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Section 5(b) of the Banking Regulation Act,1949 definesBanking as ACCEPTING, FOR THE PURPOSE OF LENDING ORINVESTMENT, OF DEPOSITS OF MONEY FROM THE PUBLIC,REPAYABLE ON DEMAND OR OTHERWISE AND WITHDRAWABLE BYCHEQUE, DRAFT, ORDER OR OTHERWISE.

Primary / Principal Functions:1.Accepting deposits2.Lending advances

Secondary / Ancillary Functions:1.Discounting of bills and cheques

2.Collection of bills and cheques3.Remittance

4.Safe custody of articles

5.Safe deposit lockers

6.Issue of Letter of Credit and Guarantees.

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Section 13 of the Negotiable Instruments Act,1881defines a negotiable instrument as apromissory note, bill of exchange or cheque,payable either to order or tobearer

Bill of ExchangeCheque (Drawer, Drawee, Payee)Difference between Cheque and Bill ofExchange

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Demand DepositsSaving DepositsCurrent Deposits

Time DepositsNon Resident Indian (NRI) Accounts:Non Resident External rupee accounts - NRE

Non Resident Ordinary rupee accounts - NRO

Foreign Currency Non Resident (Banks) accounts FCNR(B)

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1) NRO and NRE accounts can be kept in the form ofcurrent, savings or term deposits, but FCNR (B)deposits can be kept in the form of term deposits for aperiod ranging from 6 months to 3 years.

2) Remittances from abroad can be credited to any ofthese accounts. But, the earnings of NRIs on theproperty held by them in India, which are nonrepatriable, can be credited to only NRO accounts.

3) Money from an NRO account is non repatriable, butNRE and FCNR deposits are repatriable.

4) The entire interest earned on NRO accounts is eligiblefor repatriation. Persons of Indian nationality who havebeen NRIs for a period of not less than one year andhave returned to India are eligible to open a RFC(Resident Foreign Currency) account.

5) An NRO account may be jointly held with residents.NRE and FCNR accounts cannot be jointly held with

residents, but, resident power of attorney is permittedfor local payments and investments in India.6) Balances held in NRE/FCNR are exempted from wealth

tax and interest earned is exempted from income tax.There are no tax exemption on interest earned on NROaccounts.

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Mandate: It is an unstamped letter signed by thecustomer, authorizing a person to operate the account

on his behalf. Signature of the mandatory should beobtained in the letter of mandate. A letter of mandate isgenerally issued for a short and temporary period.

Power of Attorney: It is a stamped document andgenerally executed in the presence of anotary/magistrate of a court. Two types of powers aregranted special and general power of attorney. Specialpower of attorney is often for a single transaction andgeneral power of attorney confers an agent very

extensive powers.

Lien: It is the right of the creditor to retain possession ofthe goods and securities owned by the debtor until thedebt due from the latter is paid.

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Retail lending refers to the lending by banks to non

corporate borrowers i.e. individuals and small andmedium businessmen. The size of these advanceswould be small, but the number of accounts would behigh.

A simplistic definition could be banking catering tothe multiple requirements of individuals relating todeposits, advances and associatedservices

Why focus on Retail Banking?

Financial disintermediation Advent of Economic Liberalization Instant solution for the ills in banking

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Advantages of retail lending: The yield is normally high.

The risk for the bank is diversified.

Advancing to a greater number of customers andhelping them in increasing their standard of living.

The level of NPA is generally low.

Ease of processing the loan proposals.

Dis advantages of retail lending:The follow up is difficult since the number ofcustomers is

high. Cost of maintenance is high.

Personal attention cannot be given.

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Knowing the customer Technology issues

Product innovation

Pricing of product Issues related to humanresources.

Low-cost and No-cost deposits.

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CRM: Basic Concepts:CRM has three application areas. They are:

Customer Acquisition

Customer Value MaximizationCustomer RetentionCRM: Strategies/ Steps:

Appeal to the self interest of the customers duringdiscussions.

Make use of logic and emotional appeal to motivate thecustomer.

Be patient (have self control) with difficult customers. Itwill pay off in the long run.

Formulate more strategies for customer satisfaction.(SWOT)

Smile while serving the customer.

Importance ofGreeting and Meeting.

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Customers deposit is a debt for a bank given by

him/her and repayable on demand.

Firstly, the bank is an customer's debtor and thecustomer is an unsecured creditor having no claimover banks security. So, the relationship is ofDebtor and Unsecured Creditor.

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Secondly, when customer takes loan, he/shewill become the banks debtor. However, asbank obtains security for the loan, the bankbecomes a secured creditor for the customer.

Here, the relationship is of Secured Creditor andDebtor.

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Thirdly, when customer deposits securities,valuables for safe custody, the bank is thetrustee of these assets and customer remainsas owner of these assets.

Relationship here is of a trustee and owner.

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Fourthly, when the bank buys or sells securitiesor pays the utility bills of the customers, thebank becomes customers agent.

Here, the relationship is of agent and principal.

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Rights of general lien: It is the right of acreditor to retain the goods and securitiesowned by his/her debtor until the debt is

repaid.

When bankers lien is applies to a specific debtit is known as particular lien. Ex: Lien on FDs.

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Right of setoff: If two or more accounts belongto the same customer, the bank may use thecredit balance of other account even held indifferent branches.

The bank should take letter in advance from thecustomer.

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Right to appropriation: Under this right, whena customer avails several loans from the bankand when the banker receive payment from thecustomer, the deciding authority on

appropriation lies with debtor (customer).However, in absence of instructions, the bank,as the creditor can exercise the right.

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Right to charge interest and levy charges: Thebanker has the implied right to charge intereston loans given to customers. Normally, thecustomer account is debited on and when

interest is due from respective accounts.

The bank has also right to charge incidentalexpenses incurred on a current account.

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To honour cheques: Certain conditions to befilled to impose this obligation. Such as,

- There must be sufficient funds.

- All details/rules of cheque should be fulfilled.

- Must be presented in proper time.

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Dishonour of cheques should be justified with;

If cheque is post-dated/stale cheque.- Crossed, but presented for cash payment.

- Bearing alteration.

- Presented after banking hours, receipt of stoppayment letter, receipt of information regardingdeath, insolvency, unsound mind.

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To maintain secrecy: As financial position canreflect customers reputation, the bankershould- Not disclose any information of the account toa third party.

- ensure no such information is leaked.- Prevent such disclosure after closure ofaccounts.Exceptions:

- Required by law.- Practice and usage among bankers.

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to not to close the account: Banker should notclose the account until or unless he gets acomply with a written directive form thecustomer to close his/her account. The banker

should ask to return unused cheques.When a bank receives any notice on death,insanity, insolvent of customer, it can close theaccounts.

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To collect cheques and bills: The bank shouldact as a trustee and should oblige thecustomers in case of collection of cheques andbills. All the documents/procedures should be

followed accordingly or otherwise banker hasthe right to not to collect. Bank should act ingood faith without negligence.

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Commercial Banks

Non-ScheduledScheduled

S B I & its

Associates

Nationalized

Banks

IDBI

Private

Banks

Foreign

Banks

RRBs

Co-operative

Banks

Old Private

Banks

New Private

Banks

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1949 REGULATION BANKING COMPANIES ACT 1949

1955 NATIONALIZATION PHASE - I S B I

1959 NATIONALIZATION PHASE - II SBI SUBSIDIARIES

1961 INSURANCE COVER TO DEPOSITS DEPOSIT INSURANCE CORP.

1968 SOCIAL CONTROL NATIOINAL CREDIT COUNCIL

1969 NATIONALIZATION PHASE - III 14 MAJOR COMMERCIAL BANKS

1971 CREDIT GUARANTEE CREDIT GAURANTEE CORP.

1975 NEW RURAL BANKS RRBs

1980 NATIONALIZATION PHASE - IV 6 COMMERICAL BANKS WITH

OVER DEPOSITS OF Rs.200 Cr.

1985REORGANISATION OF BANKING

1996 NEW BANKS PRIVATE BANKS

1998 REVIEW RE-EXAMINATION

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1) Deposit Sources of Funds: Current accounts,Saving accounts and Term deposits etc.

2) Non Deposit Sources of Funds: Capital,Borrowings, Service fees, Cash handling

charges, Penalties and Interests etc.

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Maturity Cost of Funds

Tax Implications

Regulatory Framework Market Conditions

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Deposit Insurance and Credit GuaranteeCorporation (DICGC) was established in 1962.

It covers up to Rs.1,00,000 of deposits percustomer per bank

Certificates of Deposits, GovernmentDeposits, Inter-bank deposits and illegaldeposits are not covered.

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Current Deposits Savings Deposits

Term Deposits

Recurring Deposits

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Primarily for convenience of operations (forpayment & collection).

Targeted at business class / institutions /organizations etc.

Continuous running A/c. Almost no restrictions on withdrawals. No interest is paid on the balance. Used for routing borrowings. No pass book, only statement. Cheque book facility available.

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Targeted at individuals Minimum balance stipulations Limits on number of withdrawals/week Interest paid on balance (at a lower rate (5%)

compared to Term Deposits). Pass book facility available Cheque book facility available

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Amount deposited for a fixed term (rangingfrom 7 days to 120 months)

The term decided by the customer

Interest rates differ from bank to bank

Interest rate depends on time/amount slabs(slots) defined by the bank

Interest rates may be fixed or floating

Interest can be paid quarterly/semi-annually/annually or at maturity

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Deposits cab be renewed on/or beforematurity

Normally interest is not paid if the depositremains with the bank after maturity.However banks have the discretion to payinterest from the date of maturity, if it isrenewed later with effect from the maturitydate.

Penalty for pre-mature closure Loan facility available

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A fixed amount is deposited every month Term Deposit Interest Rates apply

Term ranges from 12 to 120 months

Minimum monthly installments Rs.100

No maximum limit

Loan facility up to 90% of value

Premature withdrawal attracts penalty

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Capital & Reserves

Call/Notice Money

Domestic Borrowing

ECB & FCCB

Refinancing- SIDBI for SME

- NABARD for Agriculture

- IDFC for Infrastructure &

- RBI for Export

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It is the difference b/w current and projectedcredit and deposit flows.

Non Deposit sources are costly

and risky.

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Any changes in cost of funds, indeed requireschanges in assets yield to uphold spreads.

It could alter the liability mix of banks andexpose the bank to liquidity constraints.

It could leave the bank less competitive in themarket.

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Servicing costs versus minimum balancerequirements.

Deposit volumes and their costs in relation toprofits.

Lending and investment avenues. Relationship with customers.

Promotional Pricing (new product).

Product differentiation in a competitivemarket.

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Impact of explicit and implicit prices on Bank Revenues and CostsBank Cashflows Explicit Prices Implicit PricesBank Costs Interest

PaymentsBelow cost services (e.g. freechequebook issues).

Gift tocustomers

More convenience tocustomers such as branchoffices, ATMs and businesshours).

Bank Revenues Service feessuch ascharges percheque issued

Minimum balancerequirements.

Other feessuch as onoverdrafts

Restrictions such as limitedcheque writing privileges.

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1. Cost plus margin deposit pricing.2. Market penetration deposit pricing.

3. Conditional pricing.

4. Upscale target pricing.

5. Relationship pricing.

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Credit risk Counterparty default riskEquity risk

Securitization riskConcentration risk

Market risk Interest rate riskEquity price riskForeign exchange risk

Operational risk

Compliance / legal riskDocumentation risk

Liquidity risk Term liquidity riskWithdrawal/Call riskStructural liquidity riskContingent liquidity riskMarket liquidity risk

Other risks Strategic riskReputation riskCapital riskEarnings risk

Outstanding risk

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Refers to the negative consequences associated withdefaults or non-fulfillment of concluded contracts in

lending operations due to deterioration in thecounterpartys credit quality.Counterparty default risk: Refers to the possibility that the otherparty in an agreement will default.

Equity risk (participations): Refers to the possibility ofdepreciation in the banks investment in the stock market due toadverse price movements of the equity due to company specificfactors.

Securitization risk: The risk arising out of securitized assets.Securitization is a process of distributing risk by aggregatingdebt instruments in a pool and then issuing new securitiesbacked by the pool.

Concentration risk: A concentration risk is any single exposureor group of exposures with the potential to produce losses largeenough to threaten banks health or ability to maintain its coreoperations.

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Refers to the risks which result from price changes inthe money and capital markets.

Interest rate risk: Refers to the changes in banks portfolio valuedue to interest rate fluctuations.

Repricing risk (Fluctuations in interest rate levels that have differingimpacts on bank assets and liabilities)

Yield curve risk (Changes in portfolio values caused by unanticipated shiftsin the slope and shape of yield curve)

Basis risk (Imperfect correlation between index rates across differentinterest rate markets for similar maturities)

Optionality risk (Risk arising from interest rate options embedded in a bankasset, liabilities and off balance sheet positions)

Equity price risk: This risk arises due to fluctuations in marketprice of equity due to general market related factors.Foreign exchange risk: This risk arises due to fluctuations inexchange rates.

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The risk of loss resulting from inadequate or failedinternal processes, people and systems or from

external events is called operational risk. Thisdefinition includes legal risk, but excludes strategicand reputational risk.Compliance / legal risk: This includes, but not limited toexposure to fines, penalties or punitive damages resulting fromsupervisory actions as well as private settlements.

Documentation risk: The unpredictability and uncertainty arisingout of improper and insufficient documentation which gives riseto ambiguity regarding the characteristics of the financialcontracts.

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Liquidity risk arises from a banks inability to meet its obligationswhen they become due, and refers to situations in which a party iswilling but unable to find counterparty to trade on asset.

Term liquidity risk: This risk arises due to an unexpectedprolongation of the capital commitment period in lendingtransactions (Unexpected delays in repayments).

Withdrawal/call risk: The risk that more credit lines will be drawn ormore deposits withdrawn than expected is referred to as withdrawal

/ call risk. This brings about the risk that the bank will no longer beable to meet its payment obligations without constraints.

Structural liquidity risk: This risk arises when the necessary fundingtransactions cannot be carried out (Or can be carried only on lessfavourable terms).

Contingent liquidity risk: Contingent liquidity risk is the riskassociated with finding additional funds or replacing maturingliabilities under potential, future stressed market conditions.

Market liquidity risk: This risk arises when positions cannot be soldwithin a desired time period or can be sold only at a discount.

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Strategic risk: Strategic risk refers to negative effects on capitaland earnings due to business policy decisions, changes in the

economic environment, deficient or insufficient implementationof decisions.

Reputation risk: Reputation risk refers to the potential adverseeffects which can arise from banks reputation deviatingnegatively from its expected level.

Capital risk: Capital risk results from an imbalance internalcapital structure in relation to the nature and size of the bank orfrom difficulties associated with raising additional risk coveragecapital quickly, if necessary.

Earnings risk: Earnings risk arises due to the inadequatediversification of a banks earnings structure or its inability toattain a sufficient and lasting level of profitability.

Outsourcing risk: Important outsourcing risks are operationaldisruption risk, data risk, quality risk and reputation risk.

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Since risk is statistically defined as the

adverse deviation of actual results fromexpected results, the likelihood of potentialadverse outcomes can be modelled usingmathematical / statistical techniques. The

capital that is estimated to cover theprobabilistic assessment of potential futurelosses is called EconomicCapital.

Economic capital can be defined as theamount of capital considered necessary bybanks to absorb potential losses associatedwith banking risks such as credit, market,

operational and other risks.

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Depositors Need assurance that the bank has enough

liquid assets to meet all demand made by depositors.There are four ways to provide this assurance. Theyare:

Adequate equity capital

Deposit insurance

Lender of last resort, and

Subordinated debt

The Basel Committee on Banking Supervision (BCBS)and the regulators recognized that the capitaladequacy is required for the long term stability of thebanks.The two concepts reflects the need of different stakeholders the banks shareholders look to economic capital, while thedepositors look to adequacy of regulated capital.

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Regulation of bank capital began with the 1988 Basel

Accord on capital standards.The G10 countries (Belgium, Canada, France, Germany, Italy,

Japan, Netherlands, Sweden, Switzerland, United Kingdom and

United States)signed the accord, which was then intendedto apply to only internationally active banks.

At that time, its focus was the measurement of capitaland the definition of capital standards for credit risk.

The definition ofcapital is broadly set in two tiers:o Tier I: Shareholders equity and retained earnings

o Tier II: Additional internal & external sources available to thebank.

The bank has to hold at least half of its measuredcapital in Tier I form.

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The two principal objectives of the Accord were:

To ensure an adequate level of capital in theinternational banking system.

To create a more level playing field incompetitive terms so that banks could no longer

build volumes without adequate capital backing.

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Each bank had its own unique way of measuring,mitigating and managing risk. Hence, there was a need

to upgrade Basel Accord I.

Structure of Basel Accord II: The new accord is based onthree mutually reinforcing pillars, which together areexpected to contribute to the safety and soundness ofthe international financial system.

First Pillar : Minimum capital requirement (Taking intoaccount credit risk, market risk and operational risk).

Second Pillar: Supervisory Review Process (Strengtheninginternal processes for linking capital to risk).Third Pillar: Market Discipline (Through enhanceddisclosure norms)

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First pillar:- Credit risk: Standardized approach- Market risk: the risk of losses in on and off

balance sheet positions arising from movements inmarket prices. Standardized approach.

- Operational risk: the risk of loss resultingfrom inadequate or failed internal processes,people and systems or from external events (Legalrisk). Basic indicator approach.

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Capital to Risk Weighted Assets Ratio (or CapitalAdequacy Ratio) is calculated by:

Risk)lOperationaRiskMarketRisk(CreditCapital

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Indian banks:

Paid up capital Statutory reserves

Other disclosed free reserves

Capital reserves representing surplus arisingout of sale proceeds of assets

Innovative Perpetual Debt Instruments

Perpetual Non-Cumulative Preference share

(PNCPS)

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Less: Equity investment in subsidiaries Intangible assets and losses Deferred tax asset Gain/Loss from securitization of Standard assets Minority interests 50% of securitization exposures 50% of investment in excess of 10% of capital ofother banks/financial institutions.

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Foreign banks: Interest free funds Statutory reserves maintained in India Remittable surplus retained, which in notrepatriable as long as bank functions in India Capital reserve representing surplus arising out ofsale of assets in India. Interest free funds remitted from abroad foracquisition of property IPDI.

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Limits: 15 per cent limit on IPDI of Tier I capital

40 per cent limit on PNCPS along with IPDI

IPDI and PNCPS can be included under Tier 2capital, up to limit allowed in Tier 2 capital.

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Both Indian and Foreign banks: Revaluation reserves

General provision and loss reserves

Hybrid debt capital instruments

Subordinated debt

IPDI and PNCPS

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Less: 50% of securitization exposures

50% of equity investment in financialsubsidiaries

50% of the regulatory capital shortfall.

50% of investment in excess of 10% of capitalof other banks/financial institutions.

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Limits: Hybrid instruments (Upper tier 2) should notexceed 100% of Tier 1

Limit on subordinated debt (Lower tier 2) is

50% of Tier 1 capital.

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Reserve requirements are mandatory if the

liquidity in the banking system is to bepreserved and to avoid any default inrepayment to depositors.

Section 42(1) RBI Act, 1934 CRR in cash ontheir liabilities.

Section 24 Banking Regulation Act, 1949 SLR

in cash or near cash form.

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As CRR aims at taking care of immediateliquidity needs, SLR aims to two; to provideprofitability along with liquidity.

CRR & SLR are prescribed as a minimumpercentage of NDTL of each bank.

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NDTL is broadly two categories of liabilities,which are from the banking system andothers.

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Includes SBI and its subsidiaries, nationalizedbanks, co-operative banks, all private sector banks,foreign banks operating in India and any financialinstitution notified by the central government, suchas PDs.

Excludes RBI, EXIM, NAMBARD, SIDBI and otherssuch as, credit societies, foreign banks having nobranch in India and RRBs.

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Includes balances with banks in currentaccounts, balances with banks and notifiedfinancial institutions in other accounts, fundsmade available to banking system by way of

loans or deposits repayable at call or shortnotice of a fortnight or less and loans otherthan money at call and short notice madeavailable to the Banking System.

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Demand Liabilities include all liabilities which are

payable on demand that include current deposits

demand liabilities portion of savings bank deposits

margins held against letters of credit/guarantees

balances in overdue fixed deposits, cash certificatesand cumulative/recurring deposits

outstanding Telegraphic Transfers (TTs), MailTransfer (MTs), Demand Drafts (DDs)

unclaimed deposits credit balances in the Cash Credit account and

deposits held as security for advances which arepayable on demand.

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Time Liabilities are those which are payable

otherwise than on demand that include fixed deposits, cash certificates, cumulative andrecurring deposits

time liabilities portion of savings bank deposits

staff security deposits

margin held against letters of credit, if notpayable on demand

deposits held as securities for advances whichare not payable on demand and

Gold deposits.

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interest accrued on deposits, bills payable,unpaid dividends

Loans/borrowings from abroad banks

Money at call and short notice will come

under liability to others Remittance facilities (accepting bank andcorrespondent bank)

Gold borrowed by banks from abroad

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Paid up capital, reserves, any credit balance in theProfit & Loss Account of the bank, amount of anyloan taken from the RBI and the amount of refinancetaken from Exim Bank, NHB, NABARD, SIDBI.

Amount of provision for income tax in excess of theactual estimated liabilities.

Amount received from DICGC towards claims andheld by banks pending adjustments thereof.

Amount received from ECGC by invoking theguarantee.

Inter bank term deposits/term borrowing liabilitiesof original maturity of 15 days and above and uptoone year.

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Scheduled Commercial Banks are exempted from

maintaining average CRR on the following liabilities :i) Liabilities to the banking system in India as computedunder Clause (d) of the Explanation to Section 42(1) ofthe RBI Act, 1934.ii) Credit balances in ACU (US$) Accounts.

iii) Transactions in Collateralized Borrowing andLending Obligation (CBLO) with Clearing Corporation ofIndia Ltd. (CCIL).iv) Demand and Time Liabilities in respect of theirOffshore Banking Units (OBUs).

Th f

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Therefore,

NDTL is the aggregate of liabilities to others

and net interbank liabilities (NIBL).

NIBL = liabilities of banking system assetswith banking system.

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The prescribed CRR is applied on reservableliabilities. Reservable liabilities are the balanceof NDTL after deductions of exemptedliabilities.

NDTL is measured on every alternate Friday,which are know as Reporting Fridays.

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It has to be maintained only as deposits with the RBI or

cash balances in the currency chest.

Currency chest is maintained at individual bankpremises, however it is deemed to be part ofRBI.

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Once requirement for cash reserve is done on

a reporting Friday, banks have to maintain thecalculated cash balance with RBI for theperiod of a fortnight.

According to latest directives from RBI, banks arerequired to maintain minimum CRR balance up to70 per cent of the total CRR requirement on alldays of the fortnight. However, on the last day ofthe fortnight, the total amount of reservesrequired for fulfilling the CRR requirement has tobe maintained without fail.

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In cases of default in maintenance of CRRrequirement on a daily basis which is presently70 per cent of the total CRR requirement, penalinterest will be recovered for that day at the

rate of 3 per cent per annum above the BankRate on the amount by which the amountactually maintained falls short of the prescribedminimum on that day and if the shortfall

continues on the next succeeding day/s, penalinterest will be recovered at a rate of5 per centper annum above the Bank Rate.

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This is where a minimum investments by banks

has to maintain in near cash items. RBI hasproposed this to satisfy not only liquidity but alsoprofitability.

Objectives of SLR: Control money supply for credit purposes.

Channel bank investments into Govt. Sec.

Ensure solvency of banks.

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a) In cash orb) In gold valued at a price not exceeding the

current market price or

in unencumbered investments in SLR

Securities. ( Dated securities as given by RBI,GOI, All Treasury bills, any other instrumentsnotified in future by RBI for SLR status

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It is similar to that of CRR. However, unlike theCRR, there is no flexibility permitted in SLR.Which implies that 100 per cent of the SLR hasto be maintained on a daily basis.

Penalties is also similar to that of CRR.