isclassified as a ‘Standard Asset’ by thefinancing banks/institutions.

The issuing company has to obtain beforehandthe specified minimum credit rating for issuanceof CP from credit rating agencies identified byRBI. At present, these agencies include CRISIL,ICRA, CARE and the FITCH Ratings India Pvt.Ltd. The prescription for minimum credit ratingis P-2 in the case of CRISIL or such equivalentrating by other agencies. Besides, these ratingsshould be the current ones and not due forreview. The credit rating agencies also specifythe size of the CP proposed to be issued.

CPs may be issued in denominations of Rs.5lakh or in multiples. Thus, the amount investedby a single investor should not be less than Rs.5lakh (face value).

CPs can be issued for maturities between aminimum of 7 days and a maximum upto oneyear from the date of issue. The maturity dateof the CP should not go beyond the date up towhich the credit rating of the issuer is valid.

CPs are now issued only in the dematerializedform. Further, the maximum period forsubscription to an issue of CP is two weeks from


the date of opening of the issue. CPs may beissued on a single date or in part on differentdates. CPs issued on different dates butpertaining to the same issue should have thesame date of maturity.

Before issuing CP, it is necessary for a companyto appoint a scheduled commercial bank to actas an Issuing and Paying Agent (IPA) for theissue. The commercial bank then makes its ownassessment about the FBWC requirements ofthe company and the extent to which the CPissue is linked with the credit limit provided bythe bank. After the agreement is reachedbetween the bank and the issuing company, thepotential investors are given a copy of the IPAcertificate. An initial investor in CP pays thediscounted value of the amount of CPsubscribed by him. In a dematerialisedenvironment, the issuing company then makesarrangements for crediting the CP to theinvestor’s account with a depository (this isequivalent to issue of a physical certificate bythe company).

When a commercial bank agrees to act as anIPA, it is making a promise to redeem theamounts covered under the CP issued by thecompany. In view of this, lending banks generallycarve an amount equal to the CP size out of theFBWC credit limit, so that the segregated limitcan be utilised at the time of redemption of CPs.

The effective FBWC credit limit available to theborrowing company is reduced correspondingly.This ensures that even after redemption of CP,there is no increase in the overall short-termborrowing facilities provided to the company. Theamount of CP issued by a company can beadjusted either against the cash credit or theloan component or both the components takentogether.

CP may now also be issued as a stand-aloneproduct. While acting as IPA, a commercial bankmay provide for CP without necessarily carvingout the CP limit from the FBWC limit. However,it is necessary that extra caution is exercised insuch cases and the facility should be madeavailable to the corporate borrowers with thehighest credit ratings awarded.

When the CP limit is carved out of the FBWClimit provided by a lending bank, restoration ofthe credit limit after redemption of the CP isusually a routine affair. This exercise should notbe considered as an enhancement of the limit.

A credit analyst should view the unredeemedportion of the CP against which a limit hasalready been carved out, as a contingent liabilityin the financial statements of the issuingcompany. This is similar to a situation where anLC or DPG has been issued on behalf of thecompany but the bills against these have notreached the company for payment.


CURRENCY SWAPS

� Currency swap is the exchange of one currency for the other.

� It is used as a hedging mechanism to guard against adverse currency fluctuations.

� It is used to convert a loan in one currency to another currency to reduce the cost ofborrowings.

� It helps in efficient management of currency exposure and cash flows.

A currency swap is a foreign exchangeagreement between two parties to exchange agiven amount of one currency for another and,after a specified period of time, to give back theoriginal amounts swapped.

There are two main applications of a currencyswap. These are:

- fully locking-in or hedging a future stream ofcash-flows denominated in a currency otherthan the currency used for accountingpurposes. An example might be where a UKcompany receives a fixed return in Swissfranc, semi annually, and wishes to removeall future foreign exchange exposure bylocking-in the current exchange rate for thelife of the income stream.

- a well-known US company would like to raisefunds in the UK, but would suffer adverseborrowing terms as it is little known inEurope. The US company therefore borrowsUS dollars domestically, where it enjoysfavourable borrowing conditions, and thencurrency swaps US$ into Sterling at a savingversus direct access to the UK financialmarkets.

Currency swaps are often combined with interestrate swaps. For example, one company wouldseek to swap a cash flow for their fixed rate debtdenominated in US dollars for a floating-rate debtdenominated in Euro. This is especially commonin Europe where companies "shop" for thecheapest debt regardless of its denominationand then seek to exchange it for the debt indesired currency.

As each sale of a currency is contingent uponthe purchase of another currency, it is a

contingent obligation and the currency swapbecomes an off-balance sheet transaction.

Advantages

- Indirect access to a market, via a swap, canbe cheaper than the direct borrowing routewhere no borrowing advantage is avail-able.

- Efficient management of currency exposureand cash flows

- Facility to restructure debt capital to align withprevailing market views/conditions.

- Flexibility allows the swap to accommodateany desired structure.

- Market depth and liquidity facilities swapreversals.

- Off-balance sheet financing/lack of publicity.

Disadvantages

Possible capital adequacy requirements to beimposed in the near future. Unknown extent ofcounterpart’s liability to other swaps with regardto default possibilities.Legal and administrativecosts.

With recent global volatility of exchange rates,Currency Swaps usually generate a largerexposure than interest rate movements.

Conclusion

As with interest rate swaps, rapid growth involumes of CSs - one of the cornerstones ofglobal banking, has particularly contributed toderegulation of international markets. It hashelped in greater use of foreign exchange inshort- and long-term asset liability management.


CURRENCY OPTIONS

� Currency option means the option to buy or sell a specific quantity of currency at anagreed rate.

� The party to the contract pays a premium upfront for the purpose.� It is better than forward contract since the decision to buy or sell is optional� Banks in India can write options.

A foreign exchange (or currency) option givesthe buyer the right, but not the obligation, to buyor sell a specific quantity of a currency at anagreed rate, and for a specified period. Theoption buyer pays the seller a premium for theprivilege of being able to buy or sell the currencyat a fixed price without actually being committedto do so.

In the options market- The option buyer becomes the HOLDER and

the option seller is called the WRITER.- A CALL gives the holder the right to buy a

specified quantity of a currency at an agreedrate over a given period.

- A PUT gives the holder the right to sell aspecified quantity of a currency at an agreedrate over a given period.

- The PREMIUM is the price paid for the optionby the buyer of an option to the seller (theoption writer). It is usually paid up-front. Theamount of the premium for an option willdepend on the option writer’s perception ofthe risk of making a loss and a higherpremium is charged when the risk seemsgreater.

- The EXPIRY DATE is the final date on whichthe option may be exercised.

- A EUROPEAN option can be exercised onlyon the expiry date whereas an AMERICANoption can be exercised on any date beforeand including the expiry date (These termshave no geographical connotation).

If currency options are bought to hedge acurrency exposure, the buyer must feel that therisk reduction justifies the premium cost and thatan option is preferable despite its cost comparedto other alternatives, such as the (zero-cost)forward exchange contract. The advantage ofan option over a forward contract lies in thechoice of not exercising the option if the spotexchange rate moves in the holder’s favourbefore the exercise date. The option holder could

then buy or sell the required currency in the spotmarket at this better rate, allowing the option tolapse.Currency options might be a suitable method ofhedging a currency exposure for the optionbuyer who can (i) lock in a worst possibleexchange rate to avoid the risk of an adverserate movement and at the same time (ii) benefitfrom any favourable rate movement by choosingnot to exercise the option and instead buying orselling the currency at the spot rate on expiry.Cross currency options were introduced in1993, but did not become popular because:� Most customers had only rupee dollar

exposure� Option contracts are not available for small

amounts� The upfront premium can be quite

substantial

FC-Rupee options were introduced on the 7thJuly 2003.

The guidelines for selling options in our Bankare:� Minimum credit rating in respect of

Corporate Customers is SB 3� Customer maintaining an account for the

last two years� Conduct of the account should have been

satisfactory� For customers below this rating specific

approval of the Board would have to besought

� The limits for the options will be assessedsepartely and not in conjunction withappraisal of normal credit facilities.Exposures calculated on the basis of creditconversion factor methodology

� The scheme of delegation of powers forsanctioning these limits will be the same asfor forward contracts

� Corporates should undertake thesetransactions to hedge their own balancesheet exposures.


A currency future is a contract for the sale orpurchase of a standard quantity of one currencyin exchange for another currency at a specifiedrate of exchange, and for delivery at a specifiedfuture time. They are bought and sold on afutures exchange, the largest being theInternational Monetary Market division (IMM) ofthe Chicago Mercantile Exchange (CME), andcan be used to hedge currency exposures.

Most currency futures are for a major currencyagainst the US dollar. On the CME, there arefutures contracts in Sterling, Australian dollars,Canadian dollars, Deutsche Marks, Yen, Swissfranc and French francs.

A buyer of a sterling future is contracting to buysterling in exchange for dollars. The seller of asterling future is contracting to sell sterling inexchange for dollars. When a futures contractis bought and sold, the price is the agreedexchange rate. For example, when X buys aMarch sterling future from Y at $ 1.75000, thisrate is both the agreed rate for the exchange ofsterling into dollars in March and also anexpression of the current market price of thefutures contract. If the market pricesubsequently goes up before the March delivery

CURRENCY FUTURES

� Currency future is a contract to buy or sell a standard quantity of one currency inexchange for the other. It is an exchange traded forward contract.

� The rate of exchange and the future date of delivery are agreed at the time of contract.

� It is a hedging as well as a speculative mechanism.

date, the buyer of the future will benefit. If themarket price falls, the seller of the future will gain.

Although currency futures can be held untildelivery date, when the currencies areexchanged, futures positions are normallyunwound before delivery.

� A buyer of a future can unwind his positionby selling a future for the same delivery date,taking a cash gain or loss on the differencebetween the buying and selling price.

� Similarly, a seller of a future can unwind theposition by purchasing a future for the samedelivery date, taking a cash gain or loss onthe difference between the selling and buyingprice.

Futures can be used for hedging currencyexposures, as an alternative to a forwardcontract. Such hedging usually involves thepurchase or sale of futures to cover a futurecurrency transaction and unwinding the futuresposition when the transaction occurs and buyingor selling the currency at the spot rate.

Currency Futures are not available in Indianmarket at present. RBI is likely to introduce thisproduct in the near future.


INTEREST RATE SWAPS

� Swap is simply an exchange of one for the other.� Interest rate swap involves the exchange of interest rates between two parties.� A simple example would be moving over to floating rate of interest in the place of

fixed rate of interest (and vice versa) during the currency of the loan.� This is done to align debt exposure with prevailing market conditions.

Definition

An interest rate swap is the transfer, contractuallyagreed, between two counterparties of theirrespective interest rate obligations.

Interest rate swaps are commonly used as ameans of converting fixed-rate to floating ratedebt and vice versa. The swap involves noexchange of principal, but restructures theinterest rate flows of existing assets andliabilities.

Interest rate swaps can be used by hedgers tomanage their fixed or floating assets andliabilities. They can also be used by speculatorsto replicate unfunded bond exposures to profitfrom changes in interest rates. As such, interestrate swaps are very popular and highly liquidinstruments.

The following are the advantages/disadvantagesof interest rates swaps.

Advantages

Indirect access to a market, via a swap, can becheaper than the direct borrowing route whereno borrowing advantage is avail-able. Efficientmanagement of interest-rate exposure and cashflows, facility to re-structure debt capital to alignwith prevailing market views/conditions, abilityto overcome balance sheet restrictions aresome of the advantages.

Disadvantages

Possible capital adequacy requirements,unknown extent of counterparty’s liability to otherswaps with regard to default possibilities andlegal and administrative costs.

Swap Applications

Interest rate swaps have been adapted andapplied in a number of ways includingCommercial Paper; Expensive debt swaps

designed to reduce interest expense onhigh-interest debt; Zero-coupon swaps fortax purposes;

The ‘fixed to floating’ or ‘vanilla’ swap still remainsthe most commonly transacted of the interestrate swap product range because of its simplicityand flexibility.

RBI has allowed the market to evolve thebenchmark rate for Forward Rate Agreements(FRAs) and Interest Rate Swaps (IRS). Banks,primary dealers and FIs are free to adopt anydomestic money or debt market rate for FRAsand IRS provided the computing of the rate isobjective, transparent and mutually acceptableto counterparties.

The RBI guidelines does not lay down anyrestriction on the minimum or maximum size ofthe “notional principal” amounts of FRAs and IRS.The guidelines stipulate separate capitaladequacy norms for banks/FIs and PDs.

Second, the adjusted value shall be multipliedby the risk weightage allotted to the counterparty.For banks/FIs, the risk weightage is 20 per centand for all others (except Governments) it is 100per cent.

In case of banks and FIs, the exposure on FRAs/IRS together with other credit exposures shouldbe within single/group borrower/counterpartylimits prescribed by RBI. While dealing withcorporates, banks, FIs and PDs should exercisedue diligence to ensure that the corporates areundertaking FRAs/IRS only for hedging their ownbalance sheet exposures.

RBI believes the financial players should notoverextend themselves and there is need to puta limit on open swap positions. Banks will haveto place various components of assets, liabilitiesand off-balance sheet positions (including FRAs,IRS) in different time buckets and fix prudentiallimits on individual gaps.


BANKINGMANAGEMENT OF

ASSETS & LIABILITIES


RISK BASED SUPERVISION OF BANKS

� Objectives: Optimise utilization of supervisory resources and minimise impact ofcrisis situation in the financial system.

� Key elements: Risk profiling of banks; supervisory cycle; Monitorable Action Plan;Enforcement process; and role of external auditors.

� Risk profiling of banks will be done for Business risks and Control risks.� Business risks are eight: Capital, credit, market, earnings, liquidity, business

strategy and environment, operational and group risks.� Control risks are four: Internal control, organisation, management and Compliance

risk.� The overall risk of bank will be assessed as low, moderate, fair or high.� Banks with lower risks will have longer supervisory cycle and lesser supervisory

intervention.

Background

With globalisation and liberalization, the stabilityof the financial system has become the centralchallenge to bank regulators and supervisors allover the world. In the last decade, Indian bankingscene has witnessed progressive deregulation,institution of prudential norm and an emulationof international supervisory best practices. Overa period of time RBI has consistently tightenedthe exposure and prudential norms of banks andenhanced the disclosure standards in phasesin order to strengthen the efficiency of itssupervisory processes. The growing diversitiesand complexities in banking business, the spateof product innovation, the “Contagion effects”that a crisis can spread to the entire financialsystems are causing pressures on supervisoryresources and calls for further streamlining ofsupervisory processes.

Risk Based Supervision announced is aninitiative in the direction of strengthening thesupervisory processes of banks by RBI. Putsimply, RBS is the approach to the supervisionof banks by RBI based on their risk exposures.Pricewaterhouse Coopers (PwC), London wasengaged by RBI for introduction of RBS. Thecurrent move of RBS approach represents afurther stage in the regulation and supervisionof banks in the light of earlier Padmanabhan andNarasimham Committee reports.

Current Approach

� Supervisory process is applied uniformly toall supervised institutions

� It is essentially on-site inspection driven (i.edirect inspection of bank branches by RBI)supplemented by off-site monitoring.

� The on-site inspections are conducted to alarge extent with reference to auditedbalance sheet dates.

� Supervisory follow-up commences with thedetailed findings of annual financialinspection.

� The process of inspection is based onCAMELS/CALCS (Capital adequacy, assetquality, management aspects, earnings,liquidity and systems; and control)

RBS - The New Approach

The objectives of RBS are two-fold:

� Optimise utilization of supervisoryresources (i.e., the time, manpower andefficiency of RBI’s supervision) and

� Minimise impact of crisis situation in thefinancial system.

RBS process essentially involves continuousmonitoring and evaluation of the risk profiles of


the supervised institutions (i.e., banks) in relationto their business strategy and exposures. Thisassessment will be based on construction of a“Risk Matrix” for each institution. The efficiencyof the RBS would clearly depend on banks’preparedness in certain critical areas such asquality and reliability of data, soundness ofsystems and technology, appropriateness of riskcontrol mechanism, supporting humanresources and organizational back-up.

Advantages of RBS Approach over thePresent CAMELS Approach

� Effective use of supervisory resources

� Systemic improvement

� Cushion against risks

� Flexibility of timing the on-site inspections

� Reduction of vulnerabilities by varyinginspection cycles

� Focused attention on weak banks

� Improvement in quality of internal audit

� Focused follow up

Major Elements of RBS Approach

1. Risk profiling of banks

2. Supervisory cycle

3. Supervisory programme

4. Inspection process

5. Review, evaluation and follow-up

6. Monitorable Action Plan (MAP)

7. Supervisory organisation

8. Enforcement process and incentiveframework

9. Role of external auditors in bankingsupervision

10. Change Management implications

Risk Profiling of Banks: Risk Profile is adocument, which would contain various kindsof financial and non-financial risks faced by a

banking institution. Risk profiling is the backboneof RBS system.

RBI has identified two classes of risks namelyBusiness risk and Control risk. Business risksare those risks that are considered inherent inthe activities undertaken by a bank irrespectiveof whether the controls are in place or not. Theassessment areas of Business risk are eight innumber and they are : Capital, Credit risk, Marketrisk, Earnings, Liquidity risk, Business strategyand environment risk, operational risk and Grouprisk. Control risks arise out of inadequacy in thecontrol system, absence of controls or possibilityof failures/breakdowns in the existing controlprocess. The assessment areas of Control risksare four in number and are: Internal control risks,Organisation risk, Management risk andCompliance risk.

Banks have to make an assessment of the riskagainst all the 12 areas (8 under Business and4 under control risk) by means of identifyingpositive and negative factors. Besides assessingthe risk, banks also are expected to assess thedirection of the risk based on past trend andcurrent judgment. Finally, banks have todetermine whether the overall level of risk is low,moderate, fair or high and the direction of risk isincreasing, decreasing or stable.

Assessment Area: Credit Risk

MAJOR COMPONENT Positive factorsNegative factors

COMPOSITION OF CREDIT PORTFOLIO

Credit concentration

Credit quality

Other credit risks - Off-balance sheet items,country risk, trading book Adequacy ofprovisions

Direction of Risk

RBI, for the purpose of risk profiling, besidesusing CAMEL rating, would draw upon a rangeof sources of information such as off-sitesurveillance and monitoring (OSMOS), market


intelligence reports, ad-hoc data from externaland internal auditors, information from otherdomestic and overseas supervisors, on-sitefindings, sanctions applied etc. The formalassessment of the risk profile of each bank wouldbe done on a regular basis.

Supervisory Cycle: The supervisory processwould commence with the preparation of thebank risk profile and on the data from othersources. The supervisory cycle would normallybe 12 months and may be shorter or longerdepending upon whether the bank is of low orhigh-risk.

Supervisory Programme: The supervisoryprogramme would be tailor-made to suitindividual banks depending upon their risk profileand would focus on high-risk areas.

Inspection process: The inspection procedurewould focus on identified high-risk areas toevaluate the effectiveness of the bank’smechanism in capturing, measuring, monitoringand controlling various risks. The transactiontesting would also be done though the extentwould vary depending on the need.

Review, Evaluation and Follow-up: Theevaluation, review and follow-up would attemptto ensure whether supervisory programme hasindeed been completed and whether it hasimproved the risk profile of the bank concerned.

Monitorable Action Plan (MAP): In the MAP,RBI would set out the improvements required inthe areas identified during the current on-site andoff-site supervisory process. Key individuals atthe bank would be made accountable for eachof the action points. Besides, RBI would considerimposing sanctions and penalties on banks fornot meeting the MAP.

Supervisory Organisation: Under RBS, therewould be a focal point of contacts for all banksat the Central office of RBI and its RegionalOffices.

Enforcement Process and IncentiveFramework: A system of incentives anddisincentives has been contemplated under the

RBS to serve attainment of RBS objectives. Theincentive is longer supervisory cycle and lessersupervisory intervention. The disincentives aremore frequent supervisory examination andhigher supervisory intervention includingdirections, sanctions and penalties.

Role of External Auditors in BankingSupervision: RBI would look forward to makemore use of external auditors as a supervisorytool by widening the range of tasks and activities,which external auditors perform at present. This,it would arrange on entering into dialogue withthe Institute of Chartered Accountants of Indiaand the bank management.

Change Management Implications: In orderto ensure a smooth change over to RBS banksshould have clearly defined standards ofcorporate governance and documented policiesin place. Some of the organizational issues andpreparations that banks have to make are givenbelow:

� Setting up of risk management architecture

� Adoption of Risk focused internal audit

� Strengthening of Management InformationSystem and Information Technology

� Addressing HRD issues such asreorientation of staff, skill formation andplacements in appropriate positions,creation of dedicated risk managementteam.

� Setting up of compliance unit headed by aChief Compliance Officer of the rank of notless than a General Manager who will beaccountable for timeliness and accuracy ofcompliance

Conclusion

Adoption of RBS would enable banks to be readyfor implementation of the Second Capital Accordof Basel Committee on Banking Supervision. Asmentioned earlier, banks have to undertakesuitable change initiatives to ensure smoothtransition to RBS.


Risk is inherent and absolutely unavoidable inbanking. Risk is the potential loss an asset or aportfolio is likely to suffer due to a variety ofreasons. As a financial intermediary, bankassumes or restructures risks for its clients. Asimple example for this would be acceptance ofdeposits. A more sophisticated example is aninterest rate swap. A bank while operating onbehalf of the customers as well as on its ownbehalf, has to face various types of risksassociated with those transactions. Prudentbanking lies in identifying, assessing andminimising these risks. In a competitive marketenvironment, a bank’s rate of return will begreatly influenced by its risk management skills.

Risks in Banking

Risks in banking are many. These risks can bebroadly classified into three categories. They are:

(I) Balance sheet risks.

(II) Transaction risks, and

(III) Operating and Liquidity risks.

The Balance Sheet Risks generally arise out ofthe mismatch between the currency, maturityand interest rate structure of assets andliquidities resulting in,

1) Interest Rate mismatch risk

2) Liquidity Risk, and

3) Foreign Exchange Risk,

The Transaction Risks essentially involve twotypes of risks. They are:

(i) CREDIT RISK which is the risk of loss onlending/investment, etc., due to counter partydefault.

RISK MANAGEMENT SYSTEMS IN BANKS

� Risk is the potential loss of an asset due to different factors.

� Risk management is concerned with identification, measurement and control of risks.

� Risks in banks comprise balance sheet risks, transaction risks; and operating andliquidity risks

(ii) PRICE RISKS which include the risks of lossdue to change in value of Assets andLiabilities. The factors contributing to pricerisks are:

(a) Market Liquidity Risk: This is the risk oflack of liquidity of an instrument or assetor the loss one is likely to incur whileliquidating the assets in the market dueto the fluctuations in prices.

(b) Issuer Risk: The financial strength andstanding of the institution/sovereign thathas issued the instrument can affect priceas well as realisability. The risk involvedwith the instruments issued by corporatebodies would be an ideal example in thiscontext.

(c) Instruments Risks: The nature ofinstrument creates risks for the investor.With many hybrid instruments in themarket, and with fluctuation in marketconditions, the prices of variousinstruments may react differently fromone another.

(d) Changes in commodity prices, interestrates and exchange rates may affect therealisable value or yield of many assetswhen transactions take place.

The Operating and Liquidity Risk encompassestwo types of risks, viz.,

(i) Risk of loss due to technical failure toexecute or settle a transaction, and

(ii) Risk of loss due to adverse changes in thecash flows of transactions.


RISK MANAGEMENT: OBJECTIVES

The objectives of risk management for anyorganisation can be summarised as under:

a) Survival of the organisation,

b) Efficiency in Operations,

c) Identifying and achieving acceptablelevels of worry,

d) Earnings stability,

e) Uninterrupted operations,

f) Continued growth, and

g) Preservation of reputation.

Risk Management: Components

Risk management may be defined as theprocess of identifying and controlling risk. It isalso described at times as the responsibility ofthe management to identify, measure, monitorand control various items of risks associated withbank’s position and transaction. The process ofrisk management has three clearly identifiable

steps, viz., Risk identification, Riskmeasurement and Risk control.

RISK CONTROL

After identification and assessment of riskfactors, the next step involved is risk control. Themajor alternatives available in risk control are:

i) Avoid the exposure

ii) Reduce the impact by reducingfrequency of severity

iii) Avoid concentration in risky area

iv) Transfer the risk to another party

v) Employ risk management instrumentsto cover the risks.

Good risk management is good banking. Andgood banking is essential for profitable survivalof the institution. A professional approach toidentification, measurement and control of riskwill safeguard the interests of the bankinginstitution in the long run.


In liberalised financial markets, banks’ assetsand liabilities variations are considerablyinfluenced by interest rate and exchange ratevolatility. The competitive environment in thebanking system due to removal of variousbarriers in their operations has added pressureto the importance of financial management.Banks have to manage not only credit risk but avariety of other financial risks including interestrate, exchange rate, liquidity, settlement, andtransfer risks to maximise profit and minimiserisks. The complexity of financial risks requiresthat a strong and dedicated risk managementsystem is put in place covering: (1) assets,liabilities and off-balance sheet risks, (2)information and scientific risk managementtechniques and (3) dedicated asset-liabilitymanagers or committee (ALCO). Asset-Liabilitymanagement as a means of risk managementtechnique is an important function in a bank. Itprimarily focuses on how various functions ofthe bank are adequately co-ordinated, essentiallycovering planning, directing, and controlling ofthe levels, changes and mixes of the variousbalance sheet accounts.

In Asset-Liability management (ALM), a bank isstrategically concerned with management ofmarket risk consisting of (a) interest rate risk,(b) foreign exchange risk, (c) equity price riskand (d) commodity price risk. Also ALM functioncovers liquidity management and capitalplanning. Broadly, the ALM objectives are tocontrol the volatility of net interest income andnet economic value of a bank. In order to achievethese results, the asset-liability managers orALCO must be guided by policies thatspecifically address the bank’s overall asset-liability management goals and risk limits, andby information that relates directly to its asset-liability positions.

ASSET - LIABILITY MANAGEMENT

� It involves management of bank’s assets and liabilities.

� It essentially focuses on managing risks caused by changes in liquidity, interest ratesand fluctuations in foreign currency rates.

� Success of ALM depends on availability of information, existence of sound policiesand risk management system.

Asset-Liability Management Structure involvesmanagement of Assets and Liabilities. Thefinancial management structure consists ofmanaging balance sheet on the one side andincome and expenditure on the other.

The banking industry, to compete in a freemarket conditions, has to give utmost priorityfor managing and minimising risks inherent inbanking operations. Across the world, it wasobserved that failure of risk management andcontrol systems were significant factors for bankfailures. The success of asset liabilitymanagement depends on the effective existenceof (1) Information and Policies, and (2) RiskManagement System.

1. Information and Policies

The primary objective of ALM is to ensure thatthere are asset-liability managers and an asset-liability committee (ALCO) that manages thebank’s balance sheet in such a manner as tominimise volatility in its earnings, liquidity, andequity to changes in market conditions asmanifested in such results as stable net interestmargins, optimal earnings, adequate liquidity,and effective control of financial risks. To reachthese objectives, the information base in a bankhas to be strong and sound. The informationrequired for ALM are (1) historical, current andprojected data on the bank’s assets-liabilityportfolios, including any projected additions,maturities, and repricing; (2) interest rates andyields of its current and projected portfolios; (3)market limitations on the banks’ ability to adjustits product prices; and (4) changes in the bank’sbalance sheet caused by customers’ decisionsto prepay their loans, wihdraw their depositsbefore maturity, and transfer their business to


other banks that relates directly to its asset-liability position.

2. Risk Management System

In view of the increasing market risks in bankingoperations, banks should be able to accuratelymeasure and adequately control market risk.Banks should have in place a well-structuredrisk management system. A risk managementprocess that includes measuring risks,controlling risks ad monitoring risks will helpbanks to attain these goals.

a) Measuring Risk

Due to difficulty in measuring interest raterisks and also the controversies present inthe understanding of the concept,measurement of interest rate risks assumesgreater importance in the ALM function. It hasbeen observed that banks’ risk exposuredepends upon volatility of interest rates andasset prices in the financial market, thebanks’ maturity/gaps, the duration andinterest rate elasticity of its assets andliabilities and the ability of the managementto measure and control the exposure. In themanagement of banks’ assets and liabilities,interest risk management lays the foundationfor a good ALM.

b) Risk Analysis and Management

Interest rate risk can be analysed in thefollowing four methods:

1. Gap analysis

2. Duration analysis

3. Value at Risk (VaR)

4. Simulation

Gap analysis is the most important basictechnique used in analysing interest raterisk. It measures the difference between abank’s assets and liabilities and off-balancesheet positions which will be repriced or willmature within a predetermined period. (Gapis the difference between rate-sensitiveassets minus rate sensitive liabilities) Theduration analysis estimates the averageamount of time required before the

discounted value or the present value of allcash flows (e.g., principal and interest) canbe recovered by an asset holder includingthat of bank’s depositor. The concept canbe used for all assets, liabilities and off-balance sheet items. Another concept whichis also used is the Value at Risk (VaR) model.VaR estimates the maximum potential lossin a position over a given holding period for agiven confidence level.

Policy Issues

Strengthening of information technology incommercial banks would be an importantprerequisite to implement effectively ALMsystem in banks. The database of banks has tocover all operations of branches for a detailedanalysis of assets and liabilities and forforecasting a comprehensive projection ofliquidity conditions under various scenarios. Thesoftware packages used must be well testedand have extensive computing power to analysethe massive amount of Asset/Liability data underalternative interest rate scenarios.

It is well understood that every financialtransaction or commitment has implications fora bank’s liquidity. A proper liquidity managementwould help the management in formulatingbusiness strategy. A schedule of liquidity reviewswith depth should be provided for. These reviewsprovide the opportunity to re-examine and refinea bank’s liquidity policies and practices in thelight of a bank’s liquidity experience anddevelopments in its business. For banks withan international presence, the treatment ofassets and liabilities in multiple currencies addsyet another layer of complexity. In the event of adisturbance, a bank may not always be able tomobilise domestic liquidity to meet foreigncurrency funding requirements. Hence, betterliquidity management becomes an importantconcern when banks undertake business inmulti currency transactions.

The ALCO at SBI is engaged in evolving optimalasset/liability structure for the Bank on an on-going basis with a view to containingmismatches, optimizing profits and ensuring riskmanagement. The Bank is using ‘Risk Manager’module to strengthen the processes of RiskManagement.


CREDIT RISK MANAGEMENT

� Credit Risk is the foremost of all risks in terms of importance.

� Major Credit Risks include risk of exposure, risk of default by the borrower, risk ofdeterioration in the standing of the borrower.

� Credit risk is managed through use of covenants, collateralisation, managingconcentration and capital allocation in relation to risk and risk-return optimization

� Credit risk models, stress testing, use of derivatives and securitisation help inmanaging credit risk.

Lack of appropriate lending discipline andinadequate systems of control generally resultin setback to banks. Banks have also sufferedfrom poor transaction management, incompletecredit information, poor documentation and grossinadequacy in pricing risks.

For banks, credit risk is the foremost of all therisks, in terms of importance. Default risk, a majorsource of loss, is the risk that customers fail tocomply with their obligation to service debt.Default triggers a total or partial loss of anyamount lent to a counter party.

Decline in the credit standing of an obligor of theissuer of a bond or stock, is also a type of creditrisk. Such deterioration does not imply default,but the probability of default increases. In themarket, a deterioration of the credit standing of aborrower does materialize into a loss because ittriggers an upward move of the required marketyield to compensate the higher risk and triggersa value decline.

The major credit risks are exposure, likelihoodof default, or a deterioration of the credit standing,and the recoveries under default. Scarcity of datamakes the assessment of these components achallenge. Ratings are traditional measure ofcredit quality of the debts. Because ratings areordinal measures of credit risk, they are notsufficient to value credit risk. Portfolio modelsshow that portfolio risk varies across banksdepending on the number of borrowers, thediscrepancies in size between exposures andthe extent of diversification among types ofborrowers, industries and countries.

There are various challenges of credit risk

measurement, enumerated as under :

Credit risk for traded instruments raises anumber of conceptual and practical difficulties:(a) What is the value subject to loss, orexposure, in future periods? (b) Does thecurrent price embed already the credit risk,since the market prices normally anticipatefuture events and to what extent ? (c) Will it beeasy to sell these instruments when signs ofdeterioration get stronger? and (d) Will the bankhold these instruments longer than under normalconditions?

Modelling default probability directly with creditrisk models remains a major challenge.

Another challenge of credit risk measurementis capturing portfolio effects. Due to scarcity ofdata, quantifying the diversification effectsposes a great challenge.

Managing Credit RiskUse of Covenants as a Pre-emptive Device

The banks may use covenants effectively as apre-emptive device before credit standingdeteriorates or losses occur. The rationalebehind use of convenants is an under :

They help to protect the banks fromanysignificant deterioration in the risk profile of theborrower transactions without prior agreement.

They allow banks to do restructuring of the loansin such instances.

Covenants make it costlier for the borrower todefault, because he loses the value of continuingoperations.


Covenants are incentives against moral hazard,since they restrict borrowers from takingadditional risk that would increase bank's risk.

Collateralization in Credit Risk Mitigation

A prudent collateralization practice can beeffectively used to mitigate credit risk. Collateralsalso act as an incentive for the borrower to fulfilldebt obligations effectively. Collaterals may bein the form of real assets, securities, goods,receivables and margin borrowing – the valueof the collaterals vis-a-vis the loan amount,would depend upon the creditworthiness of theborrower and the level of risk associated withthe credit facility.

In case the borrower fails to perform the debtobligations, the original credit risk turns into arecovery risk plus an asset value risk, whichcould be: (a) accessibility risk (difficulty toeffectively seize the collateral), (b) integrity risk(the risk of damage to the collateral), (c) legalrisk (risk of disputes arising from various lawsin connection with asset seizure), and (d)valuation risk (the liquidation value of a collateraldepends on the existence of secondary marketand the price volatility of such a market). Theseaspects need to be examined while deciding onthe nature and extent of the collaterals.

Managing Concentrations

Credit concentrations (as per Basel Committee)can be grouped into two categories: (a)conventional credit concentrations which includeconcentrations of credits to single borrowers orcounterpar ties, a group of connectedcounterparties and sector or industries, and (b)concentrations based on common or correlatedrisk factors to reflect subtler or more situation -specific factors can only be uncovered throughanalysis. Overlooking the dangers in suchsituations results in susceptibility toconcentration risk.

Capital Allocation and Risk Contributions

The risk management framework of the Indianbanks needs to lay emphasis on prudent capitalallocation system. Risk contributions are thefoundation of the capital allocation system andof the risk-adjusted performance measurementsystem. Capital allocation defines meaningful

keys for tracing back the overall risk to itssources. The capital allocation system allowsus to break down and aggregate riskcontributions according to any criteria as longas individual transaction risk contributions areavailable. The capital allocation system providesthe risk contributions for individual facilities forboth credit risk and market risk.

The goal of risk-based pricing is to ensure aminimum target return on capital, in line withshareholders' requirements. A hurdle rateserves as a benchmark for risk-based pricingand for calculating creation or destruction ofvalue.

Risk Return Optimization

Risk return optimization shows how to trade-offrisk across exposures to enhance the overallpor tfolio return. There is a potential forenhancement because income is proportionalto size while risk is not. Portfolio optimizationunder global funding constraint means:

• reducing risk, at a constant return, and

• increasing revenue, at the same time.

Indian banks need to use models as theseprovide valuable insights for restructuring andexpanding, or contracting, some portfoliosegments or individual exposures. In fact,without such models there is no way to comparevarious 'what if' scenarios and rank them interms of their risk-return profiles.

Further, Indian banks need to develop their ownexper tise and put sustained effor ts fordeveloping internal models, through focusedapproach, evidenced by internal research anddevelopmental activities. This would help Indianbanks to be Basel II compliant, in the very nearfuture.

Effective Use of Credit Risk Models

Credit risk events, defaults and migrations resultin changes in value of credit facilities. The Indianbanks need to make effective use of variouscredit risk models, depending on the size ofportfolio.

Progression Towards Stress Testing

Stress tests make risks more transparent by


estimating the potential losses on a portfolio inabnormal markets. They complement the internalmodels and management systems used bybanks globally for capital allocation decisions.Simply speaking, stress testing is a way toproduce alternative scenarios using sensitivityanalysis.

The New Basel Capital Accord uses morequantitative approaches – methods whereassumptions can be empirically evaluated.Stress testing should be able to link dramaticchanges in the economic environment to thebank's portfolio. There are, however, issuessuch as data availability, portfolio diversity andstandardization of model inputs and outputs,which need to be addressed.

Effective Use of Derivatives

Derivatives help to customize the term structureof credit risk, independent of the underlyingassets, bonds or loans. Credit derivatives allowbetter utilization of the current credit capacity,even though there are no cash deals meetingeligibility and maturity criteria.

Securitization in Credit Risk Management

The motivation for banks in securitization lies inthe following potential benefits:

• arbitraging the cost of funding in the marketwith funding on-balance sheet.

• off-loading credit risk to free capital for newoperations, and

• to modify the risk-return profile of the loanportfolio.

The issue, when off-loading risks, is whetherfreeing up capital in this way is economicallyacceptable. The solution lies in finding outwhether this makes the risk-return profile of thebanking portfolio more efficient (higher return forthe same risk or lower risk for the same return).

Analyzing the economics of the securitizationtransaction requires reviewing all costs andbenefits resulting from the specific values of eachof the various parameters at the time ofsecuritization.

Conclusion

The increasingly complex and competitivebanking warrants sophisticated models for creditrisk management. It is important to put in placean agile and dynamic Credit Risk ManagementSystem, which addresses the challenges ofcontemporary banking scenario and strengthensthem in their progression towards meeting globalbenchmarks.


Treasury Management in banks involves aneffective internal and external interface. Itperforms a myriad of functions ranging frombalance sheet management, liquiditymanagement, reserves and investment, fundsmanagement, management of capital adequacyto transfer pricing, risk management, tradingactivities and offering hedge products. It has towork on arriving at an optimal size of the balancesheet, interface with various liability and assetgroups internally, give correct pricing signalskeeping in mind the liquidity profile of the bank.On the external front, it has to provide activetrading support to the market, make two wayprices, add to the liquidity and continuously striveto provide the customers with value addedsolutions to their specific financial needs.

Balance Sheet Management

The ongoing reforms have provided the banksfreedom to price most of their assets andliabilities within a broad band specified by RBI.This implies that the balance sheetmanagement should be a dynamic andproactive process. It requires continuousmonitoring, analysis of market changes andcontrols. Demand and supply forces have to bereckoned to determine the optimal balance sheetsize and its growth rate.

Liquidity Management

Liquidity essentially means the ability to meetall contractual obligations as and when theyarise, as well as the ability to satisfy fundsrequirement to meet new businessopportunities. Liquidity planning involves ananalysis of all major cash flows that arise in thebank as a result of asset and liability transactionsand projecting these cash flows over the future.Liquidity analysis involves an analysis of the

TREASURY MANAGEMENT IN BANKS

� Treasury Management is concerned with efficient allocation of the bank’s resources.

� Some of its role includes optimizing balance sheet size, ensuring liquidity and matchingthe maturity profile of assets and liabilities.

� Treasury management includes risk management and advising clients on riskexposures.

maturity profile of existing assets and liabilitiesover which superimposed is the impact oftransactions that are planned for the future.

Effective liquidity management requires carefulattention to balance sheet growth and structure.A balance sheet that is growing rapidly needscareful scrutiny to determine whether theliquidity of the bank is being adversely affected.Very often banks put up excessive assets in theform of cash credit lendings or investment insecurities without having matching source offunds of similar tenors. This mismatch in thematurities of assets and liabilities results in thebank being subjected to liquidity risk, becausethe bank starts depending chronically andexcessively on the most easily accessiblesource of funds i.e. the inter-bank call moneymarket. Thus, the bank ends up funding long -term assets through overnight borrowings on anongoing basis.

Funds Management

Funds management by the treasury involvesproviding a balanced and well-diversified liabilitybase to fund the various assets in the balancesheet of the bank. Quality of well-diversifiedassets and optimal return are very critical forany bank. Similarly diversified liabilities implyraising funds from a variety of sources, using avariety of instruments and for a variety of tenors.Consumer deposits are often the most stablesource of funds for a bank. At the other end ofthe spectrum are the funds obtained from theinter-bank money market which are very short-term in tenor and volatile with regard to rate andavailability. Banks, therefore, have to decide onan optimal mix of funds from various sources,to ensure that there is no excessive dependenceon any single category. It is also advisable that


the maturity profile of assets conforms broadlyto that of the liabilities, so that there is no largestructural mismatch in the balance sheet thatcan lead to liquidity problems.

Capital Adequacy

The treasury also has the responsibility forsetting targets for balance sheet size and keyratios, in consultation with all business groups.Asset and liability levels need to be monitoredand managed periodically to iron out anystructural imbalances. The ALCO (Asset andLiability Committee) should meet at regularintervals for this aspect of strategic businessplanning. The size of the balance sheet has nowacquired great importance for a bank, in the lightof capital adequacy guidelines. A bank cannotafford to be driven just by volume goals whichaim at a certain percentage growth in credit anddeposits year after year. This is because balancesheet growth will mean the requirement ofadditional capital in accordance with BISguidelines. Therefore, the focus has now to shiftto the quality of assets, with return on assetsbeing a key criterion for measuring the efficiencyof deployment of funds.

Transfer Pricing

Treasury has to ensure that the funds of thebank are deployed in the most appropriatemanner without sacrificing either yield or liquidity.This is done very effectively through the meansof a transfer pricing mechanism administeredby the treasury, which can provide correct signalto various business groups as to their futureasset and liability strategy. Benchmarking ofrates provides a ready reference for businessgroups about the correct business strategy toadopt given the balance sheet structure of thebank as well as the conditions prevailing in themoney markets and the treasury’s forecastabout expected rate movements in the future.The treasury is ideally placed for this functionsince it has an idea of the bank’s overall fundingneeds as well as direct access to the externalmarkets.

Reserve Management & Investments

In the Indian banking sector, almost half the assetbase of a bank consists of statutory reserves.Since such a large proportion of funds is

deployed in the form of statutory reserves,management of these reserves is a veryimportant factor in the overall profitability of thebank. Banks should ideally take into account bothliquidity as well as yield considerations. Eventhough the longer maturity securities offer thehigher yields, they are also the most susceptibleto fall in price due to changes in the yield curve.On the other hand, short-dated securities havelow price risk but they also give lower returns.Therefore choice of an appropriate mix ofmaturity patterns in the SLR portfolio is a veryimportant objective of the treasury manager.Along with this, the market risk of the portfolioas well as its price sensitivity to interest ratechanges need to be quantified and periodicallymonitored by means of analytical tools such asduration analysis.

Customer Needs

With the growing liberalisation and the openingup of the economy to international financialmarkets and investors, the treasurydepartments of various banks would have tofunction in a multi-product, multi-currencyenvironment and cater to the multiple needs ofits customers. There will be pressure on thetreasury to offer various rupee based and cross-currency hedge products to their clients whohave foreign currency exposures on theirbalance sheets. In fact, the recent changes inthe regulations would, over a period of time,ensure the convergence of local currency andforeign currency yield curves and enable theclients to manage their foreign currency assetsand liabilities in a more profitable manner throughthe use of foreign exchange derivatives both inthe area of currency and interest rates. Whilethese products provide the client with the muchdesired interest savings, these are not withoutinherent risk. It is imperative for the banks toclearly define and explain these risks to theircorporate clients and to help them effectivelymanage these risks keeping in mind the dynamicnature of the foreign exchange markets. Thisbrings us to an important aspect of treasury, i.e.,risk management.

Risk Management

One of the major responsibilities of a successfultreasury is to manage the risks arising out of


the financial transactions entered into by thetreasury. The two most important risks which ithas to manage are liquidity risk and price risk inaddition to counterparty risk and issuer risk.These risks should be evaluated by anindependent risk manager and the reportshighlighting the limits, their usage and excesses,if any, should be generated by an independentsystem, monitored and managed by technologyand operations.

Conclusion

In conclusion, it is worth reiterating that in today’sfast changing market environment, treasury

management is inevitably acquiring a greaterdegree of complexity and sophistication. Thesuccess of any treasury thus depends a greatdeal on strong risk management, independentback-office operations and first rate technology.These become all the more important asprofitability and commercial viability become keycriteria for assessing performance. And, it isthese very fundamentals that make a successfultreasury that can sustain efficient allocation ofinternal resources on one hand and acceleratethe globalisation of our financial markets on theother.


Portfolio Management is one of the emergingopportunities for tapping the business of HighNet worth Individuals (HNIs). Many banks in Indiaare offering Portfolio Management services asa high-end product. The service besides offeringopportunities for fee-based income helps toretain loyalty of high net worth customersthrough specialized services. No longer,customers park their money in the bank for safe-keeping. HNIs expect banks to increase theirwealth and those banks, which have got theprofessional expertise in this business, arehighly sought after. In such a market, there is aneed for the functionaries of our bank to developexpertise in this area. The readers besidesreading books on Portfolio Management canenroll in courses offered by professionalinstitutions in India on Certified PortfolioManagers (CPM).

What is Portfolio Management

It is the management of the funds of each clientin accordance with the needs of the client. Theclient entrusts certain sum of money to thePortfolio Manager (PM) who manages the fundin accordance with the mutual agreementbetween the client and the PM.

Kinds of Portfolio Managers

Portfolio Managers are of two types, namely,Discretionary and Non-discretionary PortfolioManagers. Discretionary PMs will independentlymanage the funds in accordance with the needsof the client, while Non- discretionary PMs shallmanage the funds in accordance with thedirections of the client.

Registration of Portfolio Managers

Portfolio Managers are registered by SEBI asper the guidelines framed by it. SEBI hasmandated certain capital requirements and otherinfrastructure availability for eligibility. Forexample, the minimum capital requirement isRs.50 lakh. The applicant should be a bodycorporate with the Principal officer havingqualifications in finance, accounting or generalmanagement.

Obligations and Responsibilities of PortfolioManagers

• The minimum amount required for PortfolioManagement per client as stipulated by SEBIis Rs.5 lakh.

• There should be mutual agreement betweenthe client and the PM regarding their mutualrights and obligations.

The agreement between the client and thePortfolio Managers should contain the following:

• The investment objectives and the servicesto be provided

• Areas of investment and restrictions, if any,imposed by the client with regard to theinvestment in a particular company orindustry

• Type of instruments and proportion ofexposure

• Tenure of portfolio investments

PORTFOLIO MANAGEMENT

� It is management of the clients’ fund in accordance with their needs based onmutual agreement for a fee.

� It helps to tap the funds of high net worth individuals who expect the banks tomultiply their wealth.

� There are two types of portfolio managers - Discretionary and Non-discretionary.Discretionary managers exercise their discretion in investment.

� Portfolio Managers are to be registered with SEBI. As per SEBI directive, theminimum fund per client is Rs.5 lakh.


• Terms for early withdrawal of funds orsecurities by the clients

• Attendant risks involved in the managementof the portfolio

• Period of the contract and provision of earlytermination, if any

• Amount to be invested subject to therestrictions provided under these regulations

• Procedure of settling client’s accountincluding form of repayment on maturity orearly termination of contract

• Fees payable to the portfolio manager

• The quantum and manner of fees payableby the client for each activity for whichservice is rendered by the portfolio managerdirectly or indirectly (where such service isoutsourced)

• Custody of securities;

• In case of a discretionary portfolio managera condition that the liability of a client shallnot exceed his investment with the portfoliomanager;

• The terms of accounts and audit andfurnishing of the reports to the clients as perthe provisions of these regulations; and

• Other terms of portfolio investment subjectto these regulations.

General Responsibilities of PortfolioManager

Portfolio Managers have to discharge thefollowing responsibilities:

• The portfolio manager shall not accept fromthe client, funds or securities worth less thanRs.5 lakh.

• The portfolio manager shall act in a fiduciarycapacity with regard to the client’s funds.

• The portfolio manager shall keep the fundsof all clients in a separate account to bemaintained by it in a Scheduled CommercialBank.

• The portfolio manager shall transact insecurities within the limitation placed by theclient himself with regard to dealing insecurities under the provisions of theReserve Bank of India Act, 1934 (2 of 1934);

• The portfolio manager shall not derive anydirect or indirect benefit out of the client’sfunds or securities.

• The portfolio manager shall not borrow fundsor securities on behalf of the client.

• The portfolio manager shall not lendsecurities held on behalf of clients to a thirdperson except as provided under theseregulations.

• The portfolio manager shall ensure properand timely handling of complaints from hisclients and take appropriate actionimmediately.


OPERATIONAL RISK IN BANKS

� Operational Risk is the risk of loss resulting from inadequate or failed internalprocesses, people and systems or from external events.

� Some forms of Operational Risk: Control Risk, Process Risk, Legal Risk, ReputationRisk.

� Basel II has made banks to focus on Operational Risk due to its potential to causeliquidation of banks

The Basel committee defines operational riskas the risk of loss resulting from inadequate orfailed internal processes, people and systemsor from external events. Since the original BaselAccord on capital adequacy of 1988, the bankingworld has undergone a series of importantchanges. For the purpose of operational risk,there are two key elements. The first is the shiftby some banks away from traditional bankingtowards a more trading-oriented environment.This has meant that new types of operationalrisks have emerged, and the likelihood ofextensive losses has increased. The secondmajor change is the increasing concentration ofprocessing risk in some banks. This is causedpartly by outsourcing some functions outside thebank, and partly by economies of scale createdby new technology. These two keydevelopments may mean that banks may bemore vulnerable to sudden, extreme losses thanbefore. Several recent well-known cases, wherebanks have experienced large operationallosses - including Barings in 1995 and Sumitomoin 1996 - attest to this.

What is Operational Risk

When a loan is granted, there is reasonableprobability that the borrower may fail to pay intime or may not pay at all. The loan may becomebad due to lack of proper assessment of thecredit proposal also. In these two cases the riskcan be called credit risk. However, if the creditofficer has exceeded his authority in sanctioningthe loan or the credit officer is bribed to sanctionthe loan and subsequently the loan becomesbad, then the risk involved is called operationalrisk. A computer breakdown involving huge lossto the bank can be ascribed to operational risk.Any financial loss that may occur to the bankdue to the fraudulent activity of its staff member

or an outsider is to be categorized under thehead operational risk. Basel committee hasalready advised the banks to make provision foroperational risk in the balance sheet from March2007.

Types of Operational Risk

Operational risks can be broadly divided intooperational strategic risk and operational failurerisk. Strategic risk includes political, taxation,regulation, government and competition. Itper tains to the prevailing environmentalconditions. The latter arises out of the failurerelated to people, process and technology withoperational failure risk. Operational risk can arisebefore, during and after a transaction isprocessed. Risk exists before a potentialtransaction is designed. A firm is exposed toseveral risks during the processing of thetransaction. First, the sales person may not fullydisclose the various pros and cons of thetransaction to the potential client. He maypersuade a client to enter into an agreementwhich is totally inappropriate for him (client). Thisis called people risk. Second the sales personmay depend on sophisticated models to pricethe transaction, which creates what is commonlycalled model risk. It is due to the inherent defectin the model. Once a transaction is negotiatedand a ticket is written, several errors may happenafterwards. For example, an error may result indelayed settlement giving rise to heavy penalty.It may be mis-classified in the risk reports,understating the exposure. In turn it may lead tosome other sets of transaction which otherwisewould not have been performed. These aresome of the examples of process risk. If any ofthe systems are outsourced then the risk thatarises out of it is called external dependency risk.


Broad Classification of Operational Risk

(a) Control Risk: Any unexpected loss whicharises due to lack of an appropriate control.Is bifurcated into inherent risk and controlrisk. Inherent risk is associated with thespecific type of business. For example,derivative trading process is understood byonly a few key people.

(b) Process Risk: This is the risk that occursdue to the business process being inefficientcauses unexpected losses.

(c) Reputation Risk: This is the risk of anunexpected loss in share price or revenuedue to the impact of the reputation of the firm.

(d) Human Resources Risk: The organizationhas a major role in selection of the right typeof people, developing them and retainingthem. The hiring procedure and thetermination procedure should be foolproof toensure that the firm does not face anyunexpected loss.

(e) Legal Risk: The risk of suffering legal claimsdue to product liability or employee action.The risk that a legal opinion on a matter turnsout to be incorrect in a court of law.

(f) Takeover Risk : It is highly strategic but canbe controlled by making it uneconomical fora predator to take over the firm. This couldbe done by attaching the golden parachuteclause to the director's contract. It meansthat the severance payment to the directorshould be at a high price, which makes theacquirer to think twice before taking theplunge.

(g) Marketing Risk: The product may fail dueto wrong marketing strategy. The benefitclaimed about the product is misrepresentedin the marketing material.

(h) Technology Risk: The risk that may arisedue to various new developments that maytake place in the technology front by makingthe older technology redundant.

(i) Tax Changes: If tax changes are made,particularly with retrospective effect, theymay make the business unprofitable.

(j) Regulatory Changes: A change inpercentage of charge in terms of risk

weighted assets can have impact on thebusiness.

(k) Business Capacity: If the existing ITintrastructure cannot support a growingbusiness, the risks of major system failureare high.

(l) Project Risk : Project failure including delayin execution is one of biggest causes of riskin most firms.

(m) Security: The firm's assets need to besecured from both external and internal theft.

(n) Supplier Management Risk: If the businessis exposed to the performance of thirdparties, then the firm is exposed to this typeof risk.

(o) Natural Catastrophe Risk: Past history isanalyzed to assess such type of risk.Operational risk manager should seewhether the firm is likely to be affected byflood, earthquake or any other naturaldisaster.

(p) Man-made Catastrophe Risks: If the firmis situated near defence installation, prison,airport or nuclear plant, then this type of riskis expected. It also includes possible terroristthreat to such types of establishments.

(q) Technology Issues in Banks: Due toincreasing dependency on technology, thechances of IT related operational risks haveincreased. The type of controls required in acomputerized environment is different fromthat of the manual system.

Conclusion

Operational risk is an old problem with a curcialnew significance. Globalization, increasingreliance on technology, use of exotic financialproducts and a more stringent regulatoryenvironment mean that the opportunities for - andconsequences of - operational risk haveproliferated. The future will be determined by theextent to which banks allocate capital to market,credit and business strategic risks. Now thereis increasing focus on operational risk aspectas this may cause liquidation of some banks iftimely action is not taken.


ESSENTIALS OF LIQUIDITY RISK MANAGEMENT

� Liquidity Risk is the risk of loss resulting from lack of sufficient funds to meet immediatefinancial need or obligation.

� Liquidity Risk may cause inability to raise funds at normal cost.� Shortage of funds in the market, difficulty to sell the assets are the other forms of

liquidity risk.� Banks should effectively manage liquidity gaps and develop contingency funding.� Best practices in liquidity management would include strategic direction,

measurement and monitoring.

Liquidity risk refers to multiple dimensions suchas (a) inability to raise funds at normal cost, (b)market liquidity risk, and (c) asset liquidity risk.The Market liquidity risk arises out of illiquidityin the market while asset liquidity risk is causedby inability to sell the asset immediately. Fundingrisk depends on how risky the market perceivesthe issuer and its funding policy. The cost offunding is a critical profitability driver. The costof the funds depends on the bank's creditstanding. In addition, the rating drives the abilityto do business with other banks/financialinstitutions and to attract investors. The liquidityrisk of the market relates to liquidity crunchesbecause of lack of volume. In such a scenario,the prices become highly volatile, sometimesembedding high discounts from par, whencounter parties are unwilling to trade. Marketliquidity risk materializes as an impaired abilityto raise money at a reasonable cost. Assetliquidity risk results from the lack of liquidityrelated to the nature of assets rather than to themarket liquidity. In fluctuating market liquidity,holding a pool of liquid assets acts as a cushionto meet short-term obligations.

When a bank gets into trouble, massivewithdrawals of funds by depositors and closingof credit-lines by institutions results in brutalliquidity crisis, ending up in bankruptcy of bank.

There are challenges to liquidity riskmeasurement. The practices rely on empiricaland continuous observations of market liquidity.Liquidity risk models appear too theoretical topermit instrumental applications. The time profilesof projected uses and sources of funds, and their

'gaps' or liquidity mismatches, capture theliquidity position of a bank.

Ten Essentials of Liquidity Risk Management

Liquidity risk, resulting from size and maturitymismatches of assets and liabilities, makesbanks vulnerable to market liquidity risk. Liquidassets protect banks from market tensionsbecause they are an alternative source of fundsfor facing the near-term obligations. Controllingliquidity risk implies spreading over timeamounts of funding, avoiding unexpected marketfunding and maintaining a cushion of liquid short-term assets, so that selling them providesliquidity without incurring losses. The presentday market scenario necessitates that Indianbanks keep in view the following 10 essentialsof liquidity risk management:

1. Liquidity gaps generate fundingrequirements, or investments of excessfunds, in the future. Such financialtransactions occur in the future as interestrates not yet known, unless hedging themtoday. Liquidity gaps generate interest raterisk because of the uncertainty in interestrevenues or costs generated by thesetransactions.

2. Cash matching is a basic concept of liquidityrisk, implying thereby that the time profilesof amortization of assets and liabilities areidentical. The nature of interest applicableand maturities also match, i.e., fixed rateswith fixed rates and floating rates revisedperiodically with floating rates revised at the


same dates using the same reference rate.With cash matching, liquidity gaps are equalto zero.

In general, deposits do not match loans, asthese results from customers' behaviour.However, it is feasible to structure thefinancial debt in order to replicate the assets'time profile.

3. The cost of liquidity for banks often refers toanother concept: the cost of maintaining theliquidity ratio at a minimum level. The liquidityratio is the ratio of short-term assets to short-term liabilities, and it should be above one.

When a bank initiates a set of transactionssuch as borrowing short and lending long,the liquidity ratio deteriorates because theshort-term liabilities increase without amatching increase in short-term assets.

4. Excessive funding concentrations severelyreduce the bank's ability to survive a liquiditycrisis. Banks need to take advantage ofgood economic times to diversify theirfunding requirements.

5. Banks need to develop a contingency fundingplan, adequacy of projected funding sourcesand development of common contingencyscenarios.

6. Banks need to progress towards stresstesting their funding plans, using variousinterest rate shocks and adverse economicand competitive scenarios to ascertain theirimpact on both the funding portfolio andmarket access.

7. Communication lines between treasuryfunctioning and operational units need to besignificantly enhanced. Reporting systemsneed to be more effective.

ALCO (Asset - Liability Committee) of thebanks must have appropriate riskmanagement policies and procedures, activeMIS repor ting, limits and oversightprogrammes.

8. A historical funding pattern of various types

of off-balance sheet items needs to bestatistically analysed. Incorporating this intocalculations of future funding requirementsenhances the accuracy of fundingprojections.

9. Selection of funding source must integratewith the bank's interest rate sensitivity, riskappetite, profit planning, diversification andcapital management objectives.

10. A rating services view on the bank's liquidityposition needs to be taken periodically anddeficiencies corrected in early stages.

Best Practices in Liquidity Management

The Indian banks vary widely in their fundingneeds and their appetite for risk. The followingstrategies are essential for the banks to managetheir liquidity risk effectively:

(a) Strategic Direction: The bank managementmust articulate the overall strategic directionof the bank's funding strategy by determiningwhat mix of assets and liabilities will beutilized to maintain liquidity. This strategyshould address the inherent liquidity riskswhich are generated by the bank's corebusinesses.

(b) Integration: The bank's asset and liabilitymanagement policy should clearly define therole of liquid assets along with setting cleartargets and limits. Liquidity managementshould be integrated into the day-to-daydecision-making process of core business-line managers.

(c) Measurement Systems: The bankmanagement needs a set of metrics withposition limits and benchmarks to quicklyascertain the bank's true liquidity position,ascertain trends as they develop and providethe basis for projecting possible scenariosrapidly and accurately. The models may bebased on:

Cash capital: This model has a general limit,which is frequently expressed in terms of amanagement set limit on the percentage ofthe discounted value of the bank's asets to


total short-term funding; this general limit isthen broken down more finely with sub-limitsset on different types of short-term funding.

Liquidity barometers: This model calculatesthe length of time a bank can survive byliquidating its balance sheet using just twoassumptions - that the bank continues tooperate under normal operating conditionsor that the bank has suffered a complete lossof access to the money market.

(d) Monitoring: Banks must be able to track andevaluate their current and anticipated liquidityposition and capacity. A monitoring systemmust be developed, consisting of guidelines,limits, and trend development, that enablesmanagement to monitor and confirm thatcompliance is within the approved fundingtargets and if not, to pinpoint the variances.

(e) Balance Sheet Evaluation: Both the bank'sbalance sheet and market access trendsshould be periodically evaluated foremerging patterns that could adversely affectliquidity, and as the banks are becomingmore reliant on credit sensitive funding, it isvital that the bank be perceived by third partyfunding sources as being both profitable andmanaged in a safe and sound manner.

(f) Off-Balance Sheet Management Practices:It is considered a best practice to periodicallysupplement with statistical analysis ofhistorical funding patterns of various typesof off-balance sheet items. It enhances theaccuracy of future funding projections -

assuring management that naturallyoccurring contingent liabilities will not strainthe funding process.

(g) Funds Management: The funding sourcescould be deposits, capital and purchasedfunds. The various factors that must beconsidered in funding source selectioninclude integration with the bank's interestrate sensitivity, risk appetite, profit planning,diversification and capital managementobjectives.

(h) Contingency Liquidity Plan Preparation:Banks should have a formal contingencyplan of policies and procedures to use as ablueprint in the event the bank is unable tofund some or all of its activities in a timelymanner and at a reasonable cost.

Conclusion

The Indian banking system has to respond tothe new needs of the liberalized financialenvironment. Each bank will have to graduateto the complexities of changing risk profile inbanking business. A comprehensivecontingency funding plan can provide a usefulframework for meeting both temporary and long-range liquidity disruptions. A good plan shouldemphasize a reliable but flexible administrativestructure, realistic action plans, ongoingcommunications at all levels, and a set of metricsbacked by adequate management informationsystems. Availability of timely MIS reports forrapid decision making is inevitable for periodictesting of contingency plans.


The phrase, value at risk, is of fairly recent originand the science behind it owes largely to theexcellent developments in IT. When severalassets of fluctuating value, such as securitiesshares, financial derivatives, loan portfolios,foreign currency positions, and so on, are dealtwith in an organisation, an awareness of therisks of the basket of assets is relevant fordecision-making as well as in correcting anyover-exposure.

What is Value at Risk?

On the myriad balance-sheet risks that banksface today credit and interest rate risks mostlyaccount for their business risks. These and otherrisks expose a bank’s business to certainpotential losses. These losses are of three typesviz., expected, unexpected and stress loss. Theexpected loss is always insurable by the myriadhedges and therefore, forms part of banks’ costof operation. There is the unexpected loss underadverse conditions which cannot be predicted.It is this unexpected loss that is defined as valueat risk (VaR). Then there is also a third type ofloss the bank may be prepared to face underextreme conditions which occur rarely butpossibly. It is called stress loss.

Value at Risk

Value at risk technically is defined as the “Lossamount, accumulated over a certain period thatis not exceeded in more than a certainpercentage of all time”. For example, ‘VaR (99percent, 1 week) is equal to the loss amount,

VALUE AT RISK (VaR)

� The assets of the bank are subjected to expected, unexpected and stress loss. Bankscover expected loss through hedging while stress loss rarely occurs.

� VaR is the measure (amount) of unexpected loss by the bank.

� Normally VaR is measured for a specific time duration at a given level ofconfidence

� VaR ( 99%, 1 Week)= Rs.1,00,000 implies that the unexpected loss will be amaximum of Rs.1 lakh in a duration of 1 week; and the chance of it exceedingRs.1 lac can happen only in 1% of the occasion (100-99)

� Some methods of measurement: Correlation Aggregation, Historical Simulationand Monte Carlo Simulation

accumulated over one week, that is notexceeded in more than one percent of all time.For measuring VaR one relies on a model ofrandom changes in the prices of underlyinginstruments - interest rate changes, changes inforeign exchange rates, etc. - and a model forcomputing sensitivity of derivatives pricesrelative to the prices of underlying instruments.In all these, one has to remember that ‘A VaRmeasure is merely a benchmark for relativejudgments, such as the risk of one portfoliorelative to another, etc. Even if accurate,comparisons such as these are specific to atime horizon and the confidence level with whichVaR is chosen.

It is usually known as potential loss amount orthe estimated potential for loss-making for a setof assets in an organisation. It is the measureof risk to be applied to all the products/assets inthe portfolio. The distribution of profits and lossesof a portfolio, resulting from fluctuation in amarket for a day is calculated and the value atrisk is the expression of the worst loss at aconfidence level of percentage (usually above95 per cent) as may be decided in anorganisation. It is normally computed using aglobal database of Market Factor Volatility andCorrelations or from any other reliable source.

The first is the identification of market factor,which is any price or rate used directly to valuefinancial instrument. Market factors includeinterest and foreign exchange rates fixed income


bonds, equity and commodity prices, and all theirimplied volatility.

Against one unit of change for each of thesemarket factors, as relevant to the total portfolioof the individual organisation accounting for riskat value, factor sensitivity limits are also fixeddepending on the policy of risk-bearing capacityassessed by a conscious decision makingprocess. As the next step, the factor sensitivityis calculated for the positions taken for variousassets in the portfolio and the defeasance factorworked out (again, based on historical volatility).The value at risk is obtained by multiplying factorsensitivity by the defeasance factor.

VaR is evidently a probability of occurrenceexpressed mathematically and quantified inrupees for the total portfolio of trading assets ata given time. It will vary in magnitude dependingon the methodology.

Probability Methods

There are three broad approaches assetmanagers use.

Correlated aggregation: Also known as thevariance and covariance method, it provides afirst hand estimation where there has been noprevious study of estimate of VaR. This iseffective when there is a ‘normal' distributionfunction; and applies the standard deviationestimates. But even definite price-based non-option products too do not have normaldistribution functions thus limiting thetechnique’s applicability despite its simplicity.

The observed behaviour of market variablesnormally begin in the following patterns:

Greater frequency of small changes occurringwithin a standard deviation of the mean:

Lower frequency of changes that are quitemanifest between the two standard deviationsof the mean:

Greater frequency of changes that measuremore than the two standard deviations from themean that elude road-rolling and averagingassumptions in respect of market movements.This is also known as the ‘fat tail’ phenomenonin technical analysis.

Easy Historical Simulation

This technique applies the historical pricemovements directly. Depending on the productsand the system in vogue, 100 or more tradingdays’ data is used. In the historical simulationapproach, the hypothetical profit and lossportfolio of current positions is estimated forevery day in the data sample. The correlationamong the exposures and the volatility areimplicit in the historical price movements. Fromthe P&L values series so arrived at, the biggestgain and the worst loss limits are determined tofix values for the desired percentage in a day inthe historical sample of 100 days. While it isnormally 100 days for simulations, there arealways interesting debates and much dependson the particular product and the market.

Monte-Carlo Simulation

This is the most popular method. It is used forblind-landing and hence has applicability evenin the case of rocket firing. The advantage ofusing this technique is that the distribution is notassumed to be following a set pattern (such asthe bell-shaped normal distribution or the patternof past 100 days), as in the previous two cases.

Monto-Carlo can deal with any pattern of marketmovements be they humps or kinks or tails.Hence its higher efficacy. Once the particulardistribution is identified, the simulation can takecare of the scientific treatment. The method isflexible and has the best of the techniquesnarrated earlier.

For instance, Monte-Carlo simulation does nothave the problems of covariance analysis foroptions, as it deviates from the co-varianceapproach and tends towards the historicalapproach when it comes to question of patterns.

Management Tool

Management accounting is a tool and VaR is asharper one in the kit. It can be a guide fordecision-making and provide a figurative insightinto risk. Nonetheless, taking decisions basedon VaR calculations would be similar to gettinginto a pond of water on knowing the averagedepth. A constant vigil on market movementsand a good grasp of market sentiment is vitalfor efficient decision-making in financialderivatives and other assets and portfolios.


ECONOMY & FINANCEPOLICIES AND ACTS


An overheating economy is one which is growingrapidly and its productive capacity cannot keepup with the resulting demand pressures. Theemergence of inflationary pressures is usuallyseen as the first indication of overheating. In thiscontext, policy makers keenly analyse thebehaviour of the output gap, i.e., the excess ofcurrent output over potential or full capacityoutput. If the monetary authority senses thatthere is unutilized capacity, the increase indemand generated by growth can beaccommodated without inflationary pressuresand, therefore, the need to act againstoverheating may not arise. On the other hand, ifdemand runs ahead of full capacity, there willbe a case for tightening of monetary policy witha view to slowing down the economy andheading off overheating.

Although the concept of overheating isstraightforward, its implementation has anumber of problems. Globally, there is someevidence of a blurring of the relationship betweenoutput gaps and inflation. Moreover, the size anddirection of an economy’s potential output isbecoming increasingly difficult to diagnose. Inparticular, globalisation has expanded the supplypotential of various economies, especiallyemerging economies. In the recent period, itappears that the current positive supply shockhas made the concept of potential output fuzzierthan in the past. In view of the growingglobalisation, there is some evidence that

OVERHEATING OF THE ECONOMY

� An overheating economy is one which is growing rapidly and its productive capacitycannot keep up with the resulting demand pressures.

� The emergence of inflationary pressures is usually seen as the first indication ofoverheating.

domestic inflation is now increasingly influencedby global demand-supply imbalances in additionto domestic demand-supply imbalances.

These concepts and issues are furthercomplicated for a developing economy like Indiaon account of the existence of largeunemployment/underemployment of resourcesand the absence of a clear assessment ofpotential output. The concept of overheating is,therefore, less of a guide for monetary policy incountries such as India than in advancedeconomies. Furthermore, it is difficult to pass aclear judgement of potential output in aneconomy that is undergoing structuraltransformation.

Monetary management has to also look atimbalances that could be transitional. Thechallenge before the central bank is to managethe transition to a higher growth path, in thepresence of some structural rigidities, in such away that actual inflation and inflation expectationsare contained and do not become mutuallyreinforcing. If supply responses are less thanelastic, they could show up as excess demand,causing inflationary pressures and raisinginflation expectations. Against this backdrop,managing structural change while keepinginflation low without dampening the growthmomentum would be the quintessentialchallenge to monetary policy in India in the periodahead.


RUPEE APPRECIATION

� Rupee has appreciated steadily for the first time

� Traditionally an appreciating currency is considered to reflect soundness of the economy

� This has both positive and negative implications for different sectors.

The rupee has appreciated 13 per cent againstthe dollar since January, rising 10 per cent sinceApril 2007. The appreciation has been consistentduring last one year. The rise further continueswith the present Rupee level at Rs 39/- vis- a-vis. US Dollar.

Negative Impact

Exports and imports together account for around35 per cent of GDP and they have a multiplierimpact on the economy. Rupee movementimpact on FDI (around 2 per cent of GDP) andFII (around 2 per cent) and on the real economyis mainly felt through the effect on interest rates.Apart from agriculture, the entire economy issensitive to the exchange rate, some sectorsmore and others less. About 45-50 per cent ofthe economy is directly hit by appreciation. Thesituation is more harmful for exporters as 73%of Indian exporters do billing in US Dollar only. Iffor an order of Rs.100, an exporter has availeda loan Rs.90 from a bank, with the rupeeappreciating 13 per cent, the rupee receivableagainst the order is Rs.87. According to anestimate 1% change in rupee will hit theoperating margins of IT companies in FY 08 by30-50 basis points.

Even if exports grow 20% this year, theappreciation of the currency is expected to resultin Rs.53,000 crore or $13 billion loss. InformationTechnology and exporters of meat, spices andtextiles followed by leather and gems & jewelleryare worst affected. However, the concerns thatappreciating rupee could impact exports andeventually the foreign exchange reserves doesnot hold much ground in today’s context, as oureconomies globalised to a large extent andforeign investment is flowing in. These fears arebased on a deficit mindset of the 1960s whenthe foreign exchange reserves became a majorconcern leading to such slogans as ‘Export orPerish’.

Rupee appreciation has rendered 11,000 peopleemployed in textiles and garment industryjobless during March-June 2007. Impact ofRupee appreciation on employment in IT andBPO companies is visible in the form of theirvarious measures to cut costs viz., increasethe working hours of their employees. Thereare attempts to avoid immediate layoff and freshrecruitments have been stopped.

Consistent dollar remittances for investment intothe Indian stock markets by FIIs is one of themain reasons for increase in dollar supply, andthis supply has not been sucked fully by importsdemand or RBI, hence the Rupee appreciation.However FIIs who are pouring money into Indianfinancial markets are also facing the brunt ofrupee appreciation. Take the case of a FII whichentered the Indian financial markets at a dollarrate of 44. The real return, if it were to liquidateits investments today, is much lower comparedto a good return in Rupee terms. For instance,a FII which invested in Indian assets say $1000US at a rate of Rs.43.50, assuming that after ayear his assets have appreciated by 10% toRs.47,850.00, but at the same time the dollar


has depreciated to Rs 40.50; now the value ofhis assets would be Rs. 44,850.00, instead ofRs.47,850.00, so the net gain to the investor isa humble 3.10% over a year.

Positive Impact

Impact of appreciating Rupee on imports isexactly reverse, i.e. good. As per an estimatefor every 1 Rupee appreciation the input cost ofcrude dips by 2%.

The rising rupee has helped the government tocurb inflation, as the input cost of imported crudeand electronic items lowered. Rising Rupeealong with unchanged domestic petroleumprices since February has contributed tobringing down inflation to a five-year low.

Another beneficiary of rising rupee is theborrowers who have borrowed from internationalbanks. The companies like Tata steel, Mcdowell,to name a few, for their take-over plans of Corusand Whyte & Mackay. As on December 2006

the country had an external debt of $142.65 billiondollar so a 10% appreciation in dollar means theexternal debt is reduced to $128.38 billion.

Generally the appreciating Rupee is consideredto be a reflection of strong fundamentals of Indianeconomy, higher returns and expectations.However, Rupee has depreciated against Euroand GBP, so it is not be prudent to say that therise in rupee is purely based on growth ineconomy, it is also because of short-termrecession in US.

But important issue is how to manage anappreciating rupee rather than stopping ordeliberately depreciating it.The way oureconomy is growing we can expect substantialFII and FDI flows along with trade and otherinvisible receipts. It may not be easy for the RBIto continue with the practice of buying largeamounts of dollars as that would onlyexacerbate inflationary pressures.


Financial exclusion signifies the lack of accessby certain segments of society to appropriate,low-cost, fair and safe financial products andservices from mainstream providers. In India,48% of Indian households (62% in rural India)do not avail financial services from the formalsector. The data is skewed across the states –ranging from 25% in South India to 75% in NorthEast India. Financial exclusion is acomprehensive yardstick for measuring theextent to which sections of the society areoutside the mainstream and excluded fromparticipation in the country’s economy. While 10-15% households even in USA, 8-10% in UK, and7-10% in France do not have access to bankaccounts, the extent of exclusion is obviouslyhigher in India. The urban perception is that wehave a plethora of banks and branches. Afternationalisation of banks in 1969, the numbersof bank branches have increased 9 times from8,187 in 1969 to 71,781 in 2007. However, thepopulation per bank branch is still around 15,000.Although, the literacy rate is 65%, out of every100 persons only 33 have savings bankaccounts and only 34 have demand depositaccounts. Only 1.5 crore SME units havereceived financial assistance from the formalsector.

According to the report of the Internal Group setup by RBI, there are both supply side anddemand side reasons for financial exclusion.Supply side perceptions are that the poor are‘unbankable’. Deposit and loan tickets are small,distances are too long for servicing andsupporting the small accounts, transaction

INCLUSIVE GROWTH

� Inclusive growth is a term wider than financial inclusion.

� Financial exclusion signifies the lack of access by certain segments of society toformal banking system.

� The consequences of financial exclusion are large-scale unemployment, naxalismand terrorism.

� Financial input is not the sole vector for growth. It must have linkages with other realsectors for inclusive growth.

costs are high, security situation prevailing insome parts of rural India is adverse, there is lackof adequate collateral for loans and there arehuman resources constraints in terms of lackof proper orientation. The demand sideconstraints are lack of awareness of bankingfacilities, high transaction cost at client level dueto expenses such as travel costs, wage losses,incidental expenses, non-availability of idealproducts, hassles related to documentation andeasy availability of timely and doorstep servicesfrom informal sources.

The consequences of financial exclusion arelarge-scale unemployment, increase inincidence of Naxalism, terrorist activities andsocial tension. The system encouragesmoneylenders and informal lending sources togive credit at exorbitant rates, leading to a debttrap and suicides committed by the poor andthe disadvantaged.

It was for the above reasons that RBI flaggedthe issue of financial inclusion in its AnnualPolicy Statement 2005-06. RBI had suggestedsome ways and means for financial inclusion.It has advised banks to make available a basicbanking “no frills” account either with zerobalance or with very low minimum balance aswell as charges that would make such accountsaccessible to vast sections of the population.KYC procedure for opening accounts has beensimplified for those persons who intend to keepbalances not exceeding Rs.50,000/- in all theiraccounts. RBI has also advised banks tointroduce General Credit Card in rural and semi-


urban centres. These cards operate like ordinarycredit cards and there is no linkage to thepurpose and end-use of funds.

Though the above-mentioned measures canencourage the banking habit and increase thenumber of bank accounts and credit cards, thetransformation at the ‘bottom of the pyramid’ canbe brought about only through micro-credit. Theconcept of micro credit was revolutionised byGrameen Bank in Bangladesh. Grameen Bankprovides credit to the poorest of the poor in ruralBangladesh, without any collateral. At GrameenBank, credit is a cost effective weapon to fightpoverty and it serves as a catalyst in the overalldevelopment of the socio-economic conditionsof the poor who had been kept outside thebanking orbit on the ground that they are poorand hence not bankable. Professor MuhammadYunus, the founder of ‘Grameen Bank’ and itsManaging Director, reasoned that if financialresources can be made available to poor peopleon terms and conditions that are appropriate andreasonable, “these millions of small people withtheir millions of small pursuits can add up tocreate the biggest development wonder”. For hispioneering work, Prof. Yunus was honoured withthe Noble Peace Prize in 2006. In India, manycommercial banks are lending directly to thepoor and the SHGs. RBI has recently issuedguidelines to banks enabling them to use theservices of Non–Government Organizations(NGOs)/Self Help Groups (SHGs) and MicroFinance Institutions (MFIs) as intermediaries inproviding financial and banking services throughthe use of the Business Facilitator. MFIs providemicro finance services to the rural poor throughSHGs. They organize SHGs, bring peopletogether, explain the concept to them, coordinatethe group, help them to maintain accounts andlink them to the banks. During Bankers’Conference 2006, Ms Mercedes Benavides,Manager, Women’s World Bank (WWB)explained the need for intermediation by MFI’s.WWB is basically a MFI with a network of 23affiliates, many of which are working inpartnership with notable commercial banks.She explained that the average loan size in microcredit is USD $500 - $1000 for which large

commercial banks are not bullish who look toonly large loans for their portfolio. MFI employeesare groomed to work with the poor at closeproximity and to help them in forming andpromoting SHGs. Ms. Benavides explained thata partnership of MFIs with commercial bankscan translate into a profitable venture for both.WWB is working with various commercialbanks. They have partnered a commercial bankin Columbia and adapted their entire productrange for micro financing to cross sell theproducts to the poor and the SHGs. Similarly inMexico, WWB has partnered a Mexicancommercial bank in developing products andfinancing SMEs in a big way.

Dr Y.V. Reddy, Governor, RBI recentlymentioned that in the coming days financialinclusion would be a business need for Indianbanks. Lately, deposit mobilisation is the biggestchallenge to Indian commercial banks anddeposits from only small depositors are stable.Furthermore, with large corporates going in forIPOs and external commercial borrowings andthe retail sector slowing down, banks need totarget SMEs and the urban and rural poor forlending. Experts estimate that the combinedappetite of the urban and rural poor for creditstands at Rs. 2,00,000 crore, against which ameagre sum of Rs.10,000 crore is flowingthrough the banking system. Critics contend thatthe problem with the formal banking system hasbeen its inability to reach out to the really poorand needy and making the right amount of creditavailable to them. MFIs are emerging as leadbusiness generators for the banks; but they arelargely dependent on banks with a large depositbase for funds. Venture capitalists have evincedinterest with SKS, an Andhra- based MFI, raising$ 11.5 million from Sequoia Capital and otherventure funds. But such instances are still theexception. According to Vikram Akula, founderof SKS, “Most of the MFIs will become front endsfor banks originating and servicing loans, likeDSAs, with banks funding the loans and keepingthem on their balance sheets”. The partnershipcan be a win-win proposition for both the MFIsand commercial banks.


A common criticism against MFIs is that theycharge exorbitant interest rates, as high as 25%.However, Shri Vijay Mahajan, CEO, Basix, aleading MFI, explains, “The cost of funds forMFIs is 11% and bad debts is 1%. The deliverycost is 10% to 11% as the average loan of anMFI is Rs.6000/- and is repaid in upto 50 weeklyinstalments which are collected by the MFI stafffrom the door step or work place of the borrower.Therefore, the operating cost as a percentageof small amounts of each instalment is high.”Thus the profit for an MFI is only 1-2 % which isnecessary to maintain capital adequacy withRBI. The Union Finance Minister, Shri P.Chidambaram, mentioned during the BANCON2006 that interest rate on lending through MFIswould be in the range of 20-25%. Even Ms.Benavides mentioned that internationally thecost of lending through MFI is 20-25%. Theaverage rate charged by money lenders is 36%,i.e. one-and-a-half time higher than MFIs, andmoneylenders do not accept repayment ininstalments.

In India 27.09% of the rural population and23.62% of the urban population live below thepoverty line. MFIs and inclusive growth could bethe answer to our 60-year-old ‘Garibi Hatao’slogan. A word of caution, financial input is notthe sole vector for growth. It must have linkageswith other real sectors, viz., inputs (rawmaterial), infrastructure (electricity, roads,irrigation, transport), skilled and enterprisinghuman resources and market. Fifty six millionloans were disbursed under the IRDP scheme,of which 95% turned bad due to lack of linkageswith other sectors. Khadi industry is unviable inspite of huge subsidies because there is no readymarket for it. Vidarbha farmers are not able tobreak even due to the small size of theiragricultural land holding that does not facilitatemodern farming. Financial inclusion is just asubset of economic inclusion. For financialinclusion to translate into inclusive growtheconomic inclusion is a necessary pre-condition.


ECONOMIC SURVEY 2006-07

� GDP to grow 9.2%, touch Rs 28,44,000 crore in 2006-07� Inflation at 6.7% on February 3 a matter of concern� Govt’s top priority: Growth without high inflation� Risks: volatile oil prices, delays in WTO talks� Risks: Global macroeconomic imbalances� Priorities: Making growth inclusive� Priorities: Fiscal prudence, high investment� Priorities: Improving govt intervention in critical areas such as education and health� Priorities: Subsidies to be targeted� Agriculture to grow 2.7%, share in GDP dips to 18.5%� Industry to grow at 10%, share in GDP up to 26.4%� Services to grow at 11.2%, share in GDP rises to 55.1%� 10th plan average GDP growth at 7.6% vs targeted 8%� Average inflation in 52 weeks ending Feb 3 at 5%� Food items, wheat, pulses, sugar driving inflation� In industry, mining, gas and power issues of concern� Current account deficit at $11.7 billion in H-1 of FY07� Exports up 36.3% to $89.5 bn in April-Dec 2006-07� Capital flows strong, FDI up 98.4% in Apr-Sept 2006-07� FIIs sellers in H-1, but likely to be positive in H-2� Core sector growth 8.3% vs 5.5% in Apr-Dec 2006-07� Infrastructure to require $320 bn in 11th plan� Public sector to fund 60 per cent of infrastructure� Fiscal deficit budgeted at 3.8 pc in 2006-07� Tax-GDP ratio rises to 11.2% FY07 vs 10.3% in FY06� Personal income tax mop up rose 30.3% in Apr-Dec FY07� Share of direct taxes in total revenues grows to 47.6%� Stock markets buoyant, market cap rises to 91% of GDP� Rs 161,769 crore raised from IPOs in 2006� Mutual funds raise Rs 104,950 cr in 2006, up four-fold� Corporate tax collections up 55.2% in Apr-Dec FY07� Tourism earnings cross $6.6 bn in 2006� Gross domestic savings rate up at 32.4% in 2005-06� Gross domestic investment rate at 33.8% in 2005-06� Gross fixed capital formation rises to 28.1% in 2005-06� Savings of private corporates rise sharply at 8.1%� High savings rate to continue� Saving-investment gap turns negative at 1.3%� Govt to miss 2007 target of elementary education to all� Employment rate grows to 2.5% in 1999-2005� Decline in organised sector jobs� Unemployment rate up to 3.1% in 2004-05� Poverty down at 22% in 2004-05 vs 26.1% in 1999-2000


Macroeconomic Overview

� Indian economy, Asia’s fourth largest, isestimated to grow at 9.2% in FY’07, itsfastest pace in 18 years; this follows 9.0%in FY’06.

� Entrenchment of the higher growth trends,particularly in manufacturing, has boostedsentiments, both within the country andabroad.

� Overall macroeconomic fundamentals arerobust, particularly with tangible progresstowards fiscal consolidation and a strongbalance of payments position. With anupsurge in investment, the outlook isdistinctly upbeat.

� Services contributed as much as 68.6% ofthe overall average growth in GDP in thelast five years between 2002-03 and 2006-07. Practically, the entire residualcontribution came from industry. As aresult, in 2006-07, while the share ofagriculture in GDP declined to 18.5%, theshare of industry and services improved to26.4% and 55.1%, respectively.

� A notable feature of the current growthphase is the sharp rise in the rate ofinvestment in the economy. The rate ofGross Domestic Capital Formation (GDCF)for 2005-06 was 33.8% (31.5 in 2004-05).

� This sharp increase in the investment ratehas sustained the industrial performanceand reinforces the outlook for growth.

� Services sector growth has continued to bebroad-based. Among the three sub-sectorsof services, ‘trade, hotels, transport andcommunication services’ has continued toboost the sector by growing at double-digitrates for the fourth successive year.Impressive progress in informationtechnology (IT) and IT-enabled services,both rail and road traffic, and fast additionto existing stock of telephone connections,particularly mobiles, played a key role insuch growth.

� Growth in financial services (comprisingbanking, insurance, real estate andbusiness services), after dipping to 5.6% in2003-04 bounced back to 8.7% in 2004-05

and 10.9% in 2005-06. The momentum hasbeen maintained with a growth of 11.1% in2006-07.

� After an annual average of 3.0% in the firstfive years of the new millennium starting2001-02, growth of agriculture at only 2.7%in 2006-07, on a base of 6% growth in theprevious year, is a cause of concern. Lowinvestment, imbalance in fertilizer use, lowseeds replacement rate, a distortedincentive system and low postharvest valueaddition continued to be a drag on thesector’s performance.

� With more than half the population directlydepending on this sector, low agriculturalgrowth has serious implications for the‘inclusiveness’ of growth.

Inflation

� With a shortfall in domestic production vis-à-vis domestic demand and hardening ofinternational prices, prices of primarycommodities, mainly food, have been on therise in 2006-07 so far. Wheat, pulses, edibleoils, fruits and vegetables, and condimentsand spices have been the major contributorsto the higher inflation rate of primary articles.

� Inflation: As much as 39.4% of the overallinflation in WPI on February 3, 2007 camefrom the primary group of commodities.

� Including manufactured products such assugar and edible oils, food articlescontributed as much as 27.2% to overallinflation of 6.7% on February 3, 2007.

� Starting with a rate of 3.98%, the inflationrate in 2006-07 has been on a generalupward trend with intermittent decreases.However, average inflation in the 52 weeksending on February 3, 2007 remained at 5%.A spurt in inflation like in the current yearhas been observed in the recent past in1997-98, 2000-01, 2003-04 and 2004-05.

Money and Banking Sector

� Inflation, with its roots in supply-side factors,was accompanied by buoyant growth ofmoney and credit in 2005-06 and 2006-07so far. While GDP growth accelerated from7.5 per cent to 9.0 per cent between 2004-05 and 2005-06, the corresponding


acceleration in growth of broad money (M3)was from 12.3% to 17.0%. Year-on-year, M3grew by 21.1% on January 19, 2007.

� Industrial resurgence and upswing ininvestment was reflected in, and sustainedby, growth of gross bank credit (as per datacovering 90% of credit by scheduledcommercial banks), for example, to industry(medium and large) at 31.6% and forhousing loans at 38% in 2005-06. It was alsoobserved in year-on-year growth of grossbank credit at 32.0% in September 2006,albeit marginally down from 37.1% in 2005-06.

� Reconciling the twin needs of facilitatingcredit for growth on the one hand andcontaining liquidity to tame inflation on theother remained a challenge.

� RBI put a restraint on the rapid growth ofpersonal loans, capital market exposures,residential housing beyond Rs. 20 lakh andcommercial real estate loans by more thandoubling the provisioning requirements forstandard advances under these categoriesfrom 0.40% to 1.0% in April 2006.Simultaneously, it increased the risk weighton exposures to commercial real estatefrom 125% to 150%.

� Liquidity conditions remained fairlycomfortable up to early September 2006 withthe unwinding of the Central Governmentsurplus balances with the RBI and continuedintervention in the foreign exchange marketto maintain orderly conditions. During 2006-07, up to September 8, 2006, RBI had notreceived any bid for repo under LAF and thecontinuous flow of funds under reverse-repoindicated a comfortable liquidity position.

� There was some tightness with the onsetof the festival season and due to high creditexpansion and outflows on account ofadvance tax payment. From mid-September through October, 2006, whileRBI had to provide accommodation to somebanks through repo facility, with reverse repooperations simultaneously, in net terms, RBIabsorbed liquidity from the system.

� With year-on-year inflation stubbornly above5% from early-August 2006, on October 31,

2006, the RBI announced more measuresto stem inflationary expectations and alsoto contain the credit off-take at the desiredgrowth rate of 20%.

� Since deposits are growing at a lower ratethan credit, the higher repo rate signaled tothe banks the higher price ofaccommodation they would have to pay incase of credit overextension.

External Sector

� In the balance of payments, in 2005- 06 andin the first half of 2006-07, capital flowsmore than made up for the current accountdeficits of US$9.2 billion and US$11.7 billion,respectively, and resulted in reserveaccretion.

� The current account deficit reflected thelarge and growing trade deficit in the lasttwo years. Exports grew fast, but importsgrew even faster, reflecting in part theongoing investment boom and the highinternational petroleum price.

� In 2005-06, imports (in US dollar terms andcustoms basis) had grown by 33.8%. In thefirst nine months of the current year, importsgrew by 36.3%. While petroleum importscontinued to grow rapidly, non-oil importgrowth decelerated to a moderate 18.7% inthe first nine months of the current year,primarily because of high bullion pricesleading to a decline in import of gold andsilver in the first few months of the year. Thenon-POL trade balance, after remaining insurplus till 2003-04, has turned negativesince 2004-05.

� India’s exports (in US dollar terms) havebeen growing at a high rate of more than20% since 2002-03. During 2005-06, withgrowth of 23.4%, India’s exports crossed theUS$100 billion mark.

� During 2006-07, after a slow start, exportsgained momentum to grow by an estimated36.3% in the first nine months to reachUS$89.5 billion. Buoyancy of exports wasdriven by the resurgence in themanufacturing sector and sustaineddemand from major trading partners.


� Overall, the external environment remainedsupportive with the invisible accountremaining strong and stable capital flowsseamlessly financing the moderate levelsof current account deficit caused primarilyby the rise in international oil prices. Thecurrent account deficit remained moderateat 1.1 per cent of GDP in 2005-06.

� Capital flows into India remained strong.Foreign investment, as a proportion ofcapital flows, has remained in the range of39.1% to 79.3% in the last four years endingin 2005-06.

� There was strong growth in foreign directinvestment (FDI) flows (net), with threequarters of such flows in the form of equity.The growth rate was 27.4% in 2005-06followed by 98.4% in April-September 2006.This was even after gross outflows underFDI with domestic corporate entitiesseeking a global presence to harness scale,technology and market access advantagesthrough acquisitions overseas.

Capital Market

� The positive sentiments were manifest alsoin most indicators such as resourcemobilized through the primary market.Aggregate mobilization, especially throughprivate placements and Initial PublicOfferings (IPOs), grew by 30.5% cent to Rs.161,769 crore in 2006 with about 6 IPOsevery month.

� Net mobilisation of resources by mutualfunds increased by more than four-fold fromRs.25,454 crore in 2005 to Rs.1,04,950crore in 2006. The sharp rise in mobilisationby mutual funds was due to buoyant inflowsunder both income/debt oriented schemesand growth/equity oriented schemes.

� The upbeat mood of the capital markets,reflecting the improved growth prospects ofthe economy, was partly also a result ofsteady progress made on the infrastructurefront. Overall index of six core industries —electricity, coal, steel, crude oil, petroleumrefinery products, and cement, with a weightof 27% in IIP - registered a growth of 8.3%in April-December 2006 compared to 5.5%in April-December 2005.

Infrastructure

� Investment requirements for infrastructureduring the Eleventh Five Year plan areestimated to be around US$ 320 billion.While nearly 60% of these resources wouldcome from the public sector, the balancewould need to come either from the privatesector and/or through public-privatepartnership (PPP).

� The ability of Government and the publicsector to invest additional resources fordeveloping the much-needed infrastructurecritically depends on the creation of fiscalspace. The notification of the FiscalResponsibility and Budget Management Act(FRBMA) 2003, with effect from July 5, 2004,the culmination of the policy resolve to placethe process of fiscal consolidation in aninstitutional framework, has yielded richdividends in terms of creating such fiscalspace.

Fiscal Deficit

� Fiscal deficit declined to 4.1% of GDP in2005-06 and was budgeted at 3.8% of GDPin 2006-07.

� Budgeted Fiscal deficit of the States hasdeclined to less than the mandated 3% twoyears ahead of schedule, and only amarginal revenue deficit remains to beeliminated.

� The resumption of the fiscal consolidationprocess in 2006-07, without compromisingthe National Common MinimumProgramme (NCMP) objectives, indicatesthe commitment towards meeting theFRBMA targets.

� The tax-GDP ratio of the Centre has steadilyrisen from 8.8% in 2002-03 to 10.3% in 2005-06 and was budgeted at 11.2% in 2006-07.

� After growing by 20.3% and 22.7%,respectively in 2005-06, corporate incometax and personal income tax have grown by55.2% and 30.3%, respectively in April-December 2006 over April-December 2005.

� Buoyant growth in direct taxes revenue hashelped take its share in total revenue to47.6% in 2006-07 (BE). In the reduction ofrevenue and fiscal deficits, buoyant revenue


growth has been complemented by adiscernible shift in the composition ofexpenditure.

Issues and Priorities

� The economy appears to have decidedly‘taken off’ and moved from a phase ofmoderate growth to a new phase of highgrowth.

� Achieving the necessary escape velocity tomove from tepid growth into a sustainedhigh-growth trajectory requires carefulconsideration of two issues and threepriorities. The two issues are: thesustainability of high growth with moderateinflation; and the inclusive nature of suchhigh growth. The three priorities are: risingto the challenge of maintaining andmanaging high growth; bolstering the twinpillars of growth, namely fiscal prudenceand high investment; and improving theeffectiveness of Government intervention incritical areas such as education, health andsupport for the needy.

� On the first issue of sustainability of highgrowth without running into high inflation,various indicators suggest that the currentgrowth phase is sustainable.

� First, higher growth together with thedemographic dividend (from a growingproportion of the population in the workingage group) is likely to lead to a rise in thesavings rate to finance more and moreinvestment.

� Second, efficiency improvements in theeconomy since 1999-2000 reinforce theconfidence in the high-growth phase.

� Third, it is not only the sustained increasein savings and investment, availability oflabour at reasonable wage rates, andefficiency increases, but also the openingup of new avenues in services, beyond thealready well-known IT and ITES, that bolsterconfidence in the new high-growth phase.For example, in a remarkable transition, thetourism industry has displayed buoyantdouble-digit annual growth rates in each ofthe last three years. Tourism contributesover 10% of global GDP and its potential in

India, given the country’s enormous natural,human and technological resources, is wellrecognised.

� Fourth, concerns have been expressedabout whether the country is growingbeyond its growth potential thereby strainingits labour force and capital stock, and henceengendering inflationary instabilities.

� Fifth, infrastructure, that constrained foryears the growth performance of theeconomy, appears to be improving. Thereare signs of tangible progress in areas suchas power, roads, ports, and airports.Following the road shows abroad forattracting global financial capital, the settingup of a US $ 5 billion fund to finance Indianinfrastructure on February 15, 2007 by fourmajor financial institutions (Citigroup,Balckstone, Infrastructure Development andFinance Corporation and India InfrastructureFinance Company), is an encouragingdevelopment.

� The second issue is about the nature of thishigh growth in terms of inclusiveness.Putting more people in productive andsustainable jobs lies at the heart of inclusivegrowth. But such success, primarily, willdepend on the success in achieving andmaintaining high growth. There cannot beinclusive growth without growth itself.

� Unemployment has gone up not becauseof high growth, but because growth was nothigh enough. It is important to avoid themisconception that inclusive growth, bynecessity, will have to be low growth.

� Inflation in recent times has been triggeredby the rapid rise in the prices of primaryarticles all over the world. In India, prices ofessential food items have come underpressure.

� The second priority is bolstering the twinpillars of high growth, namely, fiscalprudence and high investment.

� The third priority is improving theeffectiveness of Government interventionin critical areas especially in the socialsector.


Under Article 112 of the Constitution, a statementof estimated receipts and expenditure of theGovernment of India has to be laid before theParliament in respect of every financial yearwhich runs from 1st April to 31st March. Thisstatement titled “Annual Financial Statement” isthe main Budget document. The Annual FinancialStatement shows the receipts and payments ofGovernment under the three parts in whichGovernment accounts are kept: (i) ConsolidatedFund, (ii) Contingency Fund and (iii) PublicAccount.

Consolidated FundAll revenues received by Government, loansraised by it, and also its receipts from recoveriesof loans granted by it, form the ConsolidatedFund. All expenditure of Government is incurredfrom the Consolidated Fund and no amount canbe withdrawn from the Fund withoutauthorisation from the Parliament.

Contingency FundOccasions may arise when the Governmentmay have to meet urgent unforeseen expenditurepending authorisation from the Parliament. TheContingency Fund is an imprest placed at thedisposal of the President to incur suchexpenditure. Parliamentary approval for suchexpenditure and for withdrawal of an equivalentamount from the Consolidated Fund issubsequently obtained and the amount spentfrom Contingency Fund is recouped to the Fund.

SOME BUDGET CONCEPTS

� The Annual Financial Statement shows the receipts and payments of Governmentunder the three parts in which Government accounts are kept: (i) Consolidated Fund,(ii) Contingency Fund and (iii) Public Account.

� Government Budget comprises (i) Revenue Budget; and (ii) Capital Budget.

� All public expenditure is classified into (a) Non-plan expenditure and (b) Planexpenditure.

� Revenue deficit is the excess of revenue expenditure over revenue receipts.

� Gross fiscal deficit is the excess of total expenditure (including loans, net of changesin recoveries) over revenue receipts (including external grants) and non-debt capitalreceipts.

The corpus of the Fund authorised by theParliament, at present, is Rs.500 crore.

Public Account

Besides the normal receipts and expenditure ofGovernment which relate to the ConsolidatedFund, certain other transactions enterGovernment accounts, in respect of whichGovernment acts more as a banker, for example,transactions relating to provident funds, smallsavings collections, other deposits, etc. Themoneys thus received are kept in the PublicAccount and the connected disbursements arealso made therefrom. Generally speaking, PublicAccount funds do not belong to the Governmentand have to be paid back some time or the otherto the persons and authorities who depositedthem. Parliamentary authorisation for paymentsfrom the Public Account is, therefore, notrequired.

Revenue vs. Capital Budget

Under the Constitution, Budget has to distinguishexpenditure on revenue account from otherexpenditure. Government Budget, therefore,comprises (i) Revenue Budget; and (ii) CapitalBudget.

Revenue Budget consists of the revenuereceipts of Government (tax revenues and otherrevenues) and the expenditure met from theserevenues. Tax revenues comprise proceeds oftaxes and other duties levied by the Union. The


estimates of revenue receipts shown in theAnnual Financial Statement take into account theeffect of the taxation proposals made in theFinance Bill. Other receipts of the Governmentmainly consist of interest and dividend oninvestments made by the Government, fees, andother receipts for services rendered by theGovernment. Revenue expenditure is for thenormal running of the Government departmentsand various services, interest charges on debtincurred by Government, subsidies, etc. Broadlyspeaking, expenditure which does not result increation of assets is treated as revenueexpenditure. All grants given to StateGovernments and other parties are also treatedas revenue expenditure even though some ofthe grants may be for creation of assets.

Capital Budget consists of capital receipts andpayments. The main items of capital receiptsare loans raised by the Government from publicwhich are called Market Loans, borrowings byGovernment from Reserve Bank and otherparties through sale of Treasury Bills, loansreceived from foreign Governments and bodiesand recoveries of loans granted by CentralGovernment to State and Union TerritoryGovernments and other parties. Capitalpayments consist of capital expenditure onacquisition of assets like land, buildings,machinery, equipment, as also investments inshares, etc., and loans and advances grantedby Central Government to State and UnionTerritory Governments, Government companies,Corporations and other parties. Capital Budgetalso incorporates transactions in the PublicAccount.

Plan Expenditure vs. Non-Plan Expenditure

The Central Government adopted a newclassification of public expenditure from 1987-88 Budget. Under this new classification, allpublic expenditure is classified into (a) Non-planexpenditure and (b) Plan expenditure.

Non-Plan Expenditure

Non-Plan expenditure is a generic term, whichis used to cover all expenditure of Governmentnot included in the Plan. It may either be revenueexpenditure or capital expenditure. Part of theexpenditure is obligatory in nature, e.g., interest

payments, pensionary charges and statutorytransfers to State and Union TerritoryGovernments. A part of the expenditure relatesto essential functions of the State, e.g., Defence,internal security, external affairs and revenuecollection.

Non-plan expenditure is further divided intorevenue expenditure and capital expenditure.Revenue expenditure is financed out of revenuereceipts, both tax revenue and non-tax revenue.Following are included under revenueexpenditure: interest payments, defencerevenue expenditure, major subsidies (food,fertilizers and export promotion), othersubsidies, debt relief to farmers, postal deficit,police, pensions, other general services (organsof state, tax collection, external affairs, etc.),social services (education, health, broadcasting,etc.), economic services (agriculture, industry,power, transport, communications, science andtechnology, etc.) and grants to states and UTsand grants to foreign governments.

Capital non-Plan expenditure includes suchitems as: Defence capital expenditure, loans topublic enterprises, loans to states and unionterritories and loans to foreign governments.

Plan Expenditure

The second major item of Central Governmentexpenditure is Plan Expenditure which iscomposed of:

(a) Central Plans such as agriculture, ruraldevelopment, irrigation and flood control, energy,industry & minerals, transport andcommunications, science and technology andenvironment, social services and others and

(b) Central assistance for Plans of the Statesand UTs.

Outcome Budget

With effect from Financial Year 2007-08, thePerformance Budget and the Outcome Budgethitherto presented to Parliament separately byMinistries/Departments, are merged andpresented as a single document titled “OutcomeBudget” by each Ministry/Department in respectof all Demands/Appropriations controlled bythem, except those exempted from this


requirement. Outcome Budget broadly indicatesphysical dimensions of the financial budget of aMinistry/Department, indicating actual physicalperformance in the preceding year (2005-2006),performance in the first nine months (up toDecember) of the current year (2006-2007) andthe targeted performance during the next year(2007-2008).

Outcome Budget contains a brief introductorynote on the organization and function of theMinistry/Department, list of major programmes/schemes implemented by the Ministry/Department, its mandate, goal and policyframework, budget estimates, scheme-wiseanalysis of physical performance and linkagebetween financial outlays and outcome, reviewcovering overall trends in expenditure vis-a-visbudget estimates in recent years, review ofperformance of statutory and autonomousbodies under the administrative control of theMinistry/Department, reform measures, targetsand achievements and plan for futurerefinements.

As far as feasible, coverage of women and SC/ST beneficiaries under various developmentalschemes and schemes for the benefit of NorthEastern Region are also separately indicated.

Vote on Account

The whole process beginning with thepresentation of the Budget and ending withdiscussions and voting on the Demands forGrants requires sufficiently long time. The LokSabha is, therefore, empowered by theConstitution to make any grant in advance inrespect of the estimated expenditure for a part

of the financial year pending completion ofprocedure for the voting of the Demands. Thepurpose of the ‘Vote on Account’ is to keepGovernment functioning, pending voting of ‘finalsupply’. The Vote on Account is obtained fromParliament through an Appropriation (Vote onAccount) Bill.

Deficit Definitions

1. Revenue deficit is the excess of revenueexpenditure over revenue receipts.

2. Net RBI credit to the Central Government isthe sum of increase in the Reserve Bank’sholdings of i )Treasury Bills, ii) Governmentof India dated securities, iii) rupee coins andiv) Ways and Means Advances from theReserve Bank to the Centre (since April 1,1997) adjusted for Centre’s cash balanceswith the Reserve Bank.

3. Gross fiscal deficit is the excess of totalexpenditure (including loans, net of changesin recoveries) over revenue receipts(including external grants) and non-debtcapital receipts.

4. Net fiscal deficit is the difference betweengross fiscal deficit and net lending.

5. Gross primary deficit is the differencebetween gross fiscal deficit and interestpayments.

6. Net primary deficit denotes net fiscal deficitminus net interest payments.


UNION BUDGET 2007- 08

� Consistently high GDP growth 9.2% in FY ’07 (9.0% in FY’06) fastest in 18 yrs.

� Industry (10%) & Services (11.2%) clock double digit growth. However, agriculturalgrowth at 2.3% is below the 10th Plan target of 4%.

� Inflation a major concern.

� Investment rate: 33.8% in FY’06 up from 31.5% in FY’05.

� FDI inflows more than doubled to US $.12.5 bn and outpaced portfolio investment of$6.8bn during April-Jan FY’07.

� Budget focus: inflation control, inclusive growth, infrastructure development.

Sector Measure Impact

Farm credit target of Rs.2,25,000crore for 2007-08 and addition of 50lakh new farmers to the bankingsystem

The two-percent interest subventionscheme for short-term crop loanswill continue in 2007-08 with aprovision of Rs.1,677 cr for thatpurpose

Special plan over three years for 31distresses districts in four statesinvolving Rs.16,979 cr. Water-related schemes and plan to providesubsidiary income to farmersthrough induction of high-yieldingmilch animals and related activities.

Integrated oilseeds, oil palm, pulsesand maize development programmeto be expanded

Special purpose tea fund launchedfor re-plantation and rejuvenation oftea, to be followed by similarmeasure for coffee, rubber, spices,cashew and coconut

RIDF increased by Rs.2,000cr toRs.12,000cr

Accelerated Irrigation BenefitProgramme (AIBP) revamped to

Banks to step up agricultural lending

Subvention continued for publicsector banks. Now extended toRRBs and co-operative banks.

Banks can meet the financialrequirements of farmers whoacquire irrigation facilities under thescheme, will also help banks toreduce NPAs.

Opens up opportunities to financeseed production and expandagricultural lending.

Opportunities for lending for thesecrops.

Finance for rural infrastructure. Tohelp banks meet shortfall in prioritysector lending.

As area under irrigation goes upthere will be increased productivity

Agriculture &Rural Develop-ment



complete more irrigation projects intime.

Rs.100 crore allocated for the newRainfed Area DevelopmentProgramme. World Bank has signeda loan agreement with Tamil Nadufor Rs.2,182 cr to restore 5,763 waterbodies having command area of 4lakh hectares. Similar agreementswith AP, Karnataka, Orissa and WestBengal are in the pipeline

100% subsidy to be provided tosmall and marginal farmers and 50%subsidy to other farmers for groundwater re-charge “dug-wells’ in criticalblocks identified by Central GroundWater Board.

The Indian Council of AgriculturalResearch (ICAR) may set up ateaching cum demonstration modelof water harvesting in each of 32selected State AgriculturalUniversities and ICAR institutes totrain 100 trainers and 1000 farmerseach in good water managementpractices.

A new programme to replicate theTraining & Visit (T&V) programme.

Agriculture Technology ManagementAgency (ATMA) that is now in placein 262 districts will be extended toanother 300 districts in 2007-08

Agricultural crop insurance schemeto be extended

and better prospects for bankfinance

These initiatives will help buildadditional irrigation facilities andhelp productivity and thereforeeffectiveness of bank credit in thelong run. Will promote balancedregional growth.

These initiatives will help buildadditional irrigation facilities andhelp productivity and thereforeeffectiveness of bank credit in thelong run.

This aims at ending stagnation infarm yields and giving an R & Dpush to productivity, which is apositive for bank lending.

Extension services in agriculture willget re-vamped and this should helpend the stagnation in this sector.Banks can recruit specialists orredeploy staff for extension work.

Risks for farmers as well as forbanks will be reduced

Infrastructure 7 more Ultra Mega Power Projectsunder process and at least two to beawarded by July 2007

Allocation for National HighwayDevelopment Programme upRs.12,600 cr (last year Rs.9,955cr)

Work on Golden Quadrilateral almostcomplete

Opportunity for bank financing.

Government guarantee will helpattract finance for the project fromprivate investors and banks.

Increases availability of long-termfunds for infrastructure.



It is a welcome move to utilize fundsin a better way. It would also resultin some additional business forbanks.

Mutual Funds to launch infrastructurefunds

Part of forex reserves to be used forinfrastructure funding – underexamination

PPP and viability gap funding:revolving fund with corpus of Rs 100cr to be set up. Shelf of bankableprojects.

Innovative financing for infrastructureby borrowing from NSS Funds

SMEs Excise exemption limit for SSI unitsincreased to Rs.1.5 cr from Rs.1 cr

Surcharge eliminated for small firmswith a turnover of Rs.1 cr or less

The measure will help upscale SSIunits and make them morecompetitive. Increase in scope forbank finance.

Education,Health & SocialSector

Allocation for education enhanced by34.2%

2 lakh more teachers & 5 lakh moreclassrooms

Means-cum-merit scholarship:Rs.750 cr corpus to be placed withSBI

Creation of 1 lakh jobs for physicallychallenged.

Healthcare allocation increased by21.9%

Rural landless households to bebrought under safety net by providinginsurance

Demand for education loans is likelyto go up.

Besides deposits this may alsoincrease the work-load in thebranches Increased allocation foreducation as well as Rs.750 crcorpus will give scope for lending foreducation.

Industry Reduction in peak rates of duty from12.5% to 10% for non agriculturalproducts inputs such as steel, cokingcoal, chemicals, man-made fibres,gems & jewellery, edible oils.

New Industrial Policy for Northeasternregion

J&K to continue getting tax benefitsfor industry

Reduction in peak import duty andfurther duty cut on select products.Help inflation control by reducingcosts, industries to benefit.

Scope for increased lending inindustry to these regions



Textiles

Steel

Cement

Oil & Diesel

Edible Oil

Coir

Biotech &Pharma

IT & ITes

Allocation for textile parks increasedto Rs.425 cr (last year Rs 189cr)

Textile Upgradation Fund (TUF)raised to Rs.911cr (Rs.535cr)TUF to be continued during XIth fiveyear plan

100-150 new handloom clusters tobe developed

Health insurance scheme forweavers enhanced to ancillaryindustries

Imposition of export duty on iron ore

Dual excise duty on cement, exciseduty hiked for selling 50-kg bags atRs190 or more

Reduction in excise duties on petroland diesel to 6% from 8%

Lower custom duties on edible oils,crude and refined edible oils to beexempt from additional CV duty of4%, reduction in duty on sunflower oil,both crude and refined by 15percentage points

A fund is proposed to be set up witha provision of Rs.22.5 cr

Reduction in duty from 7.5% to 5%on specified machinery inpharmaceutical and biotech industry

Pass-through status to venturecapital funds in pharmaceutical andbiotech sectors

It and BPO sector had so far enjoyedbenefits of sunrise industry but have

Industry to attract fresh investment.

This will open up avenues for bankfinance as more units are likely tocome up.

Banks to focus on identified areasfor financing.

The availability of iron-ore fordomestic steel makers is expectedto increase and government will alsoearn revenues as about 70 milliontonnes of iron ore is exportedannuallyPrices likely to go up by at leastRs.10 per bag with immediate effect.Housing may cost more.

The measures would have a positiveimpact on headline inflation and helpcontrol prices.

The measures would have a positiveimpact on headline inflation and helpcontrol prices.

Modernisation in this industry will geta fillip; scope for further lending

Boost for the biotech and pharmaindustry and increased R&D will leadto further scope for bank lending

It is a mixed bag for the industry butnew ventures are likely to benefit and



domestic market will expand asGovernment increases IT spending

Scope for bank finance.

Scope for increased lending tohotels in these regions

Banks can meet the financialrequirements of units catering to theneeds of defence.

now to pay 11.22% of adjusted netprofits as minimum alternative tax

Nanotechnology and informationtechnology to benefit through venturecapital funds. IT industry will alsobenefit indirectly as there isemphasis on e-governance

Tourism industry to get allocation ofRs.520 cr for tourist infrastructure(Rs.423 cr)

Tax holiday for 2,3 and 4 star hotelsin and around Delhi

Defence allocation increased byRs.7,000 cr to Rs.96,000 cr

Tourism

Defence

Housing Reverse mortgage scheme forsenior citizens by NHB.

Creation of housing mortgagecompanies.

The impact of this new scheme islikely to be positive for home loanand mortgage markets. Banks cancome out with new products for thisgroup.

Help banks recover dues as itprovides protection to lenders. Willhelp housing finance companies tooffer higher mortgage loans or lowerdown payments.

Banking &FinancialSector

Rs.40,000 cr provided for transfer ofSBI shares

DRI scheme limit raised fromRs.6,500 to Rs.15,000 and housinglimit from Rs.5,000 to Rs.20,000 perbeneficiary

RRBs to expand aggressively, openbranches in 80 uncovered districts.Recapitalisation of weak RRBs

RRBs to accept deposits from NRIsSARFAESI extended to loansadvanced by RRBs

PAN to be sole identification for allcapital market transactions. Self

The transaction will be deficit neutralfor the government

The impact is expected to benegligible as the amount is not verysignificant to affect credit growth orliquidity. Weaker sections to benefit.

Revival of weak RRBs andextension of branches is expectedto increase finance to rural sector

More competition for NRI depositsalthough the impact is not likely tobe felt by PSBs or foreign banks atthis stage

Provide ease, convenience andsafety of transactions.


Regulatory Organisations (SROs)for different market participants.

Mutual Funds to launchinfrastructure funds

Overseas investments allowed toindividuals via MFs

Micro Financial Sector(Development and Regulation) Billand comrehensive bill to amendinsurance laws to be introduced inBudget session

Financial Inclusion Fund andFinancial Inclusion Technology Fundto be established with Nabard withcorpus of Rs.500 cr each

Banking cash transactions taxexemption limit increased toRs.50,000 from Rs.25,000

Increase in dividend distribution taxfrom 12.5% to 15% and to 25% formoney market mutual funds andliquid mutual funds.

Allows short-selling by institutionalinvestors.

Increase in TDS exemption limit onbank deposits from Rs.5,000 toRs.10,000.

Service tax extended to lease rentals

Increase in tax deduction forinsurance from Rs.10,000 toRs.15,000 (Rs.20,000 for seniorcitizens). Increase in healthinsurance schemes for seniorcitizens by insurance companies.

Exchangeable bonds in groupcompanies.

Bond markets are likely to get aboost

Financial services are likely tobecome more streamlined withthese amendments

Hitherto unbanked areas/personswill now access financial services

Increase in BCTT limit andexemption to Central and State Govtwill reduce the burden on ourbranches.

Bank deposits are likely to becomemore attractive vis-à-vis mutualfunds.

Increased liquidity in the market.

Relief for banks and depositors.

Banks may shift to own premises tocut costs.

Increase in medical insurancecoverage. Banks can bundleinsurance with liability products.

Help companies unlock part of theirholding in group companies. Willimprove liquidity without diluting theirshareholding in the parent company.




Tax proposals

Personal &Corporate Tax

Service Tax

Increase in basic exemption limit ofRs.10,000 for personal income tax

1% additional education cess (forsecondary and higher education)levied on income tax, corporation tax,excise duties, customs duties andservice tax. The governmentcurrently has a 2% cess for primaryeducation.

CENVAT rate untouched at 16%. Taxbase widened by extending MAT tosoftware technology parks, export-oriented units.

Fringe Benefit Tax (FBT) on EmployeeStock Options (ESOPs).

Service tax left unchanged at 12%.Service tax extended to new servicesincluding renting of immovableproperty for use in commerce/business.

Surplus available with the people islikely to be used for buyingconsumer goods or for savings;Either way it opens up opportunityfor banks for more business.

Likely to be passed on and putpressure on prices.

Higher tax burden on IT companies.

Increase in tax outgo for employer.

Increase in tax outgo on account ofrented premises.

Fiscal Deficit Lower fiscal deficit 3.3% in FY08against 3.7% in FY07; revenue defi-cit in the same period 1.5% and 2%respectively.

Buoyant tax collections on the backof a confidently growing economyhave enabled the FM to reduce thefiscal deficit and revenue deficit fur-ther. Budget on course to achieveFRBM targets. With revenue defi-cit under check, government couldnow increase capital spending,which is a positive for sustaininggrowth in the medium term.


RAILWAY BUDGET 2007-08

� The Indian rail network spans over 63,000 kms and carries 14 million passengersand 1.5 million tonnes of freight everyday.

� The proposed annual outlay on railways is Rs 31,000 cr (around 1% of GDP), 32%increase over the previous year. This is the largest annual plan for railways so far.56% of the plan outlay will be sourced from internal sources (Rs17,320 crore), whichis 61% more than last year.

� Estimated profit of Rs.20,000 crore as against Rs.14,700 crore for the year 2006-07.

� Freight revenues up 17%, passenger revenues increase 14% in April-Dec. 2006.� Passenger fares to be slashed across the board: Fare reduction in all upper classes

and no raise in second class fares� Tickets to be sold at petrol pumps, ATM centres etc.� Smart rail travel cards to be introduced.� Number of berths to be increased from 72 to 84 in sleeper coaches.� Three-storey container trains planned� Among measures to benefit the travelling public: wooden seats are to be replaced by

cushioned ones in ordinary class passenger trains from next fiscal.� Unreserved compartments in new trains to be increased from four to six to help ordinary

passengers.� 50% fare concession offered for UPSC and other official examinees.� To make compartments user-friendly, changes in the design of compartments are to

be made to help the physically-disabled.� Separate coach for vendors, milkmen and petty traders in the passenger trains.� Ticket bookings and hotel bookings can be done through railway call centres to be

set up.� Six thousand automatic ticket vending machines to be set up in next two years.� Work on Dedicated Freight Corridor to begin in 2007/08.� New telephone number for railway inquiry to be 139 across India.� Railways to start 32 new trains, 8 Garib Raths this year� Railways to observe 2007-08 as Year of Cleanliness.� Mumbai Urban Transport Project to be speeded up to help suburban commuters. A

sum of Rs 5,000 crore to be allocated during the next Five-Year Plan for the purpose.� Feasibility study to be conducted for ultra-high speed trains with speed up to 250-

300 km per hour.� Railways to set up 300 new model stations, some stations to have CCTVs and all

TTEs to be provided palm tops.� More lower berths to be earmarked for women and senior citizens.� Railways to introduce 800 new wagons; 20,000 km of high-density network to be

laid; new trains for cement transportation.


Railway’s New Projects

� New Lines:

The target for construction of new lines in2007-08 has been fixed at 500 km. Thesections include:

1. Puntamba-Shirdi

2. Mahoba-Khajuraho

3. Qazigund-Kakapore and Budgam-Baramulla

4. Jaggyapet-Malachervu

5. Kottur-Harpanhalli

Gauge Conversion

� During 2007-08, a target of completiongauge conversion of about 1,800 km hasbeen fixed.

� Joint Venture with Kerala Government

At present, Railways have a limited capacityto manufacture passenger coaches. In viewof the expected increase in demand,Railways have proposed to set up a jointventure company with Steel IndustriesKerala Ltd, Aleppey, a public sectorundertaking of the Government of Kerala.

� Setting up of Wagon, Bogie Complex atDalmianagar

To manufacture higher axle load wagons,production of new technology bogies,couplers, draft gears, would be necessary,for which an industrial complex will bedeveloped at Dalmianagar.

Implication for the Economy and Banking

Inflation

The Railway Budget is aimed at tackling risingheadline inflation in the economy♣. We expectthe measures announced in the Railway Budgetwill help contain inflation.

� There is no increase in passenger fare. Onthe contrary, the Railway Budget hasactually announced a cut in passenger fareacross the board which is a welcome stepand will have a positive impact on inflation.

� The Budget has refrained from hiking freightrates. In fact, freight rates for transportationof diesel/petrol have been reduced by 5%

and by 6% on iron ore and lime stone. Thismeasure is a positive for the economy as itwill help contain costs and control inflation.

� In particular, oil companies stand to benefitas the freight cut will lead to a fall in costsand margins will improve. The Indian OilCorporation (which has a 50% market shareand freight bill of Rs.750 crore), is expectedto save around Rs.400 million a year fromthe cut in railway freight.

Fiscal Deficit

� Expected increase in profit to Railways willhave positive impact on fiscal deficit of theUnion Government.

Industry

� The plan to upgrade 20,000 kms of highdensity rail line network is expected to leadto increased demand for around 11,000 newwagons.

� Container traffic is expected to go upsubstantially to 100 million tones by 2012.

� Industries engaged in supplying equipmentto the Railways will benefit as the Budgethas planned to increase investment formanufacture of wagons.

� Increased investment in container traffic byrunning more trains will help improvedavailability of goods in the market and keepcosts down.

� Cut in freight rate will have positive impacton industry bottomlines.

� Railways’ plan to upgrade 20,000 km highdensity rail line network will facilitate coallinkages to ultra mega power projects. Webelieve that this will have a positive impacton steel and power sector.

� With increased internal accruals, capexspending by railways is likely to get a fillip.The Minister has planned to investsubstantial sum on dedicated freightcorridors over the next five years. In addition,pre-feasibility studies will be taken up for theconstruction of four high-speed passengercorridors, with trains running at 300-350 km/hr


Banking Sector

� Control of inflation and fiscal deficit will helpcontain rising interest rates. Selling ofRailway tickets through ATMs opens upbusiness opportunities for banks.

� Banks can form JVs with railwaysintroducing smart rail travel cards.

� Introduction of three-storey container trains,separate coaches for vendors, milkmen andtraders offer scope for additional business.

� Banks can tap the Railways’ increaseddemand for funds for the Dedicated FreightCorridor. Scope for increasing related feebusiness.

� Funding requirement for the proposed ultrahigh speed trains, Mumbai Urban TransportProject can be explored.

� Scope for booking additional governmentbusiness

Implications for SBI

� The Bank has already an agreement withthe Railways for setting up 200-300 ATMsat railways stations. This could beincreased in view of the additional ATMsproposed in the Budget.

� Circles may be asked to assess fund andnon-fund based requirements at centreswhere new projects have been proposed.

� New products to tap business from theproposed three-storey container trains,separate coaches for vendors, milkmen andtraders, etc. may be considered.

� Scope for increasing visibility through adsand hoardings in the 300 new model stationsto be set up.

� Dedicated freight corridor, ultra high speedtrains and Mumbai urban transport projectoffer scope for increasing infrastructurelending.


MID-TERM REVIEW OF ANNUAL POLICY FOR 2007-08

� Bank Policy rates like Repo, Reverse Repo, and Bank Rate unchanged at 7.75%,6%, and 6% respectively

� Increase in the CRR by 50 basis points from 7.0% to 7.5% with effect from the fortnightbeginning November 10, 2007

� Working Group to be constituted for preparing a road-map for migration to CBS byRRBs.

� RRBs and State/Central Cooperative Banks to disclose their CRAR as on March 31,2008 in their balance sheets.

� A road-map to be evolved for achieving the desired level of CRAR by these banks.

� Financial assistance to RRBs for implementing information and communicationtechnology based solutions.

� GDP growth forecast retained at 8.5 per cent during 2007-08, assuming no furtherescalation in international crude prices and barring domestic or external shocks

� Inflation to be contained close to 5.0 per cent during 2007-08 while resolving tocondition expectations in the range of 4.0-4.5 per cent, with a medium-term objectiveof inflation at around 3.0 per cent.

� Moderating net capital flows so that money supply is not persistently out of alignmentwith indicative projection of 17.0-17.5 per cent.

Dr. Y. Venugopal Reddy, Governor, presented theMid-term Review of Annual Policy for the Year2007-08 on October 30, 2007 in a meeting withChief Executives of major commercial banks.The Mid-term Review consists of two parts: PartI Mid-term Review of the Annual Statement onMonetary Policy for the Year 2007-08; and Part IIMid-term Review of the Annual Statement onDevelopmental and Regulatory Policies for theYear 2007-08.

Domestic Developments

• Real GDP growth during the first quarter of2007-08 is placed at 9.3 per cent as against9.6 per cent in the corresponding quarter ayear ago.

• The year-on-year (Y-o-Y) wholesale priceindex (WPI) inflation eased from its peak of6.4 per cent on April 7, 2006 to 3.1 per centby October 13, 2007.

• The average price of the Indian ‘basket’ ofinternational crude has increased to US $80.0 per barrel as on October 23, 2007 from

US $ 72.1 per barrel in July-September,2007.

• The Y-o-Y CPI inflation for industrial workersshowed a sharp increase to 7.3 per cent inAugust 2007 as against 6.3 per cent a yearago.

• The Y-o-Y growth in money supply (M3) washigher at 21.8 per cent on October 12, 2007than 18.9 per cent a year ago.

• The Y-o-Y growth in aggregate deposits atRs.5,69,061 crore (24.9 per cent) washigher than that of Rs.3,88,528 crore (20.4per cent) a year ago.

• Total credit exhibited a Y-o-Y growth ofRs.3,81,333 crore (23.3 per cent) as onOctober 12, 2007 on top of an increase ofRs.3,66,463 crore (28.8 per cent) a yearago.

• The Y-o-Y growth in total resource flow fromscheduled commercial banks (SCBs) to thecommercial sector was 22.1 per cent, over


and above the growth of 28.0 per cent a yearago.

• Banks’ holdings of Government and otherapproved securities increased to 30.0 percent of their net demand and time liabilities(NDTL) as on October 12, 2007 from 28.0per cent at end-March 2007.

• The overhang of liquidity under the LAF, MSSand the Central Governments’ cashbalances taken together increased toRs.2,22,582 crore by October 24, 2007 fromRs.85,770 crore at end-March 2007.

• The Government of India, in consultationwith the Reserve Bank, revised the ceilingunder MSS for the year 2007-08 fromRs.1,10,000 crore to Rs.1,50,000 crore onAugust 8, 2007 and further to Rs.2,00,000crore on October 4, 2007.

• During the second quarter of 2007-08,financial markets remained generally stablewith conditions of abundant liquidity andinterest rates moderated in almost allsegments of the financial system.

• During April–October 2007, public sectorbanks (PSBs) decreased their deposit rates,particularly at the upper end of the range forvarious maturities, by 25-60 basis points.

• During April-October 2007, the benchmarkprime lending rates (BPLRs) of privatesector banks moved from a range of 12.50-17.25 per cent to 13.00-16.50 per cent.

• The range of BPLRs for PSBs and foreignbanks, however, remained unchanged at12.50-13.50 per cent and 10.00-15.50 percent, respectively, during this period.

• The BSE Sensex increased from 13,072 atend-March 2007 to 19,243 on October 26,2007.

• The gross market borrowings of the CentralGovernment through dated securities atRs.1,27,060 crore (Rs.1,17,548 crore a yearago) during 2007-08 so far (up to October26) constituted 67.3 per cent of the budgetestimates (BE) while net market borrowingsat Rs.75,387 crore (Rs.65,951 crore a yearago) constituted 68.7 per cent of the BE.

External Sector

• Merchandise exports rose by 18.2 per centin US dollar terms during April-August 2007as compared with 27.1 per cent in thecorresponding period of the previous yearwhile import growth was higher at 31.0 percent as compared with 20.6 per cent in theprevious year.

• Non-oil imports rose by 44.3 per cent (10.9per cent a year ago); oil imports, however,slowed down to 6.0 per cent (44.5 per cent),mainly on account of moderation in the priceof the Indian basket of crude oil by 0.5 percent during April-August 2007.

• India’s foreign exchange reserves increasedby US $ 62.0 billion during 2007-08 andstood at US $ 261.1 billion on October 19,2007.

• The rupee appreciated by 10.3 per centagainst the US dollar, by 2.4 per cent againstthe euro, by 5.4 per cent against the poundsterling and 7.1 per cent against theJapanese yen during the current financialyear up to October 26, 2007.

Global Developments

• The downside risks to the global economicoutlook have increased from a few monthsago, accentuated by the recent financialmarket turmoil, firm inflationary pressuresand high and volatile crude prices.

• According to the IMF’s World EconomicOutlook (WEO) released in October 2007,the forecast for global real GDP growth ona purchasing power parity basis has beenretained at 5.2 per cent for 2007 as in theJuly 2007 update, down from 5.4 per cent in2006, but forecast for 2008 has been reviseddown to 4.8 per cent in October from 5.2per cent in the July 2007 update.

• In the US, real GDP growth had risen to 3.8per cent in the second quarter of 2007 ascompared with 2.4 per cent a year ago - TheIMF’s October 2007 WEO expects the USeconomy to grow at 1.9 per cent in 2007and 2008 as against 2.9 per cent in 2006.

• There was a sudden fall in credit marketconfidence in late July brought on by thespread of risks from exposure to the US sub-prime mortgages with credit crunch


spreading into corporate bond markets andequity markets.

• The European Central Bank and the USFederal Reserve, which have intervenedsince August 9 by providing liquidity to theinter-bank market, were joined by centralbanks in Canada, Japan, Australia, Norwayand Switzerland.

• Bank of England has provided liquiditysupport to a mortgage lending bank, whilegiving a blanket guarantee to depositors onthe safety of their deposits.

• Several central banks have cut policy ratesduring the third quarter of 2007 after financialmarkets were significantly affected byturbulence, such as the US FederalReserve, the Banco Central do Brasil, BankIndonesia (BI) and the Bank of Thailand.

• The central banks that have tightened theirpolicy rates include the European CentralBank; the Bank of England; the Bank ofJapan; the Bank of Canada; the ReserveBank of Australia; the Reserve Bank of NewZealand; the People’s Bank of China; theBank of Korea; the Banco de Mexico; andthe Banco Central de Chile.

• A few central banks in Asia have usedsupplementary measures for tightening,besides increasing key policy rates. The onlycentral bank that has kept policy ratessteady is the Bank Negara Malaysia.

Overall Assessment

• Some positive elements in the globaleconomy are (i) the global economy isstrong and resilient; (ii) EMEs, by and large,have a better macro-environment thanbefore; (iii) globally, corporate balance sheetsare strong and less leveraged than in thepast; (iv) large financial intermediaries areperhaps adequately capitalised to absorb theshocks of credit infirmities; and (v) theinflation environment has been, on the whole,benign.

• The global environment is fraught withuncertainties with international crude pricesat new highs, having breached the level ofUS $ 90 per barrel while elevated food andmetal prices would, in current

circumstances, pass through to domesticinflation.

• The US Federal Reserve has been the mostaggressive in terms of easing monetarypolicy, with a higher than expected rate cut,reflecting the concerns over impact ofhousing issues on consumption and, hence,growth.

• The most important issue for India is thepossible impact of global financial marketdevelopments and policy responses bycentral banks in major economies.

• The immediate task for public policy in India,therefore, is to manage the possible financialcontagion which is in an incipient stage withhighly uncertain prospects of being resolvedsoon.

• On the domestic front, aggregate demandconditions have remained firm and on theuptrend.

• Key monetary aggregates, i.e., reservemoney and money supply have beenrunning well above initial projections,reflecting the impact of higher than expecteddeposit growth and the exogenousexpansionary effects of capital inflows aswell as the drawdown of fiscal cashbalances.

• The incomplete pass-through of internationalprices of crude, metals, food andcommodities in general to consumer pricesis indicative of suppressed inflation whichcarries destabilising potential into the future.

• The policy responses in the form of activeliquidity management operations tomodulate expansionary monetary andfinancial conditions were reflected in agenerally orderly evolution of market liquidity.

• Since late July, global financial markets haveexperienced unusual volatility, strainedliquidity and heightened risk aversion.

• While the trigger was the rising default rateson sub-prime mortgages in the US, thesource of the problem was significant mis-pricing of risks in the financial system.

• Easy monetary policy, globalisation ofliquidity flows, wide-spread use of highly


complex structured debt instruments andinadequacy of banking supervision in copingwith financial innovations also contributed tothe severity of the crisis.

• At the current juncture and looking ahead,on the domestic front, the biggest challengefor monetary policy is the management ofcapital flows and the attendant implicationsfor liquidity and overall stability.

• Yet another challenge is the rapid escalationin asset prices, particularly equity and realestate, which are significantly driven bycapital flows.

• Over the next twelve to eighteen months,risks to inflation and inflation expectationswould also continue to demand priority inpolicy monitoring.

Stance of Monetary Policy

• Real GDP growth in 2007-08 is placed at8.5 per cent for policy purposes, as set outin the Annual Policy Statement of April 2007and reiterated in the First Quarter Review.

• Policy endeavour would be to containinflation close to 5.0 per cent in 2007-08 andthe resolve, going forward, would be tocondition expectations in the range of 4.0-4.5 per cent so that an inflation rate of 3.0per cent becomes a medium-term objective.

• Moderating the expansionary effects of netcapital flows is warranted so that moneysupply is not persistently out of alignmentwith the indicative projections.

• The Reserve Bank will continue with itspolicy of active demand management ofliquidity through appropriate use of the CRRstipulations and open market operations(OMO) including the MSS and the LAF, usingall the policy instruments at its disposalflexibly, as and when the situation warrants.

• Barring the emergence of any adverse andunexpected developments in varioussectors of the economy and keeping in viewthe current assessment of the economyincluding the outlook for inflation, the overallstance of monetary policy in the periodahead will broadly continue to be:

• To reinforce the emphasis on price stabilityand well-anchored inflation expectationswhile ensuring a monetary and interest rateenvironment that supports export andinvestment demand in the economy so asto enable continuation of the growthmomentum.

• To re-emphasise credit quality and orderlyconditions in financial markets for securingmacroeconomic and, in particular, financialstability while simultaneously pursuinggreater credit penetration and financialinclusion.

• To respond swiftly with all possiblemeasures as appropriate to the evolvingglobal and domestic situation impinging oninflation expectations, financial stability andthe growth momentum.

• To be in readiness to take recourse to allpossible options for maintaining stability andthe growth momentum in the economy inview of the unusual heightened globaluncertainties, and the unconventional policyresponses to the developments in financialmarkets.

Monetary Measures

• The Bank Rate has been kept unchangedat 6.0 per cent.

• The repo rate under the LAF is keptunchanged at 7.75 per cent.

• The reverse repo rate under the LAF is keptunchanged at 6.0 per cent.

• The Reserve Bank has the flexibility toconduct repo/reverse repo auctions at afixed rate or at variable rates ascircumstances warrant.

• The Reserve Bank retains the option toconduct overnight or longer term repo/reverse repo under the LAF depending onmarket conditions and other relevantfactors. The Reserve Bank will continue touse this flexibility including the right to acceptor reject tender(s) under the LAF, wholly orpartially, if deemed fit, so as to make efficientuse of the LAF in daily liquidity management.


• CRR increased by 50 basis points to 7.5per cent effective fortnight beginningNovember 10, 2007.

Developmental and Regulatory Policies

Financial Markets

• Non-Competitive Bidding Scheme in theAuctions of State Development Loans(SDLs) to be operationalised by March 31,2008.

• Re-issuance of SDLs in the second half of2007-08.

• The facility of new issuance structure forfloating rate bonds (FRBs) is being built intothe new Negotiated Dealing System (NDS)auction system being developed by theClearing Corporation of India Limited (CCIL).

• The Reserve Bank is committed forpermitting market repos in corporate bonds,once the corporate debt markets develop andthe Reserve Bank is assured of availabilityof fair prices, and an efficient and safesettlement system based on delivery versuspayment (DvP) III and Straight ThroughProcessing (STP) is in place.

• Covering of ‘Short-sale’ and ‘When Issued’transactions to be permitted outside theNegotiated Dealing System – OrderMatching (NDS-OM) system.

• Systemically important non-deposit takingNBFCs (NBFC-ND-SI) to be considered as‘qualified entities’ for accessing the NDS-OMusing the Constituents’ Subsidiary GeneralLedger (CSGL) route.

• The facility of permitting all exporters to earninterest on their Exchange Earners’ ForeignCurrency (EEFC) accounts to the extent ofoutstanding balances of US $ 1 million perexporter is extended up to October 31, 2008and banks are free to determine the rate ofinterest.

• Reinstatement of the eligible limits under thepast performance route for hedging facilityprovided that supporting underlyingdocuments are produced during the term ofthe hedge undertaken.

• Oil companies to be permitted to hedge theirforeign exchange exposures to the extent

of 50 per cent of their inventory volume asat the end of the previous quarter by usingoverseas over-the-counter (OTC)/exchange traded derivatives up to amaximum of one year forward.

• Importers and exporters having foreigncurrency exposures to be allowed to writecovered call and put options in both foreigncurrency/ rupee and cross currency andreceive premia.

• Authorised Dealers (ADs) to be permittedto run cross currency options books,subject to the Reserve Bank’s approval.

• ADs to be permitted to offer Americanoptions as well.

Credit Delivery

• Internal Working Group to be constituted toexamine the recommendations of theCommittee on Agricultural Indebtedness(Chairman: Dr. R. Radhakrishna) relevantto the banking system in general and theReserve Bank, in particular.

• Working Group to be constituted withrepresentatives from the Reserve Bank, theNABARD, sponsor banks and RRBs forpreparing a road-map for migration to corebanking solutions (CBS) by RRBs.

• RRBs and State/Central Cooperative Banksshould disclose the level of CRAR as onMarch 31, 2008 in their balance sheets. Aroad-map may be evolved for achieving thedesired level of CRAR by these banks.

• Working Group to be constituted to studythe recommendations of SenguptaCommittee report on ‘Conditions of Workand Promotion of Livelihood in theUnorganised Sector’ relevant to the financialsystem and suggest an appropriate actionplan for implementation of acceptablerecommendations.

• High Level Committee to be constituted toreview the Lead Bank Scheme.

• Proposed to prepare a concept paper onfinancial literacy-cum-counseling entresdetailing the future course of action.

• Financial assistance to RRBs forimplementing information and


communication technology (ICT) basedsolutions, including installation of solarpower generating devices for powering ICTequipment in remote and under-servedareas.

Prudential Measures

• Final guidelines on Credit Default Swapswould be issued by end-November 2007.

• Banks are urged to follow prescribed specificconsiderations while engaging recoveryagents. Abusive practices followed by banks’recovery agents would invite serioussupervisory disapproval.

• Constitution of a working group to lay downthe road-map for adoption of a suitableframework for cross-border supervision andsupervisory cooperation with overseasregulators, consistent with the frameworkenvisaged in the Basel Committee onBanking Supervision (BCBS).

• In order to enhance the effectiveness of thebanking supervisory system, the process ofconsolidated supervision to be integratedwith the financial conglomerate monitoringmechanism for bank-led conglomerates.

• It is proposed to cover, besides generalmarket risk, specific risk, especially thecredit risk arising out of deficientdocumentation or settlement risk, under thesupervisory process.

Institutional Developments

• Banks are urged to ensure that adequatedisaster recovery systems are put in placeto fully comply with the requirements.

• Banks are urged to draw up time-boundaction plans for implementation of CBSacross all their branches.

• An action plan to be drawn up forimplementation of National ElectronicClearing Service (NECS) using the existinginfrastructure of National Electronic FundsTransfer (NEFT) system with centralisedclearing and settlement at Mumbai.

• Working group to be constituted comprisingrepresentatives of the Reserve Bank, StateGovernments and the Urban CooperativeBanks (UCBs) to examine the various areas

where IT support could be provided by theReserve Bank to UCBs.

• The Committee on Financial SectorAssessment (CFSA) (Chairman: Dr.Rakesh Mohan; Co-Chairman: Dr. D.Subbarao) submitted an interim reportdelineating its approach and reviewing theprogress of work to the Finance Minister andGovernor, Reserve Bank of India in July2007. The CFSA is expected to completethe assessment by March 2008 and lay outa road-map for further reforms in a medium-term perspective.

Indian Economic Outlook: 2007-08

Real Economy

Real GDP growth originating in agriculture andallied activities has risen above trend in the firstquarter of 2007-08 and is poised to maintain thisperformance over the rest of the year on the backof a favourable south-west monsoon andimprovement in sown acreage. Recentdevelopments indicate some slackening ofmomentum in the industrial and servicessectors. Moreover, global uncertainties may havesome moderating influence on the performanceof manufacturing as well as services. Overall,these sectors are expected to sustain themomentum of growth. Accordingly, real GDPgrowth in 2007-08 is placed at 8.5 per cent,assuming no further escalation in internationalcrude prices and barring domestic or externalshocks.

Inflation

The gains achieved in reining in inflation in thefirst quarter of 2007-08 have been extended intothe second quarter and currently headlineinflation appears to be emerging out of aprolonged trough. At this juncture, however, risingand volatile international crude prices and theheightened levels of food prices pose risks tothe inflation outlook. In view of the persisting highlevels of the price of the Indian crude basket,some pass-through to domestic petroleumproduct prices appears reasonable. A key issuegoing forward in this regard is the timing of thepass-through in the context of the expected pathof headline inflation. The policy resolve goingforward should be to consolidate the success inlowering inflation on an enduring basis so that


an environment of stability prevails to nurtureand protect the transition to higher growth. Thereare indications that the public’s perceptions oninflation are increasingly converging with thepolicy preference for price stability. Accordingly,in view of the lagged and cumulative effects ofmonetary policy on aggregate demand andassuming that supply management would beconducive, capital flows would be managedactively and in the absence of shocks emanatingin the domestic or global economy, the policyendeavour would be to contain inflation close to5.0 per cent in 2007-08. In recognition of India’sevolving integration with the global economy andsocietal preferences in this regard, the resolve,going forward, would be to condition expectationsin the range of 4.0-4.5 per cent so that an inflationrate of around 3.0 per cent becomes a medium-term objective consistent with India’s broaderintegration into the global economy.

Monetary Conditions

Money supply has so far been expanding wellabove the indicative trajectory of 17.0 -17.5 per

cent. Fiscal spending and exchange marketinterventions have mainly driven this accelerationas reflected in sizeable reserve money growth.Deposit growth has been running ahead of theprojection of Rs.4,90,000 crore for 2007-08 asa whole. Non-food credit (inclusive of non-SLRinvestments) has decelerated and is currentlyclose to the projection of 24.0-25.0 per cent givenin the Annual Policy Statement. However,moderating the expansionary effects of netcapital flows is warranted so that money supplyis not persistently out of alignment with theindicative projections set out in the Annual PolicyStatement.

The Reserve Bank will continue with its policy ofactive demand management of liquidity throughappropriate use of the CRR stipulations and openmarket operations (OMO) including the MSS andthe LAF, using all the policy instruments at itsdisposal flexibly, as and when the situationwarrants.


SPECIAL ECONOMIC ZONES (SEZs)

Special Economic Zones (SEZs) denotegeographical areas which enjoy specialprivileges as compared with non-SEZ areas inthe country. The main motivating force for settingup SEZs came from the Ministry of Commercewith a view to boosting exports by attracting bothIndian and foreign corporates to undertakeinvestment in these areas. Earlier ExportProcessing Zones are now also being convertedinto SEZs.

Objectives of Setting Up SEZs

The main argument to establish SEZs is topromote exports by concentrating resources insome pockets (designated as SEZs). The policywas introduced in April 2000 to provideinternationally competitive and hassle-freeenvironment for exports. The units may be setup to manufacture goods or render services. Theunit in the SEZ area has to be a net foreignexchange earner, but no conditionality has beenimposed to export a specified proportion of theoutput.

SEZs can be set up in the public sector, privatesector or joint sector or even by stategovernments in collaboration with any corporate.

Special Privileges for SEZs

SEZs are duty-free enclaves of development andare deemed as foreign territories for purpose oftrade, duties and tariffs. The policy offers severalfiscal and regulatory incentives to developers ofthe SEZs as well as to the units within thesezones.

Corporations in SEZ will not have to pay anyincome tax on their profits for the first 5 yearsand only 50% of the tax for two years thereafter.The concession of paying only 50% of the tax

can be extended for another three years if halfof the profit is reinvested in the corporation.Besides income tax benefit, units in SEZ shallbe exempted from a host of the other taxes andduties like customs duty, excise duty, servicetax, Value Added Tax (VAT) and dividend tax.

For SEZs, the Government will acquire vasttracts of land and provide it to the corporationsor developers. A basic condition is that 25% ofthe area of SEZ must be used for export relatedactivities and the remaining 75% of the area canbe used for economic and social infrastructure.All the benefits and concessions of SEZ can beavailed of for the whole area.

The list of authorized operations include roads,housing apartments, convention centres,cafeterias and restaurants, airconditioning,telecom and other communication facilities andrecreational facilities.

Sector-specific SEZs will be allowed to haveadditional operations including hotels, schoolsand educational and technical institutes. Multi-product SEZs will also be allowed to have ports,airports and golf courses.

Sector-specific developers of SEZs will beallowed to have 7,500 houses, hotels with a totalof 100 rooms, a 25-bed hospital and schoolsand other educational institutions and a multiplexup to 52,000 sq. metres. Multi-product SEZs willbe allowed to build 25,000 houses, a 250-roomhotel and a hospital with 100 beds and multiplexof 2,00,000 sq. metres.

For sector-specific SEZs, the applicant’s networth has to be a minimum of Rs.250 crore,while the minimum investment criterion isRs.250 crore. To qualify for developing a multi-

� Special Economic Zones (SEZs) denote geographical areas which enjoy special privilegesas compared with non-SEZ areas in the country.

� The policy was introduced in April 2000 to provide internationally competitive and hassle-free environment for exports.

� During 2006-07, the total exports form SEZs were Rs.34,787 crore, i.e., 52.3% rise overthose in the previous year.


product SEZ, the net worth has to be at leastRs.250 crore and minimum investment in theproject Rs.1,000 crore. For applying for IT SEZs,net worth of applicant has to be Rs.100 crore.

SEZs would be exempt form the application oflabour laws so that they can attractentrepreneurs to set up industrial units. Thus,Labour Commissioners will have no jurisdictionto inspect SEZs, even implement safety andenvironmental norms in these units. All industrialunits and other establishments in SEZ shall bedeclared “Pubic Utility Service” in which anystrike shall be illegal. This implies that SEZs willnot comply with the provisions of the IndustrialDisputes Act, 1947. They will, however, have thefreedom to employ contract labour to any extent.The Contract Labour (Regulation & Abolition) Actis also proposed to be amended to includecertain peripheral activities.

SEZ Policy Motivated by ChineseExperience

China established in 1980 SEZs in 14 coastalcities. The main purpose was to provide a dualrole for SEZs to act as “Windows” in developingthe foreign-oriented economy, thus, generatingforeign exchange by boosting exports andimporting advanced technologies. Consequently,SEZs became “radiators” in acceleratingeconomic development. In these zones, toattract foreign investment, customs duties andincome tax were eliminated. This helped Chinato improve the coastal regions and thus

accelerate the development of these regions.The policy helped to attract foreign-fundedenterprise to invest over $30 billion in China andover 5,000 domestic enterprises from all overthe country to invest about 20 billion Yuan in SEZregions. As a result, six pillar industries took firmroots in China. These are: automobiles andspare parts and components, microelectronicsand computers, household electrical appliances,bio-medicines and optical, mechanical andelectrical products.

Present State of SEZs and FutureProgrammes

At present, India has 19 SEZs. The Governmenthas notified a total 154 SEZs as on October 3,2007. The Government stated that the cap onthe number of SEZs had been lifted, newapprovals have to wait till 75 zones take offground.

During 2006-07, the total exports form SEZswere Rs.34,787 crore, i.e., 52.3% rise over thosein the previous year.

Lured by the heavy incentives, large numberindustrial houses and developers - Indian as welland foreign - are pushing their applications tothe state governments to approve newproposals, but the sharp apprehensions and thecritique of SEZ policy have forced thegovernment to do some rethinking on the issue,though Mr. Kamal Nath, Minister of Commerceis very keen to promote development via SEZroute.


LEGISLATIVE AMENDMENTS FOR CONDUCT OFMONETARY POLICY

� The amendments to the Reserve Bank of India Act, 1934 and the Banking RegulationAct, 1949 have provided RBI greater manoeuvrability in monetary management.

� RBI now has the flexibility to change the reserve requirements for scheduled banksdepending on the evolving macroeconomic and monetary conditions.

The Reserve Bank of India (Amendment) Act,2006 was passed in June 2006. The amendmentto the Act, inter alia, removed the ceiling as wellas the floor of the CRR prescribed for scheduledbanks. RBI has, thus, been provided with thediscretion to decide the percentage of scheduledbanks’ demand and time liabilities to bemaintained as CRR without any ceiling or floor.Furthermore, consequent to the amendment, nointerest will be paid on the CRR balances so asto enhance the efficacy of the CRR, as paymentof interest attenuates its effectiveness as aninstrument of monetary policy. The amendmentAct also provides RBI with the statutory backingfor regulating the money market and trading ofover-the-counter derivatives.

The Banking Regulation (Amendment) Act, 2007(replacing the Banking Regulation (Amendment)

Ordinance, 2007 which came into effect onJanuary 23, 2007) was notified in the gazette onMarch 28, 2007. Consequent upon theamendment to Section 24 of the BankingRegulation Act, 1949, the floor rate of 25 per centfor the statutory liquidity ratio (SLR) has beenremoved and RBI has also been empowered todetermine the SLR-eligible assets. Theamendments to the Reserve Bank of India Act,1934 and the Banking Regulation Act, 1949 haveprovided the RBI greater manoeuvrability inmonetary management as it now has theflexibility to change the reserve requirements forscheduled banks depending on the evolvingmacroeconomic and monetary conditions.


GOVERNMENT SECURITIES ACT, 2006

� The legal framework relating to issuance and servicing of Government securitieswas provided by the Public Debt Act, 1944.

� The Government Securities Act, 2006 was enacted, which seeks to replace the PublicDebt Act, 1944 and repeal the Indian Securities Act, 1920.

Management of Government debt involvesissuance and servicing of Governmentsecurities. The servicing of Government debtrequires timely payment of interest and principalto the holders of Government securities andsettlement of claims in the event of death of theholder. The issue of Government securities andtheir servicing is attended to by RBI through thePublic Debt Offices, the branches of State Bankof India/Associate Banks and the districttreasuries/sub-treasuries.

The legal framework relating to issuance andservicing of Government securities was providedby the Public Debt Act, 1944. In view of the sharpincrease in the volume of the public debt andother changes in the external environment,some of the provisions of the Act and the Rulesframed thereunder were found to be onerous,and, at times, impeded further development ofthe debt market. Accordingly, the GovernmentSecurities Act, 2006 was enacted, which seeksto replace the Public Debt Act, 1944 and repealthe Indian Securities Act, 1920.

The Act proposes to consolidate and amend thelaw relating to issue and management ofGovernment securities by RBI. The Act, inter alia,provides for (i) definition of terms such as ‘bondledger account’, ‘constituent subsidiary ledgeraccount’ and ‘Government security’; (ii)recognition of title to Government security ofdeceased sole holder or joint holders; (iii)nomination by holders of Government securities;(iv) acceptance of micro films, facsimile copiesof documents, magnetic tapes and computerprintouts as documents of evidence; (v)suspension of the holders of subsidiary generalledger account from trading with the facility ofthat account in the event of misuse of the saidfacility; (vi) stripping of a Government securityseparately for interest and principal; (vii) creationof pledge, hypothecation or lien in respect ofGovernment securities. The Act also empowersRBI to call for information, cause inspection andissue directions as well as to make regulationswith the prior approval of the Central Governmentfor carrying out the purposes of the Act.

The Government Securities Act came into forcefrom December 1, 2007.


The Credit Information Companies (Regulation)Act, 2005 was passed in Parliament in May 2005.The rules and regulations for the implementationof the Act were notified on December 14, 2006.The Act was enacted with a view to strengtheningthe legal mechanism and enabling the creditinformation companies to collect, process andshare credit information on the borrowers ofbanks and financial institutions. The Act alsocovers, inter alia, responsibilities of creditinformation companies, rights and obligations ofthe member credit institutions and safeguardingof privacy rights. The salient features of CreditInformation Companies Rules and Regulationsare presented below:

I. Salient features of Credit InformationCompanies Rules

(i) A credit information company whoseapplication for certificate of registration hasbeen rejected or whose certificate ofregistration has been cancelled, canapproach the appellate authority designatedby the Central Government for the purpose.

(ii) Every credit institution and the creditinformation company should formulateappropriate policy and procedure, dulyapproved by its board of directors,specifying therein the steps and securitysafeguards with regard to (a) collecting,processing and collating of data relating tothe borrower; (b) steps for security andprotection of data and the credit informationmaintained at their end; (c) appropriate and

CREDIT INFORMATION COMPANIES (REGULATION)ACT, 2005: RULES AND REGULATIONS

� The Credit Information Companies (Regulation) Act, 2005 was passed in Parliament inMay 2005. The rules and regulations for the implementation of the Act were notified onDecember 14, 2006.

� The Act was enacted with a view to strengthening the legal mechanism and enabling thecredit information companies to collect, process and share credit information on theborrowers of banks and financial institutions.

� The Act also covers, inter alia, responsibilities of credit information companies, rights andobligations of the member credit institutions and safeguarding of privacy rights.

necessary steps for maintaining anaccurate, complete and updated data; and(d) transmitting data through securemedium. Further, the credit institution or thecredit information company should ensurethat the credit information is accurate andcomplete with reference to the date on whichsuch information is furnished or disclosedto the credit information company or thespecified user as the case may be.

(iii) In order to prevent unauthorised access,every credit information company, creditinstitution and specified user should adoptpolicy and procedures to:

(a) secure confidentiality of data;

(b) allow access to only to authorisedmanagers or employees on a need to knowbasis;

(c) ensure control access to the data atterminals, network by means of physicalbarriers including biometric access controland logical barriers by way of passwords;

(d) ensure that the passwords are changedregularly and frequently;

(e) ensure that the best practices in relation todeletion and disposal of data especially thedisposal of records or discs off-site or byexternal contractors are followed;

(f) ensure protection against unauthorizedmodification or deletion of data;


(g) ensure maintenance of log of all accessesto data, all unsuccessful attempts and allincidents involving a proven or suspectedbreach of security

(h) protection against pilferage of informationwhile passing through the public and privatenetworks.

II. Salient features of Credit InformationCompanies Regulations

(i) The Regulations indicate which companiescan obtain credit information as specifiedusers (insurance company, cellular/phonecompany, credit rating agency, stock broker,trading member, SEBI, IRDA, amongothers) in addition to those provided undersection 2(l) of the Act.

(ii) Every application by a company for grant ofcertificate of registration for continuing/commencing business of credit informationshould be made in ‘Form A’ to RBI. Oncarrying out scrutiny of the application, RBImay grant ‘in-principle approval’ to suchapplicant company and provide time to thecompany, not exceeding three months, forfulfilling the conditions included therein andmay grant the certificate of registration tothe company thereafter.

(iii) The regulations provide for the form ofbusiness in which credit informationcompanies can engage (providing DataManagement Services to members,collection/dissemination of information oninvestments made by members insecurities, fraud, money laundering, etc.) inaddition to those provided under section14(l) of the Act.

(iv) The privacy principles formulated to guidethe credit Information companies, creditinstitutions and specified users include thefollowing:

(a) Care in collection of credit information: Thecredit information shall be properly andaccurately recorded, collected and

processed and shall be protected againstloss, unauthorised access, use,modification or disclosure.

(b) Access to and modification of creditinformation: Every credit informationcompany upon request from a person shalldisclose to him, his own credit informationreport, subject to satisfactory identification.Further, every credit information company,credit institution and specified user shalltake prompt action in relation to updating ofcredit information with proper coordinationamongst them within prescribed time limit.

(c) Data use limitation: Obligation to discloseby the specified user to a borrower or clientas the case may be within thirty days incase credit is denied to him.

(d) Length of preservation of credit information:Credit information shall be preserved for aminimum period of seven years.

(v) Regulations provide for the principles andprocedures relating to personal creditinformation in respect of manner andpurpose of collection of personal data,solicitation of personal data, accountabilityin transferring data to third party, redressalof grievances of individuals and length andpreservation of personal data, amongothers.

(vi) Maximum fee leviable by a credit informationcompany is as under:

• Rs.15 lakh – Membership fee for creditinstitution and credit information company;

• Rs.50,000 and Rs.15 lakh – annual fee forcredit institution and credit informationcompany, respectively.

• Rs.100 for providing an individual his owncredit report.

• Rs.500 and Rs.5,000 for providing creditreport on individual and non-individuals,respectively to specified users.


INVESTMENT IN INDIAN COMPANIESBY FIIs/NRIs/PIOs

� FIIs can invest in a company up to 24% of its paid up capital

� NRIs and PIOs can invest in a company up to 10% of its paid up capital.

� RBI monitors these ceilings.

Foreign Institutional Investors (FIIs), Non-Resident Indians (NRIs), and Persons of IndianOrigin (PIOs) are allowed to invest in the primaryand secondary capital markets in India throughthe portfolio investment scheme (PIS). Underthis scheme, FIIs/NRIs can acquire shares/debentures of Indian companies through thestock exchanges in India.

The ceiling for overall investment for FIIs is 24per cent of the paid-up capital of the Indiancompany and 10 percent for NRIs/PIOs. Thelimit is 20 per cent of the paid-up capital in thecase of public sector banks, including the StateBank of India.

The ceiling of 24 per cent for FII investment canbe raised up to sectoral cap/statutory ceiling,subject to the approval of the board and thegeneral body of the company passing a specialresolution to that effect. And the ceiling of 10 percent for NRIs/PIOs can be raised to 24 per centsubject to the approval of the general body ofthe company passing a resolution to that effect.The ceiling for FIIs is independent of the ceilingof 10/24 per cent for NRIs/PIOs.

The equity shares and convertible debenturesof the companies within the prescribedceilings are available for purchase under PISsubject to:

i) the total purchase of all NRIs/PIOs both, onrepatriation and non-repatriation basis,being within an overall ceiling limit of (a) 24per cent of the company’s total paid-upequity capital and (b) 24 per cent of the totalpaid up value of each series of convertibledebenture and

ii) the investment made on repatriation basisby any single NRI/PIO in the equity sharesand convertible debentures not exceedingfive per cent of the paid-up equity capital ofthe company or five per cent of the total paid

up value of each series of convertibledebentures issued by the company.

Monitoring Foreign Investments

RBI monitors the ceilings on FII/NRI/PIOinvestments in Indian companies on a dailybasis. For effective monitoring of foreigninvestment ceiling limits, RBI has fixed cut-offpoints that are two percentage points lower thanthe actual ceilings. The cut-off point, for instance,is fixed at 8 per cent for companies in whichNRIs/PIOs can invest up to 10 per cent of thecompany’s paid-up capital. The cut-off limit forcompanies with 24 per cent ceiling is 22 per centand for companies with 30 per cent ceiling, is28 per cent and so on. Similarly, the cut-off limitfor public sector banks (including State Bank ofIndia) is 18 per cent.

Once the aggregate net purchases of equityshares of the company by FIIs/NRIs/PIOs reachthe cut-off point, which is 2% below the overalllimit, RBI cautions all designated bank branchesso as not to purchase any more equity sharesof the respective company on behalf of FIIs/NRIs/PIOs without prior approval of RBI. The linkoffices are then required to intimate the ReserveBank about the total number and value of equityshares/convertible debentures of the companythey propose to buy on behalf of FIIs/NRIs/PIOs.On receipt of such proposals, RBI givesclearances on a first-come-first served basis tillsuch investments in companies reach 10 / 24 /30 / 40/ 49 per cent limit or the sectoral caps/statutory ceilings as applicable. On reaching theaggregate ceiling limit, RBI advises alldesignated bank branches to stop purchaseson behalf of their FIIs/NRIs/PIOs clients. TheReserve Bank also informs the general publicabout the caution and the stop purchase in thesecompanies through a press release.


At present, a small scale industrial unit is definedas an undertaking in which investment in plantand machinery, does not exceed Rs.1 crore,except in respect of certain specified items underhosiery, hand tools, drugs and pharmaceuticals,stationery items and sports goods, where thisinvestment limit has been enhanced to Rs.5crore.

The Government of India has enacted the Micro,Small and Medium Enterprises Development(MSMED) Act, 2006 on June 26, 2006 whichwas notified on October 2, 2006. Consistent withthe notification of the Micro, Small and MediumEnterprises Development (MSMED) Act 2006,the definition of small scale industry and microand small enterprises engaged in providing orrendering of services for the purpose of prioritysector lending has been modified. Some of theimportant provisions of the Act are as under:

a) Definition of Micro, Small and MediumEnterprises

b) Delayed payment to Micro and SmallEnterprises

c) Filing of memorandum of Small and MediumEnterprises

Definition of Micro, Small and MediumEnterprises

Under the act two categories of enterprises havebeen defined namely: Industrial Enterprises andService Enterprises. While enterprises engagedin the manufacture or production, processing orpreservation of goods are classified as

MICRO, SMALL AND MEDIUM ENTERPRISESDEVELOPMENT (MSMED) ACT, 2006

� The MSMED Act, 2006 classifies enterprises broadly into (i) manufacturingenterprises; and (ii) service enterprises. These broad categories are further classifiedinto micro enterprises, small enterprises and medium enterprises, depending uponthe level of investment in plant and machinery and equipment as the case may be.

� The existing provisions of the Interest on Delayed Payment Act, 1998 to small scaleand ancillary industrial undertakings have been strengthened under the MSMED Act.

� The Act also provides for constitution of a National Board for Micro, Small and MediumEnterprises under the chairmanship of the Union Minister for MSME, with widerepresentation of stakeholders.

‘Industrial Enterprises’, enterprises engagedin providing or rendering of services such assmall road and water transport operators, smallbusiness, professional & self employedpersons, etc., are ‘Service Enterprises’

These enterprises are further classified asMicro, Small and Medium Enterprises (MSMEs)on the basis of original investment in plant andmachinery in respect of Industrial Enterprises(original cost excluding land and building and theitems specified by the Ministry of Small ScaleIndustries vide its notification No.S.O.1722(E)dated October 5, 2006) and investment inequipments in respect of Service Enterprises(original cost excluding land and building andfurniture, fittings and other items not directlyrelated to the service rendered or as may benotified under the MSMED Act, 2006).

Detailed classification is as under:

a) Industrial Enterprises:

i) A micro enterprise, where the investmentin plant and machinery does not exceedRs.25 lakh.

ii) A small enterprise, where the investmentin plant and machinery is more than Rs.25lakh does not exceed Rs.5 crore or

iii) A medium enterprise, where the wherethe investment in plant & machinery is morethan Rs.5 core but does not exceed Rs.10crore;

b) Service Enterprises


i) A micro enterprise, where the investmentin equipment does not exceed Rs.10 lakh

ii) A small enterprise, where the investmentin equipment is more than Rs.10 lakh butdoes not exceed Rs.2 crore; or

iii) A medium enterprise, where theinvestment in equipment is more than Rs.2crore but does not exceed Rs.5 core)

This classification is summarized in the tablegiven below:

Classification Original Investment in plant and machinery /equipments

Industrial ServiceEnterprises Enterprises

Micro Up to Rs. 25 Up to Rs 10lakh lakh

Small More than More thanRs.25 lakh Rs. 10 lakh& up to & up toRs. 5 crore Rs. 2 crore.

Medium More than More thanRs 5 crore & Rs. 2 crore &up to Up toRs 10 crore Rs. 5 crore.

Arising out of this, all such industrial units withoriginal investment in plant and machinery uptoRs 5 crore some of which are presentlyclassified under C&I (Mfg.) segment will have tobe classified as SSI units and segment codeallotted accordingly.

Delayed Payment to Micro and SmallEnterprises

The existing provisions of the Interest on DelayedPayment Act, 1998 to Small Scale and AncillaryIndustrial Undertakings, have been strengthenedunder the MSMED act as under:

i) The buyer to make payment on or beforethe date agreed on between him and the supplierin writing or, in case of no agreement before theappointed day. The agreement between sellerand buyer shall not exceed more than 45 days.

ii) The buyer fails to make payment of theamount to the supplier. He shall liable to pay

compound interest with monthly rests to thesupplier on the amount from the appointed dayor, on the date agreed on, at three times of theBank Rate notified by RBI.

iii) For any goods supplied or servicesrendered by the supplier, the buyer shall be liableto pay the interest as advised at (ii) above.

iv) In case of dispute with regard to any amountdue, a reference shall be made to the Micro andSmall Enterprise Facilitation Council, constitutedby the respective State Government.

Memorandum of Small and MediumEnterprises

Unlike the past where all industries were requiredto get themselves registered with the DistrictIndustries Centre, the units now have been givendiscretion under this Act to file/not file a‘Memorandum of small and medium enterprises’on the prescribed format to the DIC. Rulesregarding filing of memorandum are as under:

i) Any person who intends to establish a microor small enterprise (both industrial and service)or a medium enterprise in service sector onlyhas been given discretion to file a ‘Memorandumof small and medium enterprises’. However, amedium enterprise engaged in the manufactureor production of goods is mandated to file thememorandum of MSME.

ii) An Industry established before thecommencement of this Act and havinginvestment in plant and machinery of more thanRs.1 crore but not exceeding Rs.10 crore is alsorequired to file memorandum within one hundredand eighty days from the commencement of thisAct (2nd October 2006)

Bank’s lending to micro and small enterprisessector including all advances granted to units inthe KVI sector, (irrespective of the size ofoperations, location and amount of originalinvestment in plant and machinery in the caseof KVI units) will be included for the purpose ofreckoning under the Priority Sector.

Compilation of Separate Data for EachCategory of Enterprises

Based on the above definition, the banks arerequired to compile data separately for eachcategory of enterprise in a prescribed formatfrom the quarter ended March 31, 2007.


Mahatma Gandhi said, “The real Swaraj willcome not by acquisition of authority by few; butby the acquisition of capacity by all to resistauthority when abused.” The British Raj enactedthe Officials Secrets Act in 1923 mainly as adefence mechanism against the rising tide ofnationalism. No citizen in those days had anyaccess to official information. In recent years,there has been an ever-growing global trendtowards recognition of the right to information.The Government of India has enacted the Rightto Information Act 2005 (RTI Act 2005)recognizing that access to information is thecrucial foundation of democracy.

The RTI Act 2005 provides for setting out apractical regime of right to information under thecontrol of ‘public authorities’, in order to promotetransparency and accountability in the workingof every public authority. The Act came into effecton the 12th October 2005, extending to wholeof India except the State of Jammu and Kashmir.‘Public Authority’ includes a body or institutionconstituted under the Constitution or any otherlaw by the Parliament/State legislature. Itincludes any body owned, controlled andsubstantially financed directly and indirectly byfunds provided by the appropriate Government.Hence, State Bank of India constituted under theAct of Parliament and all Public Sector Banksowned and controlled by the Government are‘public authorities’ within the meaning of the Act.The ‘right to information’ means the access toinformation which is held by or under the controlof any public authority. It includes the right toinspection of work, documents, records, takingnotes, extracts or certified copies of documents

RTI ACT: IMPLICATIONS FOR BANKS

� Right to Information Act 2005 (RTI Act 2005) was enacted recognizing that access toinformation is the crucial foundation of democracy.

� Various provisions under the Act.

� RTI as applicable to Banks.

� Impact of RTI

or records, taking certified samples of material.Where such information is stored in computersit would include information in the form ofdiskettes, floppies, tapes, video cassettes or inany other electronic mode or through printouts.

Under the Act it is obligatory on the part of allpublic authorities to maintain all their records dulycatalogued and indexed in a manner and formwhich facilitates easy access to records. ThePublic Authority should also publish, within 120days from the enactment of the Act, theparticulars of facilities available to citizens forobtaining information, including the names,designations and other particulars of the PublicInformation Officers. Every public authorityneeds to designate Central Public InformationOfficers (CPIO) for each administrative unit anda Central Assistant Public Information Officer(CAPIO) at each sub-divisional or sub- districtlevel to receive the applications for informationunder the Act. State Bank of India has designatedBranch Heads at all the branches, Chief Manager(OAD) at Zonal Offices, Asst General Manager(OAD) at Local Head Offices and AGM (RTI) atthe Corporate Centre as the CAPIO. GeneralManagers of the respective networks has beendesignated as the CPIO for branches and ZonalOffices. The General Manager (OL &CS) is theCPIO for all the Corporate Centreestablishments. Chief General Manager(Banking Operations) is the appellate authorityfor the whole Bank. As mandated under the RTIAct, the above information has also beenuploaded on the Bank’s website www.sbi.co.in.

Any Indian citizen, who desires to obtain anyinformation under this Act, shall make a request


in writing or through electronic means in English,Hindi or in any official language of the area inwhich the application is being made to the CPIOor CAPIO. Every application must beaccompanied with fee as stipulated under theAct. In case the applicant is illiterate the CPIOor CAPIO shall render all reasonable assistanceto the person in reducing his oral request towriting. The applicant making the request forinformation shall not be required to give anyreason for requesting the information or anyother personal details except what may benecessary for contacting him. The CPIO andCAPIO have to provide the information or rejectthe request assigning one of the reasonsspecified in the Act, within 30 days of the receiptof the request. In case the information soughtfor concerns the life or liberty of a person, thesame has to be provided within 48 hours of thereceipt of the request. Failure to provideinformation within the specified period would bedeemed as refusal to provide information.

As per Bank’s guidelines, a person seekinginformation under the RTI Act should submit anapplication accompanied with a fee of Rs 10/-by way of demand draft or Bankers chequefavouring SBI either at the nearest Branch Head(CAPIO) or the General Manager of the network(CPIO). The fee of Rs 10./- can also be paid incash and receipted counterfoil must be enclosedwith the application. An applicant from belowpoverty line need not pay any fee. No formalformat for submitting an application has beenprescribed under the Act. However, anapplication for seeking information shouldcontain details necessary for contacting theapplicant, viz name, postal address, telephone/ fax etc. The CAPIO would verify the applicationreceived at the branch, brand it with receivingstamp and give an acknowledgement to theapplicant and enter it in a special register.Thereafter, immediately, he has to send it to theconcerned CPIO directly through courier underadvice to his Controller.

The CPIO has the option of requesting foradditional fee from the person seekinginformation. The details of additional fees

representing the cost of providing the informationtogether with the calculations made to arrive atthe amount has to be conveyed to the applicant.The period intervening between the despatch ofthe said intimation and payment of fees shall beexcluded for the purpose of calculating the periodof 30 days reckoned for replying to the query. Inthe case of SBI the CPIO decides on additionalfee the same has to be deposited in the samebranch.

The Act exempts certain information fromdisclosure. They include information whichwould affect the security, sovereignty andintegrity of the country, information which hasbeen expressly forbidden to be published bycourt of law, information of commercialconfidence, trade secrets, or intellectualproperty - the disclosure of which would harmthe competitive position of a third party,information including records of deliberations ofCouncil of Ministers. A request for informationmay be rejected on the ground that furnishingthe information would involve an infringement ofcopyright subsisting in a person other than theState. However, any information which cannotbe denied to the Parliament or a StateLegislature shall not be denied to any person.

Under RTI Act, the cut-off date for seekinginformation on an event is 20 years. It impliesthat an applicant can seek information on anyevent that occurred upto 20 years before the dateon which the request is made.

The Government of India has set up anautonomous body under the Act called CentralInformation Commission to oversee itsimplementation. The Commission has beenvested with powers to receive and enquire intocomplaints from any person who has beenrefused access to any information/ has not beengiven a response to a request within thestipulated time in the Act. Complaint can alsobe preferred in case the applicant believes thathe has been given incomplete, misleading orfalse information or he is required to pay anamount of fee which he or she considersunreasonable.


RTI has already caught the headlines and theimagination of all sections of the society. RTIAct helped a rickshaw puller, Masloom, inMadhubani, Bihar to get a house allotted underIndira Awas Yojana without paying the bribe ofRs 5000/- demanded by the official concerned.A daily wage labourer, Nannu, got a ration cardwithout paying a bribe of Rs 500/- . It has alsotriggered filing of numerous frivolous applicationsunder the RTI Act. Former Information

Commissioner M M Ansari said “We see thatour limited resources are being devoted toattending to frivolous applications, whichconstitute to more than 50 per cent of ourworkload. A large number of people are simplymisusing the RTI.” Maintaining records for 20years is entailing mammoth expenses to PublicAuthorities. Hopefully, RTI would influencepolicies for a better society.


According to the Asian Development Bank, oneof the biggest donors for micro-finance, theprovision of financial services, such asdeposits, loans, payment services, moneytransfers & insurance to the poor and low-income households and their micro-enter-prisesare broadly called ‘micro-financing’. The termmicro-finance came into greater currency sincethe early 1990s and has largely supplanted theterm ‘micro-credit’.

A microfinance institution (MFI) is a financialintermediary, which provides credit to the ruralpopulace. MFIs most often are NGOs, but canalso be some other bodies like the panchayats,anganwadi teachers, etc. This MFI then sets upSelf-help Groups (SHGs) which comprise about20 people (mostly women) who deposit (save)a certain amount each week/month. Then theMFI puts in an equal amount (or upto four timesthe amount) and the loan is given to individualmembers of the SHGs. The loans are givenindividually but the liability is the collectiveresponsibility of the SHG. In turn, the MFIs arere-financed by commercial banks.

The origin of SHGs can be traced to 1976, whenProfessor Mohammud Yunus of Bangladeshstarted women’s group in Bangladesh. Thisgroup later developed into the BangladeshGrameen Bank. In India, the pioneer in this fieldwas Self Employed Women’s Association(SEWA). Although it started as a trade union forwomen in the unorganised sector almost 40years ago, today it boasts of running the firstwomen’s bank in the country. In southern India,organisations like Pradan, Myrada, Asseefa andMalar have entered this rural credit system. All

MICRO FINANCE

� A microfinance institution (MFI) is a financial intermediary, which provides very smallamounts to rural, semi-urban and urban poor.

� Its objective is to raise the income and standard of living of poor.

� SHG has emerged as one of the successful instruments in Micro financing.

� During the year 2006-07, 6,86,408 new SHGs were credit linked with banks takingthe cumulative number of SHGs credit linked to 29,24,973 as on 31 March 2007.Since inception of the micro-finance (MF) programme, it has enabled an estimated409.5 lakh poor households to gain access to MF from the formal banking system.

these are high-profile NGOs getting vast fundsfrom the imperialist countries.

Following the emergence of NGO sector in thecountry and their endeavour to provide micro-credit and support to micro-entrepreneurs,several agencies and departments of theCentral and State Government like NABARD,SIDBI, HUDCO, HDFC, Ministry of Agriculture/HRD/Rural Development started using NGOsfor reaching out credit and other welfare servicesto the rural, particularly women.

In fact, there is a diversity of approaches tomicrofinance involving banks, NGOs and co-operatives. In each of these models, the groupusually assumes joint liability for loans taken byits members. SHGs of 15-20 members, forinstance, may rotate their savings as internalloans within the group as well as access loansfrom the MFI or from a bank. The group usuallyhas weekly, fortnightly or monthly meetings, inwhich the members deposit a regular savingsamount and make any loan repayments. In thesemeetings, a definite sum of Rs.10, Rs.20, etc.,is deposited by each member and thesedeposits are used for internal loans. After beingsatisfied about savings and repayments, banksgive loans to the groups

Microfinance has come a long way from linkinga few SHGs in the early 90s to launching of theNABARD’s SHG–bank linkage programme.

The Corporate Interest

Of late, the big corporate sector and themultinational firms are exhibiting an increasinginterest in microfinance. The impressive roll-callof corporates in funding SHGs, directly or by


partnerships, and supporting NGOs, includes,ICICI, Citibank, ABN Amro, Hindustan Lever Ltd.(Stree-Shakti project), ITC (e-chaupal), Mahindra& Mahindra (Subha Labh), Tata Group (KisanSansar), HDFC, Max New Life Insurance, etc.

MNCs are getting interested in SHGs asconsumers of their products. They are doingmarketing surveys through SHGs. In 2001,FMCG major, Hindustan Lever Ltd. (HLL)launched ‘Project Shakti’, a rural direct to homedistributor model, which utilizes networks ofwomen from SHGs as rural direct-to-homedistributors.

With the objective of ensuring greater financialinclusion and increasing the outreach of thebanking sector, RBI has enabled banks to usethe services of Non-GovernmentalOrganisations/ Self Help Groups (NGOs/ SHGs),Micro Finance Institutions (MFIs) and other CivilSociety Organisations (CSOs) asintermediaries in providing financial and bankingservices through the use of Business Facilitatorand Correspondent models for providingfacilitation services like identification ofborrowers and fitment of activities, collection andpreliminary processing of loan applicationsincluding verification of primary information/data,creating awareness about savings and otherproducts and education and advice on managingmoney and debt counselling, processing andsubmission of applications to banks, promotionand nurturing Self Help Groups/Joint LiabilityGroups, post-sanction monitoring, monitoringand handholding of Self Help Groups/JointLiability Groups/Credit Groups/others; andfollow-up for recovery.

The programme of linking self-help groups(SHGs) with the banking system continues tobe the major micro-finance programme in thecountry and is being implemented bycommercial banks, RRBs and co-operativebanks.

Performance

During the year 2006-07, 6,86,408 new SHGswere credit linked with banks taking thecumulative number of SHGs credit linked to29,24,973 as on 31 March 2007. Since inceptionof the micro-finance (MF) programme, it hasenabled an estimated 409.5 lakh poorhouseholds to gain access to MF from the formal

banking system. NABARD continued toemphasise scaling-up of the SHG-bank linkageprogramme in 13 priority States, which havelarge population of the rural poor. The cumulativenumber of SHGs credit linked in these Statesincreased from 10.05 lakh during 2005-06 to13.75 lakh during 2006-07 constituting 54 percent of the number of SHGs credit linked acrossthe country during the year. The regional spreadof the programme reveals that the share of non-southern regions improved significantly from 29per cent as on 31 March 2001 to 48 per cent ason 31 March 2007.

A grant assistance of Rs.1,403.96 lakh wassanctioned to promote 59,662 SHGs to 8 co-operative banks, 1 RRB, 352 NGOs and 23 IRVsduring the year, taking the cumulative sanctionto Rs.4,749.96 lakh for the promotion of 3.09lakh groups. An amount of Rs.1,980.77 lakh wasreleased and 1,52,928 SHGs were credit linkedas on 31 March 2007.

Under NABARD’s capacity building programmesfor its partner institutions, 70 exposure/field visitsto SHGs and institutions pioneering in MF for1,864 bank/NGO officials, 682 training andawareness programmes for 23,964 participantsfrom banks and NGOs, 155 sensitisationprogrammes covering 6,395 governmentofficials and elected members of PRIs werearranged during the year. NABARD alsoextended support for conducting 3,494awareness creation and capacity buildingprogrammes covering 2,01,854 SHG members.

To motivate and assist members of maturedSHGs to take up income generating activitieson a sustainable basis, NABARD continued topromote micro-enterprise development by SHGmembers. Under the Micro-EnterpriseDevelopment Programme (MEDP), 297 suchprogrammes covering 7,579 SHG memberswere conducted during the year. The pilot projectlaunched during 2005-06 for developing micro-entreprises in partnership with Marketing andResearch Team (MART), is being implementedin nine districts across nine States involving 14NGOs as ‘micro-enterprise promotion agency(MEPA)’. During the year, MEPAs completeddetailed surveys of the project districts andidentified existing opportunities and demand/supply patterns for farm/non-farm activities in


consultation with SHG members that could betaken up for sustainable income generation inthe project area. Action plan finalised by eachMEPA on the basis of the survey findings, isbeing implemented.

To facilitate matured SHGs to meet their creditrequirements of production and investments inagriculture and allied activities and to enablethem to diversify their income generatingactivities, NABARD introduced a new line ofrefinance for scheduled commercial banks,RRBs and co-operative banks. Under thescheme, cent per cent refinance is provided tobanks under ARF for financing term loan andcash credit limits sanctioned by them to SHGs.

To support the MF programme, NABARDselectively extends Revolving Fund Assistance(RFA) to MFIs for on-lending to SHGs. Duringthe year, RFA of Rs.1 crore was sanctionedtaking the aggregate support to Rs.27.98 croreas on 31 March 2007 for 31 agencies. In addition,to enable rating of MFIs and empowering themto intermediate between the lending banks andthe clients, NABARD provides financialassistance to commercial banks and RRBs toavail the services of credit rating agencies forthe purpose. The Bank also introduced ascheme to provide capital/equity support to MFIsduring 2006-07 to enable them to leveragecapital/equity for accessing funds from banks,providing financial services at an affordable costto the poor, and achieve sustainability in theircredit operations over a period of 3 to 5 years.

During 2006-07, three agencies were sanctionedtotal capital support of Rs.3 crore.

NABARD continued to implement the pilotprojects launched during the earlier years. Basedon its experience and in response to the UnionBudget (2006-07) announcement for financingof tenant farmers by banks, NABARD formulatedthe scheme for financing Joint Liability Groups(JLGs) of such farmers. NABARD designed apilot project for collaboration with Post Officesfor financing SHGs which is underimplementation in five districts of Tamil Nadu.As on 31 March 2007, 530 SHGs have openedsaving bank accounts, of which 46 have beencredit linked by the participating post offices. Apilot project for proving a social security systemfor SHG members was also sanctioned forimplementation in two villages covering 500 poorhouseholds from Betul district of MadhyaPradesh and is being implemented through anNGO for Awareness of Integrated Social Security(OASIS) with a grant assistance of Rs.8 lakh.

During the year, Rs.11.18 crore was utilised fromthe Micro-Finance Development and Equity Fund(MFDEF) for MF related activities. The MicroFinancial Sector (Development and Regulation)Bill 2007 was introduced in the Lok Sabha on 20March 2007.

SBI and Micro Credit

Cumulatively, the Bank has credit linked 7.68 lakhSHGs and disbursed loans to the extent ofRs.3,468 crore as at end-March 2007.


ECONOMY & FINANCEINSTITUTIONS


BANKING CODES AND STANDARDS BOARD OF INDIA:BANK’S COMMITMENTS TO CUSTOMERS

� Eleven Commercial Banks (six Public Sector Banks, three Private Sector Banks and twoForeign Banks) have joined RBI to set up the Banking Codes and Standards Board ofIndia (BCSBI) which was registered on 18.2.2006 in Mumbai as a society under theSocieties Registration Act.

� The Code is subject to review within a period of three years. The review will be undertakenin a transparent manner.

Eleven Commercial Banks (six Public SectorBanks, three Private Sector Banks and twoForeign Banks) have joined RBI to set up theBanking Codes and Standards Board of India(BCSBI) which was registered on 18.2.2006 inMumbai as a society under the SocietiesRegistration Act. In order to become membersof the board, the banks would be required to signan agreement expressing their commitment toabide by the codes laid down by the board. StateBank of India is a member of BCSBI.

This is a Voluntary Code which sets minimumstandards of banking practices for banks tofollow when they deal with the customers. Itprovides protection to customers and explainshow banks are expected to deal with customersin their day to day operations.

Objectives of the Code

The Code has been developed to:

� promote good and fair banking practices bysetting minimum standards in dealing withcustomers;

� increase transparency so that the customercan have a better understanding of whatshe/he can reasonably expect of the banks’services;

� encourage market forces, throughcompetition, to achieve higher operatingstandards;

� promote a fair and cordial relationshipbetween customer and bank;

� foster confidence in the banking system.

Application of the Code: The Code isapplicable to all the products and servicesoffered by the banks, whether they are provided

by branches or subsidiaries across the counter,over the phone, by post, through interactiveelectronic devices, on the internet or by any othermethod.

Key Commitments to Customers by Banks

� To act fairly and reasonably in all dealingswith the customers by the banks;

� To help customers to understand howfinancial products and services work;

� To help customers to use their account orservices by providing regular appropriateupdates and keeping them informed aboutchanges in interest rates, charges or termsand conditions;

� To deal quickly and sympathetically withthem when things go wrong;

� To treat all personal information as privateand confidential other than in the followingcircumstances:

a. if bank has to give information by law,

b. if there is a duty towards the public toreveal the information,

c. if bank’s interests require to give theinformation (e.g., to prevent fraud) butbank will not use this as a reason forgiving information about customer or hisaccounts (including name and address)to anyone else, including othercompanies, group companies, formarketing purposes,

d. if customer asks bank to revealinformation, or if permission is given tothe bank by the customer,


e. If banks are asked to give a banker’sreference about a customer, banks willneed written permission before they cangive it;

f. Bank will explain to customer the extentof his rights under the existing legalframework for accessing the personalrecords that bank holds about him;

g. Bank will not use personal informationfor marketing purposes by anyoneunless customer specifically authorizesbank to do so.

� To provide a copy of the Code to thecustomer;

� To adopt and practise a non-discriminationPolicy irrespective of age, race, gender,marital status, religion or disability.

A Few Other Important Features of the Code

� Information on interest rates, common feesand charges will be made available tocustomers through notices in branches,phone, help lines, website, designated staff,help-desk or referring to the service guide/Tariff schedule,

� Any changes in interest rates, charges andfees will be notified one month prior to therevised charges being levied/becomeeffective,

� Bank will make sure that all advertising andpromotional material is clear and notmisleading,

� In the event of receipt of any complaint fromcustomer that bank’s representative/ courieror Direct Selling Agent has engaged in anyimproper conduct or acted in violation of thisCode, bank will take appropriate steps toinvestigate and to handle the complaint andto make good the loss,

� Bank will tell the customer when it passesthe account details to credit referenceagencies and will provide a copy of suchinformation given to the credit ratingagencies or provide leaflets to the customerthat explain how credit referencing works,

� In case customer does not adhere torepayment schedule, a defined process inaccordance with the laws of the land will befollowed for recovery of dues. All themembers of the staff or any personauthorized to represent the bank will followthe guidelines set out for the purpose,

� A copy of the security policy will be madeavailable on request as per the provision oflaw,

� Complaint and grievances redressalmechanism of the bank will be madeavailable to the customer,

� Bank will display on website and by way ofnotice board to its branches explaining thatit is covered by the Banking OmbudsmanScheme 2006. Copy will be made availableon request at a nominal charge,

� Bank will ensure that salient features ofBanking Ombudsman Scheme 2006 aredisplayed at its notice board and website,

� Bank will explain the implications of thedifferent types/styles of accounts as alsothe nomination facilities at the time ofopening of accounts,

� Due diligence as required under “Know YourCustomer (KYC)” guidelines will be followed,

� Bank will exchange soiled/mutilated notesand/or small coins at notified branches asper RBI directives and will also displaynotice regarding norms for furnishing PAN,

� For any branch closure/shifting, the bank willgive notice to the customer three monthsahead if no other bank exists in the area andtwo months if there exists any bank,

� The simplified procedure will be followed forsettlement of accounts of deceasedaccount holders and bank will endeavour tosettle the claims within a period notexceeding 15 days from the date of receiptof the claim subject to production of proofof death of the depositor and suitableidentification claims to the bank’ssatisfaction,


� In case the bank offers the services oflocker, the complete rules and regulationswill be made available to the customer whois hiring the service,

� When customer buys or sells foreignexchange, information on the services,details of the exchange rate and othercharges which apply to foreign exchangewill be provided. If this is not possible, bankwill tell how these are worked out,

� The norms for transfer of money abroad willbe made known to customer,

� Bank will have a compensation policy incase of delay in remittance procedureswithin India,

� Before lending to the customer, bank willassess her/his repayment capacity. Bankwill communicate in writing the reason(s)for rejection of loan proposal where theamount of loan applied for does not exceedRs.2 lakh,

� Bank will keep the guarantor informed of anymaterial adverse change(s) in the financialposition of the borrower for whom thecustomer stands as a guarantor,

� If a customer using credit card does notrecognize a transaction that appears on cardstatement, bank will give more details if cardholder asks for it. In case the bank does notaccept contention of card holder, it willprovide the evidence that card holder hadauthorized the transaction in question,

� To protect accounts of customer, the bankwill initiate secure and reliable banking andpayment systems that customer can trust,

� Do’s and don’ts regarding the security ofcheques, PINs, passbook and internetbanking will be informed to the customer toprevent fraud and to protect the accountsof the customer,

� The norms regarding canceling paymentswill be made available to customer,

� In case customer acts fraudulently, she/heis responsible for all losses on her/hisaccount. If customer acts withoutreasonable care and this causes losses,customer may be responsible for them,

� Unless customer has acted fraudulently orwithout reasonable care, customer liabilityfor the misuse of her/his card will be limitedto the amount stipulated in the terms andconditions governing the issue of card,

� Customer is liable for misuse on accountof loss of his PIN or compromise ofpassword or of other secured informationuntil the time that bank has been notified andtaken steps to prevent misuse,

� Customer can contact BCSBI and IBA forany clarification and branches will makeavailable a copy of the Code to the customeron request.

The Code is subject to review within a period ofthree years. The review will be undertaken in atransparent manner.


Pension Fund Regulatory and Development Authority(PFRDA)

� PFRDA was established by the Government of India on 23rd August 2003.

� PFRDA is the prudential regulator for the New Pension Scheme (NPS), which is adefined contribution pension system to be launched after the PFRDA Bill, 2005, ispassed by Parliament.

PFRDA was established by the Government ofIndia on 23rd August 2003. PFRDA is theprudential regulator for the New PensionScheme (NPS), which is a defined contributionpension system to be launched after the PFRDABill, 2005, is passed by Parliament.

NPS will be available on a voluntary basis to allpersons including self employed professionalsand others in the unorganised sector. NineteenState Governments have also issuednotifications to opt for the defined contributionpension system for future State Governmentemployees who will join the services of theseGovernments. For Central Governmentemployees joining service on or after January1, 2004, the new pension scheme iscompulsory.

Pension reform is a major initiative undertakenby the Government to provide income securityafter retirement. The proposed pension law andrules and regulations to be framed thereunderwill provide strength and stability to the newpension system. The development of thepension sector is one of the main tasks ofPFRDA. Multiple strategies will be adopted topromote and maximize savings of subscribersin the long run. The strategies would includepublic awareness and education, facilitatingdeposits through neighborhood bank/postoffices, electronic connectivity to access theiraccounts through Internet, instill confidence inthe minds of the subscribers by laying downprudent norms to be followed by the variousintermediaries. Due diligence will be exercisedto ensure that the Pension Fund Managers,Central Record Keeping agency and otherplayers in the pension sector have theexperience, capability, reach, capital adequacyand other relevant qualifications to manage thescheme in a fit and proper manner.

Penal provisions are proposed in the form ofimprisonment, fines and penalties on thoseentities which do not abide by the provisions ofthe law and the rules and regulations framed.An effective grievances’ redressal system willalso be set up to redress the complaints ofcontributors to the New Pension System. Therewill be a provision for an appellate authority tochallenge the decisions of the PFRDA.

Pending passage of the PFRDA Bill inParliament, a conference of Chief Ministers ofthe various State and Union TerritoryGovernments was held in January 2007 at NewDelhi. As part of the action taken on the decisionsat the conference, the Government of India hasrequested PFRDA to appoint, from the publicsector, Central Recordkeeping Agency and FundManagers to manage the pension funds ofGovernment employees under the NPS.

PFRDA has already identified, through aprocess of competitive bidding, NationalSecurities Depository Limited (NSDL) to functionas the CRA in respect of Governmentemployees. Similarly, three public sector entitiesnamely, Life Insurance Corporation of India, StateBank of India and UTI Asset ManagementCompany Private Limited have been identifiedas sponsors of pension funds.

It is expected that the NPS architecture,including the CRA, Fund Managers, NPS Trustand Trustee Bank will be operational in respectof Government employees by the beginning ofnext year. Despite restrictions regarding choiceof intermediaries and investment options, etc.,this NPS architecture is likely to be quite similarto that envisaged under the PFRDA Bill so thatwhen the time comes it would not be difficult toscale it up. This will mark an important milestonein the development of a sustainable and efficientvoluntary defined contribution pension systemin India.


Credit Bureaus facilitate increased lendingopportunities for credit grantors while allowingeasier access to credit for borrowers. Theexistence of credit bureaus in developedcountries has facilitated increased marketpenetration of credit (to more than 66% as apercentage of GDP as compared to 3% for India)while keeping non-performing loans in check(approximately 1% of outstanding credit).

CIBIL was incorporated in 2000 and waspromoted by the SBI, HDFC , Dun & BradstreetInformation Services India Private Limited (D&B)and TransUnion International Inc., with SBI &HDFC holding a share of 40% each. At present,the shareholding pattern has been diversified toinclude various entities representing variedcategories of credit grantors and theshareholding of SBI and HDFC stands reducedto 10% each.

The aim of CIBIL is to improve the functionalityand stability of the Indian financial system bycontaining NPAs while improving credit grantors’portfolio quality. CIBIL provides a vital service,which allows its Members to make informed,objective and faster credit decisions.

CIBIL’s aim is to fulfill the need of credit grantinginstitutions for comprehensive credit informationby collecting, collating and disseminating creditinformation pertaining to both commercial andconsumer borrowers. Banks, FinancialInstitutions, NBFCs, HFCs and Credit CardCompanies use CIBIL’s services. Data sharing

CREDIT INFORMATION BUREAU (INDIA) LIMITED(CIBIL)

� CIBIL collects, collates and disseminates credit information pertaining to bothcommercial and consumer borrowers.

� Banks, Financial Institutions, Non Banking Financial Companies, Housing FinanceCompanies and Credit Card Companies use CIBIL’s services.

� Genesis: Rapid industrialization, expanding economy, growing aspirations,increased incomes, improved lifestyles, availability of high quality products andservices leading to rapid credit off-take.

� CIBIL is a composite Credit Bureau, which caters to both commercial and consumersegments

is based on the Principle of Reciprocity, whichmeans that only Members who have submittedall their credit data, may access CreditInformation Reports from CIBIL. The relationshipbetween CIBIL and its Members is that of closeinterdependence. Co-operative banks, whichare currently not under CIBIL’s purview, wouldalso be brought into the information-sharing fold.

CIBIL is a composite Credit Bureau, whichcaters to both commercial and consumersegments and provides Credit InformationReport. The Consumer Credit Bureau coverscredit availed by individuals while theCommercial Credit Bureau covers credit availedby non-individuals such as partnership firms,proprietary concerns, private and public limitedcompanies, etc. A Credit Information Report(CIR) is a factual record of a borrower’s creditpayment history compiled from informationreceived from different credit grantors. Itspurpose is to help credit grantors make informedlending decisions - quickly and objectively. TheCIR only provides available factual creditinformation and does not provide any opinion,indication or comment pertaining to whethercredit should or should not be granted. The creditgrantors who have received an application forcredit will make the credit decision. CIBIL doesnot grant or deny credit. CIBIL will provide creditinformation reports only to its members in India.

Commercial Credit Bureau: The aim of CIBIL’sCommercial Credit Bureau is to minimiseinstances of concurrent and serial defaults byproviding credit information pertaining to non-


individual borrowers such as public limitedcompanies, private limited companies,partnership firms proprietorships, etc. It willhouse the credit history of large and mid-sizedcorporates as well as the SME sector. CIBILwill maintain a central database of informationas received from its Members. CIBIL will thencollate and disseminate this information ondemand to members in the form of CIR to assistthem in their loan appraisal process.

Consumer Credit Bureau: The objective of thisBureau is to minimise defaults and maximisecredit penetration and portfolio quality byproviding comprehensive credit informationpertaining to individual borrowers. The Bureaucollects credit information from its Members. Itthen collates and disseminates, on demand, thisinformation in the form of CIR to aid in the loanappraisal process. CIBIL intends to provideworld-class service while providing both, positiveand negative information to Member creditgrantors. The basic Consumer CIR will broadlycontain the borrower information, Accountdetails like Account type, Ownership indicator,Sanctioned amount , Current balance, Amountoverdue, Suit-filed status, Days past due/Assetclassification, etc.

Access to CIBIL Information

CIBIL is maintaining a database on suit-filedaccounts of Rs.1 Crore and above and suit-filedaccounts (wilful defaulters) of Rs.25 lakh andabove and the information is in the public domainand is available at no charge. This informationis based on an application developed to enablethe users to access data through aparameterised search process across banksand companies at various geographicallocations. Suit-filed accounts of lower value arebeing covered in a phased manner.

CIBIL claims to possess credit details of morethan 60 per cent of the country’s borrowers andafter the passage of Credit InformationCompanies (Regulation) Act, 2005, details of theremaining 40 per cent, as well as newborrowers, would be added to the CIBILdatabase. The new Act allows all the details ofthe borrowers with any bank/financial institutionsto be automatically submitted to CIBIL, unlikethe old practice of seeking borrower’s consentbefore sharing the details with CIBIL or any otherthird party.


SME Rating Agency of India Limited (SMERA)is a joint initiative by Small IndustriesDevelopment Bank of India (SIDBI), Dun &Bradstreet Information Services India PrivateLimited (D&B), Credit Information Bureau (India)Limited (CIBIL) and several leading banks in thecountry. SMERA is the country’s first ratingagency that focuses primarily on the Indian SMEsegment. SMERA’s primary objective is toprovide ratings that are comprehensive,transparent and reliable.

• SMERA Rating is an independent third-party comprehensive assessment of theoverall condition of the SME

• It takes into account the financialcondition and several qualitative factorsthat have bearing on creditworthiness ofthe SME.

• SMERA Rating consists of a CompositeAppraisal/Condition indicator and a sizeindicator, for fair valuation of each SMEamongst its peers.

• An SME unit having SMERA Ratingwould enhance its market standingamongst trading partners andprospective customers.

SMERA would adopt a comprehensive,transparent and reliable rating process and itwould have a wider acceptance within thebanking system of the country. In addition tothis, SMERA would be supported by SIDBI anda large number of public and private sectorbanks in the country. It will also simplify theprocess of credit requests and make theprocess more cost-effective. A better rating fromSMERA could lead to more favourable creditterms for the SME like lower collateralrequirements, lower interest rates, and simplifiedlending norms

SME RATING AGENCY OF INDIA LIMITED (SMERA)

SMERA Ratings facilitate banks/ lendinginstitutions in reducing the turnaround time inprocessing credit applications, thereby providingSMEs access to timely and adequate credit.SMERA Ratings categorise SMEs based onsize, so that each SME is evaluated amongstits peers. This enables rational comparison ofcompanies of the same size, thus ensuring thatthe smaller companies are not at a disadvantagewhile applying for credit. SMERA Ratings takeinto account industry dynamics by factoring ina system through which an SME could compareits strengths and weaknesses with those of othercompanies in the same line of business.Composite Appraisal/Condition indicator is on ascale of 1 to 8 representing highest to lowest.For example, 1 indicates highest condition ofhealth while 8 the lowest. The Networth sizeindicator is from A to D with A for Rs.20 croreand above, B for Rs.5 - 20 crore, C for Rs.1 - 5crore, and D for less than Rs.1 crore. The ratingis displayed as a combination of both-such asB1 or C5. For example, A 1 stands for acompany with Networth of Rs.20 crore andabove with highest condition of health.SMERA had approached the Government ofIndia for release of subsidy to meet the ratingexpenses. SMERA has signed a Memorandumof Understanding (MOU) with State Bank of Indiaand Indian Overseas Bank (IOB) for rating theSME clients of the banks. SMERA expects othercommercial banks to follow the example of SIDBIin considering softer interest rates for SMEscredit-rated by SMERA. Under the MoU SBI andIOB would encourage its SME clients to be ratedby SMERA. It has also broached the subject withother banks and institutions, including SIDBI.SIDBI is considering a proposal to offerconcession in interest rate to SMEs that havebeen rated by SMERA, and quite a few schemesof the bank that have retail focus would insist onthe applicants being rated by SMERA.

� Joint initiative by SIDBI, Dun & Bradstreet Information Services India Private Limited(D&B), CIBIL and several leading banks in the country.

� Takes into account the financial condition and several qualitative factors that havebearing on creditworthiness of the SME.

� Better rating from SMERA could lead to favourable credit terms such as lowercollateral requirements and interest rates and simplified lending.

� SMERA has signed a memorandum of understanding with State Bank of India forrating the SME clients of the bank.


The Institute for Development and Research inBanking Technology (IDRBT) was set up by RBIin 1996 at Hyderabad following therecommendations of W.S. Saraff Committee onTechnology Upgradation in Payments System,with the objective of making the institute a think-tank for the promotion of technology solutionsto improve the functioning of the banking andfinancial sector.

The Institute, through its various initiatives, hasbeen spearheading the absorption of technologyin the Indian banking and financial sector. It hasmade significant contributions in every aspectof bringing in the best of technology for thebenefit of the Sector. IDRBT has taken upresearch programmes in electronic paymentsystems, security, standards, certification, datawarehousing, multi-media products, etc. with aview to provide guidance to banks in networkingand security issues in applications, The instituteis also actively associated with a number ofactivities coordinated by RBI and IBA in the areasof technology upgradation in banking sector,payment systems, messaging standards andinter-bank applications.

INFINET: The Indian Financial Networking(INFINET) a wide area satellite based networkingusing VSAT technology, has been jointly set upby RBI and IDRBT. INFINET is thecommunication backbone for the Indian bankingand financial sector. All banks, public sector,private sector, cooperative, etc., and the premierfinancial institutions in the country are eligible tobecome members of the INFINET. The INFINETis a Closed User Group (CUG) Network for theexclusive use of Member banks and financialinstitutions. It uses a blend of communicationtechnologies such as VSATs and TerrestrialLeased Lines. At present, the network consistsof over 2,300 VSATs located in 300 cities of the

THE INSTITUTE FOR DEVELOPMENT AND RESEARCHIN BANKING TECHNOLOGY (IDRBT)

� IDRBT was set up in 1996 at Hyderabad.� It aims to promote technology solutions in banks and FIs.� It has set up INFINET which provides connectivity to banks.� INFINET helps in facilitating inter-bank transactions and settlements.� IDRBT is now an authorised certifying authority for digital signatures.

country and utilises one full transponder of 36MHz on INSAT 3B. Various inter-bank and intra-bank applications ranging from simplemessaging, MIS, EFT, ECS, Electronic Debit,Online Processing, Trading in GovernmentSecurities, Centralised Funds querying forBanks and FIs, anywhere/anytime banking andInter-bank reconciliation are implementedthrough INFINET.

In tune with the developments in the field ofnetwork-based computing, the move from theClosed User Group Network of the INFINET tothe Multi-Protocol Label Switching (MPLS) hasbeen initiated by IDRBT. The MPLS provides forVirtual Private Networks (VPNs) tocommunicate in a secure manner over a privatenetwork. This improves efficiency and reducesthe cost while ensuring adequate safety andsecurity levels. The complete switch-over isexpected to be made by early 2008.

NFS: The NFS comprises a National Switch tofacilitate inter-connectivity between the Banks’Switches, and Inter-Bank Payment Gateway forauthentication & routing the payment details ofvarious e-commerce transactions, e-government activities, etc. The NFS Networknow connects 16,891 ATMs, which is the largestnumber of ATMs under a single network in thecountry.

There is a default inter-change switching feebetween the banks, if the banks do not have theirown mutual agreements. The National FinancialSwitch allows connectivity directly to theindividual bank’s switch or through their sharedATM Network Switches. It is a win-win situationfor all the banks and more importantly, for thecustomers. The Clearing Corporation of IndiaLimited (CCIL) is the clearing and settlementagency for the switch, which also facilitates the


NFS Disaster Recovery Site from its premisesat Mumbai.

SFMS: The need for a secure and commonmessaging solution that would serve as the basicplatform for intra-bank and inter-bankapplications, and would fulfill the requirementsof domestic financial messaging, gave birth tothe Structured Financial Messaging Solution(SFMS). The SFMS was launched on December14, 2001, at the IDRBT. The SFMS is built onthe lines of SWIFT but has many more utilitiesto offer. The major advantage of SFMS is that itcan be used practically for all purposes of securecommunication within the bank and betweenbanks. The intra-bank part of SFMS, which ismost important, can be used by the banks totake full advantage of the secure messagingfacility it provides. The inter-bank messaging partis useful for applications like Electronic FundsTransfer (EFT), Real Time Gross SettlementSystem (RTGS), Delivery Versus Payments(DVP), Centralised Funds Management System(CFMS), etc. The SFMS provides easy to useApplication Programme Interfaces (APIs), whichcan be used to integrate all existing and futureapplications with the SFMS. The banks candevelop comprehensive and efficient tools andapplications and integrate them easily with SFMSfor use on the Corporate Intranet. Banks canlink all their important, high volume branches,irrespective of their category to the SFMSthrough appropriate connectivity like PSTN/ISDN or Leased Lines. Moreover, use of SFMSis not restricted only to computerised or partiallycomputerised branches. The development ofForex Module as an add-on to the SFMS hasbeen completed and steps have been initiatedto test the end-to-end flow of message fromSFMS to SWIFT at DEIO of RBI. In a steptowards making available the SFMS on Internet,Client Interface through SFMS and a few fundsettlement messages have been made availableon Internet.

Eighty-four banks are participating in SFMS and47,240 branches have been listed in the IFSCDirectory as on September 30, 2007. Themapping of IFSC with BSR and MICR has beendone wherever the banks provided information.

Partcipation of banks in NEFT has tremendouslyincreased over the last one year, raising thenumber of branches to over 30,000 in 84 banks.

The Common Gateway for Small Banks, whichprovides a cost-effective solution to small andmid-sized banks enabling them to participate inSFMS/NEFT has been operationalised and 25banks have joined the Common Gateway.

MMS

Electronic Mail is transforming the way peoplecommunicate within and outside theorganisation. Messaging has not just become alot quicker, but messaging costs have dippeddrastically. Mission critical information nowpasses in and out of the user’s desktop at aclick. The Indian banking and financial sector,waking up to the wide range of possibilities andimmense benefits, was on the lookout for areliable Corporate e-mail System.

IDRBT is uniquely positioned to offer a robustbackbone for such a system since it owns andoperates a closed user group wide-area network– INFINET, for all banks and financial institutions,and IDRBT Mail Messaging System serves asthe Mail Gateway for the Indian banking system.With over 20 public sector banks, including RBImaking use of this backbone, it is perhaps oneof the largest Messaging Systems in thecountry.

CERTIFYING AUTHORITY

IDRBT has become a digital certificationauthority (CA), licensed by the Controller ofCertification Authority (CCA), Government ofIndia and will fulfill the need for trusted third partyservices in Electronic Commerce by issuingDigital Certificates that attests to some factabout the subject of the certificate, whichprovides independent confirmation of an attributeclaimed by a person offering a Digital Signature. Following this move, digital certificates issuedby the IDRBT CA are now legally valid in theIndian courts as per the Information TechnologyAct 2000.

For securing the transactions through INFINET,IDRBT provides high-end Public KeyInfrastructure (PKI) based services andsolutions to individuals, organizations as well as


governments, that enable trust and security.IDRBT has set up a high-end, global standards-based processing Center capable of issuingthousands of Digital Certificates, an importantcomponent of PKI. IDRBT CA will issue,administer and revoke the digital certificateswhich are trustworthy and legally valid.

The IDRBT Certifying Authority has issued1,14,350 Digital Certificates as on September30, 2007.The banks and financial institutions areusing the Certificates issued by IDRBT CA forCorporate E-mail, RTGS, SFMS, Web Serversused for Internet Banking,CFMS, EFT/ECS andCCIL Settlement Applications.

Indian Financial Computer EmergencyResponse Team (INFICERT)

The Institute is in the process of developing aportal on INFICERT for the benefit of INFINETCUG members. This portal would disseminate

information that would facilitate IncidentHandling/ Remedial Response to the Bankingand Financial community. The Institute is alsoin the process of analysing different toolsavailable for Incident Handling/RemedialResponse.

Service Bureau (SB) for all SWIFT Users:IDRBT has initiated steps for the establishmentof a Service Bureau (SB) for all SWIFT Users inIndia. A White Paper has been circulated to thebanks highlighting the concept, model and thepossible cost saving on joining the SB.Meanwhile, the SWIFT have agreed in principleto the idea of SB being established bythe IDRBT.

Recognizing the crucial significance of MobilePayments and the need to evolve standards,IDRBT in association with the Rural TechnologyBanking Incubator, IIT, Madras has set up theMobile Payment Forum of India.


Recognising the need for upgrading the country’sfinancial infrastructure in respect of Clearing andSettlement of debt instruments and forextransactions, RBI set up the Clearing Corporationof India Ltd (CCIL). CCIL was incorporated onthe 30th April, 2001, as the country’s first clearinghouse for the Government Securities, Forex andother related market segments. State Bank ofIndia took the lead in piloting the discussionsfinalising a blueprint for CCIL’s formation.

The primary objective of setting up CCIL hasbeen to establish a safe institutional structurefor the clearing and settlement of trades in theGovernment Securities, Forex (FX), Money andDebt Markets so as to bring in efficiency in thetransaction settlement process, and insulate thefinancial system from shocks emanating fromthe operations related issues.

The six ‘core promoters’ for CCIL are SBI, IDBI,ICICI Ltd., LIC, Bank of Baroda, and HDFC Bank.The authorized share capital is Rs.50 crore.

The following gives an overview of the activitiesof CCIL:

� Clearing house for settlement of markettrades in Government Securities

� Inter-bank foreign exchange transactions

� Facility of guaranteed settlement for tradesin Government Securities.

� Guaranteed settlement of inter-bank foreignexchange Spot trades in INR/USD andForward Trades on Spot Window.

� Launched new Money Market Instrument –“Collateralised Borrowing and LendingObligation” (CBLO), a repo variant withseveral unique features for NDS Members.

� Set up a wholly-owned Subsidiary Company– Clearcorp Dealing Systems (India) Pvt. Ltd.

CLEARING CORPORATION OF INDIA LTD. (CCIL)

� CCIL was incorporated in 2001.� Country’s first clearing house for the Government Securities, Forex and other related

market segments.� Operates Collateralized Borrowing and Lending Obligation (CBLO) a repo variant

with several unique features for NDS Members.

to manage dealing platforms in Money andCurrency Markets.

� Operationalised Anonymous Auction Systemto facilitate Buy Back of GovernmentSecurities by Government of India.

� Launched Electronic Currency DealingPlatform “FX Clear” to facilitate inter-bankforeign exchange dealing.

� Electronic movement of Member Margins/Collaterals facilitated through “Value FreeTransfer Module” of NDS.

� Extended scope of coverage of foreignexchange settlements to include INR/USDCash and TOM trades.

� Commenced net settlements in GovernmentSecurities as per DVP III Guidelines of RBI.

� Started clearing and settlement of ATMtransactions of National Financial Switchoperated by Institute for Development andResearch in Banking Technology (IDRBT).

� Operationalised “Straight ThroughProcessing” arrangement for settlement offoreign exchange trades done on FXCLEAR.

� Govt. Securities Lending and BorrowingScheme was operationalised.

� Released its Sovereign Bond Indices,CCILBROAD GILTS INDEX, consisting of top 20securities and CCIL LIQUID GILTS INDEX,consisting of the 5 most liquid bonds, to trackthe movement of the government securitiesmarket.

� Commenced settlement of cross currencytransactions through CLS.

� Released its T-Bill Index consisting of two T-bill indices – CCIL EQUAL WEIGHT T-BillsINDEX and CCIL LIQUIDITY WEIGHT T-BillsINDEX. The CCIL T-Bills indices areinstruments that would capture the market


movement in the short-term maturitysegment.

� RBI launched the anonymous screen basedorder matching trading module for govt.securities on its Negotiated Dealing System–Order Matching Segment (NDS-OM) withCCIL as the central counterparty to all deals.

� CBLOi (Internet Trading System for Non-NDS Members) commenced operations.

� Launched Overnight CollateralisedBenchmark Reference Rates for Indianmarket, namely CCIL CollateralisedBenchmark Bid Rate (CCBID) and CCILCollateralised Benchmark Offer Rate(CCBOR).

� Version - 2.0 of the NDS - OM TradingPlatform launched, enabling trading inTreasury Bills and the When Issued market.

� Received the ISO/IEC 27001:2005certification for securing its informationassets.

� Released its CCIL ALL SOVEREIGN BONDINDICES (CASBI), which would reflect thebroad movement of the market as it containsall available sovereign bonds.

� Launched its eNotice System available toall members for sending their collateralnotices in electronic form.

� Launched Intraday Securities Withdrawalin CBLO segment.

� Launched NDS - CALL, an electronicscreen-based quote driven dealing systemfor all Call, Notice and Term Moneyoperations.

� NDS Auction module went live to facilitatebidding in Primary Treasury Bill Auctions.

� Signed a Memorandum of Understanding(MOU) with Euroclear regarding post-tradeprocessing collaboration.

� Launched the CCIL MIBOR (CCIL MumbaiInter-Bank Offer Rate)/MIBID (CCIL

Mumbai Inter-Bank Bid Rate) based onDealt Quotes from NDS-Call.

� Extended the eNotice System to Non-NDSAssociate Members.

� Launched Version 3.0 of the NDS-OMenabling Odd Lot trading, trading of newsecurities in the When Issued market andtrading of CSGL entities on this platform.

� Started releasing the Daily Spot ReferenceRates through its website.

� Operationalized CCIL’s reporting platform forthe transactions in OTC Interest RateDerivatives (Interest Rate Swaps andForward Rate Agreements (IRS/FRA)).

� Launched Version 2.0 of NDS-CALLelectronic screen-based quote driven dealingsystem for Call, Notice and Term money.

Future Plans

CCIL has continuously extended its frontiersfrom the settlement of trades in the outright andrepo segment of fixed income market andFOREX trades to developing trading platformsfor transactions in the outright, FOREX andmoney market. CBLO, the money marketinstrument developed by CCIL, has been ableto capture significant volumes in the moneymarket. Trading on this platform has beenextended to Non-NDS members also. Cross-currency trades have been taken for settlementby CCIL through the CLS Bank. It has been theconstant endeavour of CCIL to fulfill marketrequirements and expectations.

Towards this end, CCIL plans to consideracceptance of Forward Trades from trade dateitself for guaranteed settlement from the existingsettlement of these trades under the Spotwindow. CCIL, in consultation with market users,has finalized the business model, including therisk management processes, for settlement ofOTC trades in Rupee Derivative Products(Interest Rate Swaps and Forward RateAgreements).


Asset Reconstruction Company India Limited(ARCIL) is the first ARC in the country to belicensed by RBI under the SARFAESI Act, 2002to initiate business in India in the year 2003, witha vision to be a major contributor to the Indianeconomy by capturing value from the impairedassets. The company’s main objective is toestablish fair and transparent business parcticesand facilitate development of a market fordistressed debt. Adopting a bank-based modelof ARC, ARCIL has been funded by importantplayers in the Indian financial sector, namely theState Bank of India, ICICI Bank, IndustrialDevelopment Bank of India and Punjab NationalBank. SBI holds 19.95% share in ARCIL. ARCILhas been established as a private sector bodywith 51% of its equity capital being held by privatesector banks. It acquired a few financial assetsfrom institutions and banks, creating a record ofbeing the first ARC to get hold of financial assetsin India. It is also an associate member of theIBA and a member of the Corporate DebtRestructuring system.

ARCIL’s Objectives� Convert NPA into performing assets

� Act as a nodal agency for NPA resolution

� Unlock value by utilizing productive assets

� Create a vibrant market for NPA/Restructured debt paper

� Revitalizing the national economy

� Re-energize the financial sector

No single promoter has a majority stake ensuringindependence of operations

ARCIL – Key Strengths

ARCIL will bring about faster debt aggregationand resolution of inter creditor issues. Debtaggregation by ARCIL will enable single pointresponsibility and ensure speedy implementation

ASSET RECONSTRUCTION COMPANY (INDIA) LIMITED

� Established in August 2003 under SARFAESI Act.

� ARCs act as debt aggregators and engage in acquisition and resolution of NPAs.

� It can restructure debts, strip and sell assets, settle with promoters, act as managersand agents for recovery.

of resolution strategy. ARCIL will pioneer thedevelopment of an active secondary market forRestructured Debt paper. ARCIL offers acomprehensive range of resolution strategiessuch as debt restructuring, mergers andacquisitions, settlement with promoters and stripsale of assets, based on an in-depth analysis ofenterprise characteristics. Resolution strategyadopted by ARCIL will be targeted towardsmaximizing realization of value for the sellingbanks.

The SARFAESI Act, 2002 provides that no freshreference to BIFR can be made once assets areacquired by an ARC. ARCs are empowered tochange / takeover management and sale / leaseof assets under the Act. This empowerment willbe available as soon as RBI guidelines in thisregard are issued. These provisions facilitatetimely and effective implementation of theresolution strategy.

The sale of the financial assets to ARCIL enablesthe NPA to be taken off the loan books of theBank/FI and unlocks capital. Sale of NPAs on aportfolio basis enables loss on sale of any oneasset to be set off against capital gains onanother, subject to RBI guidelines onprovisioning/valuation norms. Takeover of debtby ARCs reduces expenditure on NPAmaintenance (legal expenditure, follow-uprequirements, etc.) and releases resources forcore operations. Value realizable to lenders isdetermined by the fair price of the NPA (usuallydetermined by an independent valuer). Sellershave an opportunity to invest, as QualifiedInstitutional Buyers (QIBs), in Security Receipts(SRs) issued by ARCIL for acquisition of NPAs.Subsequent to the sale of NPAs no known liabilitydevolves on the Banks/FIs. The sale provides


for sharing of upside upon eventual realizationby ARCIL.

Cash Purchase Vs. Purchase through SRs

By investing in SRs of the ARCIL trusts, banksconvert their NPAs into investment in their booksas standard investment and do not requirefurther provisioning. SRs represent undividedrights, title and interest of the investors in thefinancial assets held in the Fund floated by thetrusts. Thus the banks retain direct interest inthe underlying assets (NPAs). ARCIL passes onbulk of the upside from the resolution to theinvestors and thus banks as seller investors

stand to gain by remaining invested. This is incontrast to a clean exit at the initial stages wherethe benefit of the upside, if any, will not beavailable to the banks. Cash purchase/sale ofNPAs would in all likelihood have lower pricingcompared to price offers of ARCs.

In general, banks with weaker capital bases andlow provisioning exposure choose to keep thebad loans in their own books rather than sell it toARCs because when a bank sells a loan toARCIL, it needs to provide for the differencebetween the asset’s book value and the value atwhich ARCIL acquires it.

Performance HighlightsThe Acquisition Particulars of ARCIL in respect of

Corporate Loans as on September 30, 2007(Amt. in Rs. crore)

Number of NPA accounts acquired from banks and financial institutions 919

Total dues in respect of the above NPAs 28,745

Aggregate value of Security Receipts subscribed by the investors forpayment of purchase consideration for the above NPAs 7,845

Number of banks and financial institutions from whom NPAs havebeen acquired 41

Break-up of Acquired Cases in terms of Size of Casesbased on a Cut-off of Rs.20 crore

(Amt. in Rs. crore)

Type of cases No. of borrowers Total dues SRs issued % to totalacquired SRs issued

Large cases (total 177 22,690 7,500 96outstanding over Rs.20 crore)

Small cases (total outstanding 742 6,055 345 4up to Rs.20 crore)

Total 919 28,745 7,845 100


Resolution-strategy-wise break-up –Large Cases Resolved as on September 30, 2007

(Amt. in Rs. crore)

Resolution strategy Large Resolved Cases

No. of borrowers SR value % to total SR value

Restructuring 22 1,994 46

Sale of assets 29 805 19

Sale of business/M&A 11 481 11

Settlement 42 1,017 24

Total 104 4,297 100

Details of Cases Resolved as on September 30, 2007(Amt. in Rs. crore)

Particulars Large cases Small cases Total

Total number of cases resolved 104 283 387Total dues involved 14,861 1,974 16,835Total number of cases exited 44 213 257Total dues involved 3,160 1,447 4,607Total cash recovered and distributed 2,055 220 2,275

• As on September 30, 2007 ARCIL has given a net IRR of 23% to SR holders.

• For the year ended March 31, 2007, ARCIL posted a net profit of Rs.53.97 crore, an increaseof about 75% over net profit of Rs.30.83 crore for the FY 2005-06.

Source: Booklet brought out by ARCIL, 2007.


Forward Markets Commission (FMC)headquartered at Mumbai is the regulatoryauthority for the commodity exchanges, whichis overseen by the Ministry of Consumer Affairsand Public Distribution, Govt. of India. It is astatutory body set up in 1953 under the ForwardContracts (Regulation) Act, 1952. Theexchanges that have been set up under overallcontrol of Forward Market Commission (FMC)of Government of India are Multi CommodityExchange of India Limited (MCX), NationalCommodity & Derivatives Exchange Limited(NCDEX) and National Multi-CommodityExchange of India Limited (NMCEIL)

MCX an independent and de-mutulised multicommodity exchange has permanentrecognition from Government of India forfacilitating online trading, clearing and settlementoperations for commodity futures marketsacross the country. Key shareholders of MCXinclude Financial Technologies (I) Ltd., StateBank of India (India’s largest commercial bank)& Associates, Fidelity International, NationalStock Exchange of India Ltd. (NSE), NationalBank for Agriculture and Rural Development(NABARD), HDFC Bank, SBI Life Insurance Co.Ltd., Union Bank of India, Canara Bank, Bank ofIndia, Bank of Baroda and Corporation Bank.

Headquartered in Mumbai, MCX is led by anexpert management team with deep domainknowledge of the commodity futures markets.Through the integration of dedicated resources,robust technology and scalable infrastructure,since inception MCX has recorded many firststo its credit.

MULTI COMMODITY EXCHANGE OF INDIA(MCX, NCDEX & NMCEIL)

� MCX an independent and de-mutulised multi commodity exchange for facilitating onlinetrading, clearing and settlement operations for commodity futures markets across thecountry.

� NCDEX is a professionally managed online multi commodity exchange.

� National Multi Commodity Exchange of India Limited (NMCEIL) is the first de-mutualized, Electronic Multi-Commodity Exchange in India

Inaugurated in November 2003 , MCX offersfutures trading in the following commoditycategories: Agri Commodities, Bullion, Metals-Ferrous & Non-ferrous, Pulses, Oils & Oilseeds,Energy, Plantations, Spices and other softcommodities.

MCX has built strategic alliances with some ofthe largest players in commodities eco-systemlike New York Mercantaile Exchange, Inc(NYMEX), London Metal Exchange, ChicagoExchange, etc. MCX is offering spectaculargrowth opportunities and advantages to a largecross section of the participants includingProducers/Processors, Traders, Corporates,Regional Trading Centers, Importers, Exporters,Cooperatives, Industry Associations, amongstothers. MCX being nation-wide commodityexchange, offering multiple commodities fortrading with wide reach and penetration androbust infrastructure, is well placed to tap thisvast potential.

With the view to extending the benefits of dematsystem, it has been introduced in the commoditysphere for better and efficient settlementsystem. Delivery of commodities can now beeffected through warehouse receipt in dematform.

The exchange has consistently been on a growthpath since its inception. At present, the averagedaily turnover of MCX is around USD 1.55 billion(Rs.7,000 crore - April 2006), with a record peakturnover of USD 3.98 billion (Rs.17,987 crore)on April 20, 2006. In November 2005, it enteredinto a joint venture with Dubai Metals andCommodities centre to set up Dubai Gold andCommodities Exchange. It has launched theMCX-COMDEX, India’s first composite


commodity futures Index, which is calculated anddisplayed on a real-time basis.

National Commodity & Derivatives ExchangeLimited (NCDEX)

National Commodity & Derivatives ExchangeLimited (NCDEX) located in Mumbai is a publiclimited company incorporated on April 23, 2003under the Companies Act, 1956 and hadcommenced its operations on December 15,2003. Its promoter shareholders are: NABARD,LIC and NSE. The Other shareholders are:Canara Bank, CRISIL Limited, Goldman Sachs,Intercontinental Exchange (ICE), Indian FarmersFertiliser Cooperative Limited (IFFCO) andPunjab National Bank (PNB).

NCDEX is the only commodity exchange in thecountry promoted by national-level institutions.This unique parentage enables it to offer abouquet of benefits, which are currently in shortsupply in the commodity markets. Theinstitutional promoters and shareholders ofNCDEX are prominent players in their respectivefields and bring with them institutional buildingexperience, trust, nationwide reach, technologyand risk management skills.

NCDEX is a nation-level, technology driven de-mutualised on-line commodity exchange with anindependent Board of Directors and professionalmanagement - both not having any vestedinterest in commodity markets. It is committedto provide a world-class commodity exchangeplatform for market participants to trade in a widespectrum of commodity derivatives driven by bestglobal practices, professionalism andtransparency.

NCDEX is regulated by Forward MarketsCommission. NCDEX is subjected to variouslaws of the land like the Forward Contracts(Regulation) Act, Companies Act, Stamp Act,Contract Act and various other legislations.

NCDEX is located in Mumbai and offers facilitiesto its members through about 550 centresthroughout India. The reach will gradually beexpanded to more centres.

NCDEX currently facilitates trading of 57commodities

National Multi-Commodity Exchange of IndiaLimited (NMCEIL)

National Multi Commodity Exchange of IndiaLimited (NMCEIL) is the first de-mutualized,Electronic Multi-Commodity Exchange in India.On 25th July, 2001, it was granted approval bythe Government to organise trading in the edibleoil complex. It was operationalised fromNovember 26, 2002. It is being supported byCentral Warehousing Corporation Ltd., GujaratState Agricultural Marketing Board and NeptuneOverseas Limited. It got its recognition in October2002.

Commodity exchange in india plays an importantrole where the prices of any commodity are notfixed, in an organised way. Earlier only the buyerof produce and its seller in the market judgedupon the prices. Others never had a say. Today,commodity exchanges are purely speculative innature. Before discovering the price, they reachto the producers, end-users, and even the retailinvestors, at a grassroots level. It brings a pricetransparency and risk management in the vitalmarket.

A big difference between a typical auction, wherea single auctioneer announces the bids, and theExchange is that people are not only competingto buy but also to sell. By Exchange rules andby law, no one can bid under a higher bid, andno one can offer to sell higher than somoneelse’s lower offer. That keeps the market asefficient as possible, and keeps the traders ontheir toes to make sure no one gets the purchaseor sale before they do.


Non-banking financial companies represent aheterogenous group of institutions separated bytheir type of activity, organisational structure andportfolio mix. Four types of institutions,categorized in terms of their primary businessactivity and under the regulatory purview of RBI,are equipment leasing companies, hirepurchase companies, loan companies andinvestment companies. The residuary non-banking companies (RNBCs) have beenclassified as a separate category as theirbusiness does not conform to any of the otherdefined classes of NBFC businesses. Besides,there are other NBFCs, viz., miscellaneousnonbanking companies (Chit Fund), mutualbenefit finance companies (Nidhis and PotentialNidhis) and housing finance companies, whichare either partially regulated by RBI or are outsidethe purview of RBI.

A Non-Banking Financial Company (NBFC) is acompany registered under the Companies Act,1956 and is engaged in the business of loansand advances, acquisition of shares/stock/bonds/debentures/securities, etc., or receivingdeposits under any scheme. All NBFCs are notentitled to accept public deposits. Only thoseNBFCs having minimum stipulated Net OwnedFund and holding a valid Certificate ofRegistration with authorisation to accept PublicDeposits can accept/hold public deposits.

NBFCs, which commenced operations afterApril 21, 1999 are required to have a minimumNet Owned Funds (NOF) of Rs.2 crore. NetOwned Fund is the aggregate of paid-up capitaland free reserves after adjusting a) the amountof accumulated loss, b) deferred revenueexpenditure and other intangible assets, c)

NON BANKING FINANCE COMPANIES (NBFCs)

� NBFCs are popular due to simple procedures, speed of service, higher rate of interestand timeliness in meeting credit needs of clients.

� NBFCs are now subjected to Capital Adequacy, IRAC norms, reserve requirements.

� Some types: Leasing Company, hire purchase company, housing finance company,Loan company, Residual non-banking finance company, etc.

� Revised framework made effective from April 1, 2007.

investment in shares and loans and advancesto subsidiaries, companies in the same groupand other NBFCs in excess of 10% of ownedfund. Information of NOFs can complement theinformation on CRAR.

Types of NBFCs

Some of the major types of NBFCs are asunder:

• Equipment Leasing Company: Principalbusiness is leasing or equipment orfinancing of such activity

• Hire Purchase Finance Company: Principalbusiness is hire purchase transactions orthe financing of such transactions

• Housing Finance Company: Principalbusiness is financing the acquisition orconstruction of houses including acquisitionand development of plots.

• Investment Company: Principal business isacquisition of securities

• Loan Company: Principal business isproviding finance by way of loans andadvances.

• Mutual Benefit Finance Company: Acompany notified by Central Governmentunder Sec 620 A of the Companies Act. Theyare also called Nidhi Companies

Residual Non-Banking Companies: These arecompanies not falling under any of the aboveand governed by the provisions of ResiduaryNon-Banking Companies (RBI) Directions,1987.


The NBFCs are allowed to accept/renew publicdeposits for a minimum period of 12 months andmaximum period of 60 months. They cannotaccept deposits repayable on demand. Themaximum rate of interest a NBFC can offer is11%. A NBFC cannot accept deposit withoutrating except an EL/HP company complying withprudential norms and having CRAR of 15%,though not rated, may accept public deposit upto 1.5 times of NOF or Rs.10 crore whicheveris less. Advances constitute the main assets ofNBFCs.

Prudential Norms for NBFCs

Guidelines are prescribed on incomerecognition, asset classification and provisioningrequirements applicable to NBFCs, exposurenorms, constitution of audit committee,disclosures in the balance sheet, requirementof capital adequacy, restrictions on investmentsin land and building and unquoted shares.

All the NBFCs having assets size of Rs.500crore and above but not accepting publicdeposits are required to submit Quarterly Returnon important financial parameters of thecompany. All companies not accepting publicdeposits have to pass a board resolution to theeffect that they have neither accepted publicdeposit nor would accept any public depositduring the year.

The focus of regulatory initiatives in respect ofNBFCs during 2004-05 was on deposit

acceptance norms and improved disclosures.NBFCs were allowed to enter into credit cardbusiness on their own or in association withanother NBFC or a scheduled commercialbank. NBFCs are not allowed to issue anydebit card as it tantamounts to opening andoperating a demand deposit account, which isthe exclusive privilege of banks. NBFCs whichwere granted Certificate of Registration (CoR)in the non-public deposit taking category shouldmeet the minimum capital requirement of Rs.2crore for being eligible to apply to RBI foraccepting deposits. NBFCs/RNBCs also willhave to follow certain customer identificationprocedure for opening of accounts andmonitoring transactions of a suspicious naturefor the purpose of reporting it to the appropriateauthority under the ‘know your customer’ (KYC)guidelines and were required to ensure fullcompliance with the provisions of the guidelinesbefore December 31, 2005.

Supervisory oversight by RBI over NBFCsencompasses a four-pronged strategy; (a) on-site inspection based on the CAMELSmethodology; (b) off-site monitoring supportedby state-of-the-art technology; (c) marketintelligence; and (d) exception reports ofstatutory auditors.

NBFCs are increasingly being recognised ascomplementary to the banking system; they arecapable of absorbing shocks as also spreadingrisks at times of financial distress. Theapplication of different levels of regulations tothe activities of banks and NBFCs, and even

Category of NBFC

EL/HP Companies maintaining CRAR of 15%without credit rating EL/HP Companies withCRAR of 12% and having minimum investmentgrade credit rating

LC/IC with CRAR of 12% and having minimuminvestment grade credit rating

LC/IC with CRAR of 12% and having minimuminvestment grade credit rating

Ceiling on public deposits

1.5 times of NOF or Rs 10 crore whicheveris less

4 times of NOF

1.5 times of NOF

Ceiling on acceptance of Public Deposits


among different categories of NBFCs, had givenrise to some issues arising out of the unevencoverage of regulations. Based on therecommendations of an Internal Group toexamine the issues relating to the level playingfield, regulatory convergence and regulatoryarbitrage in the financial sector and taking intoconsideration the feedback received thereon, itwas decided to put in place a revised frameworkto address the issues pertaining to the overallregulation of systemically important NBFCs andthe relationship between banks and NBFCs.Furthermore, under the revised framework, non-deposit taking NBFCs with asset size of Rs.100crore and above have been defined as‘systemically important NBFCs’ (NBFC-ND-SI).Such NBFCs are required to maintain aminimum CRAR of 10 per cent and should not(i) lend to any single borrower/any single groupof borrowers more than 15 per cent/25 per centof their owned funds, respectively; (ii) invest inthe shares of another company/any single groupof companies more than 15 per cent/25 per centof their owned funds, respectively; and (iii) lendand invest (loan/investment taken together) morethan 25 per cent/40 per cent of their owned fundsto a single party/a single group of parties,respectively. The above credit/investment normscan be exceeded by 5 percentage points for anysingle party and by 10 percentage points for asingle group of parties, if the additional exposureis on account of infrastructure loan and/orinvestment. Asset finance companies (AFCs)are permitted to exceed the exposure norms upto a further 5 percentage points of their ownedfunds, in exceptional circumstances with theapproval of their boards. NBFC-ND-SI notaccessing public funds, both directly andindirectly, may apply to the Reserve Bank for anappropriate dispensation, consistent with thespirit of the exposure limits. The ceiling oninvestment is not applicable to investment byNBFCs in the equity capital of an insurancecompany to the extent permitted by RBI. Therevised framework was made effective fromApril 1, 2007. The residuary non-bankingcompanies (RNBCs) and primary dealers willcontinue to be governed by the extant guidelines,pending a review.

In order to ensure improved customersatisfaction as also to impart transparency to

their lending operations, NBFCs were advisedin September 2006 to put in place the FairPractices Code. The Code mandates aminimum benchmark, leaving the discretion tothe NBFCs to enhance the practices. Theguidelines in this respect require the NBFCs to,inter alia, provide the specified information in loanapplication forms; introduce a system ofacknowledgement for receipt of all loanapplications; indicate a timeframe for disposalof loan applications; convey in writing to theborrower the amount of loan sanctioned alongwith the terms and conditions includingannualised rate of interest and method ofapplication thereof; give notice to the borrowerof any change in terms and conditions; refrainfrom interference in the affairs of the borrower;and refrain from undue harassment of theborrower in the matter of recovery of loans. Theboards of directors of NBFCs should also put inplace appropriate grievance redressalmechanism within the organisation to resolvedisputes arising in this regard.

NBFCs no longer engaged in the business ofnon-banking financial institution (NBFI) wereobserved to be holding the certificate ofregistration (CoR) granted by RBI, although theyare not required/eligible to hold the same. NBFCswere, therefore, advised in September 2006 tosubmit a certificate from their Statutory Auditorsevery year to the effect that they continue toundertake the business of NBFI.

In terms of extant instructions, in the case of achange of management and control of NBFCs,prior public notice of 30 days was requiredbefore effecting the sale, or transfer of theownership by sale of shares, or transfer ofcontrol, whether with or without sale of sharesor by way of amalgamation/merger of an NBFCwith another NBFC or a non-financial companyby the NBFC and also by the transferor, or thetransferee. From October 2006, such priorpublic notice has to be given by the NBFC andalso by the transferor or the transferee or jointlyby the parties concerned.

In order to strengthen the NBFC sector byallowing diversification in their area of business,NBFCs were allowed in December 2006 to (i)market and distribute mutual fund products asagents of mutual funds; and (ii) issue co-


branded credit cards with commercial banks,without risk sharing. These businesses, with theprior approval of RBI for an initial period of twoyears (to be reviewed thereafter), would besubject to fulfilment of the following minimumrequirements by the NBFCs: (a) minimum netowned fund of Rs.100 crore; (b) net profit asper last two years’ audited balance sheet; (c)net NPAs not exceeding 3 per cent of netadvances, as per the last audited balance sheet;(d) CRAR of 10 per cent for non-deposit-takingNBFCs (NBFCs-ND) and 12 per cent/15 percent for deposit-taking NBFCs (NBFCs- D). Withregard to mutual fund business, NBFCs should,inter alia, also comply with SEBI guidelines/regulations and they should only act as an agentand not acquire units of mutual funds. In the caseof credit card business, the role of NBFC would,inter alia, be limited only to marketing anddistribution.

The classification of NBFCs was modified inDecember 2006 to provide a separateclassification for companies financing physicalassets supporting productive/economic activity.Accordingly, NBFCs, whose principal business,i.e., not less than 60 per cent of their total assetsand total income is from the financing of real/physical assets supporting economic activitysuch as automobiles, general purpose industrialmachinery and the like, have been classified asasset finance companies (AFCs). Consequentupon this reclassification, the NBFCs earlierclassified as equipment leasing (EL) companiesand hire-purchase (HP) companies will emergeas asset finance companies. Since theclassification for the purpose of incomerecognition, asset classification and provisioningnorms is based on asset specification, the extantprudential norms continue as hitherto. However,the exposure norms relating to restriction oninvestments in land and buildings and unquotedshares would be modified and the provisionsapplicable to EL/HP companies would also beapplicable to AFCs.

Securitisation companies/reconstructioncompanies (SCs/RCs) were advised(September 2006) to invest in security receipts,issued by the trust set up for the purpose of

securitisation, an amount not less than 5 percent under each scheme. In October 2006, theSCs/RCs, which had obtained a CoR from RBIunder Section 3 of the SARFAESI Act, 2002,were directed to commence business within sixmonths from the date of grant of the CoR. RBImay, on an application made by the SC/RC,grant extension of time for commencement ofbusiness beyond six months, up to a maximumof 12 months from the date of grant of the CoR.In May 2007, SCs/RCs registered with RBIunder the SARFAESI Act, 2002 were advised todeclare net asset value of the security receiptsissued by them at periodic intervals. RBI has sofar granted the CoR to six SCs/ RCs, of whichthree have commenced the business ofsecuritisation/reconstruction of assets.

All NBFCs accepting/holding public depositswere hitherto required to create floating chargeon the statutory liquid assets invested in favourof their depositors. In view of the practicaldifficulties in creating charge in favour of a largenumber of depositors, NBFCs accepting/holdingpublic deposits were allowed (January 2007) tocreate the floating charge through themechanism of ‘Trust Deed’, by March 31, 2007.

As the regulation of Mutual Benefit FinancialCompanies (Notified Nidhis) (MBFCs) andMutual Benefit Companies (Potential Nidhis)(MBCs) has been taken over by the Ministry ofCompany Affairs (since renamed as the Ministryof Corporate Affairs), it was decided not to callfor returns from MBFCs and MBCs. However, ifthe application of MBCs (Potential Nidhis) for thegrant of the nidhi status is rejected by the Ministry,the provisions as applicable to NBFCs wouldapply to such companies.

In order to increase investor confidence throughadoption of best corporate practices, deposittaking NBFCs with deposit size of Rs.20 croreand above and NBFCs-ND-SI have been advisedto frame internal guidelines on corporategovernance covering, inter alia, constitution ofaudit committee, nomination committee and riskmanagement committee, and disclosure andtransparency practices.


ECONOMY & FINANCEFINANCIALMARKETS


MONEY MARKET

RBI has accorded prime attention to thedevelopment of the money market as it is thekey link in the transmission mechanism ofmonetary policy to financial markets and finally,to the real economy. In the past, developmentof the money market was hindered by a systemof administered interest rates and lack of properaccounting and risk management systems. Withthe initiation of reforms and the transition toindirect, market-based instruments of monetarypolicy in the 1990s, RBI made conscious effortsto develop an efficient, stable and liquid moneymarket by creating a favourable policyenvironment through appropriate institutionalchanges, instruments, technologies and marketpractices. Accordingly, the call money marketwas developed into primarily an inter-bankmarket, while encouraging other marketparticipants to migrate towards collateralisedsegments of the market, thereby increasingoverall market integrity.

In line with the objective of widening anddeepening of the money market and impartinggreater liquidity to the market for facilitatingefficient price discovery, new instruments, suchas collateralised lending and borrowingobligations (CBLO), have been introduced.Money market instruments such as market repoand CBLO have provided avenues for non-banksto manage their short-term liquidity mismatchesand facilitated the transformation of the callmoney market into a pure inter-bank market.Furthermore, issuance norms and maturityprofiles of other money market instruments suchas commercial paper (CP) and certificate ofdeposits (CDs) have been modified over timeto encourage wider participation whilestrengthening the transmission of policy signalsacross the various market segments. Theabolition of ad hoc Treasury Bills and

introduction of regular auctions of Treasury Billspaved the way for the emergence of a risk freerate, which has become a benchmark for pricingthe other money market instruments.Concomitantly, with the increased marketorientation of monetary policy along with greaterglobal integration of domestic markets, the RBI’semphasis has been on setting prudential limitson borrowing and lending in the call moneymarket, encouraging migration towards thecollateralised segments and developingderivative instruments for hedging market risks.This has been complemented by theinstitutionalisation of the Clearing Corporation ofIndia Limited (CCIL) as a central counterparty.The upgradation of payment systemtechnologies has also enabled marketparticipants to improve their asset liabilitymanagement. All these measures have widenedand deepened the money market in terms ofinstruments and participants, enhancedtransparency and improved the signallingmechanism of monetary policy while ensuringfinancial stability.

These policy initiatives over time have led to thedevelopment of a relatively deep, liquid andvibrant money market in the country. Activity inall the segments has increased significantly,especially during the last three years. With thedevelopment of market repo and CBLOsegments, the call money market has beentransformed into a pure inter-bank market fromAugust 2005. A recent noteworthy developmentis the substantial migration of money marketactivity from the uncollateralised call moneysegment to the collateralised market repo andCBLO markets. Thus, uncollateralised overnighttransactions are now limited to banks andprimary dealers in the interest of financialstability.

� As a result of various reform measures, the money market in India has undergonesignificant transformation in terms of volume, number of instruments and participantsand development of risk management practices.

� In line with the shifts in policy emphasis, various segments of the money market haveacquired greater depth and liquidity. The price discovery process has also improved.


Volatility in call rates has declined over the years,especially after the introduction of the LiquidityAdjustment Facility (LAF). Under the LAF, theReserve Bank sets its policy rates, i.e., repo andreverse repo rates and carries out repo/reverserepo operations, thereby providing a corridor forovernight money market rates. The weightedaverage overnight rate has largely moved withinthe corridor set by LAF rates, barring someoccasions.

The operating framework of monetary policy hasbeen the maintenance of overnight market rateswithin an interest rate corridor defined by the floorof the reverse repo (absorption) rate and ceilingof the repo (injection) rate. During periods ofsystem wide excess liquidity, overnight ratestend to hug the bottom of the corridor, whiletouching the ceiling during other periods ofliquidity shortage, as might be expected.Increased volatility in capital flows, tending toinject excess liquidity into the system, and ingovernment cash balances resulting frombunching of tax payments that suck liquidity outof the system, have made the task of liquiditymanagement somewhat more difficult over thepast year.

After the adoption of the full-fledged LAF in June2000, call rates, in general, witnessed adeclining trend up to 2004-05. The institution ofLAF has also enabled RBI to manage liquiditymore efficiently and reduce volatility in call rates.

The reduction in bid-ask spread in the overnightrates indicates that the Indian money market hasbecome reasonably deep, vibrant and liquid.

As a result of various reform measures, themoney market in India has undergone significanttransformation in terms of volume, number ofinstruments and participants and developmentof risk management practices. In line with theshifts in policy emphasis, various segments ofthe money market have acquired greater depthand liquidity. The price discovery process hasalso improved. The call money market has beentransformed into a pure inter-bank market, whileother money market instruments such as marketrepo and CBLO have developed to provideavenues to non-banks for managing their short-term liquidity mismatches. The money markethas also become more efficient as is reflected

in the narrowing of the bid-ask spread inovernight rates. The abolition of ad hoc TreasuryBills and introduction of Treasury Bills auctionhave led to the emergence of a risk free rate,which acts as a benchmark for the pricing ofother money market instruments.

Annexure: Money Market Instruments forLiquidity Management

RBI has been making efforts to develop a repomarket outside the LAF for bank and nonbankparticipants, so as to provide a stablecollateralised funding alternative with a view topromoting smooth transformation of the call/notice money market into a pure inter-bankmarket and for deepening the underlyingGovernment securities market. Thus, thefollowing new instruments have been introduced.

Collateralised Borrowing and LendingObligation (CBLO)

• Developed by the Clearing Corporation ofIndia Limited (CCIL) and introduced onJanuary 20, 2003, it is a discountedinstrument available in electronic book entryform for the maturity period ranging from oneday to ninety days (can be made availableup to one year as per RBI guidelines).

• In order to enable the market participants toborrow and lend funds, CCIL provides theDealing System through Indian FinancialNetwork (INFINET), a closed user group tothe Members of the Negotiated DealingSystem (NDS) who maintain Currentaccount with RBI and through Internet forother entities who do not maintain Currentaccount with RBI.

• Membership (including AssociateMembership) of CBLO segment is extendedto banks, financial institutions, insurancecompanies, mutual funds, primary dealers,NBFCs, non-Government Provident Funds,Corporates, etc.

• Eligible securities are Central Governmentsecurities including Treasury Bills.

• Borrowing limits for members is fixed byCCIL at the beginning of the day taking intoaccount the securities deposited by


borrowers in their CSGL account with CCIL.The securities are subjected to necessaryhair-cut after marking them to market.

• Auction market is available only to NDSMembers for overnight borrowing andsettlement on T+0 basis. At the end of theAuction market session, CCIL initiatesauction matching process based onUniform Yield principle.

• CCIL assumes the role of the centralcounter party through the process ofnovation and guarantees settlement oftransactions in CBLO.

• Automated value-free transfer of securitiesbetween market participants and the CCILwas introduced during 2004-05.

• Members can reckon unencumberedsecurities for SLR calculations.

• The operations in CBLO are exempted fromcash reserve requirement (CRR).

Market Repo

• To broaden the repo market, RBI enablednon-banking financial companies, mutualfunds, housing finance companies andinsurance companies not holding SGLaccounts to undertake repo transactionswith effect from March 3, 2003. Theseentities were permitted to access the repo

market through their ‘gilt accounts’maintained with the custodians.

• Subsequently, non-scheduled urban co-operative banks and listed companies withgilt accounts with scheduled commercialbanks were allowed to participate.

• Necessary precautions were built into thesystem to ensure ‘delivery versus payment’(DvP) and transparency, while restrictingthe repos to Government securities only.

• Rollover of repo transactions in Governmentsecurities was facilitated with the enablingof DvP III mode of settlement in Governmentsecurities which involves settlement ofsecurities and funds on a net basis, effectiveApril 2, 2004. This provided significantflexibility to market participants in managingtheir collateral.

Some Assessments

• CBLO and market repo helped in aligningshort-term money market rates to the LAFcorridor.

• Mutual funds and insurance companies aregenerally the main supplier of funds whilebanks, primary dealers and corporates arethe major borrowers in the repo marketoutside the LAF.


RBI has actively pursued the development of thegovernment securities market since the early1990s for a variety of reasons. First, with RBIacting as the debt manager to the Government,a well-developed and liquid governmentsecurities market is essential to ensure thesmooth passage of Government’s marketborrowings to finance its deficit. Second, thedevelopment of the government securitiesmarket is also necessary to facilitate theemergence of a risk free rupee yield curve toserve as a benchmark for pricing other debtinstruments. Finally, the government securitiesmarket plays a key role in the effectivetransmission of monetary policy impulses in aderegulated environment.

In order to foster the development of thegovernment securities market, it was imperativeto migrate from a regime of administeredinterest rates to a market-oriented system.Accordingly, in the early 1990s, RBI initiatedseveral measures. First, it introduced theauction system for issuance of governmentsecurities. While initially only yield-basedmultiple price auctions were conducted, uniformprice-based auctions were also employed duringuncertain market conditions and while issuingnew instruments. Second, as the captiveinvestor base was viewed as constraining thedevelopment of the market, the statutoryprescription for banks’ investments ingovernment and other approved securities wasscaled down from the peak level in February1992 to the statutory minimum level of 25 percent by April 1997. As a result, the focus shiftedtowards the widening of the investor base. Anetwork of intermediaries in the form of primary

GOVERNMENT SECURITIES MARKET

� Various measures undertaken have led to a significant improvement in the functioningof the government securities market.

� The primary market has attained a greater resilience, benefiting from measures takenfor the development of institutions and instruments.

� Introduction of the auction based system has improved the price discovery process.

� The establishment of settlement and trading infrastructure has also led to increasedactivity in the secondary market.

dealers was developed for this purpose. Retailparticipation has been promoted in the primarymarket (through a system of non-competitivebidding in the auctions) as well as in thesecondary market (by allowing retail trading instock exchanges). Simultaneously, RBI alsointroduced new instruments with innovativefeatures to cater to diverse market preferences,although the experience in this regard has notbeen encouraging.

Third, with the discontinuance of the process ofunconstrained recourse by the Government toRBI through automatic monetisation of deficitand conversion of non-marketable securities tomarketable securities,RBI gained moreoperational freedom. Fourth, in an effort toincrease liquidity, RBI has, since the late 1990s,pursued a strategy of passive consolidation ofdebt by raising progressively higher share ofmarket borrowings through re-issuances. Thishas resulted in critical mass in key maturities,and is facilitating the emergence of marketbenchmarks. Fifth, improvement in overallmacroeconomic and monetary managementthat has resulted in lower inflation, lower inflationexpectations, and price stability has enabled theelongation of the yield curve to maturities upto30 years. Finally, RBI has also undertakenmeasures to strengthen the technologicalinfrastructure for trading and settlement. Ascreen-based anonymous trading and reportingplatform has been introduced in the form of NDS-OM, which enables electronic bidding in primaryauctions and disseminates trading informationwith a minimum time lag. Furthermore, with thesetting up of CCIL, an efficient settlement


mechanism has also been institutionalised,which has imparted considerable stability to thegovernment securities market.

With the withdrawal from the primary marketfrom April 1, 2006 in accordance with the FRBM(Fiscal Responsibility and Budget ManagementAct) stipulations, RBI introduced variousinstitutional changes in the form of revampingand widening of the coverage of the PrimaryDealer (PD) system to meet the emergingchallenges. Other measures taken to deepenthe market and promote liquidity includeintroduction of ‘when issued’ trading, ‘shortselling’ of government securities and activeconsolidation of government debt through buybacks. Various policy initiatives taken by RBIover the years to widen and deepen thegovernment securities market in terms ofinstruments as well as participants haveenabled successful completion of marketborrowing programmes of the Governmentunder varied circumstances. In particular, asmooth transition to the post-FRBM phase hasbeen ensured.

The system of automatic monetisation throughad hoc Treasury Bills was replaced with Waysand Means Advances in 1997, because of whichthe Government resorted to increased marketborrowings to finance its deficit. Accordingly, thesize of the government securities market hasincreased significantly over the years.

The investor base for government securities,which was largely determined by mandatedinvestment requirements before reforms, hasexpanded with the voluntary holding ofgovernment securities. Accordingly, the shareof commercial banks has declined from 2004-05.

The PD system was essentially conceived forinstitutions whose basic interest is not to holdsecurities but to participate in the primaryauctions with the intent to act as market makersin the secondary market. PDs are responsiblefor ensuring the success of primary auctions.The presence of PDs in the governmentsecurities market has brought about an elementof dynamism, both in the primary and thesecondary segments. PDs have been activelyparticipating in the auctions of government

securities. By providing continuous two-wayquotes, PDs act as market makers in thesecondary market. The liquidity in the secondarymarket, in turn, lends support to the success ofprimary market operations. The PD system hasfacilitated better distribution of primary auctionedstock while providing better liquidity in thesecondary market. The decline in the share ofPDs in the primary issuances in the recent periodneeds to be seen in the context of increasedbidding interest by insurance companies,particularly in the long dated securities.

One of the key issues in the development of themarket for a better price discovery is liquidity ofsecurities. It was observed that, of the universeof a large number of outstanding securities, onlya few securities are actively traded in thesecondary market. RBI has been following apolicy of passive consolidation through re-issuance of existing securities with a view toenhancing liquidity in the secondary segment ofthe government securities market. The shareof re-issuances in the total securities issued was97.7 per cent during 2005-06. Activeconsolidation of government securities has alsobeen attempted under the debt buyback schemeintroduced in July 2003, which is expected to bemore actively pursued now.

As a result of the developmental measuresundertaken, the volume of transactions hasincreased manifold over the past decade.

The significant drop in turnover in 2004-05 and2005-06 could be due to a ‘buy and hold’tendency of the participants other thancommercial banks, particularly insurancecompanies, which now hold a substantial portionof government securities, particularly those oflonger maturities. The decline could also beattributed to the asymmetric response ofinvestors to the interest rate cycle. In theabsence of a facility of short selling ingovernment securities, participants generallyrefrained from taking positions which resultedin volumes drying up in a falling market.

To keep the markets liquid and active evenduring the bearish times, and more importantly,to give the participants a tool to better managetheir interest rate risk, intra-day short selling ingovernment securities was permitted among


eligible participants, viz., scheduled commercialbanks (SCBs) and primary dealers (PDs) inFebruary 2006. Subsequently, the short positionswere permitted to be carried beyond intra-dayfor a period of five trading days, effective January31, 2007. To further improve the liquidity in thegovernment securities market, guidelines fortrading in when issued ‘WI’ market were issuedby RBI in May, 2006. Trading in ‘WI’ segment,which commenced in August 2006, was initiallypermitted in reissued securities. It takes placefrom the date of announcement of auction tillone day prior to allotment of auctioned securities.The revised guidelines extending ‘WI’ trading tonew issuances of Central Government securitieson a selective basis were issued in November2006.

RBI has followed a strategy of elongating theyield curve by issuing a fine blend of long-termsecurities along with the short-term to suit thepreference of both the issuer and the investor.With the issuance of longer term securities, theyield curve on government securities hasemerged over a spectrum of 30 years, althoughthe yield curve is not liquid at the longer end ofthe maturity.

Thus, various measures undertaken have ledto a significant improvement in the functioningof the government securities market. Theprimary market has attained a greater resilience,benefiting from measures taken for thedevelopment of institutions and instruments. Thefunctioning of the government securities marketsince the mid-1990s indicates consistentincrease in its size in tandem with the growth inmarket borrowings of both the Central and theState Governments. Introduction of the auctionbased system has improved the price discoveryprocess. Reflecting the effectiveness of variousmeasures to develop the market, the turnoverin the secondary market has increased manifoldover the years. The establishment of settlementand trading infrastructure has also led toincreased activity in the secondary market. Theholding pattern of government debt shows someshift from banks to non-banks, reflecting aprogressive diversification of the investor base.The yield curve on government securities hasemerged even as it is yet to become liquid atthe longer end of the maturity. Thus, the

government securities market in India haswitnessed a transition to an increasingly broad-based market, characterised by an efficientauction process, an active secondary marketand a liquid yield curve. These developmentshave aided the smooth financing of governmentdebt, of both the central government and stategovernments, even when their fiscal deficitswere high and rising. This experience hasenabled the greater recourse of stategovernments to market borrowing as mandatedby the Twelfth Finance Commission.

Annexure: Reforms in the GovernmentSecurities Market - Institutional Measures

• Administered interest rates on governmentsecurities were replaced by an auctionsystem for price discovery.

• Automatic monetisation of fiscal deficitthrough the issue of ad hoc Treasury Billswas phased out.

• Primary Dealers (PD) were introduced asmarket makers in the government securitiesmarket.

• For ensuring transparency in the trading ofgovernment securities, Delivery versusPayment (DvP) settlement system wasintroduced.

• Repurchase agreement (repo) wasintroduced as a tool of short-term liquidityadjustment. Subsequently, the LiquidityAdjustment Facility (LAF) was introduced.

• LAF operates through repo and reverserepo auctions and provide a corridor forshort-term interest rate. LAF has emergedas the tool for both liquidity managementand also signalling device for interest ratesin the overnight market.

• Market Stabilisation Scheme (MSS) hasbeen introduced, which has expanded theinstruments available to RBI for managingthe enduring surplus liquidity in the system.

• Effective April 1, 2006, RBI has withdrawnfrom participating in primary market auctionsof Government paper.


• Banks have been permitted to undertakeprimary dealer business while primarydealers are being allowed to diversify theirbusiness.

• Short sales in Government securities isbeing permitted in a calibrated manner whileguidelines for ‘when issued’ market havebeen issued recently.

• The Banking Regulation Act, 1949 has beenamended recently whereby the floor rate of25 per cent for SLR has been removed.

Increase in Instruments in the GovernmentSecurities Market

• 91-day Treasury bill was introduced formanaging liquidity and benchmarking. ZeroCoupon Bonds, Floating Rate Bonds,Capital Indexed Bonds were issued andexchange traded interest rate futures wereintroduced. OTC interest rate derivatives likeIRS/ FRAs were introduced.

• Outright sale of Central Government datedsecurity that are not owned have beenpermitted, subject to the same beingcovered by outright purchase from thesecondary market within the same tradingday subject to certain conditions.

• Repo status has been granted to StateGovernment securities in order to improvesecondary market liquidity.

Enabling Measures

• Foreign Institutional Investors (FIIs) wereallowed to invest in government securitiessubject to certain limits.

• Introduction of automated screen-basedtrading in government securities throughNegotiated Dealing System (NDS).

• Setting up of risk-free payments andsettlement system in government securitiesthrough Clearing Corporation of IndiaLimited (CCIL).

• Phased introduction of Real Time GrossSettlement System (RTGS).

• Introduction of trading in governmentsecurities on stock exchanges for promotingretailing in such securities, permitting non-banks to participate in repo market.

• Recent measures include introduction ofNDS-OM and T+1 settlement norms.


CORPORATE DEBT MARKET

� The development of a corporate bond market in India has lagged behind in comparisonwith other financial market segments owing to many structural factors.

� It is hoped that the recent slow but steady development of insurance sector, mutualfunds, etc., coupled with the existence of a reliable government securities marketand the availability of robust reporting, trading and settlement mechanisms wouldlead to a rapid development of a vibrant corporate debt market.

The development of a corporate bond market inIndia has lagged behind in comparison with otherfinancial market segments owing to manystructural factors. While primary issuances havebeen significant, most of these were accountedfor by public sector financial institutions and wereissued on a private placement basis toinstitutional investors. The secondary market,therefore, has not developed commensuratelyand market liquidity has been an issue.

The Government had constituted a High LevelCommittee on Corporate Bonds andSecuritisation (Patil Committee) to identify thefactors inhibiting the development of an activecorporate debt market in India and recommendnecessary policy actions. The Committee madea number of recommendations relating torationalising the primary issuance procedure,facilitating exchange trading, increasing thedisclosure and transparency standards andstrengthening the clearing and settlementmechanism in secondary market. Therecommendations have been accepted inprinciple by the Government, RBI and SEBI andare under various stages of implementation.

The two stock exchanges, namely, the BombayStock Exchange (BSE) and the National Stockexchange (NSE), as well as the industry bodyFixed Income, Money Market and DerivativesAssociation of India (FIMMDA) have sinceoperationalised respective trade reportingplatforms. While all the exchange trades incorporate bonds get captured by concernedexchange’s reporting platform, OTCtransactions can be reported on any of theseplatforms. The aggregated trade informationacross the platforms is being disseminated byFIMMDA on its website. BSE and NSE have also

started order driven trading platforms in July2007. In practice, however, trading still continuesto be largely OTC.

SEBI has also implemented measures tostreamline the activity in corporate bond marketsby reducing the shut period in line with that of G-sec, reducing the size of standard lots to Rs.one lakh and standardising the day countconvention. Further, to streamline the processof interest and redemption payments, ElectronicClearing Services (ECS), Real time GrossSettlements (RTGS) or National ElectronicFunds Transfer (NEFT) are required to be usedby the issuers.

Further progress is anticipated in regard torationalising the primary issuance procedures,which is a critical step for moving away fromthe predominance of private placements.

To reduce the settlement risk and enhanceefficiency, the Patil Committee has alsoproposed setting up of a robust clearingmechanism. The settlement was proposed tobe initially on DvP I basis (i.e., trade by tradebasis) to address the counterparty settlementrisk and gradually migrate to DvP III (netsettlement of funds as well as securities) toimpart enhanced settlement efficiency. (Thedelivery versus payment (DVP) modules can bebroadly classified into three broad categories,viz., DVP I, DVP II and DVP III. Under DVP I, thefunds leg as well as the securities leg are settledsimultaneously on a contract-by-contract basis.Under DVP II, while the securities leg is settledon a contract-by-contract basis, the funds legis settled for the net amount). Under DVP III, boththe funds and the securities legs are settled forthe net amounts).


Outlook for Development of Corporate DebtMarket

Patil Committee has recommended twoimportant measures to be initiated by theGovernment, namely rationalization of stamp-duty, and abolition of tax deduction at source,as in the case of government securities.Hopefully, these would be acted upon soon.

As the corporate debt markets develop and RBIis assured of availability of efficient pricediscovery through significant increases in publicissues as well as secondary market trading, andan efficient and safe settlement system, basedon DvP III and STP is in place, RBI is committedto permitting market repos in corporate bonds.

In the medium-term, considering the overallmacro-economic situation, the ceiling for foreigninvestment in both government securities andcorporate debt will continue to be calibrated asan instrument of capital account management.In particular, a more liberalized access to foreigninvestment would be appropriate when, amongother things, an efficient and safe settlement

system is well entrenched, aggregateconsolidated public debt to GDP ratio reachesa reasonable level, say less than 50 per cent,and the corporate debt market acquires depthand liquidity with significant role for insuranceand pension funds in India.

In the past, the government securitiesdominated the debt market in India, partly onaccount of the fiscal dominance and theabsence of contractual savings. In the absenceof contractual savings only banks tended todeploy their funds in the corporate bond market,mainly through private placement. RBI is hopefulthat the recent slow but steady development ofinsurance sector, mutual funds, etc., coupledwith the existence of a reliable governmentsecurities market and the availability of robustreporting, trading and settlement mechanismswould lead to a rapid development of a vibrantcorporate debt market. A framework for thedevelopment is already available through therecommendations of the Patil Committee, theimplementation of which has already been takenup by the various agencies.


FOREIGN EXCHANGE MARKET

� The gradual development of the foreign exchange market has helped in smoothimplementation of current account convertibility and the phased and gradual openingof the capital account.

� The availability of derivatives is also helping domestic entities and foreign investorsin their risk management.

The Indian foreign exchange market haswitnessed far-reaching changes since the early1990s following the phased transition from apegged exchange rate regime to a marketdetermined exchange rate regime in 1993 andthe subsequent adoption of current accountconvertibility in 1994 and substantialliberalisation of capital account transactions.Market participants have also been provided withgreater flexibility to undertake foreign exchangeoperations and manage their risks. This hasbeen facilitated through simplification ofprocedures and availability of several newinstruments. There has also been significantimprovement in market infrastructure in termsof trading platform and settlement mechanisms.As a result of various reform measures, liquidityin the foreign exchange market increased bymore than five times between 1997-98 and 2006-07.

In relative terms, turnover in the foreignexchange market was 6.6 times the size ofIndia’s balance of payments during 2005-06 ascompared with 5.4 times in 2000-01. With thedeepening of the foreign exchange market andincreased turnover, income of commercialbanks through such transactions increasedsignificantly. Profit from foreign exchangetransactions accounted for more than 20 percent of total profit of scheduled commercialbanks in the last 2 years.

Efficiency in the foreign exchange market hasalso improved as reflected in the decline in bid-ask spreads. The bid-ask spread of Rupee/US$market has almost converged with that of othermajor currencies in the international market. Onsome occasions, in fact, the bid-ask spread of

Rupee/US$ market was lower than that of somemajor currencies.

The EMEs’ experience, in general, in the 1990shas highlighted the growing importance of capitalflows in determining the exchange ratemovements as against trade flows andeconomic growth in the 1980s and before. Inthe case of most developing countries, whichspecialise in labour-intensive and low andintermediate technology products, profit marginsin the highly competitive markets are very thinand vulnerable to pricing power by large retailchains. Consequently, exchange rate volatilityhas significant employment, output anddistributional consequences. Foreign exchangemarket conditions have remained orderly in thepost-1993 period, barring occasional periods ofvolatility. The Indian approach to exchange ratemanagement has been to avoid excessivevolatility. Intervention by RBI in the foreignexchange market, however, has been relativelysmall compared to total turnover in the market.

The exchange rate policy in recent years hasbeen guided by the broad principles of carefulmonitoring and management of exchange rateswith flexibility, without a fixed target or a pre-announced target or a band, coupled with theability to intervene, if and when necessary. Theoverall approach to the management of India’sforeign exchange reserves takes into accountthe changing composition of the balance ofpayments and endeavours to reflect the ‘liquidityrisks’ associated with different types of flowsand other requirements.

Apart from the spot segment, the foreignexchange market in India trades in derivativessuch as forwards, swaps, and options. The


typical forward contract is for one month, threemonths, or six months, with three months beingthe most common. Forward contracts for longerperiods are not as common because of the greatuncertainties involved. A swap transaction in theforeign exchange market is a combination of aspot and a forward in the opposite direction.Foreign exchange swaps account for the largestshare of the total derivatives turnover in India,followed by forwards and options (Table 5).Options have remained insignificant despitebeing in existence for three years. Withrestrictions on the issue of foreign exchangeswaps and options by corporates in India,turnover in these segments (swap and options)essentially reflects inter-bank transactions.

With greater opening of the capital account, theforward premia is getting gradually aligned withthe interest rate differential reflecting growingmarket efficiency. In the post-liberalisationphase, forward premia of the Indian rupee vis-à-vis dollar has generally remained highindicating that rupee was at a discount to theUS dollar. In recent times, however, reflectingthe build-up of foreign exchange reserves, thestrong capital flows and the confidence in theIndian economy, forward premia have comedown sharply from the peak reached in 1995-96.

As a result of various measures, the Indianforeign exchange market has evolved into arelatively mature market over a period of timewith increase in depth and liquidity. The turnoverin the market has increased over the years. Withthe gradual opening up of the capital account,the forward premia are getting increasinglyaligned with the interest rate differential. Thereis also evidence of enhanced efficiency in theforeign exchange market as is reflected in lowbid-ask spreads.

The gradual development of the foreign exchangemarket has helped in smooth implementationof current account convertibility and the phasedand gradual opening of the capital account. Theavailability of derivatives is also helping domesticentities and foreign investors in their riskmanagement. This approach has helped Indiain being able to maintain financial stability rightthrough the period of economic reforms and

liberalisation leading to continuing opening of theeconomy, despite a great degree of volatility ininternational markets, particularly during the1990s.

Annexure: Reforms in the ForeignExchange Market

Exchange Rate Regime

• Evolution of exchange rate regime from asingle-currency fixed-exchange rate systemto fixing the value of rupee against a basketof currencies and further to market-determined floating exchange rate regime.

• Adoption of convertibility of rupee for currentaccount transactions with acceptance ofArticle VIII of the Articles of Agreement of theIMF. De facto full capital accountconvertibility for non-residents andcalibrated liberalisation of transactionsundertaken for capital account purposes inthe case of residents.

Institutional Framework

• Replacement of the earlier ForeignExchange Regulation Act (FERA), 1973 bythe market friendly Foreign ExchangeManagement Act, 1999. Delegation ofconsiderable powers by RBI to AuthorisedDealers to release foreign exchange for avariety of purposes.

Increase in Instruments in the ForeignExchange Market

• Development of rupee-foreign currencyswap market.

• Introduction of additional hedginginstruments, such as, foreign currency-rupee options. Authorised dealers permittedto use innovative products like cross-currency options, interest rate swaps (IRS)and currency swaps, caps/collars andforward rate agreements (FRAs) in theinternational forex market.

Liberalisation Measures

• Authorised dealers permitted to initiatetrading positions, borrow and invest inoverseas market subject to certainspecifications and ratification by respectiveBanks’ Boards. Banks are also permitted


to fix interest rates on non-resident deposits,subject to certain specifications, usederivative products for asset-liabilitymanagement and fix overnight open positionlimits and gap limits in the foreign exchangemarket, subject to ratification by RBI.

• Permission to various participants in theforeign exchange market, includingexporters, Indians investing abroad, FIIs, toavail forward cover and enter into swaptransactions without any limit subject togenuine underlying exposure.

• FIIs and NRIs permitted to trade inexchange-traded derivative contractssubject to certain conditions.

• Foreign exchange earners permitted toretain up to 100 per cent of their foreignexchange earnings in their ExchangeEarners’ Foreign Currency accounts.

• Borrowers eligible for accessing ECBs canavail of an additional US $ 250 million withaverage maturity of more than 10 yearsunder the approval route. Prepayment ofECB up to US $ 300 million without priorapproval of RBI.

• The existing limit of US $ 2 billion oninvestments in Government securities byforeign institutional investors (FIIs)

enhanced in phases to US $ 3.2 billion byMarch 31, 2007.

• The extant ceiling of overseas investmentby mutual funds of US $ 2 billion is enhancedto US $ 3 billion.

• Importers to be permitted to book forwardcontracts for their customs duty componentof imports.

• FIIs to be allowed to rebook a part of thecancelled forward contracts.

• Forward contracts booked by exporters andimporters in excess of 50 per cent of theeligible limit to be on deliverable basis andcannot be cancelled.

• Authorised dealer banks to be permitted toissue guarantees/letters of credit for importof services up to US $ 100,000 for securinga direct contractual liability arising out of acontract between a resident and a non-resident.

• Lock-in period for sale proceeds of theimmovable property credited to the NROaccount to be eliminated, provided theamount being remitted in any financial yeardoes not exceed US $ 1 million.


NON-DELIVERABLE FORWARD MARKET

� NDFs are types of derivatives for trading in non-convertible or restricted currencieswithout the delivery of the underlying currency.

� The NDF market in the Indian rupee (INR NDF) has been in existence for around 10years or so., reflecting onshore exchange controls and regulations.

With controls imposed by local financialregulators and consequently the non-existenceof a natural forward market for non-domesticplayers, private companies and investorsinvesting in some economies such as China,India and South Korea look for alternativeavenues to hedge their exposure to suchcurrencies. In this context, non-deliverableforwards (NDFs) have become popularderivative instruments for meeting the offshoreinvestors’ demand for hedging. NDFs are typesof derivatives for trading in non-convertible orrestricted currencies without the delivery of theunderlying currency.

The NDF market for Asian currencies is largelyconcentrated in Singapore, although theirexistence is found in London and New York aswell. The major trading currencies in the NDFmarket are the Chinese renminbi, the Koreanwon, the New Taiwan dollar, the Indian rupee,the Indonesian rupiah and the Philippine peso.The volatility and bid-ask spread in the NDFmarket for Asian currencies are found to belower for shorter maturities than for longermaturities.

The NDF market in the Indian rupee (INR NDF)has been in existence for around 10 years orso., reflecting onshore exchange controls andregulations. Besides, the INR NDF market alsoderives its liquidity from (i) non-residents wishingto speculate on the Indian rupee without anyexposure to the country and (ii) arbitrageurs whotry to exploit the differentials in the prices in twomarkets. The spread as well as volatility of theINR NDF is higher than that of onshore spot andforward markets. Though an accurateassessment of the volumes is difficult, estimateddaily INR NDF turnover was around USD 100million in 2003/2004. NDF volumes havereportedly grown substantially since then. Whilethese volumes are not large enough to affectthe domestic onshore market under regularmarket conditions, in volatile market conditions,however, these may impact the domestic spotmarket. The NDF turnover for the Indian rupeeis estimated to be lower than that in the Chineserenminbi, the Korean won and the New Taiwandollar. This could be attributed to the gradualrelaxation of exchange controls and reasonablehedging facilities available to offshore non-residents with exposures to the Indian rupee.


HEDGE FUNDS

� A hedge funds are investment funds, charging performance fees and typically open toonly a limited range of investors’.

� Hedge funds give higher return.

� Reasons for hedge funds looking to India.

� SEBI’s concerns.

A hedge fund is an, investment fund, charging aperformance fee, and typically open to only alimited range of investors’ usually high net worthindividuals (HNIs). In the United States, hedgefunds are open to accredited investors only. Aninvestor with net worth of US $ 1 million or annualincome of US $ 200,000 per annum or annualincome US $ 300,000 with spouse is called anaccredited investor. Because of this restriction,they are usually exempt from any directregulation by regulatory bodies.

In many offices you may find colleagues poolingtheir money and applying for large pulic issuesand sharing the benefits if they get allotments.They are essentially running a Hedge Fund.Though Hedge Funds are not informal affairsbut legally incorporated and enter into contractswith investors. Hedge funds are no-holds-barred investment pools for wealthy individualsand institutional investors who are consideredto be sophisticated enough to take risks thatordinary investors should not. These investmentvehicles are allowed to do things that mutualfunds are barred from doing. They can followcomplex investment strategies e.g. being longor short on assets and entering into futures,swaps and other derivatives contracts.Appropriate to their name, hedge funds mayoften seek to offset potential losses in theprincipal markets they invest in by hedging viaa number of methods. However, the term‘hedge fund’ has come in modern parlance tobe overused and inappropriately applied to anyabsolute-return fund – many of them do notactually hedge their investments.

A hedge fund may for example take longpositions in certain stocks and short positionsin certain other stocks such that their portfolio

beta* is close to zero, that is, the portfolio betawill remain relatively unchanged due to thebroad market movement. Such a portfolio willprimarily change if the stocks move more thanthe broad market movements.

Consider, for instance, Hero Honda and BajajAuto. The hedge fund may buy Bajaj Auto andshort Hero Honda, such that the portfolio beta isclose to zero. Suppose Bajaj Auto moves up by10 per cent, and Hero Honda and the broadmarket move up by 7 per cent, the fund’s netgain is 3 per cent. This is because Bajaj Autooutperformed the market, precisely what thehedge fund was betting on when it constructedthe portfolio. In short, hedge funds generatesecurity-specific returns, and attempt to lowermarket risk.

Currently, there are more than 200 hedge fundseach with $ 1 billion or more in assets. Totalhedge fund industry asset in 2006 wasestimated at $ 1.442 trillion. Hedge funds do notconstitute a homogenous asset class. Manydifferent approaches are used taking differentexposures, exploiting different marketopportunities, using different technique anddifferent instruments. Investing in hedge fundsis considered to be a riskier proposition thaninvesting in a regulated fund. The primaryreasons are:

_____________________________________________________________________*Beta is a popular name of risk in a stock. Lower thebeta, lower is the risk of that stock. Its an indicator of, byhow much percent the price of a stock will changerelative to the change in overall index of the stockmarket. Higher the beta higher is the volatility of thestock relative to the market and hence higher is the risk.


� Leverage: In addition to putting money intothe fund by investors, hedge funds will alsoborrow money. Some funds borrow manytimes greater than the initial investment.Where a hedge fund has borrowed Rs 9000for every Rs 1000 invested a loss of only10% of the value of the investment can wipeout 100 % of the value of the investors stakein the fund.

� Short selling : When hedge funds useshort selling as an investment strategyrather than hedging strategy it can suffervery high losses.

� Appetite for risk: Hedge funds culturallytake more risks than other types of funds.They invest in distressed securities andcollateralized debt obligations against sub-prime.

� Lack of transparency: Hedge funds aresecretive entities. It is therefore difficult foran investor to assess trading strategies,diversification of the portfolio and otherfactors related to investment decisions.

� Lack of regulation: Hedge funds are notsubject to as much oversight from financialregulators and therefore some may carryundisclosed risks.

Investors in hedge funds are willing to take theserisks because of the corresponding rewards.Short-selling opens up new investmentopportunities, riskier investments which providehigher return; secrecy prevents imitation bycompetitors and being unregulated reduces costand gives more freedom to the fund manager.

Many hedge funds are established in off-shoretax havens so that the fund can avoid paying taxon the increase in its value of portfolio. More thanhalf of the world’s hedge funds are located inoff-shore locations such as Cayman Islands,British Virgin Islands, Bermuda and Bahamas.USA and European Union were the next mostpopular locations. However, the investors paycapital gains taxes on any profit they makewhen they realises their investments.

Why Hedge Funds Are Looking to India

The size of the hedge fund industry worldwideis over $1.5 trillion. The Indian marketcapitalisation today is around $1 trillion.Estimation about hedge fund allocations in Indiais about 5%. Few years ago hedge funds werebarely considering India as a potential market toinvest in and they were highly secretiveinvestment vehicles even in the U.S.

However, things are developing rapidly like in anyother emerging market, with new strategies,new rules and new players coming to fore.Market situations have changed and so did theattitude of these funds towards India. Today, it’sa different story. As big returns are no longereasy to come by in US, European, Japanesestock markets, international hedge funds areincreasingly looking to emerging countries likeIndia and other developing economies andevaluating investment opportunities and thepotential gains to be made.

Unlike other developing economies like China,where stock markets are not well developed andcompany information is relatively opaque, Indiahas much of the necessary institutionalframework for hedging, including a regulatoryregime and good information disclosurestandards. The Chinese economy is larger, butthe capital markets are better developed in India.

Another important reason of hedge fundsinvesting in India market place is bandwagoneffect. They are here with the idea that they’llget extraordinary returns, and of course withIndia being a growth story, those returns aredefinitely possible. Investors are looking for suchemerging market plays. If you go back to thetime when China started moving, it took peopleby surprise. Now that India is moving, everybodywants to invest in India.

Regulatory concerns

By definition, hedge funds are pooled funds thatinvest in several instruments across marketsand are organised as private investmentpartnerships. Due to closely held nature ofinvestment, hedge funds have managed toescape regulation in US for a long time. Its only


after the fall of LTCM (Long Term CapitalManagement), they have started attractingscrutiny.

The Securities and Exchange Board of India(SEBI) has told several hedge funds wanting toinvest in India that they should agree to a lock-inperiod of two years as a cushion against suddenwithdrawal under adverse circumstances.Some of these are already invested in the Indianmarket through participatory notes (PNs). SEBIis trying to persuade many other new hedgefund applicants to provide a lock-in undertaking.The regulator also wants to ensure that hedgefunds registering directly with it are regulated inthe country of their origin. As per SEBI, those

hedge funds who agree to lock-in clause will geta preference in entering the Indian stock market.By its very nature, hedge funds may be averseto accepting such a commitment.

The issue of registration of these classes ofinvestors has been discussed by the SEBI board.Officials say the regulations governing foreigninstitutional investors (FIIs), dating back to 1995,do not bar registration of hedge funds. However,the capital markets regulator has not approvedany applications from hedge funds on the groundthat they cannot come in as foreign portfolioinvestors since they are not regulated in theirhome countries.


PRIVATE EQUITY

� It is a practice of pooling capital from high net-worth individuals and investing it in companiesthrough negotiated process.

� Private Equities (PE) provide long term, committed-share capital to unquoted companies.They help to expand, start up, turnaround or revitalise a company.

� Though Private Equities have some close similarities with Hedge Funds (HF), they havemarkedly different characteristics and operating patterns.

It is a practice of pooling capital from high net-worth individuals and investing it in companiesthrough negotiated process. Private Equityinvestments usually concentrate on areas ofventure capital, buy-outs or distress financing.Unlisted securities also can be sold directly toPrivate Equity Funds. Private Equities (PE)provide long term, committed-share capital tounquoted companies. They help to expand, startup, turnaround or revitalise a company. All theseinvestments are often fraught with high risk andhigh returns. Private Equity investments aregenerally transformational and they involve in themanagement of the company they finance. PEwill receive returns on their investment by wayof IPO (in case of venture capital) or sale of thecompany after turning it around or after valueaddition.

Only high net-worth individuals and institutionalinvestors can invest in Private Equities, as theminimum investment limit is very high.Investors in PEs should be prepared to lock-intheir capital for long periods or even a completewipe out of capital. In the US only accreditedinvestors (having net worth of $1million orindividual income of $2,00,000 or combinedincome (with spouse) of $3,00,000 in the pasttwo years and expect to sustain such incomelevels in the future) are allowed to invest in PEs.Though PEs resemble to Mutual Funds by theirstructure, they are very loosely regulated thanthe Mutual Funds. The dealings between thePEs and their investors are seldom brought topublic domains.

Private Equities have made commendablecontributions to the society by nurturing new

ideas and concepts into reality through VentureCapital. Companies like Microsoft, Apple, FedExetc., were financed by PEs in their nascentyears. However sometimes PEs are blamedfor adopting predatory practices in taking overcontrol of companies.

Though Private Equities have some closesimilarities with Hedge Funds (HF), they havemarkedly different characteristics and operatingpatterns. Private Equity funds buys either all ofthe equity of a company or controlling stake andparticipate in management. Controlling stakeis not a goal in the case of Hedge Funds.Investments by PEs normally longer terminvestments spanning five to seven years orlonger as a result investments in PEs are notthat liquid whereas HFs have short-terminvestment and return target. HFs sees marketvolatility as an advantage and look for marketinefficiencies and pricing anomalies to makereturns. PEs seek to create value in thecompanies they invest through participation inor complete takeover of management.

India is favoured destination for international PEplayers. In the year 2007, the incremental PEinvestment in India is expected to cross $10billion. There is hardly any India based PE fundsthough there are venture capital funds promotedby banks and financial institutions. Also thereis no separate regulatory framework for PEs.Currently it is viewed as a different form ofMutual Fund. However RBI and SEBI haveformed study groups to analyse the structureand operating patterns of PEs.


PARTICIPATORY NOTES

� Participatory Notes are offshore derivative instruments issued by SEBI-registered(FIIs) to their overseas investors.

� Reasons for their preference by foreign investors.

� Concerns of Indian regulators.

� Recent guidelines of SEBI to regulate P-notes .

Participatory Notes are offshore derivativeinstruments issued by SEBI-registered ForeignInstitutional Investors (FIIs) to their overseasinvestors, who wish to invest in the Indian stockmarkets without registering themselves withSEBI. The investors, who buy PNs, deposit theirfunds with offices of the FIIs situated outsideIndia. The FIIs use their proprietary account tobuy stocks in India. The FIIs or the brokers actlike exchanges since they execute the tradeand use their internal accounts to settle this. FIIsissue PNs to their overseas clients which givedetails of the underlying stocks. Foreign clientsget dividends or capital gains collected from theunderlying securities.

One reason for using PNs is to keep theinvestors’ name anonymous. Some investorsuse the instrument to save on transaction costs,record keeping, overheads and regulatorycompliance overseas. Investors often find itexpensive to establish broker and custodianbank relationships, deal in foreign exchange, paytaxes and/or filing, obtain or maintain aninvestment identity or regulatory approval incertain markets, where their total exposure isnot going to be very large. Such investors lookfor derivative solution to gain exposure inindividual, or a basket of, stocks in the relevantmarket. Sometimes, investors enter the Indianmarkets in a small way using PNs, and whentheir positions become larger, they find itadvantageous to shift over to a full-fledgedForeign Institutional Investors structure.

The biggest problem is their opacity in an era oftransparency. Indian regulators do not have anyidea about the source of funds and the identity

of foreign investors putting money in PNs. Onthe other hand, Indian investors have to disclosethe full details about their funds and identity whileputting funds in the market. So there is no levelplaying field. There is also a fear that PNs bringin hot money which comes into the countrysuddenly and exits at the same speed. Finally,the government is worried about whether the PNroute is being used to launder money. Earlier, aSEBI investigation exposed how Indian moneywas routed from India to Mauritius, London,British Virgin Islands and the US and re-enteredIndia as foreign money through the PN route.

Reserve Bank of India, which had sought a banon PNs, believes that it is difficult to establishthe beneficial ownership or the identity of theultimate investor, which is possible for registeredFIIs. It fears that FIIs, which have to comply withthe know-your customer (KYC) norms, know theidentity of the investor to whom the note wasissued. But it is possible for the investor to sellthe PN to another player resulting in multi-layering. Tax officials fear that PNs are becominga favourite with a host of Indian money laundererswho use the instrument to first take out fundsout of the country, through the hawala route, andthen get it back using PNs.

Over the years, the use of PNs has increasedfrom 17 Foreign Institutional investors issuing itin 2005 to over two dozen funds now in thecurrent year. Merrill Lynch, Morgan Stanley,Credit Lyonnais, Citigroup and Goldman Sachsare the biggest issuers. The total value ofunderlying investments in equity represented bythe PNs was Rs 67,185 crore representingabout 25.7% of the cumulative net investments


in equities by FIIs at the end of June, 2005. As ofAugust 2007, the notional value of PNs was Rs3.53 lakh crore — about 51.4% of all assetsunder all FIIs present in India.

Securities and Exchange Board (SEBI) hasrecently announced the following changes in thePN business.

i. There will be no more issues of PNs againstunderlying derivatives either by FIIs or thesub-account holders.

ii. Existing positions will have to be unwoundin 18 months.

iii. Only regulated entities ( those subject tooversight in their home country by the

concerned sectoral regulator) will beallowed to invest through PN.

iv. PN issuing FIIs where outstanding PNs areless than 40% of the FIIs assets undercustody will be allowed an incrementalissuance of 5% a year subject to a cap of40% of the FIIs assets under custody; FIIsthat are already over 40% limit will beallowed to issue/renew fresh PNs only oncancellation/redemption of PNs to anequivalent extent.

The sensex initially reacted negatively on theannouncement of SEBI’s guidelines, but pickedup after Finance Minister and SEBI’sclarifications. The long-term impact of SEBI’spolicies would be known only in times to come.


CARBON CREDITS & EMISSION TRADING

� Carbon Credits are key components in emission trading schemes.

� The concept of Carbon Credits formally came into existence as a result of Kyoto Protocol

� Kyoto protocol envisages a cap and trade system. The cap lays down that the developedcountries should reduce their emissions 5.2% below their 1990 levels over the five yearperiod from 2008-2012.

� Since Carbon Credits are tradable instruments with a transparent price, financial investorslike banks, brokers, funds, and private traders have also started buying them for puretrading purposes.

Managing emissions has become one of thefastest-growing segments in financial services.Eventually emission trading is expected tobecome the biggest commodity market in theworld. Emission trading provides a free markettool to control the environmental pollution causeddue to greenhouse gases. Carbon Credits arekey components in emission trading schemes.The concept of Carbon Credits formally cameinto existence as a result of Kyoto Protocol, aninternational agreement between 175 countries.

Greenhouse effect is the warming of earthdue to presence of Greenhouse gases (GHG).The phenomenon is similar to what is happeningin a glasshouse (Greenhouse) where plants arecultivated in controlled conditions. Part of theheat energy received from the sun is absorbedby earth’s surface and part is radiated back intothe atmosphere. This return radiation is of ahigher wavelength than that of radiation receivedfrom the sun and cannot easily pass throughthe blanket of greenhouse gases covering theearth’s atmosphere, resulting in warming theatmosphere close to the earth.

The main greenhouse gases are carbondioxide, methane, nitrous oxide and variousflouro carbons of which CO2 is the largestcomponent comprising 76% of all green housegases. The main cause of CO2 emission isburning of fossil fuels like coal, oil and naturalgas. The second factor that increases CO2 levelin the atmosphere is deforestation.

Kyoto Protocol aims at reducing theemissions in the developed nations by fivepercent (5.2% to be exact) below the 1990 base

line. This has to be achieved in the time periodbetween 2008 and 2012. The present treatyexpires in 2012. The major share of past andpresent emissions is from developed countries.Per capita emissions, even in large developingcountries like India and China are low incomparison. However, even without a target orcommitment to reduce the emissions accordingto Kyoto limits, developing countries share thecommon responsibility to reduce emissions.

Kyoto protocol envisages a cap and tradesystem. The cap lays down that the developedcountries mentioned in the Annexure I of UnitedNations Framework Convention on ClimateChange (UNFCCC) should reduce theiremissions 5.2% below their 1990 levels over thefive year period from 2008-2012 (currentcommitment period). These are national leveltargets for participating countries. Countriesmanage their emission quotas through registriesat the national level. These registries arerequired to be validated by the UNFCCC. In turncountries may set quotas on the emissions ofinstallations run by various business entities andorganisations (operators).

Each operator (business entity or organisation)will get Assigned Allocation Units or in short‘Allowances’ of emission quotas. Each unit ofallowance (credit) allows an operator to emit onemetric tonne of Carbon Dioxide or otherequivalent greenhouse gas. The operators whohave not used up their quotas (or prevented theemission to that extent) can sell their unusedallowances as Carbon Credits and those whohave exceeded their quotas can buy the extra


allowance as credit from other operators directlyor from the market place. By allowing credits tobe bought and sold, an operator can decide themost cost-effective way of reducing itsemissions either by investing in low emissionmachineries or production processes or bypurchasing credits from others.

Under Kyoto Protocol, developed countries andoperators who exceed their quotas can acquireemission credits by:

(i) Setting up a greenhouse gas emissionreduction project in another developedcountry (known as JI or JointImplementation)

(ii) Sponsor a greenhouse gas emissionreduction project in a developing country(known as CDM or Clean DevelopmentMechanism)

(iii) Buy it from countries with surplus creditsunder International Emission Tradingsystem.

If an Annexure I country is not in compliance withits emissions limitation in the first commitmentperiod (2008-2012), then that country is requiredto make up the difference plus an additional 30%in the second commitment period. In addition,that country will be suspended from makingtransfers under an emissions tradingprogramme. Emission Trading under KyotoTreaty will commence from 2008. However,European Union has commenced the trading in2005 under its Emission Trading Scheme (EUETS). Though America is yet to ratify the Treaty,many of its states are contemplating introducingsuch schemes.

Emission Trading in a way makes the developednations to pay for their emission sins andrewards the countries with good compliantbehaviour. This process also causes thetransfer of technology and wealth from richnations to poor nations. The large number ofcompanies coming up in developing nations canopt for cleaner technologies. They can have anedge over companies in developed nationswhich were established in the past and aredependent on technology and machinery that donot meet new-age emission standards.Replacement of such machineries andprocesses can be prohibitively costly.

Besides the companies and manufacturingunits, community based projects can also earncarbon credits and sell it in the internationalmarket. For example, if a communityundertakes tree plantation under CleanDevelopment Mechanism (CDM), it helps toabsorb carbon from the atmosphere andbecomes eligible for carbon credits. There aredefined standards based on the woodmass toestimate the amount of carbon absorbed by thetrees in a given area.

Since Carbon Credits are tradable instrumentswith a transparent price, financial investors likebanks, brokers, funds, and private traders havealso started buying them for pure tradingpurposes.

Greenhouse gases other than CO2 also can betraded, but they are quoted as standardmultiples of carbon dioxide with respect to theirglobal warming potential. Carbon prices arenormally quoted in Euros per tonne of carbondioxide or its equivalet (CO2e) also known asEuropean Union Allowance (EUA). Currently oneEUA is traded at about 22 Euros. Climateexchanges provide spotmarket as well asfutures and options market for carbon trading.At present, there are four major exchanges,namely, Chicago Climate Exchange (CCX),European Climate Exchange (ECX), Oslo-based Nord Pool and Paris-based PowerNext,trading in Carbon Credits.

Indian share in carbon trading has crossed $5billion and the country is expected to be a majorplayer in the arena by 2012 generating 30 to 50%of the estimated 700 million units of carboncredits traded globally. Indian companies havea strategic advantage as the cost of emissionreduction in India is very low as compared tothe developed countries. However the regulatoryframework in India in respect of carbon tradingis somewhat in a nascent stage and yet to haveclear guidelines in various aspects includingtaxation of income from carbon credits, financingof CDM projects etc.

Meanwhile, Multi-Commodity Exchange of IndiaLtd (MCX) had already entered into a strategicalliance with the Chicago Climate Exchange(CCX) and is all set to launch trading in carboncredits shortly.


Though the scenario presents itself as veryappealing, some degree of caution is warranted.There appears to be some snags lurking aheadin the track. The Kyoto Treaty itself will expire in2012 which does not mean that carbon tradingwould come to an end by that date but what isnot predictable is the nature of the treaty thatwill succeed the present one. Emission Tradingmarkets depend on tough targets, without whichthere would be no demand. America, havingnot ratified the present treaty, has threatened todisrupt a major clause that exempts the largedeveloping countries like India and China fromemission cap. China is set to overtake theUSA this year as the world’s largest CO2 polluter.This has already become an election issue inAmerica. Australia, another major developedcountry yet to ratify the Kyoto Protocol, alsodemands that developing nations too have torestrict their greenhouse gas emissions. Thisdemand, if allowed, can bring down theavailability of surplus carbon credits in thedeveloping nations.

Even before 2012, there can be high volaitility inthe price due to industries exploiting loopholesin the system like exaggerating their expectedemission levels to get more quotas from thegovernment and selling such excess credits.This can bring down the price. Also if corruptingthe inspecting mechanism is easier and cheaperthan buying carbon credits, large pollutors mighttake such routes and bring down the demand inthe global market. Several environmentlists arealready against carbon trading, as the concepthardly helps to bring down the emission. Theysee it as hiring someone to diet for you. Alsothey accuse that instead of getting penalised,the big industrial pollutors are allotted with creditsworth billions.

The European Union recently adoptedemissions targets to 2020 which will guaranteeits carbon market until then, regardless of anysuccessor to Kyoto. So notwithstanding theuncertainities in price, demand, supply andregulations, emission trading is here to stay.


What are Exchange Traded Funds?Exchange Traded Funds, more popularly knownas ETFs, are a hybrid of open-ended mutualfunds and listed individual stocks. In simpleterms, ETFs are funds that are listed on stockexchanges and traded like individual stocks.Therefore, ETFs bring the trading and real timepricing advantage of individual stocks to mutualfunds.How do ETFs Compare with Mutual FundsStructurally?ETFs are not much different from mutual fundsin that they too enable an investor to own part ofa portfolio managed by a professional. Also, likemutual funds, ETFs entitle investors to aproportionate amount in their underlying portfolio.However, unlike the mutual funds, which areactively managed by the fund manager, ETFsare linked to some index and are not managed.In that sense, an investor does not have to worryabout the performance of the fund manager.But there are some significant differencesbetween mutual funds and ETFs. Unlike mutualfunds, ETFs do not sell their shares directly toinvestors for cash. A securities firm createsETFs by depositing a basket of stocks. This largeblock of stocks is called a creation unit. In returnfor these stocks deposited, the ETF receivesshares, which are then offered to investors overthe stock exchange. Thus, the stocks depositedform the holding of the ETF.In the case of mutual funds, the portfolioundergoes changes whenever an investor buysor redeems units, but in the case of ETFs,trading at the stock exchanges does not affecttheir portfolio.

EXCHANGE TRADED FUNDS

� ETFs are funds that are listed on stock exchanges and traded like individual stocks.

� ETFs are linked to some index.

� In this the underlying shares are not traded.

� The prices of ETFs are determined by market dynamics.

� Benefits: It provides the benefit of diversified index funds and brings trading flexibilityof stocks. The operating expenses are lower.

� The first ETF in India was launched in 2001.

What are the Advantages andDisadvantages of investing in ETFs?While providing the benefits of diversified indexfunds, ETFs bring in the trading flexibility ofstocks. Just like the shares, ETFs can be boughton margin, short sold, etc. Thus, investors haveready liquidity even when they own not sharesbut only a part of a diversified portfolio. Moreover,the operating expenses of these funds are lowerthan even that of similar index funds. Thisdifference is reflected in the somewhat higherNAV against an index fund of same portfolio.However, because ETFs are bought and soldover stock exchanges, there is a transactioncost involved in dealing with brokers. Also, attimes, an ETF can trade at a discount to theNAV of the underlying net asset value.What Determines the Price of ExchangeTraded Funds?Since ETFs are listed on stock exchanges, it ispossible to buy and sell these throughout theday, which one cannot do with mutual funds. Andbecause ETFs are traded on the stockexchanges, their price is determined by thedemand-supply dynamics in the market.However, since they are essentially open-endedmutual funds, the price is also dependent on thevalue of assets held by them. In practice, theytrade in a small range around the value of theassets (NAV) held by them.Does India have an Exchange Traded Fund?The first exchange traded fund in the world -Standard & Poors’ Depository Receipt (SPDR)- was launched in 1993. India’s first ETF - NiftyBenchmark Exchange Traded Scheme (NiftyBeES) - was launched towards the end of 2001by Benchmark Mutual Funds.


GOLD DEMAT

� Commodity futures including gold are traded in commodity exchanges and onlineexchanges such as MCX, NCDEX, NMCE and NBoT in India.

� Gold and silver are highly traded on the MCX; Agri commodities are traded moreon the NMCE and the NCDEX.

� The gold traded is required to meet certain pre-set quality specifications.

� MCX, in association with the World Gold Council, has launched a new product - agold contract that is settled in a week (T+7).

The lifting of the 30-year ban on commodityfutures trading in India has opened yet anotheravenue for investors. Commodity futures aretraded in commodity exchanges and popularonline exchanges such as the Multi CommodityExchange (MCX), the National Commodity andDerivatives Exchange (NCDEX), the NationalMulti-Commodity Exchange (NMCE) and theNational Board of Trade (NBoT) in India. Theseare platforms on which market participantscome together to effect their trades. The NCDEXand the MCX are located in Mumbai, the NMCEin Ahmedabad and the NBoT in Indore. Theseexchanges are promoted by leading banks. TheNCDEX is co-promoted by the NSE; the MCXby the State Bank Group; and the NMCE by theCentral Warehousing Corporation.

Investors are required to open a trading accountwith a broker or sub-broker by providingdocuments establishing address, identity proofand bank account details. Those who want togive or take physical delivery for a contract onthe MCX and the NCDEX are additionallyrequired to open a demat account with NSDL orCDSL, apart from providing local sales taxregistration details of the delivery centre.

The Forward Markets Commission (FMC)approves commodities that can be traded.Commodities available for trading include bullion— gold and silver; metals — steel, copper,aluminium, lead and nickel; crude; and severalagri commodities. Crude, gold and silver arehighly traded on the MCX, agri commodities are

traded more on the NMCE and the NCDEX.Commodity future contracts are tradeablestandardised contracts, the terms andconditions of which are set in advance by theexchanges regulating the trade.

The gold traded is required to meet certain pre-set quality specifications. On the NCDEX andMCX a minimum fineness of 0.995 and a serialnumber of an approved refiner is required whileit is 0.999 fineness in the NMCE.The Lot size iskg in MCX and 100 gm in NCDEX andNMCE.The quotation is 10 gm of 0.999 finenessin all the exchanges. The delivery centre forNCDEX is Mumbai and for MCX Mumbai andAhmedabad while NMCE has 7 delivery centres.The delivery size is 100 gm in NMCE and 1000gm in the case of NCDEX and MCX.

If a person wants to enter into a deliverysettlement for gold, he will have to enter into aminimum of 10 contracts or multiples thereof.Market participants are required to negotiate onlythe quantity and price of the contract, as all otherparameters are predetermined by the exchange.A settlement takes place either through squaringoff your position or by cash settlement or physicaldelivery. Squaring off is taking a contrary positionto the initial stance, which means in the case ofan original buy contract an investor would haveto take a sell contract. An investor who intendsto give or take delivery would have to inform hisbroker of the same prior to the start of deliveryperiod.


Delivery is at the option of the seller; a buyercan take delivery only in case of a willing seller.All unmatched/rejected/excess positions arecash settled; all open positions for which nodelivery information is submitted are also cashsettled. Under cash settlement, the differencebetween the contract price and settlement priceis to be paid or received. Unlike the stock marketsthat close by 3.30 p.m., the NMCE is open till8.00 p.m. and the MCX and the NCDEX until11.00 p.m. Unlike equity futures, which have alife cycle of three months, contract duration incase of commodity futures varies, and in someinstances extends up to six months.

Market participants can hedge their position overa longer period. Commodity futures are alsoeasier to understand compared to equity futures,as one has to just keep track of demand andsupply and not the several financial metrics thatthe latter calls for. Sales tax is applicable onlywhen a contract results in delivery.

Investors are required to maintain margins andtop up their accounts on a daily basis — marked-to-market margin — for fluctuations based onthe tick size. Margins have differentcomponents; there is an additional deliverymargin that has to be maintained once the

contract enters the delivery period in case ofdelivery settlements.

A seller intending to give delivery would have toapproach the accredited warehouse foravailability of space and the assayer, whocertifies the quality of the goods; the goods arerequired to meet the pre-set qualityspecifications. The seller has to bear storagecharges until the date of demat credit, loading/unloading and all other incidental charges,including assaying charges. A buyer intendingto take physical delivery has to request hisbroker. The buyer has to then approach thewarehouse with the document. It is possible totake partial delivery from the warehouse. Allincidental charges pertaining to taking deliveryare to be borne by the buyer.

Investors can now buy, hold and trade gold indematerialised form without having to worryabout parking it in a vault for its safe-keeping.MCX, in association with the World Gold Council,has launched a new product - a gold contractthat is settled in a week (T+7). Investors canget exposure to gold through a one-weekcontract, which is closer to a spot market. A Goldpassbook would be issued to investors optingfor this product. MCX would be linked to NSDLfor offering this product.


ConceptBook building is rather a new concept for us inIndia, being introduced only in 1995. Under bookbuilding process, the issuer (or issuingcompany) is required to tie up the issue amountby way of private placement. The issue price isnot priced in advance. It is determined by offerof potential investors about the price which theymay be willing to pay for the issue. In course ofthe roadshow exercises, the issue manager,called Book-Runner, records the amountsoffered by various investors. The price of theinstrument (i.e., equity, debenture or bonds) isarrived at as an weighted average at which themajority of investors are willing to buy theinstrument.Determining Issue PriceBook building is a process of price discovery.Book building is a pricing mechanism wherebynew securities are valued on the basis of ademand feedback following a period ofmarketing. Book building is a transparent andflexible system based on real-time feedback ofinvestors and is an alternative to the rigidity ofthe existing system of fixed pricing. Bookbuilding enables fair pricing of the issue. Fairprice is supposed to emerge out of offers givenby various institutional investors.Statutory RequirementsBook building is a novel concept and is in infancyin India. The concept has assumed significancein India as the SEBI has approved the bookbuilding process in pricing new issues with effectfrom the 1st November, 1995. SEBI has furtherclarified in December 1996 that the option ofbook building is available to all body corporateswhich are otherwise eligible to make an issueof capital to the public.SEBI has thrown open the doors for public issue

BOOK BUILDING

� Introduced in India in 1995

� It is a process of determining price of shares based on market feedback

� Under this, the offer price is not determined by the issuer but by the quotes givenby the prospective buyers. Hence, it is also called price discovery mechanism.

� Benefits: Evaluation of the intrinsic worth of the shares; savings on issue expenses;investors have a say in pricing; market determined pricing; reduction in lead time.

for companies without a profit track recordprovided they did so only through the bookbuilding route and 60% of the issue is picked upby qualified institutional buyers. SEBI furtherstipulated that all issues of over five times thenetworth via the book building route only and allpre-IPO and preferential allotments to have alock-in period of one year.Benefits of Book Building1. Book-building helps in evaluating the

intrinsic worth of the instrument beingoffered.

2. Price of instrument is determined in a morerealistic way on the commitments made bythe prospective investors to the issue.

3. The process of book building isadvantageous to the issuer company sincethe final price is decided at a date very closeto the date of opening of the issue. Bookbuilding also offers access to capital morequickly than the public issue.

4. As the issue is pre-sold, there would be nouncertainties relating to the fate of the issueinvolved.

5. The issuer company saves on advertisingand brokerage and they can chooseinvestors by quality.

6. Investors have a voice in the pricing ofissues. They have a greater certainty ofbeing allotted what they demand.

7. The issue price is market determined. It isa distant possibility that the market price ofthe shares would fall lower than the issueprice.

8. Optimal demand-based pricing is possible.9. Efficient capital raising and improved issue

procedures lead to a reduction in (a) issuecosts, (b) paper work and (c) lead time.


BUY BACK

� Buy Back is an arrangement by which shares issued to equity holders are boughtback by the company.

� Why done: To support market price; to acquire controlling interest; to deploy surplusfunds.

� Funds for buy back should come from authorised sources.

� Effects: Buy back may affect company’s liquidity, profits, EPS, Book Value andgearing ratio.

What is Buy Back?

Buy back is paying back of paid-up capital ofspecified securities (including employees stockoption or other securities as may be notified bythe Central Government from time to time)which are in excess of the requirements of thecompany.

Buy back can be in one of the following ways

1. Shares/securities bought back may beextinguished: As per Companies Act, thecompany buying back its own securitiesshall extinguish and physically destroy thesecurities bought back within 7 days of thelast date of completion of buy back.

2. Shares/securities bought back may notbe extinguished: The shares or securitiesbought back by the company can beretained and reissued after some time. Thistype of buy back is not permitted in India.

3. Liability on any of its shares/securitiesmay be reduced: Under this scheme, theliability of the company buying back canreduce the liability of the companyproportionately on the security/share but notto the full amount of the face value. Thistype of buy back is also not permitted inIndia.

Why buy back at all?

Buy back of shares is done for one or more ofthe following purposes:

1. Shares are underpriced: Sometimes,despite fundamentals of the company beingstrong, the prices of shares fall below theintrinsic value of the stock making theinvestors nervous. Companies can use buy

back as a weapon to soothe their nervesby supporting the share price during periodsof temporary weakness.

2. Company is not Performing Well: Somecompanies may not be performing wellleading to bear hammering of their scrips.Buy back of shares can be used as a marketsupport operation for the scrip of such acompany.

3. Controlling Interest: If buy back takesplace in which promoters will not sell, thepercentage holdings of the promoters willincrease without bringing in a single paisa.Thus buy back of shares by the companycan block unwelcome take-overs.

4. Returning surplus cash toshareholders: If the company is generatingmore cash than they need or when thebusiness in which they are operating doesnot offer substantial opportunity for growthand does not find long-term avenues fordeployment, then the company may decideto return the surplus cash to shareholders.

Conditions

1. Ultimate Sources

Buy back shall be out of the following sourcesas per Section 77A1 of the Companies Act.

� out of its free reserves

� out of the securities premium account

� out of the proceeds of an earlier issue otherthan fresh issue of shares made specificallyfor buy back purposes

1. In other words, the funds required for buyback shall not exceed the balances under


the above mentioned three sources. Thusthe rule has also ensured that buy back ofshares is not directly financed by issue ofsecurities.

2. The buy back shall not exceed 25% of thetotal paid-up capital and free reserves of thecompany purchasing its own shares orother specified security.

3. The ratio of the debt owed by the companyis not more than twice the capital and itsfree reserves after such buy back.

Procedure

1. Buy back from the existing securityholders on a proportionate basisthrough the tender offer: Offer by acompany to buy back its shares through aletter of offer from the holders of shares iscalled tender offer. Since the offer is to allthe shareholders, this will be onproportionate basis. The offer shall be openwithin the range of 7 to 30 days.

2. From open market: Under this it can beunder 2 ways. One is through book buildingprocess and the other through stockexchange. The announcement shall comeat least 7 days in advance.

In case of book building, the offer shall be openfor 15 to 30 days. The price shall be determinedbased on the acceptance received. The final buyback price, which shall be the highest priceaccepted, shall be paid to all the holders whoseshares have been accepted for buy back.

Effects on the company

1. Liquidity of the Company: Though thecompany may be having adequateundistributed profits, etc., these funds mighthave already been used for treasuryfunction/holding current assets/creation offixed assets. Hence the nature of immediatesource of funds for buying back the shareswill determine the liquidity position/currentratio of the company.

2. Profits of the company: If the source offunds are the sale proceeds of the earningassets, the income that would have beenearned therefrom will cease, thus reducing

the profit before tax (PBT) if all other factorsremain constant. If the funds are raised byway of interest bearing liabilities, the interestpayable on these liabilities will be a chargeon the profits and hence the PBT willdecrease if the others remain constant.

The corporate tax liability will also decreasedue to the decrease in the taxable profit ofthe company and the charges on incomeallowed by the Income Tax Act.

Since the PBT will decrease, the Profit afterTax (PAT) will also decrease even after thedecreased tax liability of the company.

3. Earnings Per Share: Though the profitswill decrease, the number of shares afterthe buy back will also decrease. Thus thenumber of shareholders eligible for dividendwill decrease. Hence the earnings per sharewill go up.

4. Book Value of the Share: Book value ofthe share will also increase after the buyback of shares.

5. Gearing Ratio: If liquidity for buy backcomes from the proceeds of assets, or fromadditional liabilities, the gearing ratios of thecompany will be adversely affected.

Shareholders’ Perspective: If the EPS of thecompany is expected to increase after the buyback of shares, why the present shareholdersshall sell the shares at all?

1. Liquidity: The shareholders in need offunds may need to dispose of some of theshares. In such a case they would disposeof the shares at the rate being bought backbecause there will be ready demand for it.

2. Profitability: Generally, the shares arebought back at a price higher than marketvalue. Such price makes it attractive forholder to dispose of the shares.

3. Booking of Profits: The holder of sharesmay decide to book profits or cut loss andtherefore surrender the shares to thecompany under buy back.

The proceeds of the shares under buy back aresubject to capital gains tax in the hands of theshare disposers.


STOCK INDEX FUTURES

● Futures are standardized contracts and are tradeable

● Standardisation implies that size, date of expiry and other features are standardized.

● Stock Index represents an average price of various scrips

● Advantages: Serves as a hedging mechanism; guards against price fluctuation causedby FII’s investment strategy; preserves portfolio value during market stress.

Futures contracts are standardised tradeablecontracts. They are standardised in size,expiration date and all other features. They aretraded on specially designated exchanges in ahighly sophisticated environment. The futurestrading system has effective in-built safeguardsin the form of cash adjustments (mark tomarket) to the account of trading member ondaily price change.

Stock Index Futures

Stock Index represents an average price ofvarious scrips. Also, Index futures do notrepresent a physically deliverable asset.Institutional and other large equity holders needportfolio hedging facility and Stock Index Futureshelp investors to hedge their funds.

Stock Index Futures offers the followingadvantages:

i) Reducing the equity exposure in a mutualfund scheme: Suppose that a balancedmutual fund scheme decides to reduce itsequity exposure from, say 40% to 30% ofthe corpus. At present, this can be achievedonly by actual selling of equity holding. Suchselling entails three problems: first, it is likelyto depress equity prices, second, it cannotbe achieved speedily and third, it is a costlyprocedure because of brokerage, etc. Thesame objective can be achieved throughindex futures at once, at much less costand with much less impact on the cashmarket.

ii) Investing the funds raised by new schemes:When a new scheme is floated, the moneyraised does not get fully invested forconsiderable time. Suitable securities atreasonable prices may not be immediately

available in sufficient quantity. Theavailability of stock index futures can takecare of this problem.

iii) Open-ended funds: In the case of open-ended scheme, repurchases maysometimes necessitate liquidation of a partof the portfolio but there are problems inexecuting such liquidations. Selling eachholding in proportion to its weight in theportfolio is often impracticable. Some of theholdings may be relatively illiquid. Rushingto the cash market to liquidate would drivedown prices. Stock Index Futures can helpto overcome these problems to theadvantage of the unit holders.

iv) Preserving the value of portfolio during timesof market stress: There are times when themain worry is the possibility that the valueof the entire equity portfolio may fallsubstantially if, say, event ‘X’ occurs. Salesof Stock Index Futures can be used toinsure against the risk.

v) International investors: The buying andselling operations of FIIs, at present, causedisproportionate price-effect on the Indianbourses. In other words, what the FIIs buy/sell is a “piece” of the whole Indian equitiesmarket. If stock index futures are available,this can be carried out with greater speedand less cost and without adding too muchto market. While trying to maximise the netinflow of FII portfolio investment, itsdisturbing effects can possibly beminimised if the facility of stock index futuresis available.

vi) Stock index is difficult to be manipulated ascompared to individual stock prices, more


so in India, and the possibility of corneringis reduced. Of course, manipulation of stockindex can be attempted by influencing thecash prices of its component securities.While the possibility of such manipulationcannot be ruled out, it is reduced bydesigning the index appropriately.

vii) Stock index futures enjoy distinctly greaterpopularity, and are, therefore, likely to bemore liquid than all other types of equityderivatives as is learnt by internationalexperience.

viii) Stock index, being an average, is much lessvolatile than individual stock prices. Thisimplies much lower capital adequacy andmargin requirements in the case of indexfutures. The lower margins will induce moreplayers to join the market.

ix) Since Index futures do not represent aphysically deliverable asset, they are cashsettled all over the world on the premise thatthe index value is derived from the cashmarket. This, of course, implies that thecash market is functioning in a reasonablysound manner and the index value basedon it can be safely accepted as thesettlement price.

Regulatory complexity is likely to be less in thecase of stock index futures than for other kindsof equity derivatives, such as stock indexoptions, or individual stock options.

Stock Index Futures Trading

The BSE and NSE ushered in a new era bylaunching index futures trading in the secondweek of June, 2000. A trader can bet on Sensexfutures of six types - one month, two monthsand three months and three spread futures(June-July, July-August and June-August). Themechanics of trading are as under:

Suppose Sensex futures for July is 5000; itmeans that the market today expects theSensex to close at 5000 on expiry of the futurescontract in July.

If we believe that the Sensex will close at a higherlevel by end-July, we can buy the index futures

at 5000. At least 50 contracts of Sensex futureshave to be bought and each contract is pricedat Rs.5.

Suppose we buy 50 July contracts of Sensexfutures at 5000, our contract value will beRs.12.5 lakhs (50 contracts x Rs.5 per contractx 5000 index).

The entire money need not be paid upfront; forfutures contracts work on a margin basis. Theinitial margin is fixed at 5 per cent or apercentage based on Value at Risk (VaR) model,whichever is higher. Suppose the margin is 5per cent, we have to pay just Rs.62,500 on thecontract worth Rs.12.5 lakh. But that is not theend of the transaction.

What if the Sensex futures rises to 5200 thenext day?

We have already gained 200 points on ourfutures contract (5200-5000 points). We have,thus, made a profit of Rs.50,000 (200 points x50 contract x Rs.5 per contract) which we willreceive from the seller. But what if the Sensexfalls to 4,700 the day after we purchase thefutures contract? Since we have lost 300points per contract, we will have to pay the sellerRs.75,000. This mark-to-market transaction iscarried out on a daily basis till the futurescontract expires.

How is the final settlement made? Supposethe contract expires on the last Thursday of Julyand the Sensex futures closes the previous dayat 5200. If the Sensex in the cash market closeson the last Thursday at 5400, we have gained200 points (5400 in the cash market - 5200, theprevious day’s futures price). We will, thus,receive Rs.50,000 (200 points x 50 contracts xRs.5 per contract) from the seller.

If, however, the Sensex loses 300 points on theexpiry of the contract, we will have to pay theseller Rs.75,000 as the final settlement.

The most important point is that on finalsettlement, the Sensex value in the cash marketis compared with the Sensex futures value ofthe previous day.


ESOP Accounting

A Stock option confers on an employee the rightto purchase the share of the company at a setprice, after a set period of time. As thecompany’s share price goes up, so will the valueof the option.

Nowhere the use of employees stock options isas widely prevalent as in corporate America.Today it is not only the chief executive who getspaid in stocks but also the lower level employee.Much of the success of the tech companies ofSilicon Valley as also the techies who inhabit itis ascribed to the stock options. Tech companieswhose success depends on the skill of humanassets found stock options a handy device tolure the human capital.

The underlying logic is that when managers ownpart of the stock of the firm they tend to makedecisions that increase the value of the firm asalso that of their holdings in the process.

Also, stock options do not result in a drain oncash resources upfront, unlike other forms ofcompensation. For employees the bootyrepresented a beautiful road to riches. The stockoptions turned many of the young techies intomillionaires.

The accounting framework makes the stockoptions a cheaper way to pay. In simpler termsdevoid of jargon what it means is that when thesalaries are paid in cash they become cost andreduce the reported profits. When the salariesare paid in the form of stock options they do not.

EMPLOYEES STOCK OPTION PLANS (ESOPS)

� Employee stock option plan gives the right to employees to purchase share of acompany at a set price.

� Under this, employees are offered shares in lieu of salary or other compensation.

� Advantages: Increased employee commitment; no drain on cash.

� Disadvantages: Stock options will not be attractive when share prices fall.

That is because the US GAAP allows them todo so. Never before in the history of corporates,the concept of shareholder value was so dearlyadored as it is in the present day. Thanks tostock options, more and more company bossestoday are more bothered about shareholdervalue than they would otherwise be. Normallythis should be considered a healthydevelopment but this led to unusual chemistryin corporate America. Shareholder value ismeasured by the increase in the market pricesof equities. The market prices in turn areinfluenced by the profitability of the firms. Themarket became so sensitive to profits, that if acompany reports a drop of 10 percent in profits,its market price gets battered by more than asmuch. That is keeping the CEOs on toes to reportyear on year increases in profits lest they shallmeet the wrath of the market. Strangely, it is thisfocus on shareholder value that is driving thecompany bosses to report highest profits, comewhat may. Given such a situation, it isunderstandable that company bosses dislike theidea of taking a shot on their company profits bytreating the stock options as cost.

While granting stock options does not result incash cost, more and more companies areborrowing money to buy back the equities toenable their employees to exercise their options.Thus companies are under double constraints,firstly they come under debt trap not forexpansion but to pay their employees. Secondly,with the market prices ruling at historic highs,they tend to buy equities at high costs. There isno gainsaying the fact that human capital is the


driving force of the tech companies, but theenormous price that is being paid, that toooutside the accounting framework, is a causefor serious concern. A bold approach has beentaken with regard to taxation of the perquisitevalue of the shares, etc., allotted under theESOP. And as a result of the amendment to theIncome Tax Act, ESOPs is not taxed as aperquisite in the hands of the employees butsubjected only to one-time capital gains tax andthat too only at the time of its sale. As a result ofthis amendment, ESOPs are virtually tax-free.

Various options are available to the employersfor granting ESOPs to their employees. Whilein some cases ESOPs can be granted byallotting to the employees equity shares of theemployer company at face value itself, in thealternative ESOPs may contain a proposal togrant shares of the employer company at a pricelower than the prevailing market price.Reversely, ESOPs may also be in form of freeissue of shares or debentures to the employees.


Margin trading is an arrangement whereby aninvestor purchases securities by borrowing aportion of the purchase value from the authorizedbrokers by using securities in his portfolio ascollateral.

The Securities Exchange Board of India (SEBI)has allowed member brokers to provide margintrading facility to their clients in the cash segmentsince April 1, 2004. Securities with mean impactcost of less than or equal to one and traded atleast 80 per cent (+/-5 per cent) of the daysduring the previous 18 month s would be eligiblefor margin trading facility. Only corporate brokerswith “net worth” of at least Rs.3 crore would beeligible to participate. Brokers wishing to extendthe facility of margin trading to their clients arerequired to obtain prior permission from theexchange(s) where the facility is proposed tobe provided. The broker may use his own fundsor borrow from scheduled commercial banksand/or NBFCs regulated by RBI. At any point oftime, total indebtedness of a broker for thepurpose of margin trading is not allowed toexceed 5 times of his net worth as defined bySEBI. The “total exposure” of a broker towardsthe margin trading facility shall be within the self-imposed prudential limit and shall not, in anycase, exceed the borrowed funds and 50 percent of “net worth”. The exposure to any singleclient at any point of time is restricted to 10 percent of the “total exposure” of the broker.

The margin arrangement has to be agreed uponbetween the authorized broker and the client

MARGIN TRADING

� Margin trading is an arrangement whereby an investor purchases securities byborrowing a portion of the purchase value

� SEBI has allowed member brokers to provide margin trading facility to their clientsin the cash segment since April 1, 2004

� Only corporate brokers with “net worth” of at least Rs.3 crore would be eligible toparticipate

subject of the SEBI guidelines prescribed onMarch 19, 2004. Initial and maintenance marginfor the client shall be a minimum of 50 per centand 40 per cent, respectively, which has to bepaid in cash. Initial margin is the minimumamount, calculated as a percentage of thetransaction value, to be placed by the client withthe broker before the actual purchase. Themaintenance margin is the minimum amount,calculated as a percentage of the market valueof securities with respect to the last trading day’sclosing price to be maintained by the client withthe broker. When the balance deposit in theclient’s margin trading accounts falls below therequired maintenance margin, the broker shallpromptly make the margin call. According to thecurrent arrangement, the broker may liquidatethe securities if: (i) the client fails to meet themargin call made by the broker; (ii) fails todeposit the cheques after the marginal call hasbeen made; (iii) where the cheque deposited bythe client has been dishonoured; and (iv) if theclient’s deposit in the margin account (afteradjustment for mark to market losses) falls to30 per cent or less of the latest market value ofthe securities. The broker shall maintainseparate client-wise accounts of the securitiespurchased on the basis of margin trading withdepositories. The SEBI and stock exchange(s)have the right to inspect the books of accountsmaintained by brokers with respect to the margintrading facility.


Worldwide, e-broking otherwise called asInternet broking has radically transformed theway people trade in stocks. Since Internet is thefastest medium to get stock quotes no othermedium can beat the net in speedydissemination of information and, therefore, net-based trading has the enormous potential forthe Indian stock market.

Objectives

Internet trading is expected to

� increase transparency in the markets

� enhance market quality through improvedliquidity, by increasing quote continuity andmarket depth,

� reduce settlement risks due to open trades,by elimination of mismatches,

� provide management information system(MIS),

� introduce flexibility in systems, so as tohandle growing volumes easily and tosupport nationwide expansion of marketactivity.

Besides, through Internet trading threefundamental objectives of securities regulationcan be easily achieved. These are:

� investor protection

� creation of a fair, and efficient market and

� reduction of the systematic risk.

INTERNET TRADING

� Internet trading is buying and selling of securities through the Internet.

� It helps in transparency, creates a fair and efficient market and reduces systemicrisk.

� SEBI has issued regulatory guidelines on Internet trading.

Banks have discounted the benefits of Internettrading long back and thus, started working inthe same line much before. The speed at whichNet brokerages are mushrooming will certainlymake a huge difference in the coming days inthe capital market. Some of the foreign andprivate banks are in the fray to provide the bestfacilities to the investors with the help of theirintegrated network. ICICI, for instance, has itsown bank, broking house, and is also adepository participant. SBI provides Internettrading in collaboration with a reputed privatebroking house.

Regulatory Initiatives

SEBI adopted the roadmap laid down by theInternational Organisation of SecuritiesCommission (IOSCO) in framing its policy onthe use of Internet in the securities market.

SEBI has laid down the conditions to be enforcedby the stock exchanges for permitting theirstockbrokers to trade on Internet. Theseconditions pertain to operational integrity, systemcapacity, signature authentication, client-brokerrelationship, contract notes, trade confirmation,risk management, network security protocolsand interface standards. Regarding theoperational and system requirements, SEBI hasdirected the exchanges to ensure that thesystem used by the stock broker has provisionsfor security, reliability and confidentiality of datathrough use of encryption technology.


VENTURE CAPITAL IN INDIA: GROWTH ANDCHALLENGES

� Venture Capitalists finance innovations or ideas, which have the potential for highgrowth with inherent uncertainties.

� VCs help in development of entrepreneurship, innovation and economic growth.

� VCs provide finance, purchase equities, assist in the development of new productsand have a long-term orientation

� Poor growth of VCs in India may be attributed to negative mindset, delay in issue oflicence, problem in scalability, regulatory issues and difficulty to exit

Introduction

Venture capital is different from traditionalsources of financing. Venture capitalists financeinnovations or ideas which have the potential forhigh growth but with inherent uncertainties. Thismakes it a high-risk, high-return investment. Apartfrom finance, venture capitalists providenetworking, management and marketing supportas well. In the broadest sense, venture capitalconnotes financial as well as human capital.Venture capitalists actively work with thecompany’s management by contributing theirexperience and business savvy gained fromhelping other companies with similar growthchallenges.

Venture capitalists are professionals, often withindustry experience, and the investors are silentlimited partners. At present, a fund generallyoperates for a set number of years (usuallybetweem 7 and 10) and then it is terminated.Normally, each firm manages more than onepartnership simultaneously. Even though theventure capital firm has the quintessentialorganisational format, there are other vehicles,the most persistent of which have been venturecapital subsidiaries of major corporations,financial and non-financial.

The venture capitalist invests in recentlyestablished firms believed to have the potentialto provide a return of ten times or more in lessthan five years. This is highly risky, and many ofthe investments fail entirely; however, the largewinners are expected to more than compensate

for the failures. In return for investing, the venturecapitalists not only receive a major equity stakein the firm, but also demand seats on the boardof directors. By active intervention andassistance, venture capitalists act to increasethe chances of survival and rate of growth of thenew firms. Their involvement extends to severalfunctions, such as helping to recruit keypersonnel, giving strategic advice andintroduction to potential customers, strategicpartners, later-stage financiers, investmentbankers and various other contacts. Venturecapitalist, therefore, provides more than money.This is a crucial difference between venturecapital and other types of funding. The venturecapital process is complete when the companyis sold through either a listing on the stockmarket or the acquisition of the firm by anotheror when the company fails. For this reason, theventure capitalist is a temporary investor. Thefirm is a product to be sold not retained. Theventure capital process requires thatinvestments be liquidated so there is thepossibility of exiting the firm. Countries that erectimpediments to any of the exit paths (includingbankruptcy) are choosing to handicap thedevelopment of the institution of venture capital.

Venture capital is collected through differentsources to invest alongside management inrapidly growing industries. It is an importantsource of equity of start-up companies. Venturecapital firms (VCF) are private partnerships orclosely held corporations funded by private andpublic pension funds, endowment funds,foundations, corporations, wealthy individuals,


foreign investors, and the venture capitalists.Venture capitalists are persons with razor sharpminds and deep pockets who are ready to takethe challenge to enter into untested areas.

Venture capitalists generally

• Finance new and rapidly growing companies;• Purchase equity securities;• Assist in the development of new products

or services;• Add value to the company through active

participation;• Take higher risks with the expectation of

higher rewards;• Have a long-term orientation.

For decades, venture capitalists have nurturedthe growth of America’s high technology andenterpreneurial communities resulting insignificant job creation, economic growth andinternational competitiveness. Companies suchas Digital Equipment Corporation, Apple, FederalExpress, Compaq, Sun Microsystems, Intel andMicrosoft are famous examples of companiesthat received venture capital early in theirdevelopment. An OECD Report (2000) has alsoidentified venture capital as a critical componentfor the success of enterpreneurial high-technology firms and recommended that allcountries consider strategies for encouraging theavailability of venture capital. In India, which isbooming with Information Technology, venturecapital in this particular sector can play animportant role, as it is faced with problems suchas rapid changes in the technologies used,upgradation and high cost of employee retention.

Development of Venture capital in India

First Stage in Venture Capital Industry

In the early 1980s, there was no conduciveenvironment for venture capital in India. Thecountry’s highly bureaucratised economy,avowed pursuit of socialism, still quiteconservative social and business worlds and arisk averse financial system provided littleinstitutional space for the development of venturecapital. But the environment began to changeafter 1985. In 1988, the Government of Indiaissued its first guidelines to legalise venture

capital operations (Ministry of Finance 1988).Prior to this, there was no policy regardingventure capital; in fact, there was no formalventure capital. These regulations really aimedat allowing state-controlled banks to establishventure capital subsidiaries, though there was apossibility for other investors to create a venturecapital firm. However, there was only a minimalinterest in the private sector in establishing aventure capital firm.

They were also allowed to exit investments atprices not subject to the control of the Ministryof Finance’s Controller of Cpaital Issues (whichotherwise did not pemit exit at a premium). Thefund promoters had to be banks, large financialinstitutions or private investors. Private investorscould own no more than 20 per cent of the fundmanagement companies (although a publiclisting could be used to raise the needed funds).The funds were restricted to investing in a smallamount per firm (less than 100 million rupees):the recipient forms had to be involved intechnology that was “new, relatively untried, veryclosely held or being taken from pilot tocommercial stage, or which incorporated somesignificant improvement over the existing onesin India”. The government also specified that therecipient firm’s founders should be “relativelynew, professionally or technically qualified andwith inadequate resources or banking to financethe project”. There were also other bureaucraticfetters including a list of approved investmentareas. Two government sponsored developmentbanks, ICICI and IDBI, were required toscrutinise portfolio firm’s application to a venturecapital firm to ensure that it fulfilled the rightpurposes. In addition, the Controller of CapitalIssues of the Ministry of Finance had to approveevery line of business in which a venture capitalfirm wished to invest.

Four state-owned financial institutionsestablished venture capital subsidiaries underthese restrictive guidelines and received a totalof $45 million from the World Bank, Of the fournew venture capital firms, two were establishedby two well-managed state-level financialorganisations (Andhra Pradesh and Gujarat), oneby a large nationalised bank (Canara Bank) and


one by a development finance organisation(ICICI).

Second Stage of Development in VentureCapital

The success of Indian entrepreneurs in SiliconValley that began in 1980s became far morevisible in the 1990s. This attracted attention andencouraged the notion in the United States thatIndia might have more possible entrepreneurs.It encouraged the entry of foreign institutionalinvestors. This included investment arms offoreign banks, but particularly important wereventure capital funds raised abroad. Very oftenNRIs were important investors. The overseasprivate sector investors became a dominantforce in the Indian venture capital industry.

In the late 1990s, the Indian government becameaware of the potential benefits of a healthyventure capital sector. In 1996, the venturecapital regulator, the Securities and ExchangeBoard of India (SEBI), announced the firstguidelines for registration and investment byventure capital firms. Since March 1999,Government of India has taken several initiativesin formulating policies regarding sweat equity,stock options; tax breaks for venture capital alongwith overseas listings have all contributed to theenthusiasm amongst investors andentrepreneurs. In the year 2000, the FinanceMinistry announced a major liberalisation of thetax treatment for venture capital funds to promoteknowledge-based enterprises and job creation.Besides this, SEBI was made the single pointnodal agency for registration and regulation forboth domestic and overseas venture capitalfunds. This liberalisation and simplification ofprocedures was done to encourage NRIs inSilicion Valley and elsewhere to invest some oftheir capital, knowledge and enterprise inventures in their motherland.

A National Venture Capital Fund for the softwareand IT industry (NFSIT) was set up in associationwith various financial institutions and the industryis operating under the umbrella of the SIDBI toencourage entrepreneurship in the areas ofsoftware, services and other IT related

segments. Many State governments have alsoset up venture capital funds for the IT sector inpartnership with local state financial institutionsand SIDBI. Thus in 1990 a number of newregulations were promulgated. Some of the mostsignificant of these were related to liberalisingthe regulations regarding the ability of variousfinancial institutions to invest in venture capital.Perhaps the most important of these, bankswere allowed to invest upto 5 per cent of theirnew funds annually in venture capital. However,banks have not made much venture capitalinvestment so far. This is because bankmanagers are rewarded for risk aversebehaviour. Lending to a risky, fast growing firmcould be unwise because the loan principal is atrisk while the reward is only interest. Since bankscontrol the bulk of discretionary financial savingsin the country, there is little internally generatedcapital available for venture investing.

Like in the United States, in India also there is aclustering of venture capital firms in Mumbai, NewDelhi and Bangalore. In contrast to the UnitedStates, where Silicon Valley asserted itsdominance as a technology centre at the end ofthe 1970s, Bangalore had a smaller share ofoffices in 1998 when compared with Mumbai andNew Delhi, which are the financial and politicalcapitals of India respectively.

Problems for the Development of VentureCapital in India

When compared to the success of venturecapital industry in U.S.A, in India there are severalhurdles for its development. These are negativemindset, delay in issue of licence, problem inscalability, regulatory issues and difficulty inexiting.

Conclusion

India still remains in difficult environment asregards venture capital. In India, venture capitalremains a small industry precariously dependentupon other institutions, particularly thegovernment, the external actors such asinternational lending agencies, overseasinvestors and successful Indian enterpreneursin Silicon Valley.


ECONOMY & FINANCEEXTERNAL SECTOR


THE SUBPRIME CRISIS

� The term subprime lending refers to loans that are given to borrowers with less thansatisfactory credit history/ credit rating.

� They are high-risk group attracting higher interest rates.

� Investment banks packaged the subprime mortgages into Mortgage BackedSecurities (Collaterlised Debt Obligations) and sold it to commercial banks, pensionfunds, hedge funds etc.

� Between 2004 and 2006 the Fed rate rose from 2% to 6.25%. The subprimemortgages were reset to very high interest rates. Delinquency, default and foreclosurebecame the order of the day and brought down the sub prime mortgage industry.

The term subprime lending refers to loans thatare given to borrowers with less thansatisfactory credit history/ credit rating. Suchborrowers do not qualify for loans at best interestrates. They are high-risk group attracting higherrates of interest. The phrase ‘subprime’indicates the inferior credit status of borrowerand not a reflection of the interest rate. Thereare variety of products for this segment like subprime mortgage loan, sub prime car loan, subprime credit cards etc.

The genesis of the current crises can be tracedto the recession in the year 2000 due to thecollapse of the dot-com bubble. The 9/11terrorist attack further aggravated the depressionin the world economy in general and USeconomy in particular. To overcome thisslowdown, US lowered the interest rates andpeople were encouraged to spend more torescue the sagging economy. Consumerismwas even equated with patriotism. The lowinterest rate encouraged all sorts of borrowingsand spending. Mortgage loans became moreattractive than ever before. For more and morepeople, own house became a reality, for manyothers it became an attractive investment option.Subprime mortgage lending generated moreinterest and fee income than the normalmortgage loans and lenders targeted thesegment enthusiastically.

The size of this segment is so huge that as ofMarch 2007 the U.S. subprime mortgage figurestood at USD 1.3 trillion. In a single year in 2005,sub prime mortgage loans grew over $800 billion.These loans were mostly sold by regulated

wholesale lenders through unregulated or underregulated brokers who tricked and trapped theborrowers. Prospective borrowers were seldomgiven the correct picture about the schemes. They were almost never told about therepayment burden. Brokers persuaded them bytelling what all they could do with this easymoney. So they were lured to avail loans (moreoften with cooked up financial statements) muchin excess of their repayment capacity. Ashousing prices saw a steady increase from 2000to 2005, attributable to demand pull due to easyavailability of funds, they were forced to buyproperties at much higher prices. Oftenborrowers were required to pay only the interestfor the first five years. So, many of them were ineffect investors trying to make ‘a quick buck’ ina rising market. Also the rising housing pricescreated a ‘feel wealthy’ effect on existinghomeowners who raised funds on the strengthof the ‘increased equity’ portion of their homesand the money thus raised were mostly spentfor consumption and speculation. The agents(brokers) of subprime financing firms weremostly young and earned handsome rewards. They earned ‘dream incomes’ with which cameall attractions like luxury cars, fancy vacationsand much more. These agents mindlesslypeddled their products in an over excitedmarket.

The wholesale lenders in turn pushed theseloans to Wall Street investment banks, whopackaged them into Mortgage Backed Securities(Collaterlised Debt Obligations - CDOs) and soldit to commercial banks, pension funds, hedge


funds etc. Such CDOs were required to be ratedby rating agencies before the investment bankscould sell them. The same investment bankernaturally paid these rating agencies for theirservices. The rating agencies in turn gave moreattention to the credentials of the invest bankerthan the CDO itself. As a result CDOs withsubprime mortgages as underlying assets oftengot high ratings.

This unbridled consumerism and low interestrates led the US economy into inflation and bythe year 2004 the Federal Reserve began toraise the interest rates. Between 2004 and2006 the Fed rate rose from 2% to 6.25%. Thenin 2006, after several years of huge profits, thescenario in subprime front began to change.The subprime mortgages were reset to veryhigh interest rates. Delinquency, default andforeclosure (take over and sale by the financierbecause of default by the borrower) became theorder of the day and brought down the sub primemortgage industry. Asset prices began to fallway below the loan outstandings. Worse still,assessing the asset price itself has becomedifficult as the market for CDOs have practicallycollapsed. Dozens of mortgage companieshave closed, put up for sale or have filed forbankruptcy. Several banks and funds are introuble. So far banks have declared over USD30 billion in subprime related losses. Theestimated losses are in the region of $200-400billion. The full impact on the economy couldbe even more substantial, because the lossescould compel banks and other lenders to curtaillending by as much as $2 trillion. CEOs offinancial giants like Citigroup and Merrill Lynchwere forced to step down. The CEO and mostof the board members of Northern Rock, a UKbased bank, were forced to step down and thebank itself is up for takeover. This is describedas one of UK’s worse banking crises in morethan a century.

Experts say the situation could get worse whichcan result in fall of asset prices in other countriesas well. Consumer rights groups predict thatthe number of foreclosures could go up to fivemillion over the next several years, as theinterest rates on subprime mortgage loans givenin 2004 and 2005 are reset from the initial lower

fixed rate to higher floating rates. The crisis hasalready spread to countries outside the USA asseveral European and Asian funds and bankshave exposure in the American subprime market.Experts are predicting a contagion where theeffect will spill over to several countries and canbring down the asset prices across the globe.Some go a step further and predict a slowdownin the global economy due to decreasingdemand across a wide spectrum.

So who are to be blamed for the mess? Greedysubprime lenders, lack of effective governmentsupervision, unscrupulous brokers who lured thesubprime borrowers into unaffordable loans,borrowers who entered into loan agreementswhich they could not meet, property agents whoinflated the prices, rating agencies who did ashoddy assessment of CDOs and investorswho bought the subprime mortgage securitieswithout verifying the strength of the underlyingassets, all of them had a role. While the fall inproperty prices since 2005 was partly the causeand partly the effect, there is another importantaspect. The securitisation of the loans hassnapped the traditional link between the lendersand the creditors, which makes the recoveryprocess more difficult and invites foreclosureas the first option.

The Indian banks are not affected by thesubprime crisis as they are not exposed toderivative instruments like CDOs. The impactof subprime crisis on Indian economy will beindirect such as the effect of slowdown of USeconomy and the effect of general liquiditycrunch in the global market. Also the stockmarket might experience selling pressure fromoverseas funds and institutions that hadexposure to subprime assets. Globally, thebooming emerging economies with largeinternal demand are expected to offset theimpact of US slowdown on world economy.

The crisis can be seen as an example of whatunbridled liquidity created through leveraging cando. The legendary investor Warren Buffet oncecalled the derivatives as financial ‘weapons ofmass destruction’. Viewed from the currentcontext, the words proved prophetic.


IMPACT OF HIKE IN OIL PRICE

� India imports 70% of its crude oil requirements. In the year 2006-07 it was $48billion i.e. 6.3% of GDP.

� Oil bonds issued to compensate oil companies only defer the payment forgovernment.

� Every dollar increase in crude price leads to 0.30% increase in WPI.

Global crude oil prices have scaled a new highand are now within kissing distance of the $100-per-barrel mark sending shock waves acrossthe world. This has triggered worries aboutinadequate supplies with the advent of the winterin the Northern Hemisphere and possiblepolitical instability in the Middle East. Thisincreases the pressure on the Government ofIndia to hike administered retail fuel prices in Indiaor to increase the fiscal outlay to compensatethe oil companies that recover less from retailsales than their costs. The rise in global crudeoil prices could leave emerging economies likeIndia and China (which are largely importdependent for their energy requirements)scarred, impacting the trade balance as well asgrowth. India, for instance, paid a whopping $48billion as oil import bill in 2006-07. India importsalmost 70% of its crude oil requirement. Withthe economy growing at around 9%, the demandfor oil is also expected to grow in the comingyears. As OPEC, the oil cartel which accountsfor more than 40% of the global oil productionhas decided to cut production, as compared tothe production levels last year, prices are unlikelyto change much in the near future. Theconsistent northward spurt in crude prices maynow force the government to take a decision onartificially depressed retail fuel prices soonerthan later. However, given the political sensitivityof such a decision, the government is expectedto adopt a combined strategy where the burdenwould be shared by consumers, upstream oilcompanies and the government. Whileconsumers may have to see a marginal hike infuel prices, government is expected to dole outa larger chunk of bonds to meet the deficit. Thegovernment’s decision to control retail fuelprices leaving them unchanged, and to make

good from the exchequer a part of the oilcompanies’ resultant losses, has led to a hugefiscal burden. While on the one hand, theincreasing oil import bill will impact the tradebalance, the government’s decision to meet thesubsidy burden through oil bonds will be a hugecost for the fiscal. The oil bonds which only deferthe payment for the government, will have to berepaid at some point. This could then pose hugethreats to the fiscal deficit targets set by thegovernment and its deficit reductioncommitment under the Fiscal Responsibility andBudget Management Act. Oil majors selling fuelat artificially low prices are managing to stayafloat thanks to the government’s bail-outpackage. But liquidity problems and high-debtburdens are beginning to impact the financialsof these companies. Petroleum ministryestimates have it that under recoveries of oilcompanies would be far greater than Rs 54,935crore projected by the Cabinet for 2007-08. Outof these, Rs 26,363 crore related to the first halfof 2007-08 for which bonds of Rs 11,257 crorehave already been recommended. Theprojected under recoveries for the second halfof 2007-08, indicated to the Cabinet, were Rs28,572 crore. These have jumped to Rs 34,891crore based on latest projections. With thepresent trend current projected annual under-recoveries of oil companies would be aroundRs 61,254 crore; this figure too may go updepending on the movement of the global crudeprices. The price of the Indian basket has beenless than $90/barrel on November 20. It hadtouched all time high on November 7 ($91.12/barrel) and the average price in the month isabout $88/ barrel. India’s oil import bill as apercentage of GDP has increased from 3.4percent in 2003-04 to 6.3 percent in 2006-07.


With India’s increasing oil imports (in volumeterms) the sharp increase in prices will lead toa higher foreign exchange outgo. There certainlyis a correlation, between international oil pricesand an increase in domestic oil prices results inincreased inflation and reduced GDP growth. Asper RBI Annual policy statement for the year2004-05, every US dollar increase in crude could

potentially add 15 basis points to WPI inflationdirectly and another 15 basis points indirectly. Astudy in the year 2001 concluded that a 20percent increase in oil price leads to a 1.3percent increase in inflation and 2.1 percentdecrease in output growth. Similar pattern hasbeen noticed in various countries world over.


CHINA'S BANKING SECTOR

� Types of banks in China

� What is their role and market share in Chinese economy

� Nature of dominance of state owned banks

� Opening of Chinese banking sector

China’s banking sector has undergonesignificant reform but it still exhibits the legacyof a centrally planned economy. There are fourtypes of banks in China: wholly state-ownedbanks, commercial banks (partially private),credit co-operatives, and foreign banks.

Wholly state-owned banks: They comprisestate-owned commercial banks and policybanks.

a. State-owned commercial banks: Thereare four state-owned commercial banks,commonly referred to as the “big four”. They arethe most dominant, influential and formidableplayers in China’s banking sector. Together theyaccount for around 60% of the banking sector’stotal assets. How they evolve will determine thedirection of the sector and the pace of economicreform. The big four are:

i. Agricultural Bank of China (ABC),originally set up to provide loans to theagricultural and rural sectors.

ii. Bank of China (BOC), initially mandatedto specialise in international transactionse.g. foreign exchange services and tradecredit.

iii. China Construction Bank (CCB), initiallyset up to specialise in financing constructionand infrastructure projects, usually in theform of long-term loans.

iv. Industrial & Commercial Bank of China(ICBC), originally mandated to provideworking-capital loans to the industrial andcommercial sectors in the urban areas.

All four banks have diversified from their originalmandate since 1994, when the government

created the so-called policy banks in order totake over the big four’s state-directed lendingrole. Despite the big four’s move away from thepolicy-directed lending function towardcommercial lending, the legacy of their pastlending continues to constrain their earnings andprofitability. The return on assets (ROA) of thebig four has lagged behind other commercialbanks in recent years.

b. Policy banks: The government establishedthree policy banks in 1994 to relieve the “big four”of their state-directed lending role.

They are:

i. Agricultural Development Bank ofChina, which primarily took over the policylending role from the ABC.

ii. China Development Bank, which primarilytook over the policy lending role from theCCB and to a certain extent from the ICBC.

iii. Export-Import Bank of China, whichprimarily took over the policy lending rolefrom the BOC, particularly the tradefinancing function.

Policy banks fund themselves primarily throughthe issuance of bonds, and they accept fewdeposits. The combined assets of the threepolicy banks have grown rapidly and now makeup around 10% of the total banking sector, whichbears evidence of the continued presence ofstate-directed lending in the banking sector.

c. Commercial banks: Equity ownership ofthese banks is distributed among theGovernment and private investors. There arecurrently 120 commercial banks, together


accounting for 18% of the banking sector’sassets. While not as prominent as the big four,they are nevertheless an important group withinthe banking sector, and their market share isgrowing. Some are looked up to for their moredynamic and bottom line-oriented style.Commercial banks are divided into 2 sub-groups:

i. Shareholding or joint-stock commercialbanks: These banks are incorporated asjoint-stock limited companies under thePeople’s Republic of China’s Company Law.Most, however, still have fairly concentratedand predominantly state-dominatedshareholding structures. There are currently11 shareholding banks, which include well-known names such as Bank ofCommunications, China Minsheng Bank,China Everbright Bank, China MerchantsBank, Shanghai Pudong Development Bankand Shenzen Development Bank. They areallowed to engage in a wide variety ofbanking services including acceptingdeposits, extending loans as well asproviding foreign exchange and internationaltransaction services. Given their smallersize and result oriented corporate culture,they are more nimble than the state-ownedcounterparts and have been successful atgaining market share at the expense of thebig four. They have made inroads particularlyinto the small and medium enterprise (SME)loan market, the area which had not beentapped by State owned banks. They alsotend to be more profitable, recording higherROA. Joint-stock banks have recently beenthe preferred joint-venture partner ofinternational banks trying to gain access toChina’s banking sector. Their expanding rolewill be instrumental in nurturing China’sbudding economy, particularly the SMEsegment, which is essential for laying a firmfoundation for the market economy in China.

ii. City commercial banks: City commercialbanks have evolved from urban credit co-operatives . Due to their history, mandateand capital strength, the scope of citycommercial banks’ business tends to be

concentrated in the city where they arelocated (according to their originalmandate). They are thus unable to operateon their own on a national or regional scale,unlike the joint- commercial banks, whichis a major comparative disadvantage fortheir future expansion.

d. Credit co-operatives: The co-operativestypically provide credit to small and medium-sized enterprises and individuals. Thecooperative sector is divided into urban creditco-operatives and rural credit co-operatives.Together there are close to 50,000 of them,accounting for around 11% of total banking-sector assets. The rural credit co-operativeswere formerly supervised by the AgriculturalBank of China (ABC) and then by China’s centralbank, the People’s

Bank of China (PBC). A new regulatory agency,the China Banking Regulatory Commission(CBRC), has taken over the supervisoryfunctions in 2003 and also supervises the urbancredit cooperatives. Due to their collective-ownership status, both types of credit co-operatives are subject to state control, thus theirloan extension is still influenced by local policyconsiderations. Some private analysts estimatethat the NPA level at rural credit cooperatives isaround 50% of total lending, and there is agrowing concern that rural credit co-operativeswill face heavy losses when China’s agriculturalsector opens up under WTO requirements.Given the significance of the rural sector inChina, with around 800 million people (almosttwo-thirds of the total population) living in ruralareas, the government has been explicit aboutits intention to provide financial support for therural credit co-operatives in need.

e. Foreign banks: There are close to 200foreign banks operating in China, most of whichare branches of foreign banks, and the rest is ahandful of locally incorporated banks (either jointventures or wholly foreign-owned banks).Foreign banks currently account for only around1% of total banking-sector assets as their roleis still constrained by China’s domestic law.However, WTO requirements will gradually allow


foreign banks greater access to China’sdomestic banking business.

The local currency business (based in Chineseyuan – CNY) was until some years ago closedto foreign banks. The original role of foreignbanks was to provide foreign currencyintermediation in order to facilitate the operationsof foreign investors and manufacturers in China.The CNY business has been opened onlygradually since 1996 when foreign banks were

first allowed to provide CNY services, but onlyto foreign companies and individuals in Shanghaiand Shenzen. Since China gained WTO entryin December 2001, the geographical restrictionhas started to be phased out, while rules on thetype of customer to whom foreign banks canprovide CNY services will start to be relaxedsoon


Global Integration

The post-reform period has witnessed theexternal sector imparting significant resilienceto the Indian economy. Indian economy is gettingmore integrated with the global economy,marked by its growing openness and two-wayfinancial flows. The ratio of merchandise exportsto GDP has been increasing since the early1990s, implying growing internationalcompetitiveness. During 2002-06, India’s exportgrowth was at a much higher level than its closecompetitors in the Asian region, except China.Simultaneously, import intensity has been risingsteadily. Domestic companies are increasinglyaccessing globally available raw materials andintermediate goods as also quality inputs forproducing world-class products for domesticconsumption as well as exports. There is astructural transformation in the India’s balanceof payments which has contributed to its stabilityand strength. The structural shift is underpinnedby services exports, led by software and otherbusiness services, and remittances. Thesurplus in net invisibles has mitigated asubstantial part of the widening trade deficit andhelped in keeping the current account deficit to1% of GDP on an average since the early 1990s.Gross current receipts (merchandise exportsand invisible receipts) and gross currentpayments (merchandise imports and invisiblepayments) taken together, at present, constitutemore than 50% of GDP, underscoring the highdegree of integration of the Indian economy withthe global economy.

EXTERNAL SECTOR: AN OVERVIEW

� The post-reform period has witnessed the external sector imparting significant resilienceto the Indian economy. Indian economy is getting more integrated with the global economy,marked by its growing openness and two-way financial flows.

� RBI has advised banks, financial institutions and corporates to remain alert with appropriaterisk mitigation strategies to deal with considerably higher volatility than before. In view ofthe above, RBI continuously urges them to monitor various types of exposures and hedgethem to protect their balance sheets.

Liberalized External Payments Regime

The external payments regime has beenliberalized to a great extent and this hasfacilitated the process of Indian corporates goingin for acquisition of foreign companies. The trendis observed both in the manufacturing andservices sectors. The principal motivationbehind this has been the prospects of reapingeconomies of scale and seizing offshoremarkets to face the global competition. Althoughoutflows have been higher, net capital inflowshave reflected a significant increase to almost5% of GDP in 2006-07 from an average of 2%during 2000-01 to 2002-03. However, theemergence of substantial net capital flows(above the current account deficit) has posedchallenges for the conduct of monetary policyand maintenance of macroeconomic andfinancial stability.

Reserve Management

RBI, the manager of the country’s foreignexchange reserves, is driven by twoconsiderations: (a) the changing composition ofthe balance of payments (b) the ‘liquidity risks’associated with different types of flows.Preservation of the long-term value of thereserves in terms of purchasing power and theneed to minimize risk and volatility in returnshave been the twin objectives of reservemanagement in India. In India, capital inflowshave been the major source of foreign exchangereserves which is in contrast with other Asianeconomies which have accumulated asignificant part of the reserves through current


account surpluses. These countries intervenein the foreign exchange market as reflected intheir high level of foreign exchange reservesacross Asia. Besides, surplus global liquidity,relatively low interest rates in major advancedeconomies and the quest for yield have resultedin large capital inflows into emerging marketeconomies (EMEs).

In India, interventions have been generallysuccessful in maintaining orderly conditions inthe foreign exchange market, and have keptoverall financial stability intact. This, aided byother factors, has resulted in India emerging asa preferred investment destination for theoverseas investors. When it comes tomanagement of increased volatility, largecorporates are in a position to manage the same.This is unlike a large section of the populationwhich is not capable of withstanding volatility inthe financial markets. RBI also keeps in viewthe interests of such sections of the populationagainst volatility. Excessive volatility can alsoendanger financial stability and adversely affectthe real sector. Therefore, the extent of volatilityhas to be in keeping with the objectives of growth,and price and financial stability. Here, it ispertinent to recall that during the Asian crisis,even large corporates could not withstandsudden volatility in exchange rates and interestrates as weaknesses in corporate balancesheets affected other participants in theeconomy, including the banking sector.

Excess foreign exchange inflows is affectingmonetary management in India as well as inseveral other countries which are also inundatedwith foreign capital flows. However, monetarymanagement at this juncture in India is moreintricate than in other EMEs for several reasons:(i) the return on foreign exchange reserves arelower than domestic interest rates, leading toquasi-fiscal costs; (ii) although the fiscal deficitand public debt have declined in recent years inIndia, by international standards, they are stillhigh. This blunts the flexibility of fiscal policy tocontrol inflation; (iii) in India, it is difficult to carryout supply management through administrativemeasures since the real sector has been

liberalized over the years. Also, several policyrigidities still in vogue constrain the quick andflexible adjustments that are needed in a well-functioning market economy; (iv) in India, thebanking system has been deregulated andmarket-based instruments dominate theconduct of monetary policy. Therefore, the roleof administrative instruments such asprescribing deposit and lending rates, whichsome other countries may be able to use, islimited; (v) Finally, it is also noteworthy that Indiais one of the few EMEs to have registeredcurrent account deficits, along with a significantlyhigh trade deficit.

Liberalization of Capital Outflows

Capital outflows liberalization has been carriedforward to a great extent; nevertheless RBIintends to carry further this policy of liberalizationin future. However, the policy towards capitaloutflows is country-specific and depends uponthe characteristics of the real sector, and notmerely the contextual level of inflows and currentabsorptive capacity of the economy. First, aliberal, but not incentivized, frameworkcharacterizes the extant regime of outflows inIndia for corporates to invest in the real economyof foreign countries, including through theacquisition route. The regime has provedsuccessful as Indian corporates are increasinglyable to synergize with overseas units, toincrease economies of scale and quicklyaccomplish domain knowledge throughacquisition. Second, the policy towards outflowsby individual households has been considerablyliberalized following recommendations of theCommittee on Fuller Capital AccountConvertibility (Chairman: Shri S. S. Tarapore,2006). RBI intends to implement furtherliberalization here also but would be guided bysome international experience which shows thatresident individuals initiate outflows beforeoverseas investors when the perceptions inrespect of domestic economy’s performance orstability appear gloomy. Third, the policy foroutflows through financial intermediaries ismarked by caution and quantitative restrictionswhereby both prudential considerations and


compulsions of management of capital accountare relevant.

Trade integration is no doubt beneficial butfinancial integration produces both, benefits andrisks, at the present stage of India’sdevelopment. Foreign Direct Investment (FDI)is generally seen as an investment creatingphysical assets and is stable. However, newtypes of FDI flows through private equity fundsand venture capital funds may not necessarilybe so. Similarly, inflows to acquire existingstakes or expanding foreign stakes in Indiancorporates are classified as FDI, but they do notcreate incremental physical assets. However,these inflows do escalate the foreign resourcesavailable for investment in the Indian economy,which would be most productive if and whencomplemented with equally good absorptivecapacity at the macro level. Similarly, FIIinvestments are generally long-term and suchinvestors have little or no interest in managerialcontrol. However, investments through FIIs inIndia have a large chunk of portfolio flowsthrough PNs and sub-accounts. However, thisproblem has been recently addressed by thecapital market regulator, SEBI. Nevertheless,direction of the volatile portfolio flows can easily

reverse and it is difficult to apply the “rules oforigin” with regard to such capital flows. Againstthis backdrop, RBI will gradually proceed withfuller capital account liberalization over themedium-term, since it knows that in a world ofgrowing trade and financial integration, microcontrols are ineffective. Thus, in India, the trade,financial and capital account liberalization gohand in hand in a harmonious and well-sequenced manner, keeping in view theprogress in the real sector, fiscal sector andinstitutional developments, includinggovernance.

A Caution

Rapid developments in global financial marketswill continue to nudge Indian markets andmonetary policy settings. Therefore, RBI hasadvised banks, financial institutions andcorporates to remain alert with appropriate riskmitigation strategies to deal with considerablyhigher volatility than before. In view of the above,RBI continuously urges them to monitor varioustypes of exposures and hedge them to protecttheir balance sheets. RBI has increased therange of hedging tools available to marketplayers over the years and helped dynamichedging.


MANAGEMENT OF MOUNTING FOREX RESERVES

The huge increase in forex reserves since 1990-91 has come in response to both internationaland domestic conditions. USA had cut interestrate drastically to check recession and tostimulate the American economy. Despite cut ininterest rates in India, relatively higher Indianinterest rate had attracted NRI investments toIndia.

There was also a strong bullish turn in the Indianstock market since 2001, particularly since May2003. This attracted foreign institutional investorfunds to India and consequent rise in forexresources.

Actually, the heavy increase in forex reserveswould have increased the money supply in India-increase in liquidity-led inflation, substantiallyappreciated the rupee, killed exports andboosted imports. But RBI managed, ratherefficiently, to neutralize the adverse effects ofheavy inflow of dollars. RBI bought dollars on

the one hand and sold Government securitiesso as to mop up liquidity on the other.Accordingly, India did not suffer from inflationarypressure. RBI, however, was left with holdinghuge forex reserves (refer to Table above), whichearn very little interest income and which arehighly volatile.

Normally, a country accumulates forex reservesto meet its commitments to other countries. Theforex reserves which India has accumulated inrecent years represent influx of foreign capitalby way of direct investment in Indian companies,investment in stock market shares and morerecently, investment in real estate. The growthof India’s forex reserves also reflects theconfidence of foreign investors in India’seconomic fundamentals and its rate of economicgrowth. Some of the forex reserves, however,may be regarded as hot money having enteredIndia for stock market speculation.

(USD million)

End of Foreign Gold SDRs Reserve TotalCurrency Tranche

Assets Position in IMF

2002-03 71,890 3,534 4 672 76,1002003-04 1,07,448 4,198 2 1,311 1,12,9592004-05 1,35,571 4,500 5 1,438 1,41,5142005-06 1,45,108 5,755 3 756 1,51,6222006-07 1,91,924 6,784 2 469 1,99,1792007-08* 2,61,923 7,811 13 434 2,70,181

*Up to November 9. Source: RBI Bulletin December 2007.

� The huge increase in forex reserves since 1990-91 has come in response to bothinternational and domestic conditions.

� The forex reserves which India has accumulated in recent years represent influx of foreigncapital by way of direct investment in Indian companies, investment in stock market sharesand more recently, investment in real estate.

� India can explore new possibilities of using forex reserves profitably and get a “reasonable”return.

� One of the possibilities being debated is to use a part of the forex reserves for infrastructuredevelopment.


Deployment of Forex Reserves

With such large forex reserves, India need notworry about ballooning of crude oil prices andthe consequences of adverse of balance ofpayments in the current account. At the sametime, RBI is always prepared for any flight of hotmoney from India. But the real questions are:how much forex reserves should RBI keep tomeet sudden withdrawals and what should it dowith the balance of reserves? For, it should notbe forgotten that forex reserves are mostlysterile, earning only two to three percent rate ofinterest.

In this connection, a few cases of forexdeployment of some Asian countries may becited. Singapore - only a city-state - has forexreserves of nearly $ 130 billion (in May 2006, 7thhighest reserves in the world), which is managedby Singapore’s Government InvestmentsCorporation (GIC). The reserves are kept in USA,Europe, Japan and in some developingcountries; the reserves are kept in USGovernment securities, equities, bonds, realestate, commodities and other investments; GIChas allowed private investment agencies tomanage 25 percent of the forex reserves. Theresult is that Singapore has managed to getannual rate of return of over 9 percent (in dollarterms) and 8.2 percent in Singapore currency(contrast this with the 3.1 percent return fromIndian forex reserves).

South Korea, China and Taiwan have alsoadopted Singapore model. For instance, SouthKorea has set up the Korean InvestmentCorporation to manage its external reserves butthe Government has kept the option to recall theassets in the event of an emergency.

China has huge forex reserves to the tune of$925 billion (in May 2006) out of which $300 billionare kept in US government securities. China hasalso planned to adopt Singapore model.

In other words, India too can explore newpossibilities of using forex reserves profitably andget a “reasonable” return. First of all, RBI hasafter a long period of hesitation, assigned a smallportion of forex reserves to be managed byinternational brokers and investments advisors.

Secondly, there is a serious discussion in India

regarding the use of forex resources within Indiaitself when the rate of growth of GDP is 9 percent- a comparable rate of return to any investmentelsewhere. Investment within India will add to theproduction capacity of the country and increaseemployment opportunities. Besides, the sectorssuffering from obsolescence of plant andmachinery and which need massive inputs ofsophisticated machinery and equipment can behelped through forex reserves. This willovercome the usual complaint of the Governmentthat it is short of resources. A good example isTaiwan, whose Government has given $15 billionto banks to finance major development projects.

Thirdly, India can follow the example of China inusing forex reserves to raise the capital base ofPublic Sector Banks (PSBs). The Governmentof India issued Rupee Bonds to recapitalizesome of the PSBs in difficulty. RBI has allowedsome PSBs to increase their capital assets byraising debt instruments abroad. Instead Indiacan follow the Chinese model. China, forinstance, injected $60 billion of its forex reservesinto Bank of China, the Construction Bank ofChina and Industrial Construction Bank of China.

Fourthly, India can use forex reserves forpre-payment of commercial debt borrowed athigher rate of interest. India has done this before;it can do so now, as it has huge reserves. Thereis, therefore, a strong opinion - initially, theproposal came from Dr. Montek Singh Ahluwalia,the Deputy Chairman of the PlanningCommission - that RBI should use/divert a partof its forex reserves for infrastructuredevelopment of the country. If this proposal isaccepted, RBI may place them at the disposalof Infrastructure Development FinanceCorporation (IDFC) and other financial institutionswhich, in turn will lend to the private and publicsector units to develop roads, ports, airports,power and so on. The development of economicinfrastructure is very essential and has actuallybeen a serious constraint on India’s economicdevelopment.

The major objection to this proposal is that whileforex reserves - at least a good part of them -constitute short-term hot money, they should notbe invested in long-term infrastructureinvestments. Since large forex reserves haveentered for purpose of stock exchange


speculation in India, they may be withdrawn atvery short notice. This necessitates that RBIshould always be prepared for this eventuality.

There is, however, no danger in using part of theforex reserves in infrastructural development. Ifneed be, the Government of India can guaranteesuch investment by RBI. Besides, for purposesof security and emergencies and marketintervention, a cut-off limit of say, $100 billion can

be kept and the balance used more productively.

Because of its strong foreign exchange reservesposition, India, a traditional borrower of IMF, hasnow become the latter ’s creditor. SinceSeptember 2002, India has been invited by IMFto contribute to its Financial Transactions Plan(FTP). These funds enable IMF to finance thebalance of payments needs of other membercountries.


ECB are a key component of India’s overallexternal debt which includes. inter alia. externalassistance. buyers’ credit. suppliers’ credit. NRIdeposits. short-term credit and Rupee debt.

ECB refer to commercial loans in the form of bankloans, buyers’ credit, suppliers’ credit,securitised instruments (e.g. floating rate notesand fixed rate bonds)] availed from non-residentlenders with minimum average maturity of 3years. The policy for ECB is also applicable toFCCBs. The issue of FCCBs are also requiredto adhere to the provisions of Notification FEMANo. 120/RB-2004 dated July 7, 2004, asamended from time to time. Any legal entitysuch as a corporate financial intermediary is aneligible borrower. In view of its implication forpotential systemic risks. ECB availed byfinancial intermediaries need to be distinguishedfrom those availed by corporates.

Banks have the facility (i) to borrow from its orbranch or correspondents outside India (includingborrowings for financing export credit, ECBs andoverdrafts from their Head Office/Nostro account)up to 50 per cent of its unimpaired Tier-I Capitalor US$ 10 million. whichever is higher. Short-term borrowings up to a period of one year or less,however, should not exceed 20 per cent ofunimpaired Tier I capital within the overall limit of50 per cent (ii) to borrow from its head officeor branch or correspondents outside India withoutlimit for the purpose of replenishing Rupeeresources (not for investment in call money orother markets) and (iii) to avail lines of creditfrom a bank ! financial institution outside Indiawithout any limit for the purpose of granting pre-shipment / post-shipment credit to itsconstituents. all borrowings in the form of

EXTERNAL COMMERCIAL BORROWINGS:THE CURRENT STATUS

� ECB refers to commercial loans availed from non-resident lenders.

� ECB can be accessed under two routes, viz., Automatic Route and Approval Route

� ECB more than US $ 20 million per borrower company per financial year is permittedonly for foreign currency expenditure.

� Prepayment of ECB up to USD 500 million is permitted without prior approval of RBI

subordinated debt placed by head offices offoreign banks with their branches in India as TierII capital, capital funds raised/augmented byissue of innovative perpetual debt instruments(IPDI) and other overseas borrowing with thespecific approval of the Reserve Bank would,however, continue to be outside the limit of 50per cent.

ECB can be accessed under two routes. viz.. (i)Automatic Route and (ii) Approval Route.

ECB for investment in real sector -industrial sector,especially infrastructure sector-in India, are underAutomatic Route, i.e. do not require RBI /Government approval. In case of doubt as regardseligibility to access Automatic Route, applicantsmay take recourse to the Approval Route.

I. AUTOMATIC ROUTE:

(i) Eligible borrowers

(a) Corporates (registered under theCompanies Act except financialintermediaries (such as banks, financialinstitutions (FIs), housing financecompanies and NBFCs) are eligible to raiseECB. Individuals, Trusts and Non-Profitmaking Organisations are not eligible toraise ECB.

(b) Non-Government Organisations (NGOs)engaged in micro finance activities areeligible to avail ECB. Such NGO (i) shouldhave a satisfactory borrowing relationshipfor at least 3 years with a scheduledcommercial bank authorised to deal inforeign exchange and (ii) would require acertificate of due diligence on ‘fit and proper’status of the board/committee ofmanagement of the borrowing entity from


the designated Authorised Dealer (AD)bank.

(c) Units in Special Economic Zones (SEZ) areallowed to raise ECB for their ownrequirement. However, they cannot transferor on-lend ECB funds to sister concerns orany unit in the Domestic Tariff Area.

(ii) Recognised Lenders

(a) Borrowers can raise ECB frominternationally recognised sources such as(i) international banks, (ii) internationalcapital markets, (iii) multilateral financialinstitutions (such as IFC, ADB, CDC etc.,),(iv) export credit agencies, (v) suppliers ofequipment, (vi) foreign collaborators and (vii)foreign equity holders (other than erstwhileOCBs). A “foreign equity holder” to be eligibleas “recognized lender” under the automaticroute would require minimum holding ofequity in the borrower company as set outbelow:

i. For ECB up to USD 5 million - minimumequity of 25 percent held directly by thelender,

ii. For ECB more than USD 5 million -minimum equity of 25 per cent helddirectly by the lender and debt-equityratio not exceeding 4:1 (i.e. the proposedECB not exceeding four times the directforeign equity holding).

(b) Overseas organisations and individualscomplying with following safeguards mayprovide ECB to Non-GovernmentOrganisations (NGOs) engaged in microfinance activities.

(i) Overseas organisations proposing tolend ECB would have to furnish acertificate of due diligence from anoverseas bank which in turn is subjectto regulation of host-country regulatorand adheres to Financial Action TaskForce (FATF) guidelines to the AD bankof the borrower. The certificate of duediligence should comprise the following(i) that the lender maintains an accountwith the bank for at least a period of twoyears, (ii) that the lending entity isorganised as per the local law and held

in good esteem by the business/localcommunity and (iii) that there is nocriminal action pending against it.

(ii) Individual Lender has to obtain acertificate of due diligence from anoverseas bank indicating that the lendermaintains an account with the bank forat least a period of two years. Otherevidence /documents such as auditedstatement of account and income taxreturn which the overseas lender mayfurnish need to be certified andforwarded by the overseas bank.Individual lenders from countrieswherein banks are not required toadhere to Know Your Customer (KYC)guidelines are not eligible to extendECB.

(iii) Amount & Maturity

(a) The maximum amount of ECB which canbe raised by a corporate is USD 500 millionor equivalent during a financial year.

(b) ECB up to USD 20 million or equivalent in afinancial year with minimum averagematurity of three years

(c) ECB above USD 20 million and up to USD500 million or equivalent with a minimumaverage maturity of five years.

(d) NGOs engaged in micro finance activitiescan raise ECB up to 5 million during afinancial year. Designated AD bank has toensure that at the time of drawdown the forexexposure of the borrower is hedged.

(e) ECB upto USD 20 million can have call/putoption provided the minimum averagematurity of 3 years is complied with beforeexercising call/put option.

(iv) All in Cost ceilings

All-in-cost includes rate of interest, other feesand expenses in foreign currency exceptcommitment fee, pre-payment fee, and feespayable in Indian Rupees. Moreover, thepayment of withholding tax in Indian Rupees isexcluded for calculating the all-in-cost. The all-in-cost ceilings for ECB are reviewed from timeto time.


The following ceilings are currently applicable:

Average Maturity All-in-cost CeilingsPeriod over 6 month LIBOR*

Three years and upto five years 150 basis points

More than five years 250 basis points

*for the respective currency of borrowing orapplicable benchmark

(v) End Use

(a) ECB can be raised only for investment[such as import of capital goods (asclassified by DGFT in the Foreign TradePolicy), new projects, modernization/expansion of existing production units] inreal sector - industrial sector including smalland medium enterprises (SME) andinfrastructure sector - in India. Infrastructuresector is defined as (i) power, (ii)telecommunication, (iii) railways, (iv) roadincluding bridges, (v) sea port and airport(vi) industrial parks and (vii) urbaninfrastructure (water supply, sanitation andsewage projects);

(b) ECB proceeds can be utilised for overseasdirect investment in Joint Ventures (JV)/Wholly Owned Subsidiaries (WOS) subjectto the existing guidelines on Indian DirectInvestment in JV/WOS abroad.

(c) Utilisation of ECB proceeds is permitted inthe first stage acquisition of shares in thedisinvestment process and also in themandatory second stage offer to the publicunder the Government’s disinvestmentprogramme of PSU shares.

(d) NGOs engaged in micro finance activitiesmay utilise ECB proceeds for lending to self-help groups or for micro-credit or forbonafide micro finance activity includingcapacity building.

(e) With effect from 7th August 2007, ECB morethan USD 20 million per borrower companyper financial year would be permitted onlyfor foreign currency expenditure forpermissible end-uses of ECB. Accordingly,

borrowers raising ECB more than USD 20million shall park the ECB proceedsoverseas for use as foreign currencyexpenditures for permissible end-uses andshall not remit the funds to India.

(f) ECB up to USD 20 million per borrowingcompany per financial year would bepermitted for foreign currency expendituresfor permissible end-uses under theAutomatic Route and these funds shall beparked overseas and not be remitted toIndia. Borrowers proposing to avail ECB upto USD 20 million for Rupee expenditure forpermissible end-uses would require priorapproval of the Reserve Bank under theApproval Route. However, such funds shallbe continued to be parked overseas untilactual requirement in India.

(vi) Parking of ECB Proceeds overseas

ECB proceeds shall be parked overseas untilactual requirement in India. ECB proceedsparked overseas can be invested in the followingliquid assets:

(a) Deposits or Certificate of Deposit or otherproducts offered by banks rated not lessthan AA(-) by Standard and Poor/Fitch IBCAor Aa3 by Moody’s;

(b) Deposits with overseas branch of anAuthorised Dealer in India; and (c) Treasurybills and other monetary instruments of oneyear maturity having minimum rating asindicated above. The funds should beinvested in such a way that the investmentscan be liquidated as and when funds arerequired by the borrower in India.

(vii) End Uses not permitted

Utilisation of ECB proceeds is not permitted for

(i) on-lending

(ii) investment in capital market

(iii) acquiring a company (or a part thereof) inIndia by a corporate,

(iv) real estate,

(v) working capital,

(vi) General corporate purpose and

(vii) repayment of existing Rupee loans.


(viii) Guarantee /LOC

Issuance of guarantee, standby letter of credit,letter of undertaking or letter of comfort bybanks, Financial Institutions and Non-BankingFinancial Companies (NBFCs) relating to ECBis not permitted.

(ix) Security

The choice of security to be provided to thelender/supplier is left to the borrower. However,creation of charge over immoveable assets andfinancial securities, such as shares, in favourof the overseas lender is subject to Regulation8 of Notification No. FEMA 21/RB-2000 datedMay 3, 2000 and Regulation 3 of Notification No.FEMA 20/RB-2000 dated May 3, 2000,respectively, as amended from time to time.

(x) Prepayment

Prepayment of ECB up to USD 500 million maybe allowed by AD banks without prior approvalof RBI subject to compliance with the stipulatedminimum average maturity period as applicableto the loan.

(xi) Refinancing of an existing ECB

The existing ECB may be refinanced by raisinga fresh ECB subject to the condition that thefresh ECB is raised at a lower all-in-cost andthe outstanding maturity of the original ECB ismaintained.

(xii) Procedure

The designated Authorised Dealer (AD) bankhas the general permission to make remittancesof instalments of principal, interest and othercharges in conformity with ECB guidelinesissued by Government / Reserve Bank of Indiafrom time to time. Borrowers may enter into loanagreement complying with ECB guidelines withrecognised lender for raising ECB underAutomatic Route without prior approval of RBI.The borrower must obtain a Loan RegistrationNumber (LRN) from the Reserve Bank of Indiabefore drawing down the ECB.

II. APPROVAL ROUTE:

(i) Eligible borrowers

a) Financial institutions dealing exclusivelywith infrastructure or export finance suchas IDFC, IL&FS, Power Finance

Corporation, Power Trading Corporation,IRCON and EXIM Bank are considered ona case by case basis.

b) Banks and financial institutions which hadparticipated in the textile or steel sectorrestructuring package as approved by theGovernment are also permitted to the extentof their investment in the package andassessment by Reserve Bank based onprudential norms. Any ECB availed for thispurpose so far will be deducted from theirentitlement.

c) ECB with minimum average maturity of 5years by Non- Banking Financial Companies(NBFCs) from multilateral financialinstitutions, reputable regional financialinstitutions, official export credit agenciesand international banks to finance import ofinfrastructure equipment for leasing toinfrastructure projects.

d) Foreign Currency Convertible Bonds(FCCB) by housing finance companiessatisfying the following minimum criteria: (i)the minimum net worth of the financialintermediary during the previous three yearsshall not be less than Rs. 500 crore, (ii) alisting on the BSE or NSE, (iii) minimum sizeof FCCB is USD 100 million, (iv) theapplicant should submit the purpose / planof utilization of funds.

e) Special Purpose Vehicles, or any other entitynotified by the Reserve Bank, set up tofinance infrastructure companies / projectsexclusively, will be treated as FinancialInstitutions and ECB by such entities will beconsidered under the Approval Route.

f) Multi-State Co-operative Societies engagedin manufacturing activity satisfying thefollowing criteria i) the Co-operative Societyis financially solvent and ii) the Co-operativeSociety submits its up-to-date auditedbalance sheet.

g) Cases falling outside the purview of theautomatic route limits and maturity period.

(ii) Recognised Lenders

(a) Borrowers can raise ECB frominternationally recognised sources such as(i) international banks, (ii) international


capital markets, (iii) multilateral financialinstitutions (such as IFC, ADB, CDC etc.,),(iv) export credit agencies, (v) suppliers’ ofequipment, (vi) foreign collaborators and (vii)foreign equity holders (other than erstwhileOCBs).

(b) From ‘foreign equity holder’ where theminimum equity held directly by the foreignequity lender is 25 per cent but debtequityratio exceeds 4:1(i.e. the proposed ECBexceeds four times the direct foreign equityholding).

(iii) Amount and Maturity

Corporates can avail of ECB of an additionalamount of USD 250 million with average maturityof more than 10 years under the approval route,over and above the existing limit of USD 500million under the automatic route, during afinancial year. Other ECB criteria such as end-use, all-in-cost ceiling, recognised lender, etc.need to be complied with. Prepayment and call/put options, however, would not be permissiblefor such ECB up to a period of 10 years.

(iv) All in Cost ceilings

All-in-cost includes rate of interest, other feesand expenses in foreign currency exceptcommitment fee, pre-payment fee, and feespayable in Indian Rupees. Moreover, thepayment of withholding tax in Indian Rupees isexcluded for calculating the all-in-cost. The all-in-cost ceilings for ECB are reviewed from timeto time.

The following ceilings are currently applicable:

Average Maturity All-in-cost CeilingsPeriod over 6 month LIBOR*

Three years and upto five years 150 basis points

More than five years 250 basis points

*for the respective currency of borrowing orapplicable benchmark

(iv) End use

(a) ECB can be raised only for investment [suchas import of capital goods (as classified byDGFT in the Foreign Trade Policy), new

projects, modernization/expansion ofexisting production units] in real sector -industrial sector including small andmedium enterprises (SME) andinfrastructure sector in India. Infrastructuresector is defined as (i) power, (ii)telecommunication, (iii) railways, (iv) roadincluding bridges, (v) sea port and airport(vi) industrial parks and (vii) urbaninfrastructure (water supply, sanitation andsewage projects);

(b) ECB proceeds can be utilised for overseasdirect investment in Joint Ventures (JV)/Wholly Owned Subsidiaries (WOS) subjectto the existing guidelines on Indian DirectInvestment in JV/WOS abroad.

(c) Utilisation of ECB proceeds is permitted inthe first stage acquisition of shares in thedisinvestment process and also in themandatory second stage offer to the publicunder the Government’s disinvestmentprogramme of PSU shares.

(d) With effect from 7th August 2007, ECBmore than USD 20 million per borrowercompany per financial year would bepermitted only for foreign currencyexpenditure for permissible end-uses ofECB. Accordingly, borrowers raising ECBmore than USD 20 million shall park the ECBproceeds overseas for use as foreigncurrency expenditures for permissible end-uses and shall not remit the funds to India.The above modifications would be applicableto ECB exceeding USD 20 million perfinancial year both under the AutomaticRoute and under the Approval Route.

(e) Borrowers proposing to avail ECB up toUSD 20 million for Rupee expenditure forpermissible end-uses would require priorapproval of the Reserve Bank under theApproval Route. However, such funds shallbe continued to be parked overseas untilactual requirement in India.

(v) Parking of ECB Proceeds overseas

ECB proceeds shall be parked overseas untilactual requirement in India. ECB proceedsparked overseas can be invested in the followingliquid assets:


(a) Deposits or Certificate of Deposit or otherproducts offered by banks rated not lessthan AA(-) by Standard and Poor/Fitch IBCAor Aa3 by Moody’s;

(b) Deposits with overseas branch of anAuthorised Dealer in India; and (c) Treasurybills and other monetary instruments of oneyear maturity having minimum rating asindicated above. The funds should beinvested in such a way that the investmentscan be liquidated as and when funds arerequired by the borrower in India.

(vi) End Uses not permitted

Utilisation of ECB proceeds is not permitted for

(a) on-lending

(b) investment in capital market

(c) acquiring a company (or a part thereof) inIndia by a corporate,

(d) real estate,

(e) working capital,

(f) General corporate purpose and

(g) repayment of existing Rupee loans.

(vii) Guarantee

Issuance of guarantee, standby letter of credit,letter of undertaking or letter of comfort by banks,financial institutions and NBFCs relating to ECBis not normally permitted. Applications forproviding guarantee/standby letter of credit orletter of comfort by banks, financial institutionsrelating to ECB in the case of SME will beconsidered on merit subject to prudential norms.

With a view to facilitating capacity expansion andtechnological upgradation in Indian Textileindustry, issue of guarantees, standby letters ofcredit, letters of undertaking and letters ofcomfort by banks in respect of ECB by textilecompanies for modernization or expansion oftextile units will be considered under the ApprovalRoute subject to prudential norms.

(viii) Security

The choice of security to be provided to thelender/supplier is left to the borrower. However,creation of charge over immoveable assets andfinancial securities, such as shares, in favourof the overseas lender is subject to Regulation

8 of Notification No. FEMA 21/RB-2000 datedMay 3, 2000 and Regulation 3 of Notification No.FEMA 20/RB-2000 dated May 3, 2000,respectively, as amended from time to time.

(ix) Prepayment

(a) Prepayment of ECB up to USD 500 millionmay be allowed by AD banks without priorapproval of RBI subject to compliance withthe stipulated minimum average maturityperiod as applicable to the loan.

(b) Pre-payment of ECB for amounts exceedingUSD 500 million would be considered by theReserve Bank under the Approval Route

(x) Refinancing of an existing ECB

The existing ECB may be refinanced by raisinga fresh ECB subject to the condition that thefresh ECB is raised at a lower all-in-cost andthe outstanding maturity of the original ECB ismaintained.

(xi) Procedure

Applicants are required to submit an applicationin form ECB through designated AD bank to theChief General Manager, Foreign ExchangeDepartment, Reserve Bank of India, CentralOffice, External Commercial BorrowingsDivision, Mumbai, along with necessarydocuments. Reserve Bank has set up anEmpowered Committee to consider proposalscoming under the Approval Route.

II . REPORTING ARRANGEMENTS ANDDISSEMINATION OF INFORMATION

Reporting Arrangements

(a) With a view to simplify the procedure,submission of copy of loan agreement isdispensed with.

(b) For allotment of loan registration number,borrowers are required to submit Form 83,in duplicate, certified by the CompanySecretary (CS) or Chartered Accountant(CA) to the designated AD bank. One copyis to be forwarded by the designated ADbank to the Director, Balance of PaymentsStatistics Division, Department of StatisticalAnalysis and Computer Services(DESACS), Reserve Bank of India, Bandra-Kurla Complex, Mumbai – 400 051 [Note:copies of loan agreement , offer documents


for FCCB are not required to be submittedwith form 83).

(c) The borrower can draw-down the loan onlyafter obtaining the loan registration numberfrom DESACS, Reserve Bank of India.

(d) Borrowers are required to submit ECB-2Return certified by the designated AD bankon monthly basis so as to reach DESACS,RBI within seven working days from theclose of month to which it relates.

Dissemination of Information

For providing greater transparency, informationwith regard to the name of the borrower, amount,purpose and maturity of ECB under bothAutomatic Route and Approval Route are put onthe Reserve Bank website on a monthly basiswith a lag of one month to which it relates.

III. STRUCTURED OBLIGATIONS

In order to enable corporates to raise resourcesdomestically and hedge exchange rate risks,domestic rupee denominated structuredobligations are permitted to be credit enhancedby international banks/international financialinstitutions/joint venture partners. Suchapplications will be considered under theApproval Route.

IV. COMPLIANCE WITH ECB GUIDELINES

The primary responsibility to ensure that ECBraised / utilised are in conformity with the ECBguidelines and the Reserve Bank regulations /directions is that of the concerned borrower andany contravention of the ECB guidelines will beviewed seriously and will invite penal actionunder FEMA 1999 (cf. A. P. (DIR Series) CircularNo. 31 dated February 1, 2005). The designatedAD bank is also required to ensure that raising /utilisation of ECB is in compliance with ECBguidelines at the time of certification.

V. CONVERSION OF ECB INTO EQUITY

(i) Conversion of ECB into equity is permittedsubject to the following conditions:

(a) The activity of the company is covered underthe Automatic Route for Foreign DirectInvestment or Government approval forforeign equity participation has beenobtained by the company,

(b) The foreign equity holding after suchconversion of debt into equity is within thesectoral cap, if any,

(c) Pricing of shares is as per SEBI anderstwhile CCI guidelines/regulations in thecase of listed/unlisted companies as thecase may be.

(ii) Conversion of ECB may be reported to theReserve Bank as follows:

(a) Borrowers are required to report fullconversion of outstanding ECB intoequity in the form FC-GPR to theconcerned Regional Office of the ReserveBank as well as in form ECB-2 submittedto the DESACS, RBI within seven workingdays from the close of month to which itrelates. The words “ECB wholly convertedto equity” should be clearly indicated on topof the ECB-2 form. Once reported, filing ofECB-2 in the subsequent months is notnecessary.

(b) In case of partial conversion ofoutstanding ECB into equity, borrowersare required to report the converted portionin form FC-GPR to the concerned RegionalOffice as well as in form ECB-2 clearlydifferentiating the converted portion from theunconverted portion. The words “ECBpartially converted to equity” should beindicated on top of the ECB-2 form. Insubsequent months, the outstanding portionof ECB should be reported in ECB-2 formto DESACS.

VI. CRYSTALLISATION OF ECB

AD banks desiring to crystallize their foreignexchange liability arising out of guaranteesprovided for ECB raised by corporates in Indiainto Rupees, may make an application to theChief General Manager, Foreign ExchangeDepartment, External Commercial BorrowingsDivision, Reserve Bank of India, Central Office,Mumbai, giving full details viz., name of theborrower, amount raised, maturity,circumstances leading to invocation of guarantee/letter of comfort, date of default, its impact onthe liabilities of the overseas branch of the ADbank concerned and other relevant factors.


UCP 600: ICC’S NEW RULES ON LETTERS OF CREDIT

� The new UCP 600, the sixth of its kind, suits the requirements of the fast changing patternof the international trade.

� There were 13 suggestions but no single suggestion received more than 10 country votes;therefore, no new articles are included in the final text.

� From 1st July 2007, UCP 500 is no longer effective in governing the application andoperations of Letter of Credit. UCP 600 is the new governing set for all parties concerned.

It is estimated that about 80% of the world tradeis settled on open account method, 3% onadvance payment method, 10% on Letters ofCredit method and remaining 7% on othermethods. The world trade settled usingcommercial letters of credit would be almostUSD 1 trillion per annum. Historically, thecommercial parties, particularly banks, havedeveloped the techniques and methods forhandling letters of credit in international tradefinance. This

has been standardised by the ICC (InternationalChamber of Commerce) by publishing the UCPin 1933 and subsequently updating it throughoutthe years.

The ICC

The international Chamber of Commerce (ICC)was founded in 1919 to serve world businessby promoting trade and investment, openmarkets for goods and services, and the freeflow of capital. The organization’s internationalsecretariat was established in Paris. Initiallyrepresenting the private sectors of Belgium,Britain, France, Italy and the United States, itexpanded to represent worldwide businessorganizations in around 130 countries. Itsconviction that trade is a powerful force for peaceand prosperity dates from the organization’sorigins, the small group of far-sighted businessleaders who founded ICC, called themselves the‘merchants of peace’.

Because its member companies andassociations are themselves engaged ininternational business, ICC has unrivalledauthority in making rules that govern the conductof business across borders. Although these

rules are voluntary, they are observed incountless thousands of transactions every dayand have become part of the fabric ofinternational trade.

The UCP

The Uniform Customs and Practice forDocumentary Credits (UCP) is a set of rulesgoverning the issuance and use of letters ofcredit. The UCP is utilised by bankers andcommercial parties in more than 175 countries.The ICC rules of practice are designed bybankers and merchants and not by legislatureswith political and local considerations. The rulesaccordingly demonstrate the needs, customsand practices of business. Because the rulesare incorporated voluntarily into contracts, therules are flexible while providing a stable basefor international review, including judicial scrutiny.International revision is thus facilitated permittingthe incorporation of the changing practices ofthe commercial parties. It remains, to date, themost successful set of private rules for tradeever developed. UCP 600 which has becomeeffective from 1st July 2007 represents the sixthrevision of the Uniform Customs and Practicefor Documentary Credits, since its inception.

History of UCP

The first UCP by the ICC was effective in 1933.UCP rules are regularly reviewed and updatedwhen necessary to reflect current banking andtrade practice. The new UCP600, the sixth ofits kind, will replace the existing UCP500 to suitthe requirements of the fast changing pattern ofthe international trade. Historically the UCP hasbeen revised about every 10 years.


• UCP 82 - 1933 created

• UCP 151 - 1951 1st revision

• UCP 222 - 1962 2nd revision

• UCP 290 - 1974 3rd revision

• UCP 400 - 1983 4th revision



A few important reasons why UCP500 wasrevised are:� High discrepancy rate in documents

presented under letters of credit subject toUCP500

� High level of inquiries pertaining to 7 articles� Law-suits highlighting unclear parts of the

UCP� New disclaimers emerging in bills of lading

UCP 600 - The Revision Process

The development of the UCP 600 revision beganin May of 2003, under the auspices of the ICCCommission on Banking Technique andPractice. The Drafting Group, comprised of 9members was headed by Mr. Gary Collyer, theTechnical Advisor to the ICC BankingCommission and formerly a Corporate Directorof ABN Bank N.V., London England. A UCPConsulting Group was also established as anadvisory body to the Drafting Group. This groupwas co-chaired by John Turnbull, DeputyGeneral Manager, Sumitomo Mitsui BankingCorporation Europe Ltd., London and Carlo DiNinni, Advisor, Italian Bankers Association, Romeand More than 40 banking and transport industryexperts from 26 countries. More than 400members of the ICC Banking Commissionreviewed and recommended changes to thevarious drafts. The majority of the 91 ICCNational Committees took an active rolesoliciting and consolidating comments from theirmembers. Representatives from the Transportand Insurance industries played an active rolein shaping the final draft. The BankingCommission has had a total of 7 days ofdiscussions on the text.

The UCP Drafting Group has met 15 times andreviewed around 5,000 individual commentsfrom national committees. There were 15 draftssent out, 3 of which were complete drafts and 9of which were reviewed by the Consulting Groupbefore being sent to the National committees.

Several relevant drafts were sent for review tothe ICC Commission of Transport and Logistics,the Commission of Commercial Law andPractice and the Committee on Insurance.

UCP Revision - National Committee Voteson Selected Issues

Retention or removal of the expression “on itsface”. 67% voted to remove, 33% to keep. Theresult was to keep it in only one place becauseof court precedents.

Delete or retain and define “reasonable time”.97% voted to delete, 3% to keep. The phrasewas removed from the final text.

If “reasonable time” were to be deleted, howmany days should be the maximum period foracceptance or refusal of documents? 41% votedfor 5 days, 25% for 6 days, 28% for 7 days, 6%gave no comments. Five days are used in thefinal text.

Whether to use the term “parties” or “banks” inthe rules. 73% voted for banks, 24% for partiesand 3% had no view either way. “Banks” is usedin the final text.

Deferred payment credits. Whether to allow fordiscounting or not. 75% voted yes, and 27%voted no. The result is three sub-articles ondiscounting included in the final text (in articles7, 8 and 12).

Whether to retain the equivalent of Article 28 ofUCP 500 or split it into three separate articles.54% voted to keep it as is and 45% voted to splitit. The final text retains road, rail and inlandwaterway transport documents in a single articleas it was in UCP 500. (The new article 24.).

Whether there was a need to keep theequivalent of UCP 500 Article 30 concerningfreight forwarder bills of lading. 82% voted toremove and 18% voted to keep. In the finalversion, sub-article 14 (i) indicates that atransport document may be issued by a partyother than the carrier, master, etc. if certainconditions are met.

Whether defined terms should be capitalized ornot. 49% voted to capitalize, 41% to not and10% offered no decision. Given the closenessof the vote and the fact that a text withcapitalization was overloaded with capital letters,the decision was taken not to capitalize.


Request for “new articles” to be included in therules. There were 13 suggestions but no singlesuggestion received more than 10 countryvotes, therefore, no new articles are included inthe final text.Non-documentary conditions. Three optionswere given, two of which were variations on thecurrent UCP 500 text. 81% voted to retain thecurrent wording with 19% splitting their votebetween the other two options. The main themeof the UCP 500 wording was included in the finaltext of Article 14.Force majeure. Whether to use the currentwording or a five banking day period after thebank re-opens. 49% voted to keep as is, 51%change to 5 days. Due to no clear guidance, thewording was retained as currently exists in UCP500.Inconsistent data – sub-article 14(d) of UCP600. 91% voted for the concept now in this sub-article with 9% voting in favor of a version thatwould not require banks to check data acrossdocuments.Whether to retain negotiation as a settlementtype. The vote was more than 3-1 to retain it.Negotiation remains in the final text as asettlement type.Final text of UCP 600 was unanimouslyapproved on October 25, 2006 at the ICCBanking Committee meeting in Paris, France.

UCP 600 - Highlights

� UCP500 Articles not incorporated intoUCP600 text:

o Article 5 [Instructions to Issue/Advise Credits]

o Article 6 [Revocable v. IrrevocableCredits]

o Article 8 [Revocation of a Credit]o Article 12 [Incomplete or Unclear

Instructions]o Article 38 [Other Documents]

� Content of Articles 2, 6, 9, 10, 20, 21, 22,30, 31, 33, 35, 36, 46 and 47 were mergedor otherwise provided for in other wayswithin the text of the UCP 600.

• The phrase “reasonable time” foracceptance or refusal of documents hasbeen replaced by a firm period of five bankingdays.

• The number of articles reduced to 39.

• New provisions allow for the discounting ofdeferred payment credits.

• Banks can now accept an insurancedocument that contains reference to anyexclusion clause.

• New sections on “definitions” and“interpretations” have been added to clarifythe meaning of ambiguous terms.

• Credit must state if reimbursement issubject to the ICC rules for bank to bankreimbursements.

• An applicant or beneficiary addressappearing in any stipulated document neednot be the same but must be within the samecountry as the address stated in the creditand contact details such as fax, phone,email and the like, when stated as a part ofthe applicant or beneficiary address will bedisregarded…unless the address andcontact details appear as part of theconsignee or notify party details on atransport document subject to the transportdocument articles of the UCP 600. In thatcase they must appear as stated in thecredit.

• The word “clean” need not appear on atransport document even if a credit has arequirement for that transport document tobe “clean on board”.

• The flight stamp shown on an airway bill willbe considered as the date of shipment,whether requested in the credit or not.

• The turndown notice has two new options:• to hold documents pending applicant waiver

or receipt of additional instructions from thepresenter or

• that the bank is acting in accordance withinstructions previously received frompresenter.

• At least one original of each documentstipulated in a credit must be presented.

• The concept of a revocable credit wasremoved from UCP.

From 1st July 2007, UCP 600 is the newgoverning set for all parties concerned; bankers,traders, transport operators, insurancecompanies, lawyers, etc. International StandardBanking Practice for examination of documentsunder documentary credits 2007 revision forUCP 600 (ICC Publication No.681) has alreadybeen brought out by ICC.


SAARCFINANCE: NETWORK OF SAARC COUNTRYCENTRAL BANKS

� SAARCFINANCE is a Network of Central Banks and Finance Secretaries of SAARCcountries.

� It aims at achieving cooperation among SAARC nations.

The 10th SAARC Summit of the Head of theStates of the SAARC Region agreed, in principle,to establish a Network of Central BankGovernors and Finance Secretaries of theSAARC Region (SAARCFINANCE) with a viewto opening dialogues on macroeconomicpolicies of the region and sharing mutualexperiences and ideas. SAARCFINANCE wasestablished on September 9, 1998 as a regionalnetwork of the SAARC Central Bank Governorsand Finance Secretaries.

Objectives

The basic objective of establishing theSAARCFINANCE Network is to shareexperiences on macroeconomic policy issuesamong member countries of the region.However, the broad objectives of theSAARCFINANCE Network are as follows:

1. To promote cooperation among centralbanks and finance ministries in SAARCmember countries through staff visits andregular exchange of information.

2. To consider and propose harmonization ofbanking legislations and practices within theregion.

3. To work towards a more efficient paymentsystem mechanism within the SAARCregion and strive for higher monetary andexchange cooperation.

4. To forge closer cooperation onmacroeconomic policies of SAARCmember states and to share experiencesand ideas.

5. To study global financial developments andtheir impact on the region includingdiscussions relating to emerging issues inthe financial architecture, IMF and WorldBank and other international lendingagencies.

6. To monitor reforms of the internationalfinancial and monetary system and to evolvea consensus among SAARC countries inrespect of the reforms.

7. To evolve, whenever feasible joint strategies,plan and common approaches ininternational fora for mutual benefitparticularly in the context of liberalization offinancial services.

8. To undertake training of staff of theministries of finance, central banks andother financial institutions of the SAARCmember countries in subjects relating toeconomics and finance.

9. To explore networking of the traininginstitutions within the SAARC regionspecializing in various aspects of monetarypolicy, exchange rate reforms, banksupervision and capital market issues.

10. To promote research on economic andfinancial issues for the mutual benefit ofSAARC member countries.

11. To consider any other matter on thedirection/request of the SAARCFINANCE,Council of Ministers or other SAARC bodies.

List of SAARC Nations : India, Nepal, Bhutan,Bangladesh, Sri Lanka, Maldives and Pakistan.


MONEY LAUNDERING MENACE FOR BANKS: ANINTERNATIONAL PERSPECTIVE

� Increased complexity of financial markets has made the task costly.

� To fight the menance of Money Lundering Governmental and International regulationsshould be increased.

� An effective coordination betwen banks and regulatory authorities is a must fordefeating money launderers.

The cost of fighting money laundering has risendramatically for banks across the world as theyhave become increasingly engaged in thestruggle against criminality. However, the taskis becoming more difficult due to the increasingcomplexity of the financial markets in which theyoperate, including greater exposure tosometimes unfamiliar emerging markets andthe dramatic growth of alternative assets,according to a global study by KPMG Forensic.

KPMG’s study among 224 banks from 55countries found that banks’ spending on anti-money laundering (AML) systems andprocesses has risen by an average of 58 percentover the last three years. In North America andin the Middle East and Africa, spending hasincreased by 70 percent or more. Theseincreases are far in excess of banks’ ownpredictions when KPMG Forensic carried out itslast study in 2004, when respondents on averagepredicted an increase of 43 percent. The biggestspending continues to be on transactionmonitoring and staff training costs.

However, just as three years ago banks under-estimated their likely level of spend in the future,so now they still seem in danger of being over-optimistic: on average, they are predicting anincrease of only 34 percent in their spending overthe next three years to 2010.

Senior management are getting more involvedin AML, with 71 percent of banks saying directorsat the highest level are actively involved in it, upfrom 61 percent in 2004. Most respondent banks(85 percent) have a global AML policy, rangingfrom a high of 100 percent in North America to alow of 58 percent in the Middle East and Africa.

However, there is significant concern amongstbanks that governmental and internationalregulation needs to be more effectively targeted.Half of respondents said they believe that whilethe overall regulatory burden is acceptable, therequirements need to be better focused, whilenearly one in ten (8 percent) believe thatregulation should actually be increased in orderto combat money laundering more effectively.

In addition, there is evidence that transactionmonitoring systems need to be enhanced.Despite sophisticated monitoring technologybeing available, 97 percent of banks say that theyare dependent on the vigilance of staff to monitorand identify suspicious activity, and a third ofbanks (34 percent) say that they are not satisfiedwith the effectiveness of their transactionmonitoring systems. Fewer than one in five (18percent) describe themselves as ‘very satisfied’.

Karen Briggs, Global Head of Anti-MoneyLaundering at KPMG Forensic and partner in theU.K. firm, said: “Banks are clearly continuing tomake increased efforts to tackle the moneylaundering threat effectively. These efforts areconsiderable, but nevertheless many banks arestruggling to design and implement an effectiveanti-money laundering strategy. Significantnumbers say that the regulatory environment isnot helping them as well as it should do – this isclearly a matter of concern, as effectivecoordination between parties is one of the keysto defeating money launderers.”

“With international banks bolstering theirpresence in emerging market economies, andwith a low interest rate environment drivinggrowth in alternative assets including hedge


funds, private equity and commodityinvestments, the need for more stringent anti-money laundering processes has only grown.Banks will need to work extremely hard from hereif they are to maintain any advantage in the waragainst money laundering and terroristfinancing.”

With greater spending and training, the numberof suspicious activity reports (SARs) beinggenerated has also increased at over 70 percentof banks. Forty-two percent of banks say thatthe number of SARs has increased“substantially”.

Banks are also making greater efforts to identifypolitically exposed persons (PEPs) who couldbe the conduits for laundered money. Overseven out of ten banks say they performenhanced due diligence on PEPs, markedly upfrom the worrying low of 45 percent three yearsago. There are significant variations here,however, with only 42 percent of banks in theAsia Pacific region and only 65 percent of banksin Europe monitoring for PEPs. Within Europe,this ranged dramatically, from 86 percent in theU.K. to only 29 percent in Spain and 13 percentin Italy. The task facing banks here is made moredifficult by the lack of a common definition of aPEP and the fact that in some markets businessand politics are closely intertwined.

Despite all of these efforts, it is clear thatsignificant challenges remain. Less than aquarter of respondent banks with aninternational presence are capable of monitoringa single customer’s transactions and accountstatus across multiple countries. There was noevidence that larger banks are any more capablein this respect than smaller banks, and this may

reflect that banking secrecy and data protectionlaws in some countries prevent the sharing ofinformation around a banking group.

North American banks are ahead of their peergroup in this respect, however, with 42 percentof banks capable of monitoring across borders.Globally, 41 percent of banks said they were notcapable of tracking across countries, and 26percent were only partially capable.

In its report, KPMG Forensic also highlights theadditional AML risks created by the enlargementof the EU. Many of the ten countries that haverecently joined have not historically had stringentAML processes in place and it is likely to takethese countries some time to bring theirprocesses up to the standards required underthe EU Third Money Laundering Directive. Somebanks may be particularly vulnerable to risks iftheir internal procedures are based on theassumption that all EU banks are low risk andaccordingly apply less scrutiny to theserelationships.

As per KPMG’s Financial Services practice thereis no doubt that a more even regulatory playingfield globally would help banks coordinate theiranti-money laundering processes moreeffectively. The desire and commitment is there,as banks recognize that money laundering isan issue with significant adverse reputationalissues for them if things go wrong. However, amixed regulatory landscape and banks’ ownlegacy issues in their KYC (know yourcustomer) information, IT systems and cultureis making the task difficult for many. As theexpansion into emerging and alternative marketscontinues apace, these challenges are onlylikely to grow.”


NATIONAL FOREIGN TRADE POLICY 2004-09

� Introduced in 2004 and replaces EXIM policy.

� Objectives: To double our share in global trade by 2009 and to act as an effectiveinstrument of economic growth with thrust on employment generation particularlyin semi-urban and rural areas.

� Sectors with export prospects and potential for employment in rural and semi-urban areas are identified as thrust sectors.

� A new scheme - ‘Vishesh Krishi Upaj Yojana’ introduced to boost exports of fruits,vegetables, flowers, minor forest produce, etc.

� Target Plus, served from India scheme, removal of age of goods and decreasein cut off of minimum depreciated value to Rs.25 crore for imported goods areother special features.

The New government terminated the five-yearExim Policy, 2002-07 and introduced a ForeignTrade Policy for a five-year term beginning thisfiscal year on the 31st August 2004.

1. Strategy:

(a) It is for the first time that a comprehensiveForeign Trade Policy is being notified. TheForeign Trade Policy takes an integratedview of the overall development of India’sforeign trade.

(b) The objective of the Foreign Trade Policy istwo-fold:

(i) to double India’s percentage share ofglobal merchandise trade by 2009; and

(ii) to act as an effective instrument ofeconomic growth by giving a thrust toemployment generation, especially in semi-urban and rural areas.

(c) The key strategies are:

(i) Unshackling of controls;

(ii) Creating an atmosphere of trust andtransparency;

2. Special Focus Initiatives:

(a) Sectors with significant export prospectscoupled with potential for employmentgeneration in semi-urban and rural areashave been identified as thrust sectors, and

specific sectoral strategies have beenprepared.

(b) Further sectoral initiatives in other sectorswill be announced from time to time. Forthe present, Special Focus Initiatives havebeen prepared for Agriculture, Handicrafts,Handlooms, Gems & Jewellery and Leather& Footwear sectors.

(c) The threshold limit of designated ‘Towns ofExport Excellence’ is reduced fromRs.1,000 crore to Rs.250 crore in thesethrust sectors.

3. Package for Agriculture

The Special Focus Initiative for Agricultureincludes:

(a) A new scheme called Vishesh Krishi UpajYojana has been introduced to boost exportsof fruits, vegetables, flowers, minor forestproduce and their value-added products.

(b) Duty-free import of capital goods underEPCG scheme.

(c) Capital goods imported under EPCG foragriculture permitted to be installedanywhere in the Agri Export Zone.

(d) ASIDE funds to be utilized for developmentfor Agri Export Zones also.

(e) Import of seeds, bulbs, tubers and plantingmaterial has been liberalized.


(f) Export of plant portions, derivatives andextracts has been liberalized with a view topromoting export of medicinal plants andherbal products.

4. Export Promotion Schemes

(a) Target Plus

A new scheme to accelerate growth of exportscalled ‘Target Plus’ has been introduced.

Exporters who have achieved a quantum growthin exports would be entitled to duty-free creditbased on incremental exports substantiallyhigher than the general actual export target fixed.(Since the target fixed for 2004-05 is 16%, thelower limit of performance for qualifying forrewards is pegged at 20% for the current year).

Rewards will be granted based on a tieredapproach. For incremental growth of over 20%,25% and 100%, the duty-free credits would be5%, 10% and 15% of FOB value of incrementalexports.

(b) Vishesh Krishi Upaj Yojana

Another new scheme called Vishesh Krishi UpajYojana (Special Agricultural Produce Scheme)has been introduced to boost exports of fruits,vegetables, flowers, minor forest produce andtheir value-added products. Export of theseproducts shall qualify for duty-free creditentitlement equivalent to 5% of FOB value ofexports. The entitlement is freely transferableand can be used for import of a variety of inputsand goods.

(c) ‘Served from India’ Scheme

To accelerate growth in export of services soas to create a powerful and unique ‘Served fromIndia’ brand instantly recognized and respectedthe world over, the earlier DFEC scheme forservices has been revamped and re-cast intothe ‘Served from India’ scheme.

Individual service providers who earn foreignexchange of at least Rs.5 lakh, and other serviceproviders who earn foreign exchange of at leastRs.10 lakh will be eligible for a duty creditentitlement of 10% of total foreign exchangeearned by them.

In the case of stand-alone restaurants, theentitlement shall be 20%, whereas in the caseof hotels, it shall be 5%. Hotels and Restaurantscan use their duty credit entitlement for importof food items and alcoholic beverages.

(d) EPCG

(i) Additional flexibility for fulfillment of exportobligation under EPCG scheme in order toreduce difficulties of exporters of goods andservices.

(ii) Technological upgradation under EPCGscheme has been facilitated andincentivised.

(iii) Transfer of capital goods to groupcompanies and managed hotels nowpermitted under EPCG.

(iv) In case of movable capital goods in theservice sector, the requirement ofinstallation certificate from Central Excisehas been done away with.

(v) Export obligation for specified projects shallbe calculated based on concessional dutypermitted to them. This would improve theviability of such projects.

(e) DFRC

Import of fuel under DFRC entitlement shall beallowed to be transferred to marketing agenciesauthorized by the Ministry of Petroleum andNatural Gas.

(f) DEPB:

The DEPB scheme would be continued untilreplaced by a new scheme to be drawn up inconsultation with exporters.

(g) New Status Holder Categorization forExport Houses

A new rationalized scheme of categorization ofstatus holders as Star Export Houses has beenintroduced as under:

Category Total performanceover 3 years

One Star Export House Rs.15 croreTwo Star Export House Rs.100 croreThree Star Export House Rs.500 croreFour Star Export House Rs.1500 croreFive Star Export House Rs.5000 crore


Star Export Houses shall be eligible for a numberof privileges including fast-track clearanceprocedures, exemption from furnishing of bankguarantee, eligibility for consideration underTarget Plus Scheme, etc.

5. Export Oriented Units (EOUs)

(a) EOUs shall be exempted from Service Taxin proportion to their exported goods andservices.

(b) EOUs shall be permitted to retain 100% ofexport earnings in EEFC accounts.

(c) Income Tax benefits on plant and machineryshall be extended to DTA units whichconvert to EOUs.

(d) Import of capital goods shall be on self-certification basis for EOUs.

(e) For EOUs engaged in Textile & Garmentsmanufacture leftover materials and fabricsupto 2% of CIF value or quantity of importshall be allowed to be disposed of onpayment of duty on transaction value only.

(f) Minimum investment criteria shall not applyto Brass Hardware and Hand-madeJewellery EOUs (this facility already existsfor Handicrafts, Agriculture, Floriculture,Aquaculture, Animal Husbandry, IT andServices).

6. Free Trade and Warehousing Zone:

(i) A new scheme to establish Free Trade andWarehousing Zone has been introduced tocreate trade-related infrastructure tofacilitate the import and export of goods andservices with freedom to carry out tradetransactions in free currency. This is aimedat making India into a global trading hub.

(ii) FDI would be permitted up to 100% in thedevelopment and establishment of thezones and their infrastructural facilities.

(iii) Each zone would have minimum outlay ofRs.100 crore and five lakh sq. mts. built-uparea.

Units in the FTWZs would qualify for all otherbenefits as applicable for SEZ units.

7.Import of Second hand Capital Goods

a. Import of second-hand capital goods shallbe permitted without any age restrictions.

b. Minimum depreciated value for plant andmachinery to be re-located into India hasbeen reduced from Rs.50 crore to Rs.25crore.

8. Services Export Promotion Council

An exclusive Services Export Promotion Councilshall be set up in order to map opportunities forkey services in key markets, and developstrategic market access programmes, includingbrand building, in co-ordination with sectoralplayers and recognized nodal bodies of theservices industry.

9. Common Facilities Centre

Government shall promote the establishment ofCommon Facility Centres for use by home-based service providers, particularly in areas likeEngineering & Architectural design, Multi-mediaoperations, software developers, etc., in Stateand District-level towns, to draw in a vastmultitude of home-based professionals into theservices export arena.

10. Procedural Simplification &Rationalisation Measures

All exporters with minimum turnover of Rs.5 croreand good track record shall be exempt fromfurnishing bank guarantee in any of theschemes, so as to reduce their transactionalcosts.Validity of all licences/entitlements issuedunder various schemes has been increased toa uniform 24 months.Time-bound introductionof Electronic Data Interface (EDI) for exporttransactions. Seventy-five per cent of all exporttransactions to be on EDI within six months.

11. Bio Technology Parks

Biotechnology Parks to be set up which wouldbe granted all facilities of 100% EOUs.


MANAGEMENT


Visualise a football full of air kept at the centre ofa table and there is no one to touch it for a week.What will be the condition of the football after aweek?

There will be dust on it, it will lose its shine andperhaps it will go out of shape. In essence,energy inside the football will dissipate resultingin losing its shine on the surface. A footballneeds someone to pay attention to it, to hit it. Afootball needs strokes.

It is not only a football which needs strokes butit is a need of every human being. Stroking for ahuman being is nothing but hunger forrecognition. Each one of us has an innate desireto be recognised. It is said that children cry andadults die for recognition. Stroking is one of theeasiest ways to satisfy this human need. Thisneed is so deep rooted that as a punishment,solitary confinement is considered worse thandeath penalty.

Strokes help in increasing the self worth of anindividual. However, if we are not careful in givingstrokes, they may have a disastrous effect.

Different Types of Strokes

Positive and Negative

Positive strokes help in enhancing the image ofan individual in his or her own eyes. Self-beliefand self-confidence go up. They are amotivating factor and encourage a person tocontinue to do well or continue to improveperformance or behaviour. Everyday everyoneis doing something good. Are we able to observeand then appreciate it? Some examples ofpositive strokes are: giving a pat on the back,

STROKES

� Strokes help in increasing the self worth of an individual.

� Positive strokes help in enhancing the image of an individual in his or her own eyes. Self-belief and self-confidence go up.

� Negative strokes on the other hand have a de-motivating and demoralising effect. Repeatednegative strokes may result in low self-worth of an individual.

� Unconditional positive strokes are the best because of their long term positive impact.

saying – ‘I liked your report’ or ‘your presentationwas good’, etc.

Negative strokes on the other hand have a de-motivating and demoralising effect. Repeatednegative strokes may result in low self-worth ofan individual. At times, the intention of the persongiving a negative stroke may be to help but itseffect will depend on how the receiver is takingit. Therefore, we need to exercise extra cautionwhile giving a negative stroke. Some examplesof negative strokes are: snubbing, spanking,shouting, reprimanding, etc. If a person is notgetting enough positive strokes, s/he mayindulge in activities to get negative strokes. Allof us are aware of attention seeking activities ofchildren.

Verbal and Non Verbal

When we use words for giving strokes, they areverbal strokes. Words have tremendous powerand this power is enhanced by the way they arespoken. Only a person with high level ofemotional intelligence can boast that ‘sticks andstones may break my bones but words cannever hurt me’. An ordinary person will perhapssay ‘injuries of sticks and stones will heal butwords will continue to haunt me’.

Human brain interprets the way anything is beingsaid more than what is being said. Therefore,influence of manner in which something is beingsaid coupled with use of body language makesthe strokes non-verbal. Do you remember‘Jaadu ki jhappi’ of the movie ‘Munna BhaiMBBS’? Many of us have come to understandthe power of touch from that movie. Non-verbalstrokes include loud voice, angry tone, eyecontact, smile, hand shake, pat on the back,embrace, etc.


Verbal and non-verbal strokes can be positiveor negative.

Genuine and Plastic

Origin of genuine strokes lies in the heart. Whena stroke is given spontaneously, it is likely to begenuine. An employee brings a deposit of Rs.10lakh and you immediately get up from your chairto shake hands with him is an example of agenuine stroke.

Plastic strokes are generally given to conformto norms of an organisation or culture. An airhostess smiling at you when you enter anaeroplane may in all probability be a plasticstroke.

Conditional and Unconditional

When we make a stroke dependent onfulfillment of some condition, it is a conditionalstroke. Many of us commonly practice it. Simpleexample is telling a child – ‘I will get you a bicycleif you score above 90% marks’. ‘I will write agood report for you if you get A+ inspectionrating’. Use of ‘if you do’ or ‘when you do’ makesany stroke a conditional stroke.

Unconditional strokes emerge out of regard forthe individuality of a person irrespective ofbackground of the person. For example, ‘Iappreciate your contribution to this Branch’. ‘Youare not fit to be an officer ’. Our biases,prejudices and task obsession come in the wayof giving unconditional strokes. We may needto get rid of them to start giving unconditionalstrokes.

Conditional and unconditional strokes can bepositive or negative.

Which combination of strokes is the best?Unconditional positive strokes are the bestbecause of their long term positive impact.This combination does not place any burden onanother person to fulfill certain conditions to get

strokes. To make a difference in the world, wemust start giving unconditional positive strokesto people around us.

The chart below indicates the impact of variouscombinations of strokes.

Type of Stroke Impact on Receiver

Verbal/Non-verbal – Positive Positive

Verbal/Non-verbal – Negative Negative

Conditional – Positive Temporary Positive

Conditional – Negative Negative

Unconditional – Positive Long term POSITIVE

Unconditional – Negative Negative

Genuine – Positive Positive

Plastic – Positive Transitory Positive

Genuine – Negative Positive*

* Positive because they are given with anintention to help the receiver

Only question that we need to ask ourselves iswhether we are giving enough strokes topeople around us?

If yes, are those strokes helpful to peoplewho are receiving them?

If not, the reason perhaps may not be far to seek.Are we giving enough strokes to ourselvesand what is the nature of those strokes?

Before ending, let us do a small exercise.Raise your arm parallel to the ground with yourpalm facing the sky. Lift it up to take your palmclose to your back. Touch your palm on yourback three times. This is a pat on your ownback. Now, was that an unconditionalpositive stroke to yourself? You deserve itand many more around you deserve it fromyou.


Burnout is a state in which a person experiencesemotional and physical exhaustion and it iscaused by excessive and prolonged stress. Itis considered to be the result of a period wherea person makes too much effort at work andhas too little time for recuperation. With thecontinuation of stress, a person begins to loseinterest or motivation to meet the challenges ofa certain role. Burnout brings down productivityas well as energy, leading to feelings ofhopelessness, powerlessness, cynicism andresentment. Unhappiness caused by burnoutmay eventually threaten a person’s health,relationships and job.

Causes

The roots of burnout generally lie in theworkplace and no occupation is immune to it.However, service professionals, who spend theirtime attending to the needs of others, are moreprone to it. If they are not paid enough, notappreciated or exposed to criticism for mattersbeyond their control, the probability of feelingburnt out increases.

Following scenarios increase the chances ofworkplace burnout:

• Unrealistic goal setting – by the self orimposed

• Expected to play too many roles for toomany people

• Unreasonably coercive or punitive rules ofwork

BURNOUT

� Burnout is a state in which a person experiences emotional and physical exhaustionand it is caused by excessive and prolonged stress.

� Unhappiness caused by burnout may eventually threaten a person’s health,relationships and job.

� Burnout does not happen overnight and since it is difficult to overcome it after itsonset, it is advisable to recognise the early signs of burnout and work on them.

� Since burnout is an outcome of prolonged stress, methods effective in controllingstress are helpful in preventing burnout also.

• Doing work which violates one’s personalvalues

• Lack of variety or challenge in the work

• Trapped in a job (which has any of the abovementioned elements) for economic reasons.

Symptoms

Burnout does not happen overnight and since itis difficult to overcome it after its onset, it isadvisable to recognise the early signs of burnoutand work on them. The earlier a personrecognises these warning signals, the more thechances of avoiding it.

As discussed earlier, the symptoms of burnoutare likely to be more mental than physical. Thefollowing feelings are indicative of burnout.

• Irritability

• Hopelessness & disgust

• Frustration and powerlessness

• Drained of emotional energy

• Detachment, withdrawal, isolation

• Being trapped

• Cynicism

• Sadness

These feelings manifest themselves inbehaviour. Common behaviour pattern isescapism or running away from reality. As aresult, the relationships, at work and in personallife, may begin to fall apart.


Difference between Stress and Burnout

Though burnout is the result of unabated stress,it still is not the same as too much stress.Stress, almost always, involves ‘too much’: toomuch work, too many demands, etc. On theother hand, burnout is indicative of ‘not enough’:feeling of emptiness, lack of motivation, etc.Someone has succinctly put ‘if excessive stressis like drowning in responsibilities, burnout isbeing all dried up’.

Stress Burnout

Overreactive Emotions Blunted Emotions

Urgency and hyperactivity Helplessness andhopelessness

Exhausts physical energy Exhaustsmotivation and drive

Leads to anxiety disorders Leads todetachment anddepression

Primary damage is Primary damage isphysical emotional

Stress may kill Burnout may neverprematurely leaving not kill, but one’s lifeenough time may not seemto finish what one started worth living.

Moreover, while a person is generally aware ofbeing under a lot of stress, one may fail torecognise when burnout happens because thesymptoms can take months to surface. It,therefore, is important that if one receives afeedback from someone close regarding changein attitude and behaviour, it makes good senseto listen to that person.

Preventing Burnout

Since burnout is an outcome of prolongedstress, methods effective in controlling stressare helpful in preventing burnout also. It is veryimportant to build a foundation of good physicalhealth by:

• Daily exercise

• Proper diet

• Taking enough sleep

• Learning to relax

• Striking a balance in one’s life

To prevent job burnout, the best thing is to stopdoing what you are doing and start doingsomething else. Some of the ways are:

• Clarify job description or develop role clarity

• Request for transfer – internal or external

• Ask for new duties

• Seek career advice

Best Defence against All Burnout: Beingwith Other People

While poor relationships and isolation contributeto burnout, good relationships definitely help inpreventing or reducing onset of burnout.

• Invest in your close relationships – with yourspouse, children and friends – by makingthe time spent with loved ones positive andenjoyable.

• Develop informal social relationships withpeople at workplace, deliberately avoidingnegative minded people.

• Connect with a cause or a community groupwhich is personally meaningful to you.

• Learn and practice healthy communication.Since burnout involves negative feelings thatfester and grow, express your emotions inhealthy and productive ways.

Avoiding Burnout

••••• Understanding where pressure comes from- by deliberately developing the practice ofself awareness. If need be, maintain astress diary for some time to pinpoint thestressor.

••••• Too much to do, too little time… the onlyway out is to practice effective timemanagement techniques and delegation.Learn to say no in an assertive manner toavoid your commitments getting bigger andbigger.

••••• Political and people problems can best beavoided by striking a fine balance between


being reasonably open and available topeople one lives and works with anddistancing oneself from those who drainone’s emotional energy.

••••• Avoiding exhaustion by taking adequate restand sleep and practicing relaxationtechniques, even on the job, regularly.

••••• Finding a meaning in the job. The best wayto do this is by thinking about the people oneserves. If you burn out, how will they getthe benefit of your energy and enthusiasm?

Burnout: As a Tool for Personal Growth

Understanding Why You Burned Out

This can be done by taking a deliberate, long,rational and dispassionate look at thecircumstances which lead to the situation ofburnout. This learning will help in avoiding therecurrence of those circumstances.

You may also take the help of someone you trustand talk the situation through in detail, looking atevery aspect which contributed to its creation inthe first place.

While reflecting, you will probably discover somemistakes that you made, but you may alsorealise these are excusable and there arelessons to be learnt from them.

Typical lessons to be learnt through this processare:

••••• no one is superhuman

••••• hard work does not cure all ills

••••• help and support of other people is equallyimportant for major achievements in life.

Moving on… finding new direction. It is essentialto re-evaluate one’s life goals. Let these goalsbe set in a balanced manner, after taking aholistic view of life. Do your personal SWOTAnalysis to evaluate where you stand vis-à-visyour goals. Thereafter, develop an action planand translate it into action to reap the rewardsof a more fulfilling life.

Finally, if it is one set of actions which push aperson towards burnout, it is another set ofactions which pull one out of it. Therefore, beaware of what actions are you taking.


INTRODUCTION

Values and ethics are central to anyorganisation. What exactly do we mean byvalues and ethics?

Both are extremely broad terms, and we needto focus in on the aspects most relevant forleaders and decision makers. First is thedistinctive nature of ethics for public officials,second the forces which influence ethicalbehaviour of individuals in an organisation andlastly the actions needed to build an ethicalclimate.

VALUES

Values are the moral, ethical and professionalattributes of character. Individuals decide theirown personal values and morals from which theyevolve a basic model of ethics for their interactionwith others.

Values can be defined as those things that areimportant to or valued by someone. In anorganisation they are an embodiment of what itstands for and are the basis for the behaviour ofits members. However, what if members do notshare or internalise the organisational values?Obviously, a disconnect between individual andorganisational values will be dysfunctional.Additionally, an organisation may publish one setof values perhaps in an effort to push forward apositive image, while the values that really guideorganisational behaviour are very different. Whenthere is a disconnect between individual andstated values, it may be difficult to determine

VALUES & ETHICS

� Values can be defined as those things that are important to or valued by someone.

� Organisational values are the embodiment of what an organisation stands for.

� A disconnect between individual values and organisational values will be dysfunctional.

� Ethics is defined as the rules or standards governing the conduct of a person, right/wrong: good/bad.

� Ethics are a subset of values. The principles or assumptions underpinning the wayindividuals or organisations ought to conduct themselves.

what is “acceptable.” Group members learnoperating values, or they don’t survive for long.To the extent that they differ from stated values,the organisation will not only suffer from doingthings less effectively, but also from the cynicismof its members.

ETHICS

Ethics are standards of right or wrong, good orbad. Ethics are concerned with what one oughtto do to fulfil one’s moral duty.

EVOLVING A PERSONAL CODE OF ETHICS

There are two aspects to ethics:

� Being able to determine what is right orwrong, good or bad.

� Committing to doing what is right and good.

The latter aspect means that being ethical ismore than understanding what the right thing isto do; it means that one must do ethical actions– one must “walk the talk”. Just becausesomething is desirable, it does not mean it isethical. Using only a personal value system toguide behaviour is not sufficient. Being ethicalrequires that decisions are based on ethicalstandards as well as being guided by one’svalues.

The influence of family, church, community andschool determines individual values. Theorganisation is thus, to a large extent, dealingwith individuals whose value base has beenestablished.


There are three qualities individuals mustpossess to make ethical decisions. The first isthe ability to recognise ethical issues and toreason through the ethical consequences ofdecisions. The second is deciding what is rightin a particular set of circumstances. This issimilar to the ability to reframe. The third is theability to deal with ambiguity and uncertainty;making a decision on the best informationavailable.

The ethical standards that one observes in theorganisation will have a significant effect onindividual behaviour. People will do what they arerewarded for doing. People are guided by theirpersonal value systems. They often “choose theharder right instead of the easier wrong”specifically because of their intrinsic value ofwhat is right.

ETHICAL DILEMMAS AND CHALLENGES

We all believe that we are ethical people. In fact,each of us believes we are more ethical thanmost people. However it is not possible foreveryone to be more ethical than everyone else.So, even though we may have the best intentionsin the world, even the most conscientious peoplerationalize their behaviour. And, there are timeswhen making a decision that incorporates someethical values may violate others. A few commonchallenges and dilemmas are:

� It is for a good cause.

� The end justifies the means.

� Multiple loyalties.

� Concealment.

Four questions to ask yourself, to help determineethical behaviour, ask:

1. Am I doing to others what I would want doneto me?

2. Would I mind seeing what I am doing onthe front page of a newspaper?

3. Am I comfortable with members of myfamily knowing what I am doing?

4. Do I want to encourage employees to dothis?

Therefore, individuals have to think about theirpersonal values and morals, from which theycan evolve a basic model or code of ethics fortheir interactions with others in their circle ofinfluence.

The first step starts in becoming self aware aboutone’s actions, the intended and actual outcomeof those actions. It is important to observe howthese outcomes affect others and what theeffective results of those actions are.

CONCLUSION

Developing a personal code of ethics andaligning it to the organisation will lead to commongood and integration into the interest of all.


CORPORATE GOVERNANCE

� Corporate Governance (CG) means monitoring the functions of a company toensure enhancement of shareholders’ value through ethical conduct of business.

� CG aims to provide positive effect on all stakeholders such as customers,employees, suppliers, regulatory bodies and community at large.

� Essential elements of CG: Adequate disclosure, distribution of power; supervisionand audit of executive functions and performance; expertise of the Board.

� Birla Committee recommendations provide institutional framework for CG.

Good governance is an essential element forany organisation that wishes to maximise itseffectiveness. This is true in all the private/publicsector commercial and noncommercialorganisations, not-for-profit organisations, andthe economies representing different states. Theareas of discontent in corporate managementcluster around the following:

� Low ethical and professional standardsleading to poor performance and a loss ofvalue in the various organisations.

� Double standards allowing practice to differfrom stated ideals.

� Failure of commercial organisations as aresult of inadequate controls orunsatisfactory checks and balances.

Corporate Governance: Some Definitions

� Corporate Governance means doingeverything better; to improve relationsbetween companies and theirshareholders; to improve the quality ofoutside directors; to encourage people tothink longer term; to ensure that informationneeds of all stakeholders are met; to ensurethat executive management is monitoredproperly in the interests of shareholders,such as through audit and othercommittees, and so on.

� Corporate Governance is nothing but thetraditional responsibility the corporate

managers and their Board of Directors havein enhancing the shareholder value thuscontributing for the greater image of thecompany by following the moral code ofconduct.

Why Corporate Governance?

Liberalisation, privatisation and globalisation ofeconomies followed by the establishment ofWorld Trade Organisation (the WTOAgreement) to which India is a signatory, usheredin a new era of global economic cooperation,reflecting the widespread desire to operate in afairer and more open multilateral trading system.The implication of this WTO Agreement fordeveloping countries is removal of tariff and non-tariff barriers to improve market access forpartner countries signifying that protectionismhas become a thing of the past. Though differentconcessions, relating to time frame and tariff/non-tariff barriers, have been given to developingcountries like India, it is a fact that India will beable to gain from the global free-trade, markedby reduced barriers, only when the Indiancorporates learn to govern and manage theirfinancial and non-financial affairs more efficiently.With these liberalisation/globalisation measures,facilitating increased flow of foreign directinvestment in different sectors of the economy,Indian corporates would not be able to avoid therigours of international regulation and many ofthe best business practices prevalent indeveloped countries.


Good corporate governance enhances theimage/reputation of the corporation and helpsit, as a user of the capital, to build long-termrelationship with the suppliers of capital. Withthe transnationalisation of financial markets, itis used as a marketing tool to tap internationalcapital markets to raise required capital at lowestpossible cost.

Cadbury Committee Recommendations

� There should be a clearly accepted divisionof responsibilities at the head of a companywhich will ensure balance of power andauthority, such that no one individual hasunfettered powers of decision.

� A Director’s term of office should run for nomore than three years without shareholders'approval for reappointment.

� The Board should monitor the ExecutiveManagement.

� Where the Chairman is also the CEO, thereshould be a strong independent element onthe board with an independent leader.

� Non-Executive Directors of the Board shouldsignificantly influence Board decisions.

� Directors should have access toindependent professional advice at theCompany’s expense.

� There should be an Audit Committee inevery organisation. The terms of referenceof the audit committee should inter-aliainclude the following:

▲ review the draft annual accounts priorto their approval by the board

▲ review the compliance with statutoryand stock exchange requirements forfinancial reporting

▲ discuss the scope of the audit with theexternal audit

▲ discuss the matters arising from theaudit with the external auditors

In India, SEBI has prescribed that the mandatoryrecommendations of Kumar Mangalam BirlaCommittee be complied with by listedcompanies.

PROCESS OF CORPORATE GOVERNANCE

� Improving the relationship betweencompanies and their shareholder and otherstakeholders (including banks, etc.)

� Improving the quality of outside (Nonexecutive) directors.

� To encourage the people to think long-term.

� To enable markets to value the sharesproperly by improving the quantity, qualityand frequency of financial and managerialdisclosure.

� To improve the monitoring mechanism(inside the company) by improving thequality of information that managementsshare with their boards.

� maintaining excellent relationship withcustomers and suppliers.

� Improving compliance with applicable legaland regulatory requirements.

� Consideration and care for the interest ofthe employees and local community.

Corporate Governance in Banking Sector

Basel Committee Publication (Sep 1999)

In the opinion of the Committee there are fourimportant forms of oversight that should beincluded in the organisational structure of anybank in order to ensure appropriate checks andbalances: (1) Oversight by the board of directorsor supervisory board; (2) Oversight by individualsnot involved in the day-to-day running of thevarious business areas; (3) Direct linesupervision of different business areas; and (4)


Independent risk management and auditfunctions.

As regards the role of the Board, the Committeesets out the following:

� Establishing strategic objectives and a setof corporate values that are communicatedthroughout the banking organisation.

� Setting and enforcing clear lines ofresponsibility and accountability throughoutthe organisation.

� Ensuring that board members are qualifiedfor their positions, have a clearunderstanding of their role in corporategovernance and are not subject to undueinfluence from management or outsideconcerns.

� Ensuring that there is appropriate oversightby senior management.

� Effectively utilizing the work conducted byinternal and external auditors, in recognitionof the important control functions theyprovide.

� Ensuring that compensation approachesare consistent with the bank’s ethical values,objectives, strategy and controlenvironment.

� Conducting corporate governance in atransparent manner.

� Ensuring an environment supportive ofsound corporate governance.

Developments in the last 3 years

Task Force set up by Department ofCompany Affairs and CRISIL rating

The task force of the Study Group set up by theDepartment of Company Affairs in May 2000suggested setting up of a centre for corporateexcellence in order to promote good corporategovernance. CRISIL has volunteered to rate thecorporate governance of companies, eventhough the rated companies can choose todisclose it or not.

Narayana Murthy Committee Report onCorporate Governance (appointed by SEBI)

The Committee submitted its report in Mar 04.

Some of the recommendations made by theNarayana Murthy Committee are:

� Whistle Blower Policy: Personnel whocome to know about unethical or improperpractices should be able to approach thecompany’s audit committee ‘withoutnecessarily informing their supervisors’.Whistle blowers should be protected from‘unfair termination and other unfairprejudicial practices.’

� Corporates should take steps to see thatthe right of access to audit committees iscommunicated to all employees throughinternal circulars.

� The audit committee members should benon-executive directors.

� The management should give their viewsand auditor’s comment on managementviews regarding contingent liabilities shouldbe given in the annual report

� Regarding reports of security analysts, theSEBI should make rules for ‘disclosurewhether the company that is being writtenabout is a client of the analyst’s employeror an associate of the analyst’s employer,and the nature of services rendered to suchcompany, if any and also whether theanalyst employer hold or intend to hold anydebt/equity of the issuer company.

Ganguly Committee Recommendations

Report of the consultative group of Directors ofBanks/Financial Institutions set up by RBI underthe Chairmanship of Dr.A.S.Ganguly submittedin Apr 02 made 31 recommendations. Some ofthe key recommendations relate to carrying outdue diligence of directors, creating a pool oftalented and professional persons for inductionas non-executive directors, qualification andexpertise of Board, separation of the office ofChairman and M.D, periodical and rigorousreview of performance by the Board, setting upof Supervisory Committee of the Board andexpansion of eligibility of Chairman of Audit


Committee to include specialization in Bankingand Finance.

Naresh Chandra CommitteeRecommendations

The Enron and Anderson debacle resulted in theenactment of Sarbanes-Oxley Act, 2002 in U.S.The Act besides providing for setting up of aPublic Company Accounting Oversight Boardcontains rigorous provisions for regulating therelationship between a Company and the Auditfirms. The Act provides for penalty ofimprisonment up to 5 years for CEO and CFOfor violation of Security Exchange Act.Consequent to this, Department of CompanyAffairs set up a committee in Aug 2002 underthe Chairmanship of Shri Naresh Chandra. TheCommittee made a number ofrecommendations relating to company-auditfirm relationship, certification of accounts byCEO and CFO etc. Some of the keyrecommendations of the Committee aredisqualification for audit assignments, list ofprohibited non-audit services, compulsoryrotation of audit partners, disclosure ofcontingent liabilities, consultation of auditcommittee for appointment of auditors,certification of statements by CEO and CFO,proposal for setting up of Corporate SeriousFraud Office in Department of Company Affairs(Cabinet has since approved the same), settingup of independent quality review Board,minimum board size, disclosure of timing andduration of Board meeting, provision of teleconferencing and video conferencing of theBoard, indemnity for non-executive directors andprovision of training for Board members

Corporate Governance in State Bank ofIndia

� The Bank has articulated its corporategovernance objectives, which are disclosedin the Annual Report.

� The Central Board has constituted eightCommittees of Directors, viz., (1) ExecutiveCommittee, (2) Audit Committee, (3)Shareholders'/Investors' GrievanceCommittee, (4) Risk ManagementCommittee, (5) Special Committee forMonitoring of Large Value Frauds (Rs.1crore and above), (6) Customer ServiceCommittee, (7) Technology Committee and(8) Committee on Rural Sector Business.

� Board of Directors meet regularly and thedate and attendance of the meeting arepublished in the Annual Report.

� The Bank has a well documented andtransparent management process.

� Board has free access to all needed andrelevant information.

� The Bank communicates its financialperformance to the public throughpublication of quarterly, and half yearlyresults.

Conclusion

In sum, Corporate Governance aims to maintaina high level of business ethics and to optimizethe value for all stakeholders. CorporateGovernance facilitates effective managementand control of business. Corporate Governancehas become a corporate business imperative.Since banks deal with public money, properimplementation of corporate governancepractices in banks would safeguard depositors’interest while ensuring better returns forstakeholders.


BALANCED SCORE CARD

� Developed by Dr Robert Kaplan and David Norton of Harvard Business School.

� It is a performance measurement and monitoring tool.

� Through measurement monitors, it attempts to link the vision, mission and valuesof the organisation for application by employees.

� Four perspectives namely business process, customer, financial and learning.

� It helps to promote goal-oriented behaviour.

Background

Balanced Scorecard (BSC) is a managementdecision tool for performance measurement andmanagement. Traditional perfomancemeasurement tools such as financial reports,sales reports, production reports, customersurvey reports, etc., measure performance onmultiple dimensions and hence are not balancedin providing better view of performance. A newapproach to strategic management wasdeveloped in the early 1990’s by Drs. RobertKaplan (Harvard Business School) and DavidNorton. They named this system as the‘balanced scorecard’. Recognizing some of theweaknesses and vagueness of previousmanagement approaches, the balancedscorecard approach provides a clearprescription as to what companies shouldmeasure in order to ‘balance’ the financialperspective.

The balanced scorecard is a managementsystem (not only a measurement system) thatenables organizations to clarify their vision andstrategy and translate them into action. Itprovides feedback around both the internalbusiness processes and external outcomes inorder to continuously improve strategicperformance and results. When fully deployed,the balanced scorecard transforms strategicplanning from an academic exercise into thenerve centre of an enterprise.

The balanced scorecard suggests that we viewthe organization from four perspectives, and todevelop metrics, collect data and analyze it

relative to each of these perspectives:� The Learning and Growth Perspective� The Business Process Perspective� The Customer Perspective� The Financial Perspective

What is Balanced Scorecard?

Performance Management is the use ofperformance measurement information to effectpositive change in organisational culture,systems and processes, by helping to setagreed upon performance goals, allocating andprioritizing resources and informing managersto either confirm or change current policy orprogramme directions to meet those goals, andsharing the results of performance in pursuingthose goals.

The Balanced Score Card is a set of financialand non-financial measures relating to anorganization’s critical success factors. It helpsmanagement make right and fast decisions onwhat to improve and celebrate.

Strategic Perspective of BalancedScorecard

To put it differently, the BSC is a conceptualframework for translating an organisation’s visioninto a set of performance indicators among thefour perspectives namely the Financial,Customer, Internal Business Processes andLearning and Growth as mentioned above.

After a company has articulated its Vision,Mission and Strategy, it has to raise the followingquestions on the four perspectives:

� Customer: To achieve our vision how


should we be seen by our customers?

� Financial: To succeed financially what kindsof financial performance should we provideto our investors.

� Internal Business Processes: To satisfycustomers where and how should we excelin our processes?

� Learning and Growth: To achieve our vision,how will we sustain our ability to change andgrow?

On each perspective, the organisation has toset objectives, measures, targets and initiativesso as to achieve its stated vision and mission.Measures are important to align employeebehaviour with mission, strategy and values.Measures would promote right behaviour andserve to numerically define the meaning of‘Success’.

To understand it better, let us look at one of ourmission statements: “Committed to excellencein customer satisfaction”. Let us also look at oneof our values: “Excellence in customer service”.According to BSC, we have to further define whatexcellence in customer service means throughselect objectives and measures which wouldindicate our definition of excellence; and givetargets (benchmarks) to various functionariesto achieve them. For example, the followingmeasures may be set for excellence incustomer service:

� Customer satisfaction rate of ‘Excellent’ inat least 90% of the cases. This can beobtained through customer feedback.

� Processing of credit products within the setTurnaround Time (TAT). For example,delivering housing loans in ‘7’ days. Themeasures should be set, communicated,monitored and improved. The processesshould be tuned to meet this standard.

� Customer grievance redressal in ‘4’ days.

These measures must be communicated to thestakeholders. We then have to track progressby seeing the action of each stakeholder andinitiate suitable corrective action to reach the

desired outcome.

In the absence of measurable targets, visionstatements remain as show pieces withoutdirecting appropriate behaviour amongemployees. The authors of BSC suggest thatnormally one can have 4 to 5 measures undereach perspective so that the number ofmeasures does not exceed 20. Many Fortune100 companies have reportedly used BalancedScorecard with success.

Implementing a Balanced Scorecard

The following steps are essential for effectiveimplementation of Balanced Scorecard:� Make a commitment at all levels - especially

at the top level� Develop organisational goals� Offer training in improvement techniques� Establish a reward and recognition system

to foster performance improvements� Break down organisational barriers� Coordinate Headquarers and Branch

Responsibilities� Demonstrate a clear need for improvement� Make realistic initial attempts at

implementation� Integrate the Scorecard into the organization� Change the corporate culture� Institutionalise the process.

Conclusion

The Balanced Scorecard attempts to alignemployee behaviour with the organisation’svision, mission and values. It placesorganisation’s strategic vision at the centre ofthe performance assessment structure. It is aninstrument through which organisations cannurture goal-oriented behaviour andinstitutionalize performance culture throughmeasurement matrix. We find in mostorganisations Vision, Mission and Values areneither known to most employees norunderstood. The BSC is a wonderful tool not onlyto effectively communicate the strategy of theorganisation to all its people but also to achieveexcellent results by focusing their energiestowards the ultimate goal of the organisation.


“Managers are people who do things right,while leaders are people who do rightthings.”—Warren Bennis. On becoming aleader.

Leadership has been defined as “a process ofinfluencing the activities of an individual or agroup in efforts towards accomplishingorganizational goals.” Influencing has beendefined as the ability of the leader to makefollowers do, willingly or on their own, what hewants them to do; and the measure of successof a leader is the extent of willingness he cangenerate in the followers.

In today’s world characterized by radical change,mergers, acquisitions, downsizing, businessprocess re-engineering, customer focus, etc.,the business leader must balance thetremendous demands of managing the changecomplexity with performance and productivity.High performance team is the key word today.

Management in the 21st century will focus onthe value based theory of transformationalleadership, rather than behaviour based conceptof transactional leadership. Successfulleadership depends far more on the followers’perception of the leader than on the leader’sabilities. In other words, leadership is in the eyeof the followers.

TRANSACTIONAL LEADERSHIP

The concept of transactional leadership is basedon the followers carrying out what they have“transacted” to do with the leader. These leaders

TRANSFORMATIONAL LEADERSHIP

motivate followers either by promises, praise andrewards or by threat and disciplinary action. Theleadership style is characterized by directions,close control. The focus is on outcome andbehavioural compliance only. Negativefeedbacks are used as a tool for correcting thefollowers. The inner state of feeling and thinkingof a follower is not a matter of concern. Theytreat the followers as mere means to achievetheir self-satisfying needs.

TRANSFORMATIONAL LEADERSHIP

Transformational leadership, on the other hand,is defined in terms of the ability of a leader toinfluence the values, attitudes, beliefs andbehaviours of others by working with and throughthem in order to accomplish the organisation’smission and goal. (Rouche, Baker, and Rose,1989)

Transformational leaders foster model values ofhonesty, loyalty, and fairness and end values ofjustice, equality and human rights.Transformational leadership aims attransforming people.

CHARACTERISTICS OFTRANSFORMATIONAL LEADERS

The following six characteristics are likely to bepresent in the transformational leaders:

1. VISIONARY

Transformational leaders have a great visionabout their organization and the road map to

� Leadership is the ability to make followers do he wants them to do, willingly or on theirown, towards accomplishing an organizational goal.

� Transactional leadership is based on the leader and the followers having “transacted” todo it characterized by close direction, control and follow-up. The focus is on behaviouralcompliance and outcome. The inner state of thinking and feeling are not matters of concern.

� Transformational leadership aims at transforming people by working with and throughthem on their values, beliefs, attitudes and behaviour. It aims at emotionally connectingthe followers to the vision of the leader so that they are galvanized to achieve the vision.


attain it. They have the great communicationability to communicate and emotionally connectthe followers to the vision; the followers aregalvanized to achieve it.

2. INSPIRATIONAL

Transformational leaders are charismatic, whoare able to obtain the devotion of the followersby sheer personality. These leaders are ethical,listen carefully to followers, provide support, areflexible, do not make fun of opinions of othersand are open to criticism. They will be rolemodels and have great influence on professionaland personal development of the followers.

3. THOUGHTFUL

Transformational leaders encourage theirfollowers to provide innovative solutions and newideas for achieving their vision. They encouragepositive thinking and creative problem solving.When things go wrong, they focus on ‘what’ and‘why’ of the problem rather than on ‘who’ to putthe blame on.

4. CONSIDERATE

Transformational leaders treat every individualas a distinct and significant human being. Theyhave positive regard for every follower, and listento their problems with empathy. They takeinterest in the development of each individual.

5. TRUSTWORTHY

Transformational leaders enjoy the trust of theirfollowers by being value based and maintaininghigh standards of personal credibility. They areethical in their dealings, keep theircommitments. They also trust their followers.They have no difficulty in delegating decision-making.

6. CONFIDENT

Transformational leaders always maintain apositive self-concept and exhibit self-confidenceand optimism. They also repose confidence intheir followers. They treat their followers withdignity and respect. They accept issue baseddifferences of opinion.


LEARNING ORGANIZATION

� A learning organisation is one which is skilled in creating, acquiring and transferringknowledge and changing its behaviour to reflect new knowledge and insights.

� Learning provides competitive advantage and helps in organisational transformation.

� Some of the characteristics include openness, encouragement for creative ideas,sharing and constant change.

Introduction

In a competitive environment, the market placeis characterized by moves and counter-movesthereby moving beyond the traditional businessethics. The organization needs to unlearn manyof the business practices and stategies whichhave out-lived their utility and redefine itsbusiness, rediscover the markets, realign itsattitudes that foster customer delight. In orderto meet such a growing internationalcompetition, it is imperative for all organizations- irrespective of their activity - to reposition theircompetitive edge by reorienting their businessgoals, strategies and their managementpractices.

This emerging economic and business ordercalls for a new approach on the part of theorganizations to transform themselves into atreasure of newer skills, knowledge and abilitieswhich can translate the emerging competitioninto business advantage by discovering newproducts and services meeting the ever-changing customer demands and preferences.Besides, the sudden breakthrough in theInformation Technology and BusinessCommunication renders the traditional skills andknowledge redundant, thereby making evensome of the high-profile academic literatesvirtually computer illiterates. As human beingsstrive to exist in the organization, for their verysurvival even in the midst of turbulence, there isevery need for them to acquire new skills,knowledge and attitudes lest the system itselfwill make them redundant. This is possible onlywhen there exists a collective and continuoussystem for effective learning in the organizations

with the avowed objective of transforming thetraditional organizations into 'LearningOrganizations'.

Concept of 'Learning': An Overview

It is the ability to assimilate new ideas fromothers and past experiences and to translatethose ideas into action faster than a competitorcan. 'Learning' can be viewed as changes tothe structure of the living system that allows itto continue to respond to environmentalperturbations.

Every human being is capable of learning butthe methodology used for learning and also theskills, knowledge and attitudes of both the partiesto the process, i.e., the learner and the trainer,do play a vital role in achieving the objectives oflearning. Learning is a continuous interactionbetween the individual and the particular socialenvironment in which he or she functions.Learning is more effective when one sheds one'shalf-knowledge, prejudices, bias, likes anddislikes and when one abandons the 'I know'attitude and adopts the 'I want to know' approach.

'Learning Organizations': Concept,Definition and Features

'Organizational Learning' is a process ofcontinuously redefining people's beliefs andperceptions about how things work. In a dynamicenvironment, it is important for organizations tocontinuously learn and adapt, organizationswhich discover how to tap people's commitmentand capability to learn at all levels, will onlybecome truly successful and excel in future. Inother words, the traditional organizations need


to transform themselves into a new breed oforganizations which are called as 'LearningOrganizations'.

A 'Learning Organization' is an organizationwhich is not only skilled in creating, acquiringand transferring knowledge but also at modifyingbehaviour to reflect new knowledge and insights.It is a holy place where all people working with it- irrespective of their positions and cadre - willcollectively and continuously learn theknowledge and skills for mutual benefit ofthemselves and the organization. LearningOrganization practises how to learn in an on-going way - the periodic surfacing andexamination of why and how work isaccomplished. This enables the organization,not only to acquire skilled people and skilledprocesses but also to acquire learnedexperience which enhances the adaptability andprobability of success, particularly in turbulentand uncertain conditions.

The core competence of any organization isnothing but the quantum of individual andcollective learning and the value addition itcreates in the organization. The LearningOrganizations are the complex economicinstitutions in which thinking, learning andknowledge creation takes place and creativeideas are constantly generated so as to permitorganizational transformation.

The chief characteristics of 'LearningOrganizations' can be listed out as under :

It is a place where high quality human learninggoes on on a continuous basis.

The objective to transform is to learn and growand change, as opposed to the traditionalbureaucratic models of organizational structure.

It is a place where the capacity to be creativeand innovative is continuously expanding.

It endeavours to unlearn old and obsoleteknowledge and to acquire new knowledge andenhance the existing knowledge.

It creates open and frank communicationchannels - vertical, horizontal and cross-sectional - interdepartmentally andinterpersonally.

It is a place where the human beings areencouraged to unveil their creative ideas andknowledge for its competitive advantage.

It disseminates learning and shares knowledgeand vision throughout the organization.

It keeps the company in a state of constantchange.

The ultimate objective of the LearningOrganization is to develop core competenciesfor forging ahead with the change of times.

Organizational excellence can be achievedthrough the holistic well-being of employees, asthe 'people in the organization are the key factorsfor transforming the organization as a 'LearningOrganization'. The organizations are incrasinglyrealizing that their stategic and competitiveadvantage lies mostly in leveraging knowledgeand working with empowered multifunctionalteams. In order to achieve this holistic purpose,the organizations have been adopting modernmethods like Constant Learning,Empowerment, Benchmarking, CustomerRelationship Management (CRM), EmployeeCare and Welfare, Economic Value Added(EVA), i.e., Return on Investment (ROI)Concepts, Retention of Creative Talents andTotal Quality Management (TQM).

Essential Pre-requisites for 'OrganizationalLearning'

Effective organizational learning aims to improvegroup performance, expand communicationfocus on creating learning values and motivationand creating and nurturing a culture ofcontinuous improvement. Extensive usage ofInformation Technology and adopting systemsapproach to problem - solving are the essentialtools for improving these processes in theorganization.


There are certain essential prerequisites formaking organizational learning more effective.They are :

The organizational learning should be a part ofthe corporate vision and mission and thereshould be a genuine commitment to this conceptfrom the top management.

The organization should develop a culture andpolicies that continually support learningbehaviours.

The modus operandi being evolved fororganizational learning should be compatible withthe culture, philosophy and ethos of theconcerned organization.

Appropriate time should be spent by theorganization in reorienting behaviour towards aneffective learning culture and as such the wholeconcept of time expenditure requires radicalchange.

The quality and efforts of organizationalmembers should be par excellent and themistakes and failures should be viewed aslearning opportunities and stepping stones forsuccess.

The organizational structure, work processes,decision-making tree, reporting relationships,communication channels, control systems andleadership styles, etc., should be supportive andeffective enough for nurturing a learningexperience among the people in theorganization.

There should be effective control, monitoring andprompt feedback systems to assess theeffectiveness of the organizational learning and

also to take immediate and prompt correctiveaction, wherever needed.

Organization should develop an effectivesystem for constant scanning of external as wellas internal environment so as to bring requiredresilience into the learning methods andstrategies.

There should be a proper system formaintenance of constructive relationshipsamong all stakeholders in the organization.

The organization should adopt an attiude ofopenness and bias towards change; never beingsatisfied with the status quo and alwayssearching for ways to do better.

The learning costs should be viewed as potentialinvestments in the endeavour to achieve topclass tangible performance at all levels.

In view of the imperative need for collectivelearning, organizations have been adoptinglearning as one of their fundamental values. Theexisting learning systems are constantlyreviewed and the training endeavour is beingrevitalized into initiatives for changemanagement. The individual training needs areintegrated into the organizational needs and thetraining is being increasingly used to bridge thegap with the external world. The organizationalperformance and ultimate success heavily drawfrom the level of organizational learning, andlearning is the only significant mechanism forsubstantive positive change. In a knowledge-based economy, the rate at which organizationslearn and adapt may become the onlysustainable source of competitive advantage.


INTELLECTUAL CAPITAL

� Intellectual Capital is the product of commitment and competence. Both shouldexist in an employee for organizational effectiveness.

� Competence should align with business strategy.

� Competence can be built, bought and borrowed by organizations.

� Commitment can be fostered by articulating vision and sharing power andresources with the employees.

� Leaders should raise standards, set high expectations and demand moreperformance and provide corresponding resources to meet high demands.

In the ongoing debate about where managersshould focus their attention something has beenmissing: a focus on intellectual capital.Intellectual capital-the commitment andcompetence of workers- is embedded in howeach employee thinks about and does work andhow an organization creates policies andsystems to get work done.

First, intellectual capital is a firm’s onlyappreciable asset. Most other assets (building,plant, equipment as machinery, and so on) beginto depreciate the day they are acquired.Intellectual capital must grow if a firm is toprosper. A manager’s job is to make knowledgeproductive, to turn intellectual capital intocustomer value.

Second, knowledge of work is increasing, notdecreasing. As the service economy grows, theimportance of intellectual capital increases.Service generally comes from relationshipsfounded on the competence and commitmentof individuals.

Third, employees with the most intellectualcapital have essentially become volunteers,because the best employees are likely to findwork opportunities in a number of firms. Thisdoes not mean that employees work for free.Volunteers are committed because of theiremotional bond to a firm; they are less interestedin economic return than in the meaning of theirwork.

Fourth, many managers ignore or depreciateintellectual capital. In the aftermath ofdownsizing, increased global competition,customers’ higher requirements, fewer

management layers, increased obligations, andpressures exerted from almost every othermodern management practice, employees’work lives have not always changed for thebetter.

Fifth, employees with the most intellectualcapital are often the least appreciated.

Sixth, current investments in intellectual capitalare misfocused. Under the name “corporatecitizenship,” many senior executives talk aboutwork-family issues.

What is Intellectual Capital?

While many agree that intellectual capitalmatters, few can explicitly quantify it. A simple,yet measurable and useful definition would be:intellectual capital = competence x commitment.This equation suggests that with a unit,employees’ overall competence should rise butthat competence alone does not secureintellectual capital. Intellectual capital requiresboth competence and commitment. Becausethe equation multiplies rather than adds, a lowscore on either competence or commitmentsignificantly reduces.

Tools for Increasing Competence

There are two primary challenges in increasingcompetence: First, competencies must alignwith business strategy. Second, competenciesneed to be generated through more than onemechanism. There are five tools for increasingcompetence within a unit (firm, site, business,or plant): buy, build, borrow, bounce, and bind.Appropriately using all five ensure a stable flowof competence.


Buy: Managers can go outside the unit to replacecurrent talent with higher quality talent. Buyinginvolves staffing and selection from the entrylevel to the officer level.

Build: By building, managers invest in thecurrent workforce to make it stronger and better.A build strategy for intellectual capital workswhen senior managers ensure thatdevelopment is more than an academicexercise, when training is tied to business resultsnot theory, when action learning occurs, andwhen systemic learning from job experienceoccurs.

Borrow: In borrowing, managers invest inoutside vendors who bring in ideas, frameworks,and tools to make the organization stronger.Effectively used consultants or outsourcingpartners may share knowledge, create newknowledge, and design work in a way that peopletoo close to the work would not have done.However, appropriately used, borrowingcompetence is a viable way to secure intellectualcapital.

Bounce: Managers must remove thoseindividuals who fail to perform to standard. A firmshould systematically and courageously removethe bottom percentiles in performance.Managers must make difficult personneldecisions decisively.

Bind: Retaining employees is critical at all levels.Keeping senior managers who have vision,direction, and competence is important, andretaining technical, operational, and hourlyworkers also matters because investment madein individual talent often take years to pay back.

How to Foster CommitmentA company can foster commitment in threeways. First, it can reduce demands. Second, itcan increase resources. Third, it can turndemands into resources.Reduce Demands: Employees have manydemands of varying importance. Helping themseparate legitimate from groundless demandsand then removing the unnecessary ones maybalance their lives. Even with priority setting,focusing, and reengineering, demands onemployees will continue to increase. Regardless

of how many demands are removed or reduced,competition continues.

Increase Resources: Not all demands can bereduced. Business demands accompany afirm’s desire to compete in tough markets.Walking away from competition would, in manycases, equate to failure. Demands will inevitablybe high in globally competitive firms. Resourcesrepresent the values, practices, and actions thecompany takes to respond to demands. Certainresources may counterbalance demands.

In sharing power and giving up control,managers implicitly trust that their employeeshave the skills and motivation to do a good job.Having control demonstrates trust and buildsemployees commitment. Managers may usecontrol as a resource by creatively and flexiblyanswering: where is work done? How is workdone? What work is done? When is work done?Who does what work? As long as employeesunderstand and are committed to the goals, theycan share the way goals are accomplished.

Employees commitment often comes from aleader who shares a clear vision thatpassionately communicates agenda and intent.Many executives articulate visions or directionsthat give employees resources and add to theirresolve to cope with increased demand.

Companies are learning that sharing theeconomic gains of reaching targets helpsemployees stay motivated to reach increasinglydifficult goals. When employees see that aparticularly demanding project results ineconomic payback, they are likely to be morecommitted. When the line of sight between workand reward is clear, employees may cope betterwith increased demands.

Intellectual capital comes from employees’competence and commitment. Both must existtogether for intellectual capital to grow. Leadersinterested in investing, leveraging, and expandingintellectual capital should raise standards, sethigh expectations, and demand more ofemployees. They must also provide resourcesto help employees meet high demands.Employees will become engaged and flourish,and the organization’s intellectual capital willbecome its defining asset.


KNOWLEDGE MANAGEMENT

� HRM needs to develop Knowledge Management System due to changing customertrends, competitive products and services and changing society.

� The Collective knowledge of the employees gives distinct competitive advantage.

� The integrated system of KMS should value collection of knowledge, react quickly tomarket changes and facilitate faster decisions.

� Banks should specifically focus on finding, creating, sharing and applying knowledgethat it is relevant to its business.

The importance of knowledge for achievingcompetitive success has been recognized in theearly 1990s, but it is only recently that the formalsystem for managing the acquisitions and theuse of knowledge has begun to emerge, oftencreated on the back of new informationtechnology applications and systems. Bankingtoday is more competitive and technology drivenwhere human capital can play a pivotal role indetermining the worth of the institution. Theorganizational structure of the banks is graduallychanging and in keeping with the global trend,most banks are focusing on the implementationof core banking solution where the branchnetwork should be downsized but the deliverysystem will be more dependent on technology.The rapid pace with which the changes are takingplace in the banking industry is phenomenal. Inorder to keep pace with the changes, it isessential that the Human ResourceDevelopment (HRD) in the banks develop theKnowledge Management System (KMS) withinthe organization so that maximum benefitaccrues to the organization. From a businessstrategic perspective, changing customertrends, competitive products and services andchanging societal and governmental pressuresmake the existing business models, businesspractices and business value propositionsobsolete. Banks that can figure out the ‘next rightthing’ and prepare well in advance to ride the nextwave will be more effective in the longer run. Allthe information, technology and database cannotassure bank’s competitive advantage in the long-term unless the same are translated intoactionable value propositions. Banks have to

keep in mind that the only long-term competitiveadvantage they can have is how effectively tomanage the corporate knowledge.

Role of KMS in Banking

It may be noted that most of the new generationprivate sector banks and foreign banks havecreated sophisticated database of clients andhave been able to utilize the knowledge base oftheir staff member with the aid of IT, to improvethe productivity to a higher level. Interestingly,talent drawn from the public sector banks ismanaging most of the new generation privatesector banks. It is interesting to note that thereis a phenomenal gap between employeeproductivity of the PSU banks and that of the newgeneration private sector banks. The strengthof any bank is reflected by the collectiveknowledge of its employees. It is a source ofsustainable competitive advantage, as the samecannot be copied by other banks. In a serviceorganization like banks, KMS is very importantas the end products are to be delivered to theclient in multiple bases.

KMS - Experience of Leading Corporates

Leading corporates across the world areinvesting in millions to stay ahead of theircompetitors in terms of competitiveness andtechnology. They institutionalize the people inteams through formal/informal structures forthem to effectively share the knowledge. Thecompanies have created a group ofcommunicators that comprise a team of peoplewho are practitioners of a well-defined knowledge


domain. As and when the need arises, thecorporates can take advantage of the databaseof knowledge for enhancing the value of theshareholders.

New Delivery Channels and KMS

With the advent of Internet, a new potentialdelivery channel is being opened to clients wherebanks should take maximum advantage ofknowledge management structure that willenable them to interact with the clients in a moreproductive way. More and more time and energycan now be spared by the employees for thegrowth of the organization rather than to attendto routine customer transactions. No doubt, thecustomers need to be educated in the use ofthe innovative products that may demand someextra attention at the initial stages but in the longrun the benefits to the banks outweigh thedisadvantages.

Integrated System of KMS

Banks can formulate an integrated process ofKnowledge Management of their organization byaddressing some critical issues as given below.Thye have to capture knowledge and informationfor effective sharing amongst their employees.

• Banks should recognize the value ofcollective knowledge base.

• Banks should ensure that the system reactsto the market changes fast.

• Banks should see that they should not sufferfrom any information overload.

• Banks’ core team should be in a position totake timely and accurate decision.

• Banks should try to find synergy between theapplication of IT and KnowledgeManagement System.

• Banks can be protected against theknowledge degradation that results in losses,employee defections, and the inaccessibilityof experts at the right place.

• The speed of doing business can beaccelerated through the availability of the

organization’s implicit knowledge base.Implicit knowledge is the kind of knowledgethat is presumed to be possessed by highlyskilled individuals who are capable ofperformances that mystify others.

• Banks should significantly increase thetangible assets of organizations.

• Banks can create new opportunities typicallyresulting from the ability to create implicitknowledge base.

Every bank’s knowledge base depends on thequality of the people in terms of education andskills, the software and hardware it uses in thebusiness process and the process of storageof data for future use. The function of HRD is toensure that this base is fine-tuned in the light ofchanging banking environment at regularintervals. There should be a system where like-minded colleagues communicate with eachother regularly and try to innovate ways for betterproductivity of banks. A sort ofcompartmentalization can be made whereinevery group can follow a specific target like sayretail products marketing, IT development,streamlining of systems and procedures inbanks and recovery of NPA, etc. There shouldbe project driven groups in every bank that willfocus their attention on specific area where somedeficiency is noted in terms of competition withother banks or in terms of lacunae in the system.This group can be formed from the same branchof the bank or it can be a cluster group of staffmembers from the branches in the same citysituated at an approachable distance. Banksneed people who continuously strive to increaseknowledge. Incentives should be given to thegroup achieving superordinate performance.

KMS Effectiveness and Role of HR

Banks should focus on building capabilities,making sure they are shared across theorganization, and using those capabalities tocreate growth opportunities. The knowledgestrategy shows how the creation, disseminationand use of knowledge can create customer andshareholder value. In particular, it focuses on the


Human Resources (HR) management inenhancing an organization’s ability to respondto market forces and meeting businessobjectives. Recognizing the key link between thecapabilities of bank employees and its overallsuccess, the HR function has been transformedinto a ‘strategic capabilities unit’ for use of theindividual, the team and organizational learningwith the objective of serving the customer in abetter way. Here the role of HR is to create asuccessful database for the bank and take careto synchronize the function of education andknowledge that is documented in the corporatedatabase. The knowledge exchange connectsemployees and allows them to share information.In particular, a climate should be created by HRdepartment to ensure that employee’s skill andknowledge are kept up-to-date in topics likefinance and banking and in more general areasof management, technology and leadership. Itshould also facilitate the training and educationneeds of the organization by aligning HRdevelopment and learning strategies with overallstrategies of the bank. If need be, framework forthe knowledge management structure may beoutsourced which will take care of the growingneed of the bank in future years to come.

Employee Communications in KMS

Like any other corporate structure, bankingcompanies typically require a host of linkedknowledge management practices. Banksshould develop the valuable expertise in this areathrough a series of strategies. For example, themanagement should now be specificiallyconscious about finding, creating, sharing andapplying knowledge that is relevant to its manylines of business. KM forum should contributeto knowledge sharing by stimulatingcommunication between employees across theorganization. Most organizations recognize the

value of helping employees to communicate witheach other. The mission of KnowledgeManagement group is to facilitatecommunication across the bank by developingits IT infrastructure and building communities ofpractice, extended across the formalorganizational structure, to enable the bank towork more efficiently than if it were formed alongtraditional functional lines. Ultimately,communities of practice are seen as essentialto accommodate the rapid growth of the bank.Banks should encourage intranet to encouragetheir front-line staff to initiate contact withcustomers as well as with fellow colleagues.

Conclusion

The Knowledge Management is first seen as aintegral part of overall corporate strategy, andaims to grow, extract and exploit the bank’sknowledge to increase shareholders’ value.Secondly, it focuses on improving upon theknowledge necessary to carry specific businessprocesses and thereby improve efficiency. Thefuture of KM depends on the extent to which itcan make value addition to shareholders’ valueand managing the knowledge systematicallywhich is important for the welfare of theorganization. It will continue to matter as long asorganizations rely on the ability of their employeesto make good decisions. It also gives opportunityto the employees to make good decision and tocontinue to innovate for the benefit ofshareholder’s value. To get the optimum benefitof KMS, banks should make a methodicalapproach through the whole process of KM andthe same should be understood by peopleinvolved at all levels. Traditional managementlooks at technologies,systems and peopleseparately. Banks need to develop KMS, whichshould treat three of them as an integratedsystem with a people focus.


Information Technology Governance (ITgovernance) or Information and CommunicationTechnology (ICT governance) is a subsetdiscipline of corporate governance focused oninformation technology (IT) systems and theirperformance and risk management. The risinginterest in IT governance is partly due tocompliance initiatives such as the Sarbanes-Oxley Act and Basel II, as well as theacknowledgement that IT projects can easily getout of control and profoundly affect theperformance of an organisation. This is morerelevant for the financial sector, including thebanking sector, where the lack of IT governancemay even lead to catastrophic consequences.IT governance is ideally a sub-set of the broaderlevel of corporate governance.

A recurring theme of IT governance discussionsis that the IT capability can no longer be a blackbox. Owing to limited technical experience andIT complexity, key decisions in the traditionalhandling of IT management by board levelexecutives are deferred to IT professionals. ITgovernance implies a system in which allstakeholders, including the board, internalcustomers and related areas such as finance,provide the necessary input into the decision-making process. This prevents a singlestakeholder, typically IT, being blamed for poordecisions. It also prevents users from latercomplaining that the system does not behaveor perform as expected.

IT governance follows many models. While thereexist many supporting mechanisms developedto guide the implementation of IT governance,some of the more common ones are:

� The IT Infrastructure Library (ITIL), which isa detailed framework with hands-oninformation on how to achieve a successfulgovernance of IT.

� Control Objectives for Information andrelated Technology (COBIT) which is anapproach to standardize good information

IT GOVERNANCE

� IT governance is ideally a sub-set of the broader level of corporate governance.

� This is more relevant for the financial sector, including the banking sector, wherethe lack of IT governance may even lead to catastrophic consequences.

technology security and control practices.This is done by providing tools to assessand measure the performance of 34 ITprocesses of an organisation. The ITGI (ITGovernance Institute) is responsible forCOBIT.

� The ISO/IEC 27001 (ISO 27001) is a set ofbest practices for organisations to follow toimplement and maintain a securityprogramme. It started as the BritishStandard 7799 (BS7799), which waspublished in the United Kingdom andbecame a well-known standard in theindustry that was used to provide guidanceto organisations in the practice ofinformation security.

� The Information Security ManagementMaturity Model ISM3, which is a processbased ISM maturity model for security.

� AS8015-2005 - an Australian Standard forCorporate Governance of Information andCommunication Technology.

� CMM - The Capability Maturity Model whichlays focus on software engineering.

� The Balanced Scorecard (BSC) which is amethod to assess an organisation’sperformance in many different areas.

� Six Sigma which aims to focus on qualityassurance.

IT governance is, however, characterised by afew incumbent challenges as well. Themanifestation of IT governance objectivesthrough detailed process controls (for instance,in the context of project management) is afrequently controversial matter in large scale ITmanagement. Further, difficulties in achieving abalance between financial transparency andcost-effective data capture in IT financialmanagement (i.e., to enable chargeback) is atopic for which clear conclusions have not yetbeen arrived at.


As Managers rise higher and higher in anorganization, they are expected to develop newcompetencies, which enable them to performmore effectively. Technical skills, which mostmanagers acquire through work experience/training, are not enough to handle thecomplexities of higher roles in an organization.These must be supported by human skills, i.e.,how we manage/lead people in work settings.As managers become executives in anorganization, the technical component of theirrole gets reduced and human skills andconceptual skills assume an integral part of theirjob component. Again, the competenciesrequired for different roles may vary significantly.

The Assessment Centres identify the variouscritical attributes, functional expertise, aptitudesand skills that are required in our jobs, and makean assessment of the adequacy or otherwiseof the same through the use of variousstructured experiences and administration ofinstruments and in-basket exercises. Typically,this is a tool that devises an intensive laboratoryto run tests on candidates for promotion/orevaluating their training needs, etc., probing theirleadership qualities, prodding their ability toinnovate, palpating the managerial possibilitiesthat lurk within them.

A typical assessment center test may havegroup exercises as well as individual exercises.Competencies that are measured could be afew or all of the following:

1. Assessing the negotiating skills, ability topersuade and ability to compromise.

2. Assessing the ability to handle uncertainty,changing office environment and stress.

ASSESSMENT CENTRE

� Assesses the adequacy of various critical attributes, functional expertise, aptitudesand skills required in the job.

� Used for higher level executives.

� Some of the competencies assessed are leadership, teamwork, decision makingcapability, communication skills and market orientation.

3. Assessing the ability to lead/work in teamsand solve problems collectively

4. Assessing ability to plan, organize, decide,manage, and delegate

5. Assessing the decision making capabilityon scientific basis

6. Assessing communication skills, patienceand interpersonal skills

7. Assessing the market orientation

As against the above, certain criteria anddescriptors are selected, and processobservation is made by experts to find evidenceof particular behaviour / traits amongst theassessees. Just to give an example, thefollowing criteria and descriptors may be lookedfor (‘+’ means positive behaviour, ‘-‘ meansnegative behaviour in an assessee):

Criteria for Team Work Exercise

+ Presents idea sensitively to maintain harmonywith the group.

+ Builds bridges with others.

- Waits to be invited to draw out his/her ideas

+ Allows others to give their views

- Prefers working on his/her own

+ Cooperates effectively

- Presents ideas aggressively; dominates.

Criteria for Leadership

+ Acts as a focal point for the group’s ideas

- Shows little influence on the group working

+ Directs the group to achieve objectives

- Plays a passive role.

Apparently, today's executive is required to havemultiple skills beyond functional abilities tosucceed in Assessment centre.


COMPETENCY MAPPING

� Aims to match the competency of the employee with those of the job requirement.

� Competency is a combination of knowledge, skill, behaviour and personalcharacteristics.

� There are different tools including psychometric tests used to map competency.

� A formal implementation of the system will help organisations to save on costsand improve performance.

Competency and Performance

One of the major objectives of every companyis to improve its performance every year andset new standards and norms. For everyoperation and machine there is a human beingand it is the quality of the man behind the machineor the process which determines theperformance of the company. In view of this, theperformance of the company depends not onthe human assets but the human asset havingright match of competencies and their levels forperformance requirements. If the right match ofcompetencies is available with the employees,then it is their motivation, work environment andincentives which help them to give their bestperformance. Company can use goal setting,performance appraisal, incentives, careerplanning, and succession planning as measuresto further improve the performance of theemployees.

To select the employees with right match forperforming the job efficiently, companiesnormally recruit people based on qualificationsand conduct interview for final selection. But theeffectiveness of this technique in selecting theright people is not even 10%. Therefore, in orderto improve performance, the companies mustlook for better and more reliable techniques toidentify the right competencies among theemployees.

In view of this, some companies conductpsychometric tests so that they can identify the

competencies of the candidates for recruitmentand selection. The main purpose of such testsis to decide whether candidates possessknowledge, skills, attitude and ethics whichmatch with those that the company needs in thejob for which they are recruiting.

What is Competency?

Competency is underlying skills, personalcharacteristics, or motive demonstrated byvarious observable behaviours that contributeto outstanding performance in a job.Competencies exist at different levels ofpersonality. The various levels are:

� Knowledge: Information that an individualhas in a particular area.

� Skills: An individual’s ability to do somethingwell.

� Behaviour: Action of a person in a givensituation.

Personal Characteristics

� Traits: A typical way of behaving such astaking initiative.

� Motive: A fundamental and oftenunconscious driver of thoughts andbehaviour for example, concern forexcellence.

Personal characteristics, unlike knowledge andskills, are hard to develop and it is more cost-effective to select people having the desiredpersonality traits.


What is Competency Mapping?

Competency mapping involves thedetermination of the extent to which the variouscompetencies related do a job are possessedby the person. For example, the extent to whicha person is adjustable, resourceful, capable ofworking efficiently under stress, capable ofanticipating threats, finding solutions andcontributing in innovations. This is comparedwith the extent to which the variouscompetencies are required for a job. Thecomparison enables one to know the suitabilityof a person for a job. It is also useful for settingstandards and checking the employees standingon the various competencies’ platform and toidentify the training needs.

Competency Mapping and DevelopmentalNeeds

The competencies required for a job may beidentified by head of that functional departmentor a team which has core knowledge andexperience of that area. This team or head ofthe functional department tries to identify theskills, attitude, and behaviours required for thatjob. Competencies may be classified into fourdifferent areas: Behavioural, Technical,Emotional and Conceptual competencies.

� Behavioural competencies tell us the kindof behaviour one should have to perform aparticular job.

� Technical competencies relate to thetechniques required for performing aparticular job.

� Emotional competencies relate to theemotions like anxiety, jealousy, anger, fear,etc.

� Conceptual competencies relate to theinformation and concepts for performanceof the job.

HR department designs a performanceappraisal method to check what allcompetencies and to what extent are beingdisplayed by the employee during his job. Thena comparison is made between thecompetencies that head of the functionaldepartment was looking for and thecompetencies being displayed by the employeein that job. This provides us the missing links orgaps which can be bridged by training.

The degree to which these competencies arerequired also matter a lot. Some competencieswhich are extremely essential for a job can bestated as Core Competencies which relate tothe Key Responsibility Areas (KRA) and arerequired to a very high degree in an individual.

Just as every coin has two sides, everymethodology has certain merits and demerits.The drawback of this model is that thecompetencies required in a person performinga particular job are defined by the Head ofDepartment (HOD) who might have moreinclination towards some specificcompetencies.


INTRODUCTION

Every Organisation has its own distinct cultureand structure.

Culture has its origin in the organisationalinteraction. Culture pervades all therelationships in the organisation and influencesall its decisions.

Organisational Culture is the easiest thing tocomprehend and at the same time the mostdifficult thing to define. This is because of theaura of mystique that surrounds OrganisationalCulture.

DEFINITION

Organisation Culture refers to a system ofshared meaning held by members thatdistinguishes the organisation from otherorganisations. Organisation culture is the keyto much that happens (or does not happen).Organisation Culture is the fabric of meaning interms of which human beings interpret theirexperience and guide their action.

An organisation’s culture is also described as“the way we do things here”. It is a combinationof deeply felt values, beliefs and attitudes abouthow the work of the organisation ‘should’ bedone. Cultures are acquired during periods ofsuccess, and employees see the culture as thereason for that success. However, the realreasons for success are more likely to relate tothe organisation’s markets and the relevance ofits competencies

Organisation culture is akin to the DNA of ahuman organism, which is unique and specific.

ORGANISATION CULTURE

� Organisation culture refers to ‘the way we do things here”.

� It is the easiest thing to comprehend but most difficult to define.

� It is unique and distinct for every organisation.

� The Johnson and Scholes cultural web model contains six inter-related elements –rituals and routines, stories, organisation structure, symbols, power structures andcontrol systems.

There are certain characteristics that have madethe organisation what it is. Each organisation’sculture has its own strengths and weaknesses.

JOHNSON AND SCHOLES CULTURAL WEBMODEL

This model enables one to look into the elementsthat make an Organisation’s culture.The cultural web contains 6 inter-relatedelements:

1. Rituals and routines - are concerned withthe day-to-day behaviour of people in theorganisation, e.g., the way customers aredealt with or the existence of privileges forcertain staff. They are things that are takenfor granted by existing staff but have to belearned by new people. They often presentsignificant barriers to change, if people areprotective of their ‘customs’. Rituals suchas training programmes or personnelprocedures can reinforce the perception ofhow things are done, and demonstrate tostaff what behaviour is desirable and valuedby senior management

2. Stories - within the Organisation focus uponpast events in the organisation and are toldto people both outside and inside theorganisation. They communicate somethingof the organisation’s culture. Company‘heroes’, such as charismatic leaders of thepast, and mavericks can be perceptions of‘normal’ behaviour.

3. Symbols - Logos, language, status symbols,e.g., company cars, office carpets, etc., canall provide a visible reflection of companyculture.


4. Power structures – Top management andsenior managers with the most power, arelikely to have the most influence.

5. Organisational structure - Both the formalstructure (as found on the organisation chart)and the informal structure are likely to reflectpower structures and play an important partin influencing the core values of anorganisation.

6. Control systems - the measurement andreward systems used in the organisation

When an employee joins an organisation, he orshe needs to look at these aspects tounderstand the culture of the organisation.Interacting with various people in theorganisation, observing the processses taking

place in the organisation will definitely give anemployee an idea of the culture of theorganisation. The quicker an employeeunderstands the culture of the Organisation andtunes his or her behaviour accordingly, thegreater the chances of adaptability with theorganisation.

CONCLUSION

An organisation’s culture evolves over time, andis influenced by a variety of factors. As anorganisation grows and develops, theorganisation culture that originally proved sohelpful may begin to get in the way. Hence theculture of an organisation must be able to tuneitself to the changing environment.


MENTORING

� It is a process of making an employee more effective in his job through developingpersonal working relationship.

� Coaching, counselling, providing guidance, social and emotional support are someof the ways.

� Advantages: Higher performance of employees, building a better organisationalclimate, generate positive feelings of pride and satisfaction.

� Institution of formal mentoring process would benefit organisations.

Background

Every organization has its own culture as definedby formal and informal organization. The‘Should’ and ‘Should nots’ in any organizationare sometimes at variance with what anyindividual has experienced before joining theorganization. Besides this, the political climateand culture of any organization are unknown tonew recruits or new role holders. The newrecruits many times are unable to reconcile thedilemma between competition andcollaboration. These and many other processesare clarified through a process of mentoring,where the new recruit can approach the mentorwithout the fear of putting his/her career at stake.

What is Mentoring?

Mentoring has been a recognized form ofpersonal development for thousand years. Sincemost ancient experiences in mentoring areinformal, considering the benefits of mentoring,many organizations have introduced formalmentoring processes in their companies.

Mentoring is a process of making a person(generally new recruits or new role holders) moreeffective in the profession by developingpersonal working relationship. A mentor issomeone with the skills, experience andperspectives that are needed by theorganization; who has a reasonable amount oforganizational influence; and who is willing todevelop a personal working relationship with

someone of less experience and status in orderto help the person to become more effective.The Protégé is the person who is being helped(otherwise termed as ‘mentee’).

Activities in Mentoring

Following activities form part of the mentoringprocess:

Coaching: Coaching enables the mentee tocorrect performance problems and find newways of approaching the task. It involvesimparting knowledge and skills to the protégéfor improving the quality of output. The mainfocus is task-centred.

Counselling: Counselling addresses theemotional problems of mentees, at home or atwork, which people may encounter affectingtheir job performance. It aims to restore thenormal cognitive abilities in people, temporarilyshut by emotional disturbances. Effectivecounselling needs the counsellors to haveempathy, listening skills and skills inparaphrasing so that the affected person is ableto view the problem and initiate redressalproviding political guidance: every organizationhas its own norms and values, its own politicalstructures, which manifest itself into a culture,which a new entrant is ignorant of. These aremostly unstated, unpublished, and yet vital, forthe social order. One of the important functionsof the mentor is to create the awareness in thementee about these norms and values, which


govern group behaviour, the ‘dos’ and ‘don’ts’ andhow the power is distributed in a particularorganization.

Providing Social and Emotional Support: TheMentor besides the above must providecontinuous encouragement to the mentee, asthe latter takes on new challenges. The mentorshould create a climate where the mentee feelssafe to air grievances, anger and sadness beforethe mentor.

For discharging the afore-mentioned activitieseffectively, mentor should himself be seen asan ideal role model, highly positive and loyal tothe organization. He should be held in esteem.He should also have other traits such asawareness of the self, strengths andweaknesses, comfortable relationship withpeers and seniors, patience, ability to deal withthe feelings of people, skill to generate alternativesolutions besides deriving satisfaction as amentor.

Advantages of Mentoring

The organization gains through higherperformance of the protégés. It helps to tap thelatent potentials for mentoring in many of thesenior functionaries of the organization. It would

nurture present protégés to become ablementors in future. This in effect would result inbuilding a new climate in the organizationfounded on closer inter-personal relationship,through a network of protégés and mentors.Thus mentoring promises organizations a higheraccretion of human capital.

The advantages to mentors are many. Learningnew skills, the development of the ability to seethings in new light, recognition from peers andsuperiors, loyalty and support from protégés,ability to generate positive feelings of pride,satisfaction, happiness and commitment andfinally the capacity for higher contribution to theorganization and the world at large.

Sensing this potential, many organizations haveset up a formal mentoring process in theirinstitutions. With the complexity of businessesgrowing at rapid pace with each passing day,organizations need to find effective ways to buildtheir human capital. Mentoring is one of thepotent tools for strengthening human capital andbuilding a company with emphasis on ‘humancare’. Therefore, it pays to the organization todevelop and strengthen the mentoringcompetencies of their senior functionaries andcreate a formal structure for mentoring.


360–DEGREE TECHNIQUE

� Seeks to measure the performance of employees on the job from multiplestakeholders.

� Focuses more on intrinsic qualities and strengths than on achievements.

� Promotes team work and voluntary self change.

� Creates an atmosphere of openness and improves inter-personal relations.

Limitations of Traditional Appraisal

Performance appraisal has long been regardedas one of the most critical area of humanresource management. Most of the appraisalsystems are designed to evaluate pastperformance and stress less on futurerequirements such as employees careeraspirations, potential latent skills identification,career planning training & developmentrequirements to take up higher assignments.

The traditional 90-degree performance appraisal(done by the immediate boss) judges theoutcome of an appraisee’s efforts but ignoresthe road taken. He focuses on achievementsrather than the intrinsic qualities and strengths.

360-degree Feedback

The 360-degree feedback is understood assystematic collection of performance data onan individual or group, derived from a number ofstakeholders-the stakeholders being theimmediate supervisors, team members,customers, peers and self. In fact, anyone whohas useful information on ‘how an employeedoes the job’ may be one of the appraisers. Thepersonality of each manager-his talents,behavioural traits, values, ethical standards,tempers, loyalties-is to be scanned, sorted outand stethoscoped. Corporations like GeneralElectric India (GE), Reliance Industries Ltd.(RIL), Crompton Greaves, Godrej Soaps, Wipro,Infosys, Thermax and Thomas Cook arereportedly using this to know everything abouttheir managers.

Methodology

The methodology used involves collectingresponses through standard assessment formsabout a manager from his bosses, peers andsubordinates. They cover several parametersof performance as well as behaviour. Indeednothing excluded from the ambit – even values,ethos, fairness and balance courtesy.

The forms are designed to measure subject’srating on three parameters – strengths,weakness and improvement required. Eachmanager is assessed by a minimum of ninepersons-at least two of them being his bosses,two or three of them peers, and two or three ofthem subordinates. Data collected is analyzedand graphed by computer. The responses arepresented collectively to the appraiser.Depending on the interpretations of the data andfindings, counselling sessions are held to solvethe specific problem and the weaknesses asidentified by 360-degree appraisal. This is apowerful tool for self-development especially atthe senior level, which is where one tends toget isolated.

Benefits

If 360-degree appraisal is done in a systematicmanner, it will contribute to motivation ofemployees, clarify role of employees, providescope to express individual views and opinions,recognize talents, placement requirements,training needs and career planning. The meritsof the technique are:

� The organization gains from heightened


self-awareness of the top managers. Itreveals the strengths and weakness of theirmanaging style.

� The gap between self-assessment and theviews of one’s colleagues is reduced.

� Teamwork develops once peer groupassessment is included in the methodology.

� Empowerment is facilitated.

� Facts about organizational culture andambience are brought to light.

� Inflexible managers are forced to mitigateself-change.

360-degree feedback technique holds brilliantpromises provided it is used with utmost carekeeping in view the following guidelines:

� The 360-degree assessment programmewill be effective only when the topmanagement backs it with the assuranceto managers that the exercise will be usedexclusively for individual development andbenefit only.

� System should be introduced only after athorough study of the organizational climateand the requirements of the system in agiven set-up.

� People should be prepared mentally toadapt to the system. Their doubts must beclarified. There should be full transparencyabout its mechanism.

� Employees need to believe that the data isunbiased and objective.

� 360-degree feedback system should notreplace the existing appraisal system of theorganization but it should be done as anaddition to that system.

� Assessors should encourage opendiscussions on the feedback.

� 360-degree assessment form should

contain those items only that assessors arecapable of observing and are competent toassess.

� Assessors should be trained in what andhow to observe.

� Organizations considering 360-degreefeedback should start small and moveslowly.

� 360-degree feedback works best inorganizations where the environment isopen and participatory, where giving, andreceiving feedback is seen as valuablesource of information and development.

Conclusion

The 360-degree feedback provides a broaderperspective about employees’ strengths andweaknesses. It facilitates greater self-development to employees. It enables anemployee to compare his or her perceptionsabout self with the perceptions of the assessors.Besides, 360-degree feedback creates anatmosphere of more openness, improved inter-personal relations and teamwork. It makesemployees feel more accountable to the internaland external customers. However, there aredrawbacks associated with 360-degreefeedback. Receiving feedback on performancefrom multiple sources can be intimidating.Further, selecting the assessors, designingquestionnaires and analyzing data may becumbersome and time consuming tasks. Inaddition, there might be difficulties in gettingobjective feedback due to personal differencesand biases. Notwithstanding, more and morenumber of companies are using 360-degreefeedback. It is essential that the organizationshould follow the above-mentioned guidelinesand create a conducive environment byemphasizing the positive impact of the techniqueon employees’ performance and development.


Emotional Intelligence is the key ingredient whichdistinguishes star performers from performers.It is one of the differentiating factors for successand a study of 15 global companies attributes85 to 90% of leadership success to emotionalintelligence. Emotional competence is twice asimportant as cognitive abilities for all jobs, for allroles. Intelligent Quotient is only a thresholdcompetence, but it is emotional intelligence thatdistinguishes star performers from others.

Emotional intelligence is the capacity forrecognising our own feeling and those of others,for motivating ourselves, and for managingemotions well in ourselves and others. Itcontributes to effective performance at work,outstanding leadership, and deeply satisfyingrelationships in life.

Building one’s emotional intelligence cannot andwill not happen without sincere desire andconcerted efforts.

Daniel Goleman, author of the book EmotionalIntelligence describes four fundamentalcapabilities of people who are high in emotionalintelligence.

Self-Awareness

Emotional Self-awareness

� The ability to read and understand one’semotions as well as their impact on workperformance, relationships, and the like.

EMOTIONAL INTELLIGENCE

� Emotional Intelligence is the capacity to recognise one’s own feelings and thoseof others.

� It helps to motivate oneself, manage emotions of self and others; contribute toeffective performance in the job and developing satisfying relationship in life.

� Most leaders succeed because of EI.

� Four essential capabilities: emotional self awareness; self-management; socialawareness and social skill.

� Accurate self-assessment: a realisticevaluation of your strengths and limitations.

� Self-confidence: a strong and positive senseof self worth.

Self-management

� Self-control: the ability to keep disruptiveemotions and impulses under control.

� Trustworthiness: a consistent display ofhonesty and integrity.

� Conscientiousness: the ability to manageyourself and your responsibilities.

� Adaptability: skill at adjusting to changingsituations and overcoming obstacles.

� Achievement orientation: the drive to meetan internal standard of excellence.

● Initiative: a readiness to seize opportunities.

Social Awareness

� Empathy: skill at sensing other people’semotions, understanding their perspective,and taking an active interest in theirconcerns.

� Organisational awareness: the ability toread the currents of organisational life, builddecision networks, and navigate politics.

� Service orientation: the ability to recogniseand meet customers’ needs.


Social Skills

� Visionary leadership: the ability to takecharge and inspire with a grand vision.

� Influence: the ability to wield a range ofpersuasive tactics.

� Developing others: the propensity to bolsterthe abilities of others through feedback andguidance.

� Communication: skill at listening and atsending clear, convincing and well tunedmessages.

� Change catalyst: proficiency in initiating newideas and leading people in a new direction.

� Conflict management: the ability to de-escalate disagreements and encourageresolutions.

� Building bonds: proficiency at cultivating andmaintaining a web of relationships.

� Team work and collaboration: competenceat promoting cooperation and buildingteams.

All these four capabilities and theircompetencies are interlinked andinterdependent.

As one becomes more aware emotionally, oneis able to see what causes these emotions and

learns empathy – the awareness of others'emotions. The highest level of emotionalawareness is Interactivity, where one is sensitiveto the ebb and flow of emotions around one.

Emotional awareness is only the first steptowards emotional literacy, which is acornerstone of Emotional intelligence. Selfmanagement or the ability to manage one’semotions coupled with conscientiousness,adaptability and initiative is also essential forEmotional Intelligence.

Emotional regulation aims at examining thevalues, beliefs and assumptions that areresponsible for each emotion, and trying to finda way to manage the emotion, so that one canbe more responsible for one's emotions.

The mindset for a better Emotional Quotient(EQ) would be to remember that all feelings aretelling us something, there is no failure, onlyfeedback; the map (of emotional journey andexperiences) is not the same for all of us; peoplehave within them all the resources they need,and mind and body are part of the same system.

Thus emotional intelligence, which refers to thecapacity for recognising our own feelings andthose of others, for motivating ourselves, andfor managing emotions well in ourselves and inour relationships can be learnt, but withcommitment, diligence and practice.


Stress is the single most important growthrelated stimulus for all living organisms. If thereis no stress, there is no growth and,consequently, there would be death soon. Stressis an integral part of life, and we cannot get ridof stress.

It is our abnormal response to stress thatcauses disease and disability. This is bettercalled ‘distress’. Whereas stress is good andwelcome, distress is the killer that needs to bemanaged well. Up to a certain point, increasedstress improves performance. After a criticallevel, our ability to perform effectively declinesrapidly with increasing stress.

Psychologists have defined stress as “demandsof life”. Technically these demands of life arecalled stressors and the actual wear and tear ofour body for fulfillment of the same is stress.

Stress can also be defined as an adaptiveresponse to an external situation that disturbs aperson’s healthy mental and physical well being.

Dr. Hans Selye has classified reactions to stressas the general adaptation syndrome (GAS). GAShas three stages:

• Alarm Reaction: The stressor activates thebody to prepare for fight or flight.

• Resistance Stage: The sign of alarmreaction are diminished or non-existent.

• Exhaustion Stage: The exposure to astressor has nearly depleted the organism’sadaptive energy.

WHERE DOES STRESS COME FROM?It is important to identify the different categoriesof stressors to strengthen our copingmechanism:• Emotional stressors like fear and anxiety

STRESS MANAGEMENT

• Family stressors on account of ourinteraction with family members

• Social stressors involve our interaction withpeople

• Change stressors result when we alteranything important in life.

• Chemical stressors like abuse of drugs,caffeine, nicotine, pesticides andsweeteners in food.

• Work stressors – the tensions andpressure we experience in work place.

• Decision stressors arise on account ofavailability of more alternatives and lessdecision time.

• Commuting stressors caused by longdistance to work and facing rush hour traffic.

• Phobic stressors caused by exaggeratedfears

• Physical stressors arise when weoverextend ourselves—lack of sleep,malnutrious diet, injury.

• Disease and pain stressors as a result oflong- or short-term disorders and also oldaches and pains of new and old injuries.

• Environmental stressors such as crampedoffices, burning heat of summer or chillingcold of winter.

COPING WITH STRESSThree important stepping stones in learning tocope with stress are:

• Admit the existence of negative attitudes anddestructive behaviour patterns.

• Believe that you can change your potentiallydestructive attitudes and behaviours.

• Work out positive steps, put them intopractice, accept some failings, but persevereand give yourself a pat in the back for everysuccess you have.

� Stress is an integral part of life.� We need to manage our abnormal response to stress that cause disease and disability.� We have to identify the stressors and symptoms of stress.� There are three levels on which stress management techniques are focused: BODY,

MIND and BEHAVIOUR.� Exercise, diet and relaxation constitute our response at body level.� Positive thinking and attitude and prayer are coping techniques at mind level.� Self monitoring, change of life style, laughter and balanced life activities are our strategies

at behaviour level.


There are three levels on which stress managedtechniques are focussed:I. BODY

a) Exercise:• Seek medical advice beforehand• Maintain regularity

b) Diet:• Have a balanced diet and eat in

moderation• Intake of salt, sugar, caffeine, alcohol,

etc., should be in moderation• Avoid tobacco products• Drink at least 8-10 glasses of water

every day—it helps in elimination oftoxins from our body

• Take dinner at least two hours beforesleeping

• Drink the food and eat the liquid—masticate properly what you eat andsip the liquids slowly.

c) Relaxation:• Breathing exercise—breathe slowly

using diaphragm. This makes thewhole lung expand and body cellshave better oxygenation.

• Shavasana or deep musclerelaxation: This Yoga postureprovides complete relaxation in 15-20 minutes.

• Meditation: Meditation is silence thatis golden, and listening to our saneinner voice.

II. MIND:a) Positive thinking and attitude: We

can use the power of mind for selfhypnosis and imagery training. We canreplace our negative thoughts withpositive thoughts and this in turn willinfluence our thinking.

b) Prayer: Prayer simply means passing onour worries and anxieties to the Almightyor Mother Nature. Scientific studies haveshown that believers have significantlylower rates of stress related ailments.

III. BEHAVIOUR• Self Monitoring: Take a few minutes for

yourself in the evening/night to analysestressful situations of the day and plancorrective action for the future.

• Change lifestyle: Getting up early,regularity of exercise, food habits, timemanagement, reasonable workinghours, etc., and take corrective action.

• Laughter: Develop a habit of laughing atyourself by saying “Do not take thisperson seriously”. A good laugh relaxesmuscles, lowers blood pressures,suppresses stress related hormonesand enhances the immune system.

• Balanced life activities: Avoid buildingyour life around one person or one thing.Live a balanced life, have many sourcesof happiness.

Physical Psychological Behavioural

Tension headaches Nervousness Reduced performance

Migraine Anxiety Lower productivity

Sleep disorder Irritability/ anger Mistrust or hostilitytowards associates

Fatigue Depression Missing deadlines

Overeating Losing sense of humour Shirking responsibilities

Loss of appetite Feeling withdrawn Minor accidents

Constipation/diarrhoea Feeling that you do not want Increased errorsto do things that you have to do

Low back pain Feeling emotionally drained Indecisive use of drugs

Allergy problems Difficulty in remembering Excessive use of drugs

Skin rashes Excessive use of alcohol

Aching neck/shoulders Excessive use of tobacco

Ulcers

SYMPTOMS OF STRESS


Empowerment has become a buzzword in thelate 1990s. Organisations see it as a competitiveedge and have started using this as a Motivationtool.

VARIOUS DEFINITIONS OF EMPOWERMENT

(a) Empowerment has been defined asrecognising and releasing into theOrganisation the power that people have intheir wealth of useful knowledge and internalmotivation.

(b) It is also the authority to make decisionswithin one’s area of responsibility without firsthaving to get approval from someone else.

(c) It is the process of sharing power andproviding an enabling environment in orderto encourage employees to take initiativeand make decisions to achieve organisationaland individual goals.

NEED FOR EMPOWERMENT

As people in an Organisation mature, the needarises for them to use their talents andcapabilities. The competencies or skills requiredalso undergo change as Organisations preparethemselves for facing the competition.Empowering people may seem scary but withtrust in oneself and in one’s people it can beovercome. Every employee needs to feel thathe or she is very important to the Organisation.Empowerment is one such way.

According to David McClelland, every employeehas three basic motivating needs - Need forPower, Need for Achievement and Need forAffiliation. The Need for Achievement is due tothe desire to do something better or moreefficiently. The focus is on personalimprovement. People with high “Need forAchievement” will look upon Empowerment asa great Motivational tool.

Empowerment works when Organisations• Understand that the more power you give

the more you have• Have faith in their employees, i.e., they

perceive their employees as capable in

EMPOWERMENT

� Empowerment is the authority to make decisions within one’s area of responsibility withoutfirst having to get approval from someone else.

� Empowerment is a Motivational tool in the hands of the organisation.

� It enables employees to use their talents and capabilities.

decision making, problem solving, goalsetting, etc.

• Recognize that their employees areresourceful and have vast untapped capacityand potential

• Treat their employees as valued membersof the Organisation

Some of the misconceptions aboutempowerment are:• It results in loss of control• People do not want power; they want to be

led• Power is a fixed quantity; if you give it away,

you lose it• It always leads to beneficial results

Empowerment leads to:• Respect for team members• Open Communication• Opportunities for learning new

competencies/skills• Opportunities for self development• Autonomy

Consequences of empowerment:• Organisational commitment• Work environment satisfaction• Role satisfaction• Job involvement

CONCLUSION:

Empowerment does not mean that employeescan “break all the rules” with impunity nor thatleaders abdicate their responsibilities.Empowerment is a movement that is probablyirreversible in organisational life. For higherproductivity, Organisations need to find moreand more areas in which they can empower theiremployees. In the end, empowerment must beseen by the employees as something whichhelps them to satisfy their “Need forachievement”. It also must be seen as a toolwhich improves their quality of work life.


SERVICE QUALITY MANAGEMENT

Quality is difficult to define because it is highlydependent upon customer perception. The taskis made more complicated in the case ofservices industries because of the intangiblenature of services and the variation in servicesoffered to different customers.

The American Society for Quality Control hasdefined quality as “the totality of features andcharacteristics of a product or a service that bearon its ability to satisfy stated or implied needs’e.g. banking services is not only for selling ofproducts and services to the customers but alsothe total environment attached to it like how muchvalue is added to the products and servicesincluding the physical ambience and the qualityof the products and services.

The well-known approaches to improvement ofquality are:

(a) Bottom-up approach

(b) Top-down approach

In the case of bottom-up approach, theimplementation of any policy begins from thelowest level of employees. It slowly transmitsitself upwards. For example, card punching orswiping of cards at entry or exit from workplacemay begin with the lowest cadre employee andlater adopted by higher levels of managementto give a semblance of fairness.

In top-down approach, the top managementmakes an initial and definitive commitment topolicy implementation and the approach ispercolated down to all levels of employees.

For example, top management commits to theconsumer that the bank while consideringhousing loan proposal not only takes care ofconstruction and value of land but alsoconsiders the cost of consumer or beautification

items also. This should be percolated down tofulfill the commitment.

The quality initiatives have no chance of successwithout the top management’s blessings.Changes in quality occur only after changes inattitudes and behaviour take place. The newapproach to quality improvement comprises notof rejecting defective output and presenting onlygood quality of products and services to thecustomers, but also not producing defectivegoods or services at all. Once a customerrejects a product it is always a bad productwhatever superior quality it may have.

The quality service delivery results in customersatisfaction and their retention as it reinforcesthe perception that the value of the servicereceived is greater than the price paid for it. Betterquality leads to productivity and increases theprofitability. The mechanism acts as under:

First step improvement:

(a) Image/perception of bank goes up

(b) Volumes are built up because of the service/product preference

(c) Inspection cost is less due to improved builtin quality

(d) Repetition of tasks is reduced by providingbetter quality service the very first time itself.

(e) Complaints are considerably reduced aboutmaintenance of quality.

Second step improvement:

(a) Better price can be charged or price yield isbetter

(b) Economy of scales accrue due to highervolumes

� Two well-known approaches to improvement of quality are Bottom-up approach andTop-down approach.

� The quality service delivery results in customer satisfaction and their retention.

� Quality is a winning attitude and it always needs improvement.


(c) Costs of cross selling are reduced

(d) Costs of networking are reduced as word ofmouth publicity increases.

(e) Adherence to quality norms and proceduresensures the high quality of the system andreduction in non-conformance. About 35%of the company’s costs are due to faults andtheir corrections.

Final results: Profitability improvement

Quality improvement is not a win/lose strategywhere we lose a lot of costs in order to win moreprofitability but a win/win strategy wherepermanent changes are made to ensure thatthe high quality is built in to the system.

Gap Model of Service Quality Delivery

Gap 1: Not knowing what customers expect:Gap between perceived and expected levels ofservice quality delivery.

Reasons are:

(a) No direct interaction with customers

(b) Unwillingness to ask customers aboutexpectations

(c) Unpreparedness to address theexpectations

(d) Lack of market segmentation to understandthe needs of each segment

Gap 2: Inability to set the right type ofstandards: The customers have servicestandard expectations that may be either higheror lower that the standards set by the Banks.

Reasons are:

(a) Absence of customer-driven standards ofservice delivery

(b) Absence of formal quality –control goals

(c) Vague or undefined service standards

Gap 3: Not delivering to service standards:This is the most common type of failures broughtabout by day to day difficulties in service delivery.The common causes for this failure are:

(a) Lack of right type of employees or theirtraining in service delivery

(b) Lack of empowerment of the employees

(c) Lack of training to the franchisee’s staff

(d) Insufficient customer education especiallywhen banks are handing over their platformfor customers’ use.

Gap 4: Mismatch between promises andperformance: In this era of competition thereis a great temptation to promise the world inorder to win over customers. However, it maybe either physically impossible or financiallyunviable to provide all that was promised. Thisresults in customer disappointment. The typicalreasons for this kind of failure are:

(a) Unrealistic communication to customers

(b) Overpromising through advertisement orpersonal selling

(c) Lack of internal communications.

Delivery of High Quality Service: High-qualityservice delivery is not just the function of thefront-end employees but of all the members ofthe organization. The factors that could play acrucial role in the quality of service delivery aremany. A few important factors amongst themare:

(a) Human factor: To ensure that ‘I shall notdeliver substandard service nor shall I letanybody else deliver substandard service’

(b) Systems support: The computerized systemin bank has to ensure accurate and timelydelivery of the customer’s request

(c) Organisational factor: Organisation withmighty structure has very poor interactionbetween the front-end employees and thehigher top officials within the organization.The interaction between the supervisors andthe front-end service delivery employees isvery important.

(d) Feedback: Organisations need to encouragefeedback from customers and every employeeincluding the front-end employees as a part ofthe quality monitoring system.


Employees have to be told that their opinion isvaluable for the organizational success.

(e) Prevention of Customer defection.

While obtaining feedback from the customers,the banks can take care of the followingdimensions to specifically evaluate servicequality:

(i)Credibility: To ensure trustworthiness,credibility and honesty of the service provider.

(ii) Security: To ensure safety and freedom fromrisk

(iii) Access: To ascertain approachability andease of contact

(iv) Communication: Listening to customers andkeeping them informed

(v) Understanding the customer: Making theeffort to know the customers and their needs

(vi) Tangibles: Opinion on physical facilities,equipment, environment, etc.

(vii)Reliability: Whether delivery of promisedservice can be assured.

(viii)Responsiveness: Whether providers arewilling to help and provide prompt service

(ix) Competence: Whether service providersare in possession of skills and knowledge todo the job.

(x) Courtesy: To examine politeness, respect,consideration and friendliness of the contactperson.

Quality is a winning attitude and it always needsimprovement. The improvement is never endingand calls for review according to marketscenario.


A niche market is a group of potential custom-ers who share common characteristics thatmake them receptive to a particular produce orservice.A niche market is a focused, targeted portion ofa market. By definition, a business that focuseson a niche market is addressing a need for aproduct or service that is not being addressedby mainstream providers. One can think of aniche market as a narrowly defined group ofpotential customers.Launching a product into a niche market is farcheaper than launching a mass-market product.The potential customers are easier to identifyand to target. Niche markets often develop frommass markets and mass-market manufacturerssometimes choose to launch niche product aswell. Conversely, what are expected to be nichemarkets sometimes develop into mass markets.When Apple came up with the PC in the early1980s, for instance, it did not expect it to be-come a mass-market product. Yet, it did, andout of that mass market there ultimately emergedsome niches, such as the educational PC mar-ket.The trouble with niche markets that do not de-velop into mass markets is that they soon reachtheir maximum size. A niche, which can be sohelpful in getting a product off the ground, cansoon become a straitjacket. Manufacturers haveto find another niche product, or another marketin which to sell their existing product.The Internet has features that make it ideal forniche marketing. Through its mailing lists andnewsgroups it gathers electronically in one spotof cyberspace precisely those groups of cus-tomers with similar interests that are a nichemarketer’s dream. Mailing lists and newsgroupsfocus on specific topics. In each discussiongroup there can be as many as regular readerswith a special interest in that topic.The trick to capitalizing on a niche market is tofind or develop a market niche that has custom-ers who are accessible, that is growing fast

NICHE MARKET

� A niche market is a group of potential customers who share common characteristicsthat make them receptive to a particular produce or service.

� Launching a product into a niche market is far cheaper than launching a mass-market product.

� The Internet has features that make it ideal for niche marketing.

enough, and that is not owned by one estab-lished vendor already.Three Steps of Niche MarketFirst off, it’s too expensive and usually a verydifficult task to try and develop one’s own niche.It is better to identify and plan on addressing anexisting niche that has good potential for usingunique product or services.For example, it is assumed that one has inventeda fantastic sports drink and want to develop themarket for his product.Here are the first three steps to find niche:1. Assess self and determine what areas of

life are most interested (in the product) andhow it will interface with product.

2. Assess potential market to determine ifthere is an area that could use services.An easy way to make this determination isjust to talk to the people in targetedcommunity. Another is to join groups ofpeople who have similar interests such ashealth clubs, little league boosters, andsoccer clubs or at car racing activities.

3. Once a promising niche is found, then itneeds to be determined whether the samecan be comfortable with the anticipatedincome from it.

ConclusionSome have seen niche marketing as a phase ina 20th - century journey from mass marketing toone-to-one marketing. The 50s and 60s werethe heyday of mass marketing. There was onekind of Coca-Cola soft drink for the thirsty, onekind of Holiday Inn hotel for the traveler. The 70sbecame a decade segmentation and line exten-sion. It was followed in the early 80s by intensi-fied niche marketing that sliced market intosmaller and smaller groups of consumers. Thewhole world has started moving from mass mar-keting to segmented marketing to niche market-ing to tomorrow’s world of one to one marketingthrough Internet in the 21st Century.


What is Six Sigma

Sigma is a mathematical term that representsa measure of variation around the mean. It helpsto determine how good or bad the performanceof a process is. It helps to measure how manymistakes a company makes in doing whateverit does, from manufacturing steel to deliveringPizza at the customers’ doorstep.

If a company works at one sigma level, it willhave 7,00,000 defects out of 10,00,000, whichmeans that it is doing things right 30% of thetime. Similarly, the defect levels for other sigmawould be as under:

SIGMA Defects DefectsPer Million Percentage

One 7,00,000 70%

Two 3,00,000 30%

Three 67,000 6.7%

Four 6,000 0.6%

Five 230 0.0002%

Six 3.4 0.000034%

� At Six Sigma level, there will be 3.4 defects(called DPMO - Defects Per MillionOperations) out of 1 million parts produced.Six Sigma therefore implies being rightalmost 100% of the time.

Six Sigma as a Quality tool was first introducedby Motorola in 1988 with tremendous success.Later the concept was taken up by Jack Welch,the CEO of General Electric, who got the ideafrom Lawrence Bossidy, the former CEO ofAllied Signal, a company with 70,000 employeesmaking fibres, plastics and aerospace andautomotive parts. Bossidy applied Six Sigma to

SIX SIGMA : FOR QUALITY

� It is a quality tool.

� It denotes tolerance of only 3.4 defects in 10 lakh operations.

� Companies like Motorola and G.E have implemented this with success

� Helps in customer satisfaction and retention, elimination of waste and reduction incost

� In our Bank, CAG has successfully implemented it for issue of LC.

everyone of the business processes frominventing and commercializing a new productto billing and collecting after they deliver theproduct. Six Sigma improved Allied Signal’sproducts, their price, customer satisfaction andcash flow significantly.

In 1995 GE’s operating margin was about 13.5per cent. By 1998, after adopting Six Sigma, itwas up to 16.7 per cent, a number Welchpreviously thought was impossible. Thisincrease represented a $600 million bonus tothe bottom line. Today, it is reported that manyof the Fortune 500 companies have adopted SixSigma.

WHY ADOPT SIX SIGMA?� To eliminate errors for achieving Customer

Satisfaction and retention: Six Sigma helpsin measuring the level of error in order toperfect the processes. So it pays to adoptSix Sigma to retain customers and delivercustomer satisfaction.

� To improve the bottom line: By focusing onwastes and redundancies, Six Sigma helpsto enhance profits of the firm.

� To eliminate waste: Six Sigma helps to tracewasteful activities in order to eliminate them.

In Six Sigma, quality improvement is a meansto an end and not an end itself. The goal of SixSigma is not simply to improve quality for qualitysake, but to make customers happier and addmoney to the bottom line. If we improve qualityby losing money without satisfying or addingvalue to customers, we are missing the point.� Thus the main thrust of Six Sigma is to

reduce errors and waste in every kind ofbusiness endeavour to please customers


and fatten the bottom line. Six Sigma aimsto give customers excellent products andexcellent services at an acceptable price.

Where Can It be Applied?

Six Sigma can be used in the service industry,manufacturing, operations- everything fromaccounts receivables to automobile spare parts,from software to hardware.

How to Go About It?

Idea Generation

� Find out what the customer wants

� Take one problem at a time

Golden Rule: Pick the problem that gives themost trouble, the one that is costing thecompany most, the one that is makingcustomers unhappy- the one that will reward usthe most if we can fix it.

Getting Started- The Five Steps (DMAICCycle)

Find out the number: It is important to knowwhere we stand and where we want to go. Forthis, we need to define our problems in numbers,as other methods are subjective and henceimpossible to measure performances andachievements. Numbers bring clarity. To cite anexample, if we wish to improve our despatchprocesses, we need to define on how manyoccasions our letters are delivered wrongly.

� Define the problem : Problem definitionis the biggest challenge in any problemsolving effort. Wrong and incompletedefinition of the problem results in wastageof money and effort. The more accuratelywe define the problem, the more precisewill be our target, the better are the chancesof hitting the bull’s eye.

� Measure: The next step is measurement.Unless the problem is measurable it wouldbe difficult to quantify and much moredifficult to effectively implement changeinitiatives. While doing this, we need tomeasure as to how many opportunities fordefects the current process presents. Thiswould help us to adopt a new process,which would not lend scope for congenital

defects. In this step, benchmarking mayalso be useful. Benchmarking is essentiallyfinding out how our competitors perform inthis area in order to set our standardsagainst those benchmarks. During thisphase, we need to identify processes whichare ‘critical to quality’ (CTQ)- that is thosethat have the most impact on the outcomein order to work on them.

� Analyse: This is done to find out how wellor poorly the processes are workingcompared with what is possible and withwhat the competitors are doing. This wouldhelp us to know the maximum resultspossible if everything is perfect and alsohow far our company is falling short. If thegap is not great, we may not stand to gainmuch and hence can move to some otherproblem. In this phase, we need to raisequestions such as why are the errorscommitted and how to fix them. If we cananswer when, where and how and howoften the defects occur it would facilitate usin remedying the problem.

� Improve: Having identified the processes‘critical to quality’ and the defects in it, wehave to implement the changes which willimprove performance.

� Control: Like all management processes,it is important to measure the actualperformance against the expected in orderto implement corrective action when thereis a deviation.

Experience in Service Industry

In the Services sector, some insurancecompanies such as MetLife and non-bankingfinance companies in the USA have verysuccessfully achieved Six Sigma status. In ourBank, CAG, Mumbai has successfullyimplemented Six Sigma for issue of Letter ofCredit. Since customer expectation andcompetition is intensifying every passing daymany service companies are exploring newways to enhance their service quality. Six Sigmais one of the potent tools in the hands oforganisations in this mission.


The Management gurus in the 1970s and 1980swere engaged with the theme of profitmaximisation which was seen as the mainagenda of an enterprise. However during 1990s,the focus has shifted to customers and frontlineemployees are expanding their reach into servicemanagement and service quality resulting in thegrowth of knowledge about TOTAL QUALITYMANAGEMENT (TQM). The concept of TQM isincreasingly recommended as the means ofsatisfying the needs and expectations of theircustomers. This management philosophy of‘tireless striving towards perfection’ is gainingwide acceptance as evidenced by the explosionof published material on the topic. In developedcountries, the interest in quality extends to everycompetitive business and industry. To stayahead of the competition, the organisations sellquality as a value-added service introducingrevolutionary ideas into a very traditionalbusiness.

TQM DEFINED

TQM is a co-operative form of doing businessthat relies on talents and capabilities of bothlabour and management to continually improvequality and productivity using teams. Embodiedin this definition are three main ingredientsnecessary for TQM to flourish in an organisation:a. Participative managementb. Continuous process improvement andc. Use of teams

Participative management comes about bypracticing TQM. Unlike a switch, it cannot simply

TOTAL QUALITY MANAGEMENT (TQM)

� TQM means ensuring error free functions all around in the organization� It aims to continually improve quality through employee and management

participation.� It attempts to increase productivity through building teams.� The focus of TQM is to satisfy the needs and expectations of customers� Zero defects, Kaizen (continuous improvement), benchmarking are its key

approaches

be turned on. It is an evolutionary process oftrust and feedback which develops over time.Continuous process improvement meansaccepting small, incremental gains as a step inthe right direction towards quality. It recognisesthat substantial gains can be achieved by theaccumulation of many seemingly minorimprovements whose synergies yieldtremendous gains over the long run. Finally TQMinvolves teams. The employees are aligned withthe organisation’s goals for improvement. Thispersonal commitment is achieved in exchangefor individual and team rewards, recognition andjob security.

The sum total of an error-free function all round— knowledge of the work, motivation,productivity, rationalism in work place, goal-oriented work, quality assessment, functionalassessment — is Total Quality Management.

TQM is a science and not a witchcraft. Nothingcan happen out of the blue. A set of methodssystematically applied for a period of time whichare properly planned, done, checked and actedupon will eventually result in total quality controlcircle. Improvements from the presentstandards, a positive and perfect frame of mindand ‘do it right at the first time’ approach wouldculminate in full quality culture and in turn fullcustomer satisfaction.

ESSENTIALS OF TQM

� The importance of management:Commitment of managers at all levels isessential for sustained improvement.


� The involvement, commitment andresponsibility of everybody: When we talkof everybody being involved, we mean thecustomers, employees, investors, all ofwhom can affect quality.

� Quality in all processes: Processes cutacross departments and the right qualitydepends on the right relations betweendepartments and organisation.

� Quality as strategy: This means that theorganisation must recognise theimportance of quality and evolve a strategyfor improving quality. The quality strategyshould be part of the business strategy inthe market.

� Focus on prevention rather thaninspection: Instead, it is a matter ofpreventing poor quality at the earliest point.

� Quality by design: Old services need tobe redesigned with the customer’s needsoverriding back office needs. Servicedesign is a way of avoiding inbuilt faults inthe system from the start.

� Continuous improvement - ‘Kaizen’approach: The Japanese practice theconcept of KAIZEN widely which means“ON-GOING IMPROVEMENT” involvingevery one including management andworkers. Kaizen stresses the value ofprogress on a continuous basis.

� Zero defects: It means doing the job rightat the first time. Zero defects are in relationto the specifications laid down andgrounded in the customers’ needs. Theconcept originated in manufacturing, but isnow a key part of TQM for services also.

� Meeting the needs of target customers:This means adjusting the services to therequirements, needs and expectations ofidentified special groups of customersthereby avoiding dissatisfied consumers. Inother words, marketing should be orientedto avoid creating wrong and often excessive

expectations in customers. It is theresponsibility of the service provider toeducate the public so that the customerdoes not have unrealistic demands andexpectations of the service.

� Recovery: Recovery means acting quicklywhen the customer is not satisfied by, forexample,

— recognising the customer’s perceptionand apologising,

— giving the customer a reasonableexplanation for what had occurred,

— compensating the customer for theinconvenience,

— ensuring that the problem does not occuragain.

� Benchmarking: Benchmarking iscomparing oneself with the standards of thebest in a particular field though thecomparison need not be with a competitoror even with an organisation in the sameline of business.

CONCLUSION

The TQM approach addresses tough issues anddescribes costs and rewards of implementingthe change process. TQM philosophy createsan opportunity which does not require in-depthcost justification to convince the rank and file. Itis a challenging blueprint for corporate-widechange.

In order to be effective and successful, theconcept of Total Quality Management has to beapplied throughout — top to bottom, vertically,horizontally, functional and cross functional —just with one aim that is total customersatisfaction. The focus should be on customerthrough management commitment, totalparticipation and systematic analysis. TotalQuality Management is not a programme, it is acontinuous process — never ending. Thesystematic methods form the architecture thatlinks quality to customer satisfaction.


Today most organisations operate in a businessclimate in which uncertainty, risk and complexityin the external environment are becomingfundamental facts of life. Pressures ofinternational competition and marketglobalisation are such that organisationsintending to become corporate leaders shouldaim to be the best in class in the key areas thatsustain competitive advantage. The marketplace is rapidly changing and consumer’sexpectations continue to rise. Customers arebecoming more informed and more demandingof their suppliers.

To continue to succeed, companies must focusincreasingly on product and servicedevelopment and on consumer and marketresearch. This requires the ability to focusexternally, in order to compare the firm’sstrengths and weaknesses in meetingcustomer’s expectations relative to the bestperformers. It also requires targeting in weakareas within the organisation for specificimprovement in activities. Benchmarkingenables the organisation to enhance itscompetitive advantage by learning from practiceof others internally and externally, at strategic,operational or business management level.

Benchmarking is a continuous managementprocess that helps firms to identify thebenchmark and to use that knowledge indesigning a practical plan to achieve superiorityin the market place. The measurement ofrelative performance takes place along the threecomponents of a total quality programme-

BENCHMARKING

� It means observing Best Practices in competitors or companies in other industriesin some activity, function or processes and comparing one’s own performance totheirs.

� In effect, it implies setting benchmarks for excellence and working towards it.� Normally the measurement is done along three components - Products/Services,

Process/Procedure and People.� Being externally focused, Benchmarking leads to setting higher standards.

products and services, business processes andprocedures and people.

This brings about changes that lead to quantumand continuous improvements in products,processes and services that result in totalcustomer satisfaction and competitiveadvantage. The strategy consultants McKinsey& Co viewed benchmarking as a skill, an attitudeand a practice that ensures an organisationalways has its sights set on excellence, notmerely on improvement.

Benchmarking involves observing competitorsor companies in other industries that exemplifybest practice in some activity, function orprocess and then comparing one’s ownperformance to theirs. This externally orientedapproach makes people aware of possibleimprovements needed; beyond what they wouldhave thought possible. In contrast, internalyardsticks that measure current performancein relation to prior period results, current budget,or the results of the other units within thecompany rarely have such an eye-openingeffect. Moreover, these internally focussedcomparisons have the disadvantage of breedingcomplacency through a false sense of securityand of stirring up more energy for intramuralrivalry than for competition in the market place.

There are four types of benchmarking activitywhen seen from the perspective oforganisations/divisions in relation to whom thebenchmarking is done. They are, internal,functional, competitive and generic.


An effective benchmarking process has thefollowing six steps:

� Determine the key performance areas to bebenchmarked. They may include productand services, customers, businessprocesses in all departments and theorganisation, business culture and thecalibre and training of employees.

� Identify the most relevant competitors andbest-in-class companies.

� Set the key standards and variables tomeasure

� Measure regularly and objectively

� Develop an action plan to gain or maintainsuperiority.

� Specify programmes and actions to closethe gap, implement and monitor ongoingperformance.

In the service industry environment criticalbusiness processes are similar and capable ofbeing benchmarked in the same way as inmanufacturing environments. Key operationalissues which have been identified in service are:productivity improvement, standardisationversus customization, batch versus unitprocessing, job design, managing queues andcapacity management.

Focus on the Bottom Line

A successful approach to benchmarkinginvolves a clear focus on the business andbottom line and continuing emphasis on beingexternally, rather than internally, focused.Experts cite the following keys to successfulimplementation of benchmarking initiatives.

� Commitment to the aims and the processthroughout the organisation.

� Involving the people who will make thechanges.

� Understanding customer needs and owninternal business processes.

� Focusing on the processes first and themetrics second.

� Identification of the right performancevariables to benchmark.

� Taking small steps at a time by focusing ona few key processes initially.

� Making the measurements objective andtruly comparable.

� Being honest in assessment, in sharinginformation and in providing feedback.


What is ISO?

ISO stands for International StandardsOrganisation. It is a worldwide federation ofNational standards bodies. National standardbodies of different countries are members of ISO.ISO was first established in 1985 when around85 countries became signatories to this universalstandard. The Headquarters of ISO is in Geneva,Switzerland. Earlier different countries followeddifferent standards and hence there was nouniformity. ISO seeks to establish universalstandards of quality and thus help in bringingabout quality improvement worldwide.

Establishment Standards

The work of preparing International Standards isnormally carried out through ISO technicalcommittees. Each member body interested in asubject for whom a technical committee has beenestablished has the right to be represented onthat committee. International organisations,governmental and non-governmental, in liaisonwith ISO, also take part in the work. Publicationas an International Standard requires approvalby at least 75% of the member bodies casting avote on draft International Standards.

What is Quality

Interestingly, the ISO standard does not prescribeany rigid measure of quality. According to ISO,quality is defined as ‘The degree to which a setof inherent characteristics fulfill requirements’.The definition takes into account the difficulty inprescribing the uniform measure of quality dueto inherent differences in resources,infrastructure and the expectations of customersacross countries. However ISO demands thatthere should be ‘continual improvement’ in quality.By implication this means that while eachinstitution can define its own measure of quality,it should continuously strive for progressiveimprovements in it.

Revision

The ISO standard was first adopted in 1987. Itwas later revised in 1994. The present versionISO 9001:2000 is adopted in 2000. The standard

ISO 9001

� ISO 9001 is an international quality standard and adopted first in 1987.

� The standard aims to promote quality and continual improvement in organizations.

� The certification is issued by Registrars.

is revised at periodical intervals in order to reflectthe changes in the environment and to updatethe provisions based on experience.

Registrar and Consultant

It is pertinent to note that while ISO adoptsstandards it does not give certification. Eachnation has a National Body, which is an accreditedmember of ISO. These National bodies in turnempower Registrars for issuing certificates to userInstitutions on its behalf. Registrars aredesignated by the National bodies based on thetheir competency, track record and experience.The Registrars issue ISO certification on behalfof the National body to various institutions. Thecertificate is valid for three years. However,periodical inspections are conducted to reviewQuality Management in a span of 6 to 9 months.In case Quality standards as accepted by theusers are not maintained, Registrars have theright to cancel certification. Registrars charge afee for certification and for conducting periodicaudit. The fee charged by different Registrarsare different. A consultant is one who guides thecertification-seeking institution, for a fee, inobtaining certification.

Auditing

Auditing is necessary for maintenance andimprovement of any systems and procedures. Asalready mentioned, periodical auditing is doneunder ISO certification by Registrars. Besides this,the users themselves should conduct periodicalinternal audit through their own staff designatedfor the purpose. This exercise helps not only inregular rectification of irregularities but also infamiliarizing the people in office with the qualitymanagement practices of the user institution.

ISO Certification will institutionalize a culture ofQuality in the organisation.The certifying bodies are proposing to issuecertificates for those companies which areadhering to both quality and environmentstandards under Integrated ManagementStandard (IMS) to save on multiplicity of structure,documents and procedures.


What is ISO 14000?The ISO 14000 standards are voluntaryenvironmental management system standardsbeing created under the auspices of theInternational Organization for Standardization.ISO has 111 member countries representedmainly by industry and government standardsgroups.

The standards can be classified according totheir focus:

Organization and process evaluation standards-Environmental management system (ISO14000,14004), environmental auditing (ISO14010, 14011/1, 14012) and environmentalperformance evaluation (ISO 14031).

Product-oriented standards - Life-cycleassessment (ISO 14040, 14041, 14042, 14043),environmental labelling (ISO 14021, 14024,14025) and environmental aspect in productstandards (ISO 14060).

Definition standard - A terms-and-definitionsstandard (ISO 14050) harmonizes the languageamong the others.

ISO 14001, the environmental managementsystem specification, is intended as the onlystandard establishing requirements againstwhich companies will be audited for certification.It is the backbone of the series.

ImplementationWorldwide interest in these standards amongboth countries and governments is growing.Many countries and companies have alreadystarted implementing ISO 14001 with an eyetoward certification.

The list of reasons companies are now adoptingan environmental management system, andISO 14001 in particular, includes identifyingareas for reduction in energy and other resource

ISO 14000

� ISO 14000 is a quality standard for environmental management.

� The standard is voluntary.

� It can be obtained for the whole company or a department.

� It helps in reduction of energy consumption, liability and risk and improvescompliance to legal and regulatory requirements.

consumption, reducing liability and risk andimproving compliance with legislative andregulatory requirements.

It is VoluntaryISO 14001 is not a mandatory requirement: it isvoluntary. But it may end up being a requirementfor conducting international trade. It is not aperformance-based standard that prescribeslevels of emissions and releases. But you mustcommit to following the laws of the land andpreventing pollution. ISO 14001 is not a productstandard. Rather, it is a systems-based standardthat gives the company a blueprint for managingenvironmental impacts. ISO 14001 can beimplemented piece meal, in any fashion, fromthe corporate level to the single-unit level.

What are the Major Requirements ?The standard’s first requirement is that acompany should have a publicly availableenvironmental policy articulated by topmanagement. It should be appropriate to thenature of the organization and includecommitments toward pollution prevention.Establishment and maintenance of proceduresto identify significant environmental aspects andtheir associated impacts are also envisaged.Procedure to ensure compliance should beconsistent with the environmental policy andinclude legal and other requirements. Objectivesand targets are to be documented and must beconsistent with the goals of the environmentalpolicy, including continual improvement andpollution prevention.The certifying bodies are proposing to issuecertificates for those companies which areadhering to both quality and environmentstandards under Integrated ManagementStandard (IMS) to save on multiplicity ofstructure, documents and procedures.


Quality circle is a small group of employees inthe same work area, who meet regularly toidentify, analyse and solve work-relatedproblems in their work area. If necessary, helpfrom specialists can be taken.

OPERATION OF QUALITY CIRCLE

� Identity problems

� Prioritise the problems

� Choose one problem for the project

� Analyse the causes of the problem

� Develop solution

� Present it to Management for approval

� Implement solution

� Review implementation and results

� Move over to next project

PARETO ANALYSIS: Pareto is an Italianeconomist. Pareto analysis helps in identifyingthe vital few from the trivial many at a glance,when projected using column graph named afterPareto. It facilitates fixing the priorities forselection of the problem to be taken up serially,listed after brain storming and data collection.

ISHIKAWA OR FISHBONE DIAGRAM: Thistechnique was devised by Dr. Ishikawa whoconceived Quality Circles. In this diagram, asystematic arrangement of all possible causeswhich give rise to the effect are made. Beforetaking up a problem for detailed study it isnecessary to list down all the possible causesthrough brain storming so that no importantcause is missed.The causes are generally divided into the fourmajor sources (groups) viz Man, Machine,Method and Material. Each source is ultimatelydivided into sub-sources. After the Ishikawadiagram, brainstorming is undertaken to arrive

QUALITY CIRCLES

� QC is a small group of employees in the same work area, who meet regularly toidentify, analyse and solve work related problems.

� The members identify problems, prioritise the most important problem to beaddressed, develop solutions and implement them.

� Brain Storming, Pareto Analysis and Fish Bone Diagram are the key techniquesused.

at solutions/recommendations to resolve eachcause individually.

BRAIN STORMING

1. Each member will be, in rotation, asked forideas. This has to continue until all ideasare exhausted. To enable flow of ideas eachcan ask himself- What, why, when, where,who and how ?

2. No idea shall be dismissed as irrelevant/stupid - Free flow of ideas shall be allowed.

3. No evaluation of ideas shall be done duringthe process of brain storming.

4. Leader shall help in summarising the ideaand enable clarity of expression bymembers.

5. After ideas are exhausted and brainstorming completed, each idea shall betaken up for detailed discussion andconsensus arrived at on those which arevalid and vital.

6. Prior distribution of agenda to members willenable them to think in advance andparticipate in QC deliberations.

7. If non-members drop in during brainstorming, they may be allowed to join in.

8. Keep a record of the brain storming forfuture reference.

MANAGEMENT PRESENTATION: It is theculmination of the Quality Circles’ project studyand helps in making the recommendationsbased on the solutions to the problems chosen,more effectively and purposefully.

IMPLEMENTATION: Following therecommendations of the QC, implementationhas to be given priority after securing thenecessary approvals.


Definition

Financial engineering is a multi-disciplinaryapproach to the management of risk and returnwhich involves the use of derivative instrumentsto decompose standard financial transactionsinto their elements and then synthesise theseelements into innovative cross market structurescustomised to the particular requirements ofcounter parties.

The term ‘financial engineering’ was coined inthe mid-1980s, among London investmentbanks and is the product of several paralleldevelopments.

The emergence of both derivative instrumentsand financial engineering has only been possiblebecause of the development of new informationtechnology, in particular, the PC andspreadsheet software. These innovations haveprovided a fast and flexible means of managingthe large volumes of information which arenecessary to construct complex transactions.Other innovations, mainly in the field oftelecommunication, have reduced the cost ofgenerating and delivering the information. Lowercosts have in turn increased the availability ofinformation, which has extended the range ofopportunities for financial engineering to exploit.

An important force behind the emergence offinancial engineering has been the trend towardsliberalisation of financial markets which beganat the end of the 1970s. The removal of officialbarriers has permitted the cross-market activitythat characterises financial engineering. Thecompetition it has unleashed has encouragedthe process. However, care needs to be taken

FINANCIAL ENGINEERING

� Financial Engineering is a sophisticated management technique aimed to managethe risk and return of financial transactions.

� It uses derivative instruments to hedge (counter balance) risks.

� Advancement in IT and telecommunication has strengthened financial engineering.

� Increasing volatility of prices and interest rates underline the importance of financialengineering.

in attributing cause and effect in this area.Financial engineering has played a part inencouraging liberalisation, by undermining theeffectiveness of regulation.

The increasing volatility of prices during the1970s and 1980s increased both the need tohedge risk and the opportunities for taking risk.Financial engineering is the product of thegrowing sophistication of risk managementtechniques. It reflects the more rigorousapplication of the scientific method to finance,in particular, analysis into elements andempirical testing (in the form of financialmodelling and sensitivity analyses). It has alsobeen seen in a trend towards the recruitment ofstaff with scientific rather than financial training.

Multi-disciplinary Approach

Financial engineering straddles severaltraditional financial markets. It is also frequentlyused to exploit anomalies in the tax, accountingand regulatory frameworks within which marketsoperate. Financial engineering is thereforeconducted by ‘teams’, which bring togethertraders, financial analysts, syndication staff,corporate finance officers, lawyers, taxspecialists, accountants, mathematicians,statisticians, compliance officers, programmersand other specialists.

Financial Engineering involves the application ofderivative instruments such as swaps andoptions. Through the process of decompositionof financial instruments into forward and optioncontracts and synthesising them into newcombinations, the objective of FinancialEngineering is achieved.


ECONOMIC VALUE ADDED (EVA)

� EVA helps to measure the extent of value created for shareholders

� EVA= Net Operating Profit After Tax (NOPAT) – (Cost of capital * OperatingCapital)

� Eg: If NOPAT is Rs. 100000/-; Capital employed is Rs.500000 and Cost of Capitalis 12% then EVA= {100000- (500000 * 12%)= 100000-60000= Rs.40000

� Capital includes both equity and debt; and determining cost of equity is difficult

� The speciality of EVA is that it takes into account Capital employed and the risk asmeasured by cost of capital

Various indicators are used to identifycompanies which are investment worthy. Sales,net profit, book value, dividend yield, Return onnetworth, return on capital employed, EPS, EPSgrowth and so on, have enjoyed popularity atdifferent times. One such measure is ‘economicvalue-added’ (EVA).

Simply put, EVA is the difference between therates at which the company is earning from itsoperations and its cost of capital. Mathematically,it is the difference between the net operatingprofit after tax (NOPAT) and the operating capitalemployed times the cost of capital. It hasemerged as a useful tool in corporate finance tothe extent that it is able to capture the cost ofcapital employed.

The EVA looks at how well the company hasdeployed its capital to get optimal returns. It looksat the rate at which the assets are put to useand compares the cost of such capital. If thecompany is able to earn a return which is morethan its cost of capital, it is said to be creatingwealth for its shareholders.

EVA as a measure has an edge over traditionalmeasures like earnings per share (EPS) andreturn on equity (ROE) which are pure returnfunctions and do not factor in risk. To that extent,EVA provides a more refined barometer of valueaddition after defraying the costs of owed andowned funds. There are, however, some popularmyths which one need to be aware of tounderstand EVA more effectively.

One of the myths about EVA is that the onlycomplication in calculation of EVA is theestimation of the cost of equity to arrive at the

cost of capital. In reality, calculating EVA for anycompany involves hundred of adjustments toarrive at a credible figure of operating profit. Thisis because any changes in depreciation policy,inventory valuation policy or in accounting fordeferred taxation as also lease adjustments canhave a major impact on profits and all thesefactors need to be adjusted.

Another dangerous myth about EVA is that it isan ideal measure for comparing value creationacross companies and industries. EVA bydefinition is biased against companies which arecapital intensive. This is because EVA onlyconsiders the capital outlay necessary forcreation of physical assets and ignores theimplicit capital outlay involved in the creation ofintangible assets.

The last and perhaps the greatest myth aboutEVA is that companies with high EVA are cashrich. What EVA actually depicts is the notionalvalue created by a business. It has no relationto the liquidity requirements of the business.More so for companies that are cash sensitiveand where shortage of cash can lead tobankruptcy of the company. That explains whymany software companies which show high EVAin their books of accounts could still be on theverge of bankruptcy if their cash sensitivity isfactored in.

EVA is the ideal measure for matured companiesor matured industries. But for cash sensitivecompanies or companies in the growth stageof the business cycle, where liquidity is a majorfactor, the CVA (Cash Value Added) could betterdepict value creation.


Market Value Added (MVA) is used by manycompanies to show how they have rewardedtheir shareholders. The MVA is defined as theexcess of the market value of the company overthe value of the investor’s capital.

It quantifies the premium the market is willing topay for the value created by the company.Mathematically, it is defined as the sum of thecurrent market value of debt and equity, less theeconomic book value.

The MVA of a company is determined by twofactors: The market value of the capitalemployed and its economic value. In the caseof equity, it is possible to find out the market valueif the shares are regularly traded in the stockexchange. In the case of unlisted companies orinfrequently traded companies, it is difficult todetermine the market value of equity. Hence,MVA, as a concept, is not applicable to suchcompanies.

In the case of debt, it is difficult to determine themarket value, as term loans from banks andfinancial institutions constitute 75-80 per centof the total borrowings by companies. For suchterm loans, there is no secondary market and,hence, it is not possible to determine the marketprice. Where the borrowers have issueddebentures, which are listed, it is possible todetermine market value, but even then the ratesmay not reflect the price, as the secondarymarket is not well developed.

Conversely, it is possible to find out the

MARKET VALUE ADDED (MVA)

� MVA is defined as the excess of the market value of the Company over the value ofinvestors’ capital.

� Thus MVA= (Market value of debt and equity – Book value of debt and equity).

� Book value of equity is the equity plus retained earnings.

� MVA is similar to Price Earning Ratio except that MVA indicates an absolute figurewhile PER is a ratio.

theoretical market price assuming the currentinterest rate and the rate at which the companyhas borrowed. In other words, what would bethe price, if the total borrowings were listed inthe market, assuming the current interest rates,its credit rating and the risk perception of thecompany. But this may indicate only thetheoretical market value and not the true value.This is also not the cost to the company as itmay be able to borrow at a rate that issignificantly different from the market rate in thepast. Benchmarking these borrowings againstthe current interest rate may not reflect the truecost to the company too. Hence, the bestalternative would be to use the book value asmarket value. This is what many companieswhich give MVA finally boils down to thedifference between the market value of equityand its economic book value. A company createsvalue in the market if its MVA is positive. Thiswould mean that the company has created morewealth than it has raised from its shareholdersas well its retained earnings which have beenreinvested.

The MVA is same as the price-to-book-valuefigure. The former is the difference between themarket value and the economic value whereasthe latter is the ratio between the two parameters.A price-to-book-value of more than one indicatesthat the company has created value in terms ofmarket valuation, which is the same as a positiveMVA.


EMERGING TRENDS IN BANKING AND FINANCE:ROLE OF NEW GENERATION MANAGERS

� The pace of changes in the world today calls for managers who have not just ‘probityand prudence’ but the capacity to handle ‘competing priorities’.

� 5 significant trends: Balance sheet to Off-balance sheet intermediation, Capitaladequacy to capital efficiency, physical to virtual distribution, fragmentation toconsolidation and data to knowledge through information.

� New Generation Managers should have the capacity to manage transition.

Building up an organizational architecture thatgenerates intellectual capital has been a hugechallenge for banks and financial institutions. Itis even more so today, when we are undergoinga period of the most rapid acceleration of whatis alluded to as ‘creative destruction’ in the historyof the financial sector. In the process of creativedestruction, new constructs emerge. It is herethat ‘new generation’ managers may have a rolemore demanding than that of the managers ofyesteryears. A role which calls for more than just‘probity and prudence’ that characterized thebanker of yesteryears and increasingly focuseson managing ‘competing imperatives’.

EMERGING TRENDS

First, there is the transition from banking tofinancial services. Banks are uniquely poised tobroaden their product lines into the completeofferings that would go under the rubric offinancial services. This would imply a newfounded emphasis on marketing; be it ofinvestment, insurance and other products thatconsumers want. Banks have advantages intheir image of trustworthiness and their extensivedistribution systems. How they convert this intoa marketing advantage will determine how theywin market shares.

Trend from Balance Sheet to Off-BalanceSheet Intermediation

Then there is the trend from balance sheet tooff-balance sheet intermediation. Banking is nolonger confined to ‘acceptance of deposits forthe purposes of lending’ - today it refers tointermediating and managing risk. As the scopeof intermediation expands to incorporate marketrisks, bankers are taking a view on how they will

strategically position themselves in this newenvironment. While some will, perhaps, chooseto migrate rapidly to off-balance sheet investmentor merchant-banking activities, others maystress on volume origination which they cansecuritize and then manage for a fee, and stillothers may continue to position themselves astraditional banking retail players focusing ondeposit intermediation. Nevertheless, the trendtowards off-balance sheet intermediation and thecomplexities that it entails will demand that themanagers of the future be equipped with financialskills in a significantly greater measure.

Trend from Capital Adequacy to CapitalEfficiency

Thirdly, there is the transition from capitaladequacy to capital efficiency.

The Basel II prescriptions have already put uson track for transition from the traditionalregulatory and market measures of capitaladequacy to an evaluation of whether a bank hasfound the most efficient use of its capital tosupport its new business mix. In effect, futureplans may, therefore, include the fluid use ofcapital, an approach that has been called the“just-in time balance sheet” management, inwhich capital flows quickly to its most efficientuse. In this transition, how capital is used andhow much capital is needed will become asignificant factor in evolving return on equitystrategy for years ahead and strategic plans maybe required to execute this kind of approach.

Trend from Physical to Virtual Distribution

Perhaps the most visible and overt change inbanking in the eyes of the public has been thetrend for banks to move away from branch


banking to electronic, anywhere-anytimedistribution of financial services. If this hastriggered the ‘death of distance’, the Real TimeGross Settlements (RTGS) System isthreatening to consign time lags in settlement offinancial transactions to history. In reality, deliverysystems like ATMs, online banking and phonebanking are a continuum of options from whichthe consumer selects. Consumers select thedelivery system that is right for them. In otherwords, distribution differentiates a bank when itsets up a delivery system that attracts certaincustomers. Distribution is the new way tosegment consumer markets and the transitionof distribution systems is in fact emerging as anessential part of bank repositioning strategy.

Trend from Fragmentation to Consolidation

The forces of change today are favouring largerentities which bring mergers and acquisitionssquarely into the strategic decision-making ofthe banking sector. We are slowly moving froma regime of ‘a large number of small banks’ to ‘asmall number of large banks’. Every bank will, ofcourse, depending on its strategy, have tomigrate to its best position in this new structure.Picking a market position and transitioning to itis one of the most significant strategic decisionsa bank must make. All types of entities can behighly profitable if they transition to the rightmarket position and right cost structure toexecute the strategy.

Trend from Data to Information to Knowledge

Perhaps the most talked about, yet leastunderstood, transition ahead is in the area ofinformation technology and informationapplication. Distribution and processingtechnology transitions are keys to the shift tovirtual banking which is prompted by the desireto have low cost operations. But technology-driven information transformation is at the centre

of the even more important management,marketing, and risk transitions that banks mustmake. Information is only valuable if it can beput to work and used for decision tools such asprogrammed trading, target marketing, predictivecredit modeling and scoring, amongst others.Most new financial services are in fact based ontechnology. The transition from an old world ofdata processing and information managementto a new world in which knowledge is being putto work on competitive advantage will be a majorstrategic preoccupation in the years ahead.

ROLE OF NEW GENERATION MANAGERS

Managing these transitions well is the secret tostrategic execution. Organizations ultimatelystand or fall on the quality of the work anddecisions made by their people. So what setsmost successful organizations apart is how theymanage human resources. Increasingly, banksall over are, therefore, adopting the socio-technical approach to job design that recognizesthe productivity gains of optimum technologicalarrangements as well as the importance ofworkplace sociology. The new generationmanagers on their part will have to learn how tocreate and thrive in an environment thatembraces change not as a threat but as anopportunity.

While leadership skills, the ability to multi-taskand manage competing impreatives will be thenecessary ingredients of the new generationmanagers, the old-fashioned qualities of a desireto learn, a strong sense of professional ethics,an enquiring mind, a strategic view, the qualitiesof humility and empathy, a willingness toembrace practical experience, and aneagerness to adapt to new experiences wouldbe critical.


COMMITTEES


COMMITTEE ON FULLER CAPITAL ACCOUNTCONVERTIBILITY

� The Committee on Fuller Capital Account Convertibility (Chairman: Shri S. S. Tarapore)submitted its Report in July 2006.

� The committee’s recommendations encompassed almost all segments of the financialmarkets.

The Committee on Fuller Capital AccountConvertibility (Chairman: Shri S. S. Tarapore)submitted its Report in July 2006. The majorrecommendations were as follows:

Money Market

• Prudential regulations should bestrengthened to encourage capital inflows.

• More players should be allowed to accessthe repo market.

• The CBLO and the repo markets should beallowed to cover corporate debtinstruments.

• Skills should be upgraded to develop theinter-bank term money market.

• Prudential limits for commercial paper (CP)and certificates of deposit (CD) may befixed.

• The market in interest rate futures shouldbe activated and interest rate options shouldbe allowed. Provision for netting of derivativetransactions should be made, beforeopening up the swap market.

• Fixed Income Money Market and DerivativesAssociation (FIMMDA) be suitablyempowered to act as a self-regulatoryorganisation to develop market ethics,trading standards and also undertakeregulation of participants, besidesdisseminating information.

Government Securities Market

• The share of mark-to-market categoryshould be progressively increased.

• Short-selling across settlement cycles withadequate safeguards should be permitted.

• Gilt funds should be exempted from thedividend distribution tax and income up to a

limit from direct investment in gilts could beexempted from tax to stimulate retailinvestments in gilts.

• STRIPS in Government securities shouldbe expeditiously introduced.

• Non-resident investors, especially longerterm investors, could be permitted entry toexpand investor base.

• Repo facility in Government securitiesshould be widened by allowing all marketplayers without any restrictions.

• The limit for FII investment in Governmentsecurities could be gradually raised to 10per cent of gross issuance by the Centreand States by 2009-10. The allocation bySEBI of the limits between 100 per cent debtfunds and other FIIs should be discontinued.

Foreign Exchange Market

• The spot and forward markets should beliberalised and extended to all participants,removing the constraint on pastperformance/underlying exposures.

• Bank margins on foreign exchangetransactions of smaller customers need tobe reduced by separating foreign exchangebusiness from lending transactions andintroducing an electronic trading platform.

• The Reserve Bank’s intervention in theforeign exchange market should be throughthe anonymous order matching system.

• To nurture interest rate parity in forwardmarkets, more flexibility may be provided tobanks to borrow and lend overseas both onshort-term and long-term, depending uponthe strength of their balance sheet.

• Currency futures may be introduced subjectto risks being contained through proper


trading mechanism, structure of contractsand regulatory environment.

• The existing guaranteed settlement platformof CCIL needs to be extended to theforwards market.

• The banking sector should be allowed tohedge currency swaps by buying and sellingwithout any monetary limits.

Fiscal Consolidation

• The Central and the State Governmentsshould graduate from the present systemof computing the fiscal deficit to a measureof the public sector borrowing requirement(PSBR).

• The Office of Public Debt should be set upto function independently outside RBI.

Strengthening of the Banking System

• All commercial banks should be subject toa single banking legislation.

• The minimum share of the CentralGovernment/RBI in the capital of the publicsector banks should be reduced from 51per cent (55 per cent for the State Bank ofIndia) to 33 per cent. The proposed transferof ownership of the State Bank of India fromthe RBI to the Central Government shouldbe put on hold.

• Setting up of new private sector banks andconversion of nonbanking financecompanies into banks should beencouraged.

• Issues of corporate governance in banksneeded early attention.

Monetary Policy

• RBI should activate variable rate repo/reverse repo auctions/operations on a realtime basis and also consider somewhatlonger-term LAF facilities.

• To the extent RBI assesses the excessliquidity to be more than transient, it shouldalso use the Cash Reserve Ratio (CRR)and the Statutory Liquidity Ratio (SLR).

• The authorities may consider the impositionof an unremunerated reserve requirementon fresh FII inflows in extreme situations.

• RBI and the Central Government shouldjointly set out the objectives of monetarypolicy for a specific period and this shouldbe put in the public domain. A formalMonetary Policy Committee should be setup for strengthening the institutionalframework.

External Sector

• A monitoring exchange rate band of +/- 5.0per cent around the neutral real effectiveexchange rate (REER) may be consideredand the REER should incorporate servicesto the extent possible.

• As an operative rule, if the current accountdeficit persists beyond three per cent ofGDP, the exchange rate policy should bereviewed.


TECHNICAL GROUP TO REVIEW THE LEGISLATIONSON MONEY LENDING

� The Technical Group recommends strict regulation of moneylenders by Stategovernments.

The Technical Group (Chairman: Shri S.C.Gupta) made the following recommendations:

� Moneylenders should be registeredcompulsorily with the State Governments.Unregistered moneylenders will bepenalised. The procedure for registrationand renewal should be made simple andhassle free.

� In order to focus the legislation on theregulation of money lending transactions,banks, statutory corporations, co-operatives, financial institutions, NBFCs andRBI need to be kept out of the purview ofthe legislation.

� To provide the State Governments with theflexibility of adjusting the rates of interest inaccordance with the market realities, themaximum rates of interest to be chargedby moneylenders should be notified by theState Governments from time to time. Whiledetermining the maximum rate, the rangeof interest rates and costs and otherexpenses being charged should be takeninto account. In order to prevent usury, therule of damdupat has been recommended.

� Alternate dispute resolution mechanismssuch as Lok Adalat and Nyaya Panchayatfor speedy and economical dispensation ofjustice have been recommended.Alternatively, State Governments may thinkof setting up of fast-track Courts/designatedCourts to deal with disputes relating tolending transactions by money lenders andaccredited loan providers. The choice of the

forum can be decided by the StateGovernments depending upon the localconditions.

� In order to ensure that the enforcement/administration of the legislation is properlymonitored, a new section has beenproposed which would require StateGovernments to place an annual report onthe administration of the legislation beforethe State Legislature.

� The State Governments should takeadequate steps to publicise the maximumrates of interest notified under the Act, theoffences under the Act and the disputeredressal machinery provided thereunder.

� A new chapter in the States’ money lendinglegislations, aimed at establishing a linkbetween the formal and informal creditproviders, to be called ‘Accredited LoanProviders’, has been recommended.

� The Technical Group has recommended aset of conditions in the agreement betweenthe banks/financial institutions and the‘accredited loan providers’ as safeguardmeasures.

� The advances made by institutionalcreditors to accredited loan providers maybe treated as priority sector lending. Thiswould encourage the banks to take up therole of institutional creditors and disburseloans through the linkage with accreditedloan providers as an additional business.


NATIONAL COMMISSION ON FARMERS

� Prime farm land must be conserved for agriculture and should not be diverted fornon-agricultural purposes.

� Livestock Feed and Fodder Corporations, National Livestock Development Counciland National Biotechnology Regulatory Authority may be established with farmers’representatives.

� User-friendly insurance instruments covering production, post-harvest operations andmarket risks be introduced.

� The policy and legal framework governing the cooperatives may be reviewed.

The Government of India constituted a NationalCommission on Farmers (NCF) under thechairmanship of Shri Sompal on February 10,2004 to examine various issues confronting theIndian farmers and to suggest appropriateinterventions for improving the economic viabilityand sustainability of diversified agriculture,including horticulture, livestock, dairy andfisheries, and for doubling the farmers’ income.The Commission was subsequently re-constituted under the chairmanship of Prof. M.S.Swaminathan on November 18, 2004. The NCFsubmitted five Reports between December2004 and October 2006 to the Government ofIndia. The major recommendations of theCommission are:

• Prime farm land must be conserved foragriculture and should not be diverted fornon-agricultural purposes.

• Livestock Feed and Fodder Corporations,National Livestock Development Council andNational Biotechnology Regulatory Authoritymay be established with farmers’representatives.

• User-friendly insurance instrumentscovering production, post-harvestoperations and market risks be introduced.

• The policy and legal framework governingthe cooperatives may be reviewed.

• The Minimum Support Price (MSP) of cropsshould be linked to the input costs. TheGovernment should procure the staple

grains needed for the Public DistributionSystem (PDS) at the prices that privatetraders are willing to pay to farmers. TheMSP should be at least 50 per cent morethan the weighted average cost ofproduction and should be expanded to coverall crops of importance for ensuring food andincome security to the small farmers. TheCommission on Agricultural Costs andPrices (CACP) should be an autonomousstatutory organisation. The PDS should beuniversal and should undertake the task ofenlarging the food security basket.

• The Indian Trade Organisation (ITO) maybe established to safeguard the interests offarmers.

• A few Centres of Excellence on the modelof the Indian Institute of Technology (IITs)/Indian Institute of Management (IIMs) shouldbe established to enhance competitivenessof the agriculture graduates.

• As price fluctuation/competition fromproducts imported from abroad are amongthe major problems facing a large numberof small farmers engaged in the cultivationof plantation crops, a Price StabilisationFund may be considered. Agriculture RiskFund and Food Guarantee Act should beformulated.

• A multi-stakeholder National Food Securityand Sovereignty Board chaired by the PrimeMinister may be set up.


• There is a need for an Agriculture CreditPolicy and both credit and insurance literacyin villages. Drought prone areas shouldhave a 4-5 year repayment cycle for croploans, taking into account the managementof risk. NABARD should function like aNational Bank for Farmers.

• The Ministry and Departments of Agriculture,both at the Centre and the States, may berestructured to become Ministry/Department of Agriculture and Farmers’Welfare in order to highlight their critical rolein ensuring the income and work securityof over 600 million members of India’spopulation.

The key recommendations covering the entirefarming spectrum have been incorporated in theRevised Draft National Policy for Farmers. TheMinistry of Agriculture, Government of India, helda Conference of State Ministers on December23, 2006 to discuss the recommendations ofthe NCF. The State Ministers of Agriculture andAllied Sectors have supported therecommendations made by the NCF and havealso given a number of suggestions. Thesuggestions made by the NCF are underconsideration of the Government of India.


NATIONAL DEVELOPMENT COUNCIL:RESOLUTION ON AGRICULTURE

� A Food Security Mission to be launched as a Central scheme with the objective ofproducing over the next four years an additional eight million tonnes of wheat, 10million tonnes of rice and two million tonnes of pulses over the base year (trienniumending 2006-07).

� Plan for each district to be formulated utilizing resources available from all existingschemes. State agricultural plans to be formulated based on district plans aimed atachieving the States’ agricultural growth objective.

Actions to be taken by the CentralGovernment

(i) A Food Security Mission to be launched asa Central scheme with the objective ofproducing over the next four years anadditional eight million tonnes of wheat, 10million tonnes of rice and two million tonnesof pulses over the base year (trienniumending 2006-07).

(ii) A new Additional Central Assistance (ACA)to State Plans to be introduced to incentiviseStates to draw up plans for their agriculturesector taking into account agro-climaticconditions, natural resource issues andtechnology integrating livestock, poultry andfisheries.

(iii) Additional resources to be provided forirrigation via Accelerated Irrigation BenefitProgramme (AIBP), including a componenton modernisation, linked to adoption ofimproved participatory irrigationmanagement and command areadevelopment. Schemes involving intra-Statelinking of rivers could also be consideredfor AIBP.

(iv) Additional resources to be provided for theNational Strategic Research Fund. Initiativesto be taken to improve the skill developmentin the farming community for employingmodern methods of agriculture.

(v) The pattern of Rural InfrastructureDevelopment Fund (RIDF) allocation byNABARD to be restructured so as to build itproperly into the State and District plans.

(vi) Steps to be initiated to restructure thefertiliser subsidy programme for properdelivery to the farmers as also for providingbalanced plant nutrition without adverseeffects on soils. The use of bio-fertilisers,organic manure and micro-nutrients toenhance soil health will be promoted.

Actions to be taken by the StateGovernments

(i) Plan for each district to be formulatedutilizing resources available from all existingschemes. State agricultural plans to beformulated based on district plans aimed atachieving the States’ agricultural growthobjective. Each State will ensure that thebaseline share of agriculture in its total StatePlan expenditure is maintained to enable itto access the new ACA.

(ii) Special efforts to be made to completeprojects under the AIBP without time andcost overrun and prioritise irrigation projectsaccording to their agriculture productiontargets. States to also endeavour for betterwater management and improved water useefficiency.

(iii) Highest priority to be accorded to ensureadequate supply of quality seeds of cropsand fodder at reasonable prices and at theright time to help in reducing the existing yieldgaps.

(iv) A major expansion and revamping of Stateagricultural extension systems to beundertaken involving the State AgriculturalUniversities and Krishi Vigyan Kendras,


while using public private partnership (PPP),wherever possible.

(v) Signing of the Memorandum ofUnderstanding (MoU) (if not done so far) tobe expedited for early implementation of theVaidyanathan Committeerecommendations and monitorabledeadlines to be set for revamping the co-operative credit structure.

(vi) Development of modern markets to beencouraged by amending the Agricultural

Produce Marketing Committee (APMC) Actand notifying the rules thereunder. A varietyof instruments including cooperatives offarmers and contract farming to be used forreforms in agricultural marketing. Theprocess of notifying rules under theamended APMC legislation should becompleted during 2007-08.

Concrete proposals to implement these stepswill be spelt out in detail both by the CentralGovernment and the State Governments at theearliest.


SADASIVAN WORKING GROUP ON REASONABLESERVICE CHARGES BY BANKS TO CUSTOMERS

� The Working Group identified 27 services related to deposit/loan accounts, remittancefacilities and cheque collections, as an indicative list of basic banking services to beoffered by banks.

� In order to ensure reasonableness in fixing and communicating the service charges,the Working Group suggested a set of principles.

The Working Group to formulate a scheme forensuring reasonableness of bank chargesexamined various issues such as basic banking/financial services to be rendered to individualcustomers, the methodology adopted by banksfor fixing and notifying the charges and thereasonableness of such charges.

The Working Group identified 27 services relatedto deposit/loan accounts, remittance facilitiesand cheque collections, as an indicative list ofbasic banking services to be offered by banks.In order to ensure reasonableness in fixing andcommunicating the service charges, theWorking Group suggested a set of principles.According to these, for basic services renderedto individuals, the banks should (a) levy chargesat rates lower than the rates applied when thesame services are given to non-individualentities; (b) levy charges only if they are just andsupported by reason; and (c) levy servicecharges ad valorem only to cover incrementalcost, subject to a cap. For basic servicesrendered to special category of individuals, banksshould levy charges on more liberal terms thanthe terms on which the charges are levied toother individuals.

The recommendations of the Working Groupwere accepted by RBI with certain modifications

and RBI advised banks in February 2007 toidentify the basic banking services on the basisof the broad parameters indicated by theWorking Group and implement the acceptedrecommendations of the Working Group onmaking available such services at reasonableprices/charges. The list of services identified bythe Working Group is only an indicative one andbanks may, at their discretion, include within thecategory of basic services such additionalservices as they may consider appropriate.Banks are required to provide to customerscomplete information upfront on all chargesapplicable to basic services and any proposedchanges in charges, in a timely manner.Changes in the service charges are to becarried out only with prior notice to thecustomers of at least 30 days. Banks shouldinform the customers in an appropriate mannerregarding recovery of service charges. Banksare also required to inform customers in allcases where a transaction initiated by the bankitself results in or is likely to lead to a shortfall inthe minimum balance required to be maintained.The recommendations of the Working Grouprelating to redressal of grievances and financialeducation may also be implemented by banks.


COMMITTEE ON FINANCIAL SECTOR ASSESSMENT

� A Committee on Financial Sector Assessment (CFSA) was constituted by theGovernment of India in September 2006 (Chairman: Dr. Rakesh Mohan; Co-Chairman: Dr. D. Subbarao).

� Based on an objective analysis of the present strengths and weaknesses of thefinancial sector and the status with regard to standards, the CFSA is expected to laydown a roadmap for further reforms in a medium-term perspective.

A Committee on Financial Sector Assessment(CFSA) was constituted by the Government ofIndia in September 2006 (Chairman: Dr. RakeshMohan; Co-Chairman: Dr. D. Subbarao) with thefollowing terms of reference:

� To identify the appropriate areas, techniquesand methodologies in the Handbook onFinancial Sector Assessment brought outby the IMF/World Bank and also in any otherpertinent documents for financial sectorassessment relevant in the current andevolving context of the Indian financialsector;

� To apply relevant methodologies andtechniques adapted to the Indian systemand attempt a comprehensive and objectiveassessment of the Indian financial sector,including its development, efficiency,competitiveness and prudential aspects;

� To analyse specific development andstability issues as relevant to India;

� To make available its report(s) through RBI/Government of India websites.

The central plank of the assessment is basedon three mutually reinforcing pillars, viz., (i)financial stability assessment and stress testing;(ii) legal, infrastructural and market developmentissues; and (iii) assessment of the status andprogress in implementation of internationalfinancial standards and codes. To assist in theprocess of assessment, the CFSA hasconstituted four Advisory Panels for theassessment of (i) Financial Stability and StressTesting; (ii) Financial Regulation and Supervision;

(ii) Institutions and Market Structure; and (iv)Transparency Standards. The Advisory Panelswill prepare separate reports covering each ofthe above aspects. The Advisory Panelscomprise non-official experts with domainknowledge in respective areas and officials withsimilar expertise represented as specialinvitees. The panels would have the option ofcoopting as special invitees any other expertsas they deem fit.

The Advisory Panel on Financial Stability andStress Testing (Chairman: Shri M.B.N. Rao)would conduct macro-prudential surveillance(including system-level stress testing) to assessthe soundness and stability of the financialsystem and suggest measures forstrengthening the financial structure and systemand its development in a medium-termperspective.

The other three panels would (i) identify andconsider the relevant standards and codes ascurrently prescribed and applicable to differentareas; (ii) evaluate their implementation in theIndian context; (iii) identify gaps in adherence torespective standards; and (iv) suggest possibleroadmaps towards compliance in a medium-term perspective. The Advisory Panel onFinancial Regulation and Supervision(Chairman: Shri M.S. Verma) would consider therelevant standards and codes applicable forfinancial regulation and supervision pertainingto the banking sector, financial markets andinsurance. The Advisory Panel on Institutionsand Market Structure (Chairman: Shri C.M.Vasudev) would consider the relevant standardsand codes applicable to bankruptcy laws,


accounting and auditing, payment andsettlement systems and corporate governancepolicies. The Advisory Panel on TransparencyStandards (Chairman: Shri Nitin Desai) wouldconsider the relevant standards and codesapplicable for transparency in monetary,financial, fiscal and data dissemination policies.

To provide the Panels with technical notes andbackground material, the CFSA has set upTechnical Groups consisting of officialsrepresenting mainly regulatory agencies and theGovernment in all the above subject areas whichhave progressed with technical work andassisting Advisory Panels in respective areas.

With a view to enhancing credibility of selfassessment, the assessment of the Advisory

Panels is proposed to be peer received byinternational experts. The views of the peerreviews would be taken on board while finalisingAdvisory Panels Reports.

The CFSA would publish Advisory Panel reportsand also its own report. Based on an objectiveanalysis of the present strengths andweaknesses of the financial sector and thestatus with regard to standards, the CFSA isexpected to lay down a roadmap for furtherreforms in a medium-term perspective. TheCFSA is expected to complete the assessmentby March 2008.


NARASIMHAM COMMITTEE - I(On Financial Sector Reforms-1991)

� Report submitted in 1991.

� Purpose: To suggest measures for financial sector reforms

� Some key recommendations: Reduction in SLR/CRR; deregulation of interest rates;introduction of IRAC norms; creation of ARF; entry of private/new banks; abolitionof branch licensing; liberal opening of foreign offices; shift to syndicated lending;removal of dual control of RBI and Government.

Some of the important recommendations of theCommittee are as follows:

1. Reduction in SLR/CRR. SLR to be broughtdown in a phased manner in about 5 years. SLRshould not be a major instrument for financingthe Public Sector. RBI should have the flexibilityto operate CRR to serve its monetary policyobjectives.

Interest rate on SLR investments and on CRRin respect of impounded deposits above thebasic minimum should be increased. Rates onSLR investments should be progressivelymarket-related while that on the CRR above thebasic minimum should be broadly related tobanks’ average cost of deposits.

2. Directed Credit. For redistributive objective,the fiscal system should be used rather thanthe credit system. Directed credit programmesshould be phased out. Priority sector should beredefined to include the weaker sections. Thecredit target for the redefined priority sectorshould be 10% of the aggregate credit.

3. Deregulation of Interest Rates.Deregulation to reflect emerging marketconditions. Interest rate on Govt. borrowingsgradually brought in line with market-determinedrates. Interest rate structure should bear arelationship to the Bank Rate. Desirable toprovide for a prime rate, which would be the floorof the lending rates of banks and DFIs.

4. Capital Adequacy. The BIS standard of 8%should be achieved by banks and FIs by March1996.

5. Income Recognition and AssetsClassification. No income to be recognised inNPAs. An asset would be considered non-performing if interest on such assets remainspast due for a period exceeding 180 days as atthe balance sheet date.

6. Transparency of Balance Sheet. BalanceSheets of banks and FIs should be madetransparent with full disclosures.

7. Alignment with Income Tax Rules. Criteriarecommended for NPAs and provisioningrequirements be given due recognition by thetax authorities.

8. Creation of Assets Reconstruction Fund(ARF). An Assets Reconstruction Fund shouldbe established to take over from the banks andFIs a portion of the bad and doubtful debts at adiscount, the level of discount being determinedby independent auditors on the basis of clearlystipulated guidelines. The ARF should beprovided with special recovery powers. Capitalof ARF to be subscribed by the public sectorbanks and FIs.

All bad and doubtful debts should be transferredto the ARF in a phased manner. Banks and FIsshould pursue recovery through the specialtribunals.

Banks/DFIs would have to write off the lossesincurred on account of transfer of doubtful assetsto ARF, which may be difficult due to their weakcapital position. GOI should, where necessary,


provide a subordinated loan counting for capitalto meet this contingency.

9. Proposed Structure of the BankingSystem. Suggested Structure:

a) 3 or 4 large banks (including SBI),international in character.

b) 8 to 10 National Banks with a network ofbranches throughout the country engagedin universal banking.

c) Local banks whose operations would begenerally confined to a specific region.

d) Rural banks (including RRBs) whoseoperations would be confined to the ruralareas and predominantly engaged in thefinancing of agriculture/allied activities.

The revised system should be market-driven andbased on profitability considerations and broughtabout through a process of mergers andacquisitions.

10. Setting up of Rural Banking Subsidiaries.Each Public Sector Bank to set up one or morerural banking subsidiary, to take over all its ruralbranches, and where appropriate, swap its ruralbranches with those of other banks, dependingon the size/administrative convenience of thesponsor bank. Such rural banking subsidiariesshould be treated at par with RRBs in regard toSLR/CRR requirements and refinance facilitiesfrom NABARD. Interest rate structure of RRBsshould be in line with those of the commercialbanks. RRBs may have the option to merge withthe sponsor banks (becoming a separate 100%owned subsidiary) or to maintain a separateidentity.

11. Entry of Private/New Banks. No furthernationalisation of banks. Private Sector Banksshould be on par with Public Sector Banks.There should be no bar for entry of new banksin the private sector, subject to meeting statutoryand other requirements.

12. Branch Licencing/Expansion. Branchlicencing should be abolished. Opening/closingof branches (other than rural branches for thepresent) should be left to the commercialjudgment of the individual banks.

13. Entry of Foreign Banks. RBI should allowforeign banks to open branches/subsidiariesmore liberally, subject to fulfilling usualrequirements. Foreign banks should be placedon par with domestic banks.

14. Rationalisation of Foreign Operations ofIndian Banks. In addition to SBI, there is scopefor one or more of the large banks to haveoperations abroad in major international financialcentres and in regions with strong ethnicpresence.

15. Freedom from RBI/GOI Directives inInternal Administration. Various RBI/GOIguidelines/directives in relating to internaladministration such as creation/categorisationof posts, promotion procedures, etc., affectingthe banks should be rescinded.

16. Supervision over Banks. Supervision tobe based on evolving prudential norms andregulations, and not excessive controls. Greateremphasis on internal audit and inspectionsystems.

17. Removal of Dual Controls. RBI should bethe primary agency for regulating the bankingsystem and dual control of RBI and Ministry ofFinance-Banking Division should end. A separateauthority to operate as a quasi-autonomousbody under the aegis of RBI should be set upand Government should not engage in directingregulatory functions.

18. Depoliticising Appointments of CMDs.Appointments to CMDs posts may be made bythe Govt. as hitherto. They should be based ona convention of accepting recommendations ofa group of eminent persons.

19. Consortium Lending. Existing Consortium


lending system should be changed tosyndication or participation in lending, at theinstance of not only the lenders but also theborrowers.

Commercial banks should be encouraged toprovide term finance to industry. DFIs shouldincreasingly engage in providing core workingcapital, thus enhancing, healthy competitionbetween banks and DFIs.

20. State-level Financial Institutions. To bedistanced from the State Governments and to

function on business principles based onprudential norms, and to have a managementset-up suited for this purpose.

Conclusion

The Committee sought to consolidate the gainsmade in the Indian financial sector whileimproving the quality of portfolio, providinggreater operational flexibility, and functionalautonomy in the internal operations of banks andFIs, so as to usher in a healthy, competitive andvibrant financial sector.


NARASIMHAM COMMITTEE - II(On Banking Sector Reforms - 1998)

� Report submitted in 1998.

� To review the progress in Banking sector reforms.

� Major areas covered: Strengthening capital adequacy, Asset quality, Prudentialnorms & disclosure requirements; Systems and methods in Banks and structuralissues.

� Some recommendations: Marking government security to market; increase in CAR;transferring NPA to ARC as a one time measure; reduction in transit time fromsub-standard to doubtful; provision for standard asset; bringing down governmentholding in nationalized banks.

Financial sector reform process in India, as apart of the broader programme of structuraleconomic reforms, was initiated in 1992. Therehave been major changes in themacroeconomic environment, policy andinstitutional development. Thus the need wasfelt to examine the problem issues and reviewsome of the recommendations made earlier tosee their relevance in the changed environment.Accordingly, a Committee was set up under thechairmanship of Shri M. Narasimham mainly toreview the progress in banking sector reformsover the past six years, especially with referenceto the recommendations made by CFS. Thereport of the Committee was submitted on April24, 1998.

The following are the importantrecommendations of the Committee:

Strengthening Capital Adequacy

� Capital adequacy requirements should takeinto account market risks in addition to thecredit risk. It implies taking into account thelarger exposure of banks to off-balancesheet risks.

� In the next three years the entire portfolio ofgovernment securities should be marked tomarket and the schedule for the sameannounced at the earliest; government andother approved securities which are nowsubject to a zero risk weight, should have a5 per cent weight for market risk.

� Risk weight on a government guaranteedadvance should be the same as for otheradvances. This should be madeprospective from the time the newprescription is put in place.

� Foreign exchange open credit limit risksshould be integrated into the calculation ofrisk weighted assets and should carry a 100per cent risk weight.

� CRAR be increased from the existing 8 percent to 10 per cent; an intermediateminimum target of 9 per cent be achievedby 2000 and the ratio of 10 per cent by 2002.

� PSBs which are in a position to access thecapital market to be encouraged.

Asset Quality

� An asset be classified as doubtful if it is inthe substandard category for 18 months inthe first instance and eventually for 12months, and loss if it has been identifiedbut not written off.

� For evaluating the quality of assets portfolio,advances covered by Governmentguarantees, which have turned sticky, betreated as NPAs.

� For banks with a high NPA portfolio, twoalternative approaches could be adopted.One approach can be that, all loan assets


in the doubtful and loss categories, shouldbe identified and their realisable valuedetermined. These assets could betransferred to an Assets ReconstructionCompany (ARC) which would issue NPASwap Bonds.

An alternative approach could be to enablethe banks in difficul-ty to issue bonds whichcould form part of Tier II capital, backed bygovernment guarantee to make theseinstruments eligible for SLR investment bybanks, LIC, GIC and Provident Funds.

� The interest subsidy element in credit forthe priority sector should be totallyeliminated and interest rate on loans underRs.2 lakh should be deregulated forscheduled commercial banks as has beendone in the case of Regional Rural Banksand cooperative credit institutions.

Prudential Norms and DisclosureRequirements

� In India, income stops accruing wheninterest or instalment of principal is not paidwithin 180 days, which should be reducedto 90 days in a phased manner by 2002.

� Introduction of a general provision of 1 percent on standard assets in a phasedmanner be considered by RBI.

� As an incentive to make specific provisions,they may be made tax deductible.

Systems and Methods in Banks

� There should be an independent loan reviewmechanism especially for large borrowalaccounts and systems to identify potentialNPAs. Banks may evolve a filteringmechanism by stipulating in-houseprudential limits beyond which exposureson single/group borrowers are takenkeeping in view their risk profile as revealedthrough credit rating and other relevantfactors.

� Banks and FIs should have a system ofrecruiting skilled manpower from the openmarket.

� Public sector banks should be givenflexibility to determine managerialremuneration levels taking into accountmarket trends.

� There may be a need to redefine the scopeof external vigilance and investigationagencies with regard to banking business.

� There is need to develop information andcontrol system in several areas like bettertracking of spreads, costs and NPAs forhigher profitability, accurate and timelyinformation for strategic decision to identifyand promote profitable products andcustomers.

� Public sector banks should speed upcomputerisation and focus on relationshipbanking.

Structural Issues

� With the conversion of activities betweenbanks and DFIs, the DFIs should, over aperiod of time, convert themselves to banks.

� Mergers to Public Sector Banks shouldemanate from the management of thebanks. Merger should not be seen as ameans of bailing out weak banks. Mergersbetween strong banks/FIs would make forgreater economic and commercial sense.

� ‘Weak Banks’ may be nurtured into healthyunits by slowing down on expansion,eschewing high cost funds/borrowings, etc.

� Small local banks should be confined tostates or cluster of districts in order to servelocal trade, small industry and agriculture.

� The minimum share of holding byGovernment/RBI in the equity of thenationalised banks and the SBI should bebrought down to 33%.


� There is a need for a reform of the depositinsurance scheme based on CAMELSratings awarded by RBI to banks.

� Inter-bank call and notice money market andinter-bank term money market should bestrictly restricted to banks; only exceptionto be made is primary dealers.

� Non-bank parties be provided free accessto bill rediscounts, CPs, CDs, TreasuryBills, MMMFs.

� RBI should totally withdraw from the primary

market in 91 days Treasury Bills.

� Functions of banks’ boards andmanagement need to be reviewed so thatthe boards remain responsible forenhancing shareholder value throughformulation of corporate strategy, and notget involved in credit-decision making andother aspects of day-to-day management.The Committee made a strong pitch forprofessionalising and depoliticising of bankboards, especially for appointment of non-official directors.


STATISTICALPROFILE


Item As at end-March

2006 2007

Amount Per cent Amount Per centto to

total total

1 2 3 4 5

Liabilities1. Capital 25,206 0.9 29,559 0.92. Reserve and Surplus 1,57,974 5.7 1,89,615 5.53. Deposits 21,64,681 77.7 26,96,980 77.9

3.1. Demand Deposits 2,92,945 10.5 3,51,998 10.23.2. Saving Bank Deposits 5,42,874 19.5 6,31,651 18.23.3. Term Deposits 13,28,861 47.7 17,13,330 49.5

4. Borrowings 2,03,147 7.3 2,42,870 7.05. Other Liabilities and

Provisions 2,34,852 8.4 3,04,381 8.8Total Liabilities/Assets 27,85,863 100.0 34,63,406 100.0Assets1. Cash and Balances

with RBI 1,44,475 5.2 1,95,372 5.62. Balances with Banks

and Money at Call andShort Notice 1,16,443 4.2 1,58,413 4.6

3. Investments 8,66,508 31.1 9,50,769 27.53.1 Government Securities (a+b) 6,90,421 24.8 7,54,456 21.8 a. In India 6,86,464 24.6 7,50,733 21.7 b. Outside India 3,957 0.1 3,723 0.13.2 Other Approved Securities 13,949 0.5 12,760 0.43.3 Non-ApprovedSecurities 1,62,137 5.8 1,83,551 5.3

4. Loans and Advances 15,16,811 54.4 19,81,216 57.24.1 Bills Purchased and Discounted 1,03,657 3.7 1,24,424 3.64.2 Cash Credits, Overdrafts, etc. 5,65,001 20.3 7,12,866 20.64.3 Term Loans 8,48,152 30.4 11,43,924 33.0

5. Fixed Assets 25,081 0.9 31,362 0.96. Other Assets 1,16,542 4.2 1,46,271 4.2

Source : RBI Report on Trend and Progress of Banking in India, 2006-07.

Table 1: Consolidated Balance Sheet of Scheduled Commercial Banks(Amount in Rs. crore)


Table 2: Important Financial Indicators of Scheduled Commercial Banks


Item 2004-05 2005-06 2006-07

Amount Per cent to Amount Per cent to Amount Per cent toAssets Assets Assets

1 2 3 4 5 6 7

1. Income 1,90,236 8.1 2,20,756 7.9 2,76,201 8.0a) Interest Income 1,55,801 6.6 1,85,388 6.7 2,37,271 6.9b) Other Income 34,435 1.5 35,368 1.3 38,929 1.1

2. Expenditure 1,69,278 7.2 1,96,174 7.0 2,44,998 7.1a) Interest Expended 89,079 3.8 1,07,161 3.8 1,43,965 4.2b) Operating Expenses 50,133 2.1 59,201 2.1 66,319 1.9 Of which : Wage Bill 29,479 1.3 33,461 1.2 36,160 1.0c) Provision and Contingencies 30,065 1.3 29,812 1.1 34,714 1.0

3. Operating Profit 51,023 2.2 54,394 2.0 65,917 1.94. Net Profit 20,958 0.9 24,582 0.9 31,203 0.95. Net Interest Income/Margin (1a-2a) 66,722 2.8 78,227 2.8 93,306 2.7

Note : The number of scheduled commercial banks in 2004-05, 2005-06 and 2006-07 were 88, 85 and 82, respectively.



Table 3: Financial Performance of State Bank Group(Amount in Rs. crore)

Item 2005-06 2006-07 VariationAbsolute Percentage

1 2 3 4 5

A. Income (i+ii) 58,826.53 64,137.84 5,311.31 9.03(100.00) (100.00)

i) Interest Income 49,300.60 56,338.67 7,038.07 14.28(83.81) (87.84)

of which: Interest on Advances 25,517.09 36,147.51 10,630.42 41.66 Income on Investments 19,089.26 16,512.38 -2,576.88 -13.50ii) Other Income 9,525.93 7,799.17 -1,726.76 -18.13

(16.19) (12.16) of which: Commission & Brokerage 5,310.38 6,661.30 1,350.92 25.44

B. Expenditure (i+ii+iii) 52,870.05 57,565.80 4,695.75 8.88(100.00) (100.00)

i) Interest Expended 28,040.10 33,859.19 5,819.09 20.75(53.04) (58.82)

of which: Interest on Deposits 25,288.64 28,638.81 3,350.17 13.25ii) Provisions and Contingencies 9,069.99 7,719.86 -1,350.13 -14.89

(17.16) (13.41) of which: Provision for NPAs 475.28 1,783.88 1,308.60 275.33iii) Operating Expenses 15,759.95 15,986.75 226.80 1.44

(29.81) (27.77) of which: Wage Bill 10,665.09 10,470.17 -194.92 -1.83

C. Profiti) Operating Profit 15,026.47 14,291.90 -734.57 -4.89ii) Net Profit 5,956.48 6,572.04 615.56 10.33

D. Net Interest Income/Margin 21,260.50 22,479.48 1,218.99 5.73

E. Total Assets 6,91,846.91 8,05,795.15 1,13,948.25 16.47

Note : Figures in brackets are percentage shares to the respective total.



Table 4: Lending to the Sensitive Sector by Scheduled Commercial Banks(As at end-March)


Sector 2006 2007

Amount Per cent Amount Per centto Total to Total

1 2 3 4 5

1. Capital Market 22,303 7.8 30,637 7.6(40.6) (37.4)

2. Real Estate Market 2,62,053 91.7 3,70,689 91.9(80.0) (41.5)

3. Commodities 1,413 0.5 2,206 0.6(-40.3) (56.1)

Total (1+2+3) 2,85,770 100.0 4,03,533 100.0(74.4) (41.2)

Note : Figures in brackets are percentage variations over the previous year.


Table 5: Cost of Funds and Return on Funds – Bank Group-wise(Per cent)

Indicator Public Sector Old Private New Private Foreign ScheduledBanks Sector Banks Sector Banks Banks Commercial Banks

2005-06 2006-07 2005-06 2006-07 2005-06 2006-07 2005-06 2006-07 2005-06 2006-07

1 2 3 4 5 6 7 8 9 10 11

1. Cost of Deposits 4.3 4.5 4.5 4.9 3.6 4.7 2.8 3.2 4.1 4.52. Cost of Borrowings 2.5 3.4 3.1 3.4 3.1 3.1 4.5 4.7 3.0 3.63. Cost of Funds 4.2 4.4 4.5 4.8 3.5 4.5 3.2 3.5 4.0 4.44. Return on Advances 7.1 7.7 7.9 8.6 7.3 8.3 7.6 8.7 7.2 7.95. Return on Investments 8.2 7.5 7.2 7.2 5.5 6.6 7.5 7.6 7.7 7.36. Return on Funds 7.5 7.6 7.7 8.1 6.6 7.7 7.6 8.3 7.4 7.77. Spread (6-3) 3.3 3.2 3.2 3.3 3.1 3.2 4.3 4.8 3.3 3.3

Note : 1. Cost of Deposits = Interest Paid on Deposits/Deposits.2. Cost of Borrowings = Interest Paid on Borrowings/Borrowings.3. Cost of Funds = (Interest Paid on Deposits + Interest Paid on Borrowings)/(Deposits + Borrowings)4. Return on Advances = Interest Earned on Advances/Advances5. Return on Investments = Interest Earned on Investments/Investments6. Return on Funds = (Interest Earned on Advanced + Interest Earned on Investments)/(Investments + Advances)



Table 6: Capital Adequacy Ratio – Bank Group-wise(As at end-March)

(Per cent)

Bank Group 2000 2001 2002 2003 2004 2005 2006 2007

1 2 3 4 5 6 7 8 9

Scheduled Commercial Banks 11.1 11.4 12.0 12.7 12.9 12.8 12.3 12.3Public Sector Banks 10.7 11.2 11.8 12.6 13.2 12.9 12.2 12.4 Nationalised Banks 10.1 10.2 10.9 12.2 13.1 13.2 12.3 12.4 SB Group 11.6 12.7 13.3 13.4 13.4 12.4 11.9 12.3Old Private Sector Banks 12.4 11.9 12.5 12.8 13.7 12.5 11.7 12.1New Private Sector Banks 13.4 11.5 12.3 11.3 10.2 12.1 12.6 12.0Foreign Banks 11.9 12.6 12.9 15.2 15.0 14.0 13.0 12.4


Table 8: Branches and ATMs of Scheduled Commercial Banks(As at end-March 2007)

Bank Group Number of Bank/Branches Number of ATMsOff-site ATMs as

Rural Semi- Urban Metro- Total On-site Off-site Total ATMs as percenturbanURBAN politan percentage of

age of Branchestotal

ATMs

1 2 3 4 5 6 7 8 9 10 11

i) Nationalised Banks 12,986 7,573 7,612 7,465 35,636 6,634 3,254 9,888 27.4 27.7ii) State Bank Group 5,126 4,155 2,556 2,193 14,030 3,655 2,786 6,441 43.3 45.9iii) Old Private Sector Banks 855 1,510 1,294 947 4,606 1,104 503 1,607 31.3 34.9iv) New Private Sector Banks 130 554 824 989 2,497 3,154 5,038 8,192 61.5 328.1v ) Foreign Banks – 2 44 227 273 249 711 960 74.1 351.6

Total (i to v) 19,097 13,794 12,330 11,821 57,042 12,796 12,292 27,088 42.3 47.5


Table 7: Computerisation in Public Sector Banks(As at end-March)

(Per cent)

Category 2006 2007

1 2 3

Fully Computerised Branches (i+ii) 77.5 85.6

i) Branches Under Core Banking Solution 28.9 44.4

ii) Branches already Fully Computerised # 48.5 41.2

Partially Computerised Branches 18.2 13.4

# : Other than branches under Core Banking Solution.



Table 9: Gross and Net NPAs of Scheduled Commercial Banks – Bank Group-wise(As at end-March)


Bank Group/Year Gross Gross NPAs Net Net NPAsAdvances Amount Per cent to Per cent to Advances Amount Per cent to Per cent to

Gross Total Net TotalAdvances Assets Advances Assets

1 2 3 4 5 6 7 8 9

Scheduled Commercial Banks2004 9,02,026 64,812 7.2 3.3 8,62,643 24,396 2.8 1.22005 11,52,682 59,373 5.2 2.5 11,15,663 21,754 2.0 0.92006 15,51,378 51,097 3.3 1.8 15,16,811 18,543 1.2 0.72007 20,12,510 50,486 2.5 1.5 19,81,216 20,101 1.0 0.6

Public Sector Banks2004 6,61,975 51,537 7.8 3.5 6,31,383 19,335 3.1 1.32005 8,77,825 48,399 5.5 2.7 8,48,912 16,904 2.1 1.02006 11,34,724 41,358 3.6 2.1 11,06,288 14,566 1.3 0.72007 14,64,493 38,968 2.7 1.6 14,40,123 15,145 1.1 0.6

Old Private Sector Banks2004 57,908 4,398 7.6 3.6 55,648 2,142 3.8 1.82005 70,412 4,200 6.0 3.1 67,742 1,859 2.7 1.42006 85,154 3,759 4.4 2.5 82,957 1,375 1.7 0.92007 94,872 2,969 3.1 1.8 92,890 891 1.0 0.6

New Private Sector Banks2004 1,19,511 5,983 5.0 2.4 1,15,106 1,986 1.7 0.82005 1,27,420 4,582 3.6 1.6 1,23,655 2,353 1.9 0.82006 2,32,536 4,052 1.7 1.0 2,30,005 1,796 0.8 0.42007 3,25,273 6,287 1.9 1.1 3,21,865 3,137 1.0 0.5

Foreign Banks2004 62,632 2,894 4.6 2.1 60,506 933 1.5 0.72005 77,026 2,192 2.8 1.4 75,354 639 0.8 0.42006 98,965 1,928 1.9 1.0 97,562 808 0.8 0.42007 1,27,872 2,263 1.8 0.8 1,26,339 927 0.7 0.3



Table 10: Share Prices and Price/Earning Ratios of Bank Stocks at BSE

Bank Average Daily Closing Percentage Variation P/E RatioPrice (Rs.) in Prices ( End-March)

2005-06 2006-07 2006 2007

1 2 3 4 5 6

Public Sector BanksAllahabad Bank 85.44 80.11 -6.24 5.0 4.3Andhra Bank 96.29 81.19 -15.68 8.1 6.9Bank of Baroda 226.15 237.63 5.08 10.1 7.6Bank of India 117.00 150.61 28.73 9.2 7.3Bank of Maharashtra 33.35 32.19 -3.48 26.0 6.2Canara Bank 225.17 242.09 7.51 8.2 5.6Corporation Bank 370.63 316.81 -14.52 12.3 7.7Dena Bank 32.87 32.24 -1.92 20.3 5.0Indian Overseas Bank 89.85 100.81 12.20 6.7 5.6Oriental Bank of Commerce 260.46 212.28 -18.50 7.4 5.7Punjab National Bank 420.43 455.11 8.25 10.3 9.7Syndicate Bank 75.66 73.42 -2.96 8.7 4.7Union Bank of India 118.47 113.76 -3.98 9.1 6.2Vijaya Bank 60.48 47.18 -21.99 18.0 6.3State Bank of India 811.67 997.31 22.87 11.6 11.5State Bank of Bikaner and Jaipur 2,757.41 3,465.41 25.68 14.4 5.5State Bank of Mysore 3,513.28 5,391.86 53.47 10.5 7.4State Bank of Travancore 2,697.68 3,575.63 32.54 8.0 4.6UCO Bank 27.96 21.45 -23.28 10.8 5.4Other Public Sector BanksIDBI Ltd. 98.28 75.18 -23.50 10.1 8.9Private Sector BanksAxis Bank 273.09 394.79 44.56 20.5 21.0Bank of Rajasthan Ltd. 52.07 37.94 -27.14 39.8 3.8City Union Bank Ltd. 97.83 128.98 31.84 4.8 5.7Centurion Bank of Punjab Ltd. 19.08 27.39 43.55 152.0 48.5Dhanalakshmi Bank 31.81 38.14 19.90 10.5 11.6Federal Bank Ltd. 175.56 205.36 16.97 7.7 6.3ING Vysya Bank 158.37 144.76 -8.59 143.6 17.9Indusind Bank Ltd. 61.38 45.13 -26.47 36.9 19.7Jammu and Kashmir Bank Ltd. 442.28 494.24 11.75 12.4 11.4Karnataka Bank Ltd. 102.68 121.61 18.44 6.9 11.7Karur Vysya Bank Ltd. 174.89 228.93 30.90 6.5 8.7Kotak Mahindra Bank Ltd. 192.96 347.18 79.92 72.7 110.7South Indian Bank Ltd. 65.72 73.99 12.58 8.5 6.7United Western Bank # 37.46 28.89 -22.88 -2.4 _Bank of Punjab Ltd. * 34.42 _ _ _ _HDFC Bank Ltd. 658.46 911.35 38.41 27.8 26.6ICICI Bank Ltd. 506.31 711.37 40.50 21.8 28.8Yes Bank 72.10 109.13 51.36 49.0 41.8

#: United Western Bank Ltd. was merged with IDBI Ltd. on September 30, 2006.* : Bank of Punjab Ltd. Merged with Centurion Bank Ltd.– : Not Available.Note: Averages are calculated using daily closing prices.



Table 11: Share of Top Hundred Centres in Aggregate Deposits and Gross BankCredit

(Per cent)

As at Deposits Creditend-March

Offices Amount Offices Amount

1 2 3 4 5

2000 21.9 59.0 21.5 74.72001 22.3 58.9 21.9 75.32002 22.5 59.1 22.1 77.02003 22.7 61.0 22.4 75.92004 23.1 63.6 22.9 75.52005 23.8 65.3 23.7 75.92006 24.2 67.0 24.0 76.52007 24.9 68.9 24.8 77.4


Table 12: Overseas Operations of Indian Banks(Actually Operational)

Name of the Bank Branch Subsidiary Representative Joint Venture TotalOffice Bank

2005-06 2006-07 2005-06 2006-07 2005-06 2006-07 2005-06 2006-07 2005-06 2006-07

1 2 3 4 5 6 7 8 9 10 11

I . Public Sector Banks 106 116 15 19 24 26 6 7 151 1681. Allahabad Bank – 1 – – 1 1 – – 1 22. Andhra Bank – – – – 1 1 – – 1 13. Bank of Baroda 40 43 7 8 3 4 1 1 51 564. Bank of India 20 22 1 2 4 3 1 1 26 285. Bharat Overseas

Bank 1 – – – – – – – 1 –6. Canara Bank 1 2 1 1 1 1 – – 3 47. Indian Bank 3 3 – – – – – – 3 38. Indian Overseas Bank 5 6 1 1 2 2 – – 8 99. Punjab National Bank 1 1 – 1 4 4 1 1 6 710.State Bank of India 30 33 5 6 7 7 3 4 45 5011.Syndicate Bank 1 1 – – – – – – 1 112.UCO Bank 4 4 – – 1 2 – – 5 613.Union Bank N.A. – N.A. – N.A. 1 N.A. – N.A. 1

I I . New Private Sector Banks6 9 4 3 10 13 1 – 21 2514.Axix Bank 1 3 – – – 1 – – 1 415.Centurian Bank of

Punjab Ltd. – – 1 – – 1 1 – 2 116.HDFC Bank Ltd. – – – – 1 1 – – 1 117.ICICI Bank Ltd. 5 6 3 3 7 8 – – 15 1718.IndusInd Bank Ltd. – – – – 2 2 – – 2 2Total 112 125 19 22 34 39 7 7 172 193

– : Nil/Negligible. N.A. : Not Available.Note : Data for 2005-06 relate to end-September 2006 while that for 2006-07 relate to end-August 2007.Source : RBI Report on Trend and Progress of Banking in India, 2006-07.


Table 13: List of Foreign Banks Operating in India – Country-wise(As at end-October, 2007)

Sr. No. Name of Bank Country of No. of branchesIncorporation in India

1 2 3 4

1. ABN-AMRO Bank N.V. Netherlands 282. Abu Dhabi Commercial Bank Ltd. UAE 23. Arab Bangladesh Bank Ltd. Bangladesh 14. American Express Bank Ltd. USA 75. Antwerp Diamond Bank N.V. Belgium 16. Bank International Indonesia Indonesia 17. Bank of America USA 58. Bank of Bahrain & Kuwait BSC Bahrain 29. Bank of Nova Scotia Canada 510. Bank of Tokyo-Mitsubishi UFJ Ltd. Japan 311. BNP Paribas France 812. Bank of Ceylon Sri Lanka 113. Barclays Bank Plc UK 414. Calyon Bank France 515. Citibank N.A. USA 3916. Chinatrust Commercial Bank Taiwan 117. Deutsche Bank Germany 1118. DBS Bank Ltd. Singapore 219. HSBC Hongkong 4720. J.P. Morgan Chase Bank N.A. USA 121. Krung Thai Bank Public Co. Ltd. Thailand 122. Mizuho Corporate Bank Ltd. Japan 223. Mahreqbank PSC UAE 224. Oman International Bank SAOG Sultanate of Oman 225. Shinhan Bank South Korea 226. Standard Chartered Bank UK 8327. Sonali Bank Bangladesh 228. Societe Generale France 229. State Bank of Mauritius Mauritius 3

Total 273



Table 14: Return on Assets of Indian Banks vis-à-vis Select Countries

(Per cent)

Bank Group/Country As at end-March2001 2007

1 2 3

IndiaPublic sector banks 0.4 0.8Private banks 0.7 0.9 Old private banks 0.6 0.7 New private banks 0.8 0.9Foreign banks 0.9 1.7

Scheduled Commercial Banks 0.5 0.9

Emerging MarketsArgentina 0.0 2.1Brazil -0.1 2.1Mexico 0.8 3.2Korea 0.7 1.1South Africa 0.8 1.4

Developed CountriesUS 1.1 1.2UK 0.5 0.5*Japan -0.6 0.4*Canada 0.7 1.0*Australia 1.3 1.8#Global range for 2006 [0.2 (Tunisia) to 4.3 (Saudi Arabia and Ghana]

* : pertains to 2006. # : pertains to 2005.



Table 15: Ratio of Gross Non-performing Loans to Gross Advances of Indian Banksvis-à-vis Select Countries

(Per cent)

Bank Group/Country As at end-March

2001 2007

1 2 3

IndiaPublic sector banks 12.4 2.7Private banks 8.4 2.2 Old private banks 10.9 3.1 New private banks 5.1 1.9Foreign banks 6.8 1.8


Emerging MarketsArgentina 13.1 3.2Brazil 5.6 4.0Mexico 5.1 2.2Korea 3.4 0.8South Africa 3.1 1.1

Developed CountriesUS 1.3 0.8UK 2.6 0.9Japan 8.4 2.5*Canada 1.5 0.4*Australia 0.6 0.2

Global range for 2006 [0.2 (Estonia, Luxembourg and Australia) to 24.7 (Egypt)]* : pertains to 2006.



Table 16: Capital Adequacy Ratio- IndianBanks vis-à-vis Select Countries

(Per cent)

Bank Group/Country As at end-March

2001 2007

1 2 3

IndiaPublic sector banks 11.2 12.4Private banks Old private banks 11.9 12.1 New private banks 11.5 12.0Foreign banks 12.6 12.4


Emerging MarketsArgentina – –Brazil 14.8 18.5Mexico 13.9 16.1Korea 11.7 13.0South Africa 11.4 12.7

Developed CountriesUS 12.9 13.0UK 13.2 12.9*Japan 10.8 13.1*Canada 12.3 12.4Australia 10.4 10.4

Global range for 2006 [7.1 (Sweden) to 34.9 (Armenia)]* : pertains to 2005.



Table 17: Distribution of Commercial Bank Branches in India –Bank Group and Population Group-wise

Bank Group No. of Number of BranchesBanks# As on June 30, 2006@ As on June 30, 2007@

Rural Semi- Urban Metro- Total Rural Semi- Urban Metro- Totalurban politan urban politan

1 2 3 4 5 6 7 8 9 10 11 12

1. State Bank of India 8 5,143 4,103 2,491 2,142 13,879 5,159 4,150 2,564 2,185 14,058and Associates (37.1) (29.6) (17.9) (15.4) (100.0) (36.7) (29.5) (18.2) (15.5) (100.0)

2. Nationalised Banks 19 12,903 7,211 7,135 7,050 34,299 12,990 7,504 7,557 7,361 35,412(37.6) (21.0) (20.8) (20.6) (100.0) (36.7) (21.2) (21.3) (20.8) (100.0)

3. Other Public 1 2 18 66 95 181 48 82 126 180 436Sector Banks (1.1) (9.9) (36.5) (52.5) (100.0) (11.0) (18.8) (28.9) (41.3) (100.0)

4. Old Private 16 897 1,503 1,281 977 4,658 804 1,460 1,218 859 4,341Sector Banks (19.3) (32.3) (27.5) (21.0) (100.0) (18.5) (33.6) (28.1) (19.8) (100.0)

5. New Private 8 95 325 682 898 2,000 183 617 884 1,042 2,726Sector Banks (4.8) (16.3) (34.1) (44.9) (100.0) (6.7) (22.6) (32.4) (38.2) (100.0)

6. Foreign Banks 29 – 1 37 224 262 – 2 43 227 272in India – (0.4) (14.1) (85.5) (100.0) – (0.7) (15.8) (83.5) (100.0)

7. Regional Rural 96 11,456 2,471 514 55 14,496 11,444 2,481 522 59 14,506Banks** (79.0) (17.0) (3.5) (0.4) (100.0) (78.9) (17.1) (3.6) (0.4) (100.0)

8. Non-Scheduled 4 4 12 10 – 26 5 14 11 – 30Commercial Banks (15.4) (46.2) (38.5) – (100.0) (16.7) (46.7) (36.7) – (100.0)(Local Area Banks)Total 181 30,500 15,644 12,216 11,441 69,801 30,633 16,310 12,925 11,913 71,781

(43.7) (22.4) (17.5) (16.4) (100.0) (42.7) (22.7) (18.0) (16.6) (100.0)

– : Nil/Negligible.# : as on June 30, 2007.@ : Population group wise classification of branches is based on 2001 Census.** : No. of Regional Rural Banks as on June 30, 2007 was 96, after effecting the amalgamation of RRBs, that have taken place.Note : 1. Number of branches data exclude administrative offices.2. Data for June 2006 are revised and that for June 2007 are provisional.3. Figures in brackets indicate percentages to the total in each group.



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FEEDBACK FORM


LIST OF RESEARCH STUDIES 1. Study of Collections / Remittances (Jan., 06) 2. Dissemination of information on Bank’s products and schemes - Policy imperatives (Feb., 06) 3. A study suggesting best practices for branch security in the background of burglary,

dacoity and robbery (Feb., 06) 4. Cross-selling to enable our customers in CAG/Corporates to offer various services/facilities

to their suppliers (Mar., 06) 5. Empowering employees : Myth or Reality (Mar., 06) 6. Weaving industry in Andhra Pradesh (Apr., 06) 7. A study of contribution of business to domestic branches by the exchange houses

managed by us (Apr., 06) 8. A study on Convenience Banking, 7 Day Banking and 8 to 8 Banking (Apr., 06) 9. A diagnostic study on Customer Queues (May., 06)

10. A study on AUCA - Follow-up and Recovery (Jun., 06) 11. A study on Drop Boxes (Jul., 06) 12. A study on Bank’s Exit Policy (Jul., 06) 13. Training of Women Officers (Sep., 06) 14. Quality, Integrity and Purity of Data Relating to Loans and Advances (Oct., 06) 15. Mortgage Loan (Oct., 06) 16. Developing a Model to ascertain Staff Requirement at Branches (Nov., 06) 17. Likely Demand for proposed Insurance Linked Recurring Deposit Scheme (Nov., 06) 18. Updated Savings Bank Rules (Nov., 06) 19. SECC Processes - Beyond TAT (Feb., 07) 20. Study on how other banks are attracting small depositors and strategy for our Bank to

attract low-cost deposits (Feb., 07) 21. Effectiveness of Advertisements (Mar., 07)

LIST OF REGULAR PUBLICATIONS1. Perhaps You Are Aware (recent trends) (monthly)2. Chayanika (selected articles) (bi-monthly)3. Parivartan - House Magazine (Quarterly)4. AIMS (list of project works done by the trainers in various SBLCs) (half-yearly)5. Quest (Quality Circle events in the Bank) (yearly)

LIST OF PUBLICATIONS1. Preventive Vigilance (Jan, 06)2. Training Manual for POs/TOs - General (Vol. I)

(Jan, 06)3. Credit Management (Jun., 06)4. Rural Marketing (Jun., 06)5. HandBook on FEMA Regulations - Imports & Exports (Jan., 07)6. BPR: Achieving Excellence through Transformation (Jan., 07)7. HandBook on Personal Segment Loan Products (Feb., 07)8. Discipline and Disciplinary Proceedings (Feb, 07)9. N.R.I. Business (Mar, 07)

10. Service Conditions of Supervising Staff (Sep., 07)11. Marketing of SME Products (Oct., 07)12. Banking Briefs (A Compendium of readings of relevance to Bankers) (Jan., 08)

Banking Briefs 2008

Documents

Transcript of Banking Briefs 2008