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Capital Funds

Equity contribution oI owners. The basic approach oI capital adequacy Iramework is that a
bank should have suIIicient capital to provide a stable resource to absorb any losses arising
Irom the risks in its business. Capital is divided into diIIerent tiers according to the
characteristics / qualities oI each qualiIying instrument. For supervisory purposes capital is
split into two categories: Tier I and Tier II.
Tier I Capital

A term used to reIer to one oI the components oI regulatory capital. It consists mainly oI
share capital and disclosed reserves (minus goodwill, iI any). Tier I items are deemed to be
oI the highest quality because they are Iully available to cover losses Hence it is also termed
as core capital.
Tier II Capital

ReIers to one oI the components oI regulatory capital. Also known as supplementary
capital, it consists oI certain reserves and certain types oI subordinated debt. Tier II items
qualiIy as regulatory capital to the extent that they can be used to absorb losses arising Irom
a bank's activities. Tier II's capital loss absorption capacity is lower than that oI Tier I
Revaluation reserves

Revaluation reserves are a part oI Tier-II capital. These reserves arise Irom revaluation oI
assets that are undervalued on the bank's books, typically bank premises and marketable
securities. The extent to which the revaluation reserves can be relied upon as a cushion Ior
unexpected losses depends mainly upon the level oI certainty that can be placed on
estimates oI the market values oI the relevant assets and the subsequent deterioration in
values under diIIicult market conditions or in a Iorced sale.
Ratio oI assets to capital.
Capital reserves

That portion oI a company's proIits not paid out as dividends to shareholders. They are also
known as undistributable reserves and are ploughed back into the business.
Deferred Tax Assets

Unabsorbed depreciation and carry Iorward oI losses which can be set-oII against Iuture
taxable income which is considered as timing diIIerences result in deIerred tax assets. The
deIerred Tax Assets are accounted as per the Accounting Standard 22.
Deferred Tax Liabilities

DeIerred tax liabilities have an eIIect oI increasing Iuture year's income tax payments,
which indicates that they are accrued income taxes and meet deIinition oI liabilities.

$ubordinated debt

ReIers to the status oI the debt. In the event oI the bankruptcy or liquidation oI the debtor,
subordinated debt only has a secondary claim on repayments, aIter other debt has been
Hybrid debt capital instruments

In this category, Iall a number oI capital instruments, which combine certain characteristics
oI equity and certain characteristics oI debt. Each has a particular Ieature, which can be
considered to aIIect its quality as capital. Where these instruments have close similarities to
equity, in particular when they are able to support losses on an ongoing basis without
triggering liquidation, they may be included in Tier II capital.
BA$L Committee on Banking $upervision

The BASEL Committee is a committee oI bank supervisors consisting oI members Irom
each oI the G10 countries. The Committee is a Iorum Ior discussion on the handling oI
speciIic supervisory problems. It coordinates the sharing oI supervisory responsibilities
among national authorities in respect oI banks' Ioreign establishments with the aim oI
ensuring eIIective supervision oI banks' activities worldwide.
BA$L Capital accord

The BASEL Capital Accord is an Agreement concluded among country representatives in
1988 to develop standardised risk-based capital requirements Ior banks across countries.
The Accord was replaced with a new capital adequacy Iramework (BASEL II), published in
June 2004. BASEL II is based on three mutually reinIorcing pillars hat allow banks and
supervisors to evaluate properly the various risks that banks Iace. These three pillars are:
Minimum capital requirements, which seek to reIine the present measurement Iramework
supervisory review oI an institution's capital adequacy and internal assessment process;
market discipline through eIIective disclosure to encourage saIe and sound banking
Risk Weighted Asset

The notional amount oI the asset is multiplied by the risk weight assigned to the asset to
arrive at the risk weighted asset number. Risk weight Ior diIIerent assets vary e.g. 0° on a
Government Dated Security and 20° on a AAA rated Ioreign bank etc.
CRAR(Capital to Risk Weighted Assets Ratio)

Capital to risk weighted assets ratio is arrived at by dividing the capital oI the bank with
aggregated risk weighted assets Ior credit risk, market risk and operational risk. The higher
the CRAR oI a bank the better capitalized it is.

Credit Risk

The risk that a party to a contractual agreement or transaction will be unable to meet its
obligations or will deIault on commitments. Credit risk can be associated with almost any
Iinancial transaction. BASEL-II provides two options Ior measurement oI capital charge Ior
credit risk
1.standardised approach (SA) - Under the SA, the banks use a risk-weighting schedule Ior
measuring the credit risk oI its assets by assigning risk weights based on the rating assigned
by the external credit rating agencies.
2. Internal rating based approach (IRB) - The IRB approach, on the other hand, allows
banks to use their own internal ratings oI counterparties and exposures, which permit a Iiner
diIIerentiation oI risk Ior various exposures and hence delivers capital requirements that are
better aligned to the degree oI risks. The IRB approaches are oI two types:
a) Foundation IRB (FIRB): The bank estimates the Probability oI DeIault (PD) associated
with each borrower, and the supervisor supplies other inputs such as Loss Given DeIault
(LGD) and Exposure At DeIault (EAD).
b) Advanced IRB (AIRB): In addition to Probability oI DeIault (PD), the bank estimates
other inputs such as EAD and LGD. The requirements Ior this approach are more exacting.
The adoption oI advanced approaches would require the banks to meet minimum
requirements relating to internal ratings at the outset and on an ongoing basis such as those
relating to the design oI the rating system, operations, controls, corporate governance, and
estimation and validation oI credit risk components, viz., PD Ior both FIRB and AIRB and
LGD and EAD Ior AIRB. The banks should have, at the minimum, PD data Ior Iive years
and LGD and EAD data Ior seven years. In India, banks have been advised to compute
capital requirements Ior credit risk adopting the SA.
Market risk

Market risk is deIined as the risk oI loss arising Irom movements in market prices or rates
away Irom the rates or prices set out in a transaction or agreement. The capital charge Ior
market risk was introduced by the BASEL Committee on Banking Supervision through the
Market Risk Amendment oI January 1996 to the capital accord oI 1988 (BASEL I
Framework). There are two methodologies available to estimate the capital requirement to
cover market risks:
1) The Standardised Measurement Method: This method, currently implemented by the
Reserve Bank, adopts a building block` approach Ior interest-rate related and equity
instruments which diIIerentiate capital requirements Ior speciIic risk` Irom those oI
general market risk`. The speciIic risk charge` is designed to protect against an adverse
movement in the price oI an individual security due to Iactors related to the individual
issuer. The general market risk charge` is designed to protect against the interest rate risk in
the portIolio.
2) The Internal Models Approach (IMA): This method enables banks to use their
proprietary in-house method which must meet the qualitative and quantitative criteria set
out by the BCBS and is subject to the explicit approval oI the supervisory authority.

perational Risk

The revised BASEL II Iramework oIIers the Iollowing three approaches Ior estimating
capital charges Ior operational risk:
1) The Basic Indicator Approach (BIA): This approach sets a charge Ior operational risk as
a Iixed percentage ("alpha Iactor") oI a single indicator, which serves as a proxy Ior the
bank`s risk exposure.
2) The Standardised Approach (SA): This approach requires that the institution separate its
operations into eight standard business lines, and the capital charge Ior each business line is
calculated by multiplying gross income oI that business line by a Iactor (denoted beta)
assigned to that business line.
3) Advanced Measurement Approach (AMA): Under this approach, the regulatory capital
requirement will equal the risk measure generated by the banks` internal operational risk
measurement system. In India, the banks have been advised to adopt the BIA to estimate the
capital charge Ior operational risk and 15° oI average gross income oI last three years is
taken Ior calculating capital charge Ior operational risk.
Internal Capital Adequacy Assessment Process (ICAAP)

In terms oI the guidelines on BASEL II, the banks are required to have a board-approved
policy on internal capital adequacy assessment process (ICAAP) to assess the capital
requirement as per ICAAP at the solo as well as consolidated level. The ICAAP is required
to Iorm an integral part oI the management and decision-making culture oI a bank. ICAAP
document is required to clearly demarcate the quantiIiable and qualitatively assessed risks.
The ICAAP is also required to include stress tests and scenario analyses, to be conducted
periodically, particularly in respect oI the bank`s material risk exposures, in order to
evaluate the potential vulnerability oI the bank to some unlikely but plausible events or
movements in the market conditions that could have an adverse impact on the bank`s
$upervisory Review Process ($RP)

Supervisory review process envisages the establishment oI suitable risk management
systems in banks and their review by the supervisory authority. The objective oI the SRP is
to ensure that the banks have adequate capital to support all the risks in their business as
also to encourage them to develop and use better risk management techniques Ior
monitoring and managing their risks.
Market Discipline

Market Discipline seeks to achieve increased transparency through expanded disclosure
requirements Ior banks.
Credit risk mitigation

Techniques used to mitigate the credit risks through exposure being collateralised in whole
or in part with cash or securities or guaranteed by a third party.
Mortgage Back $ecurity

A bond-type security in which the collateral is provided by a pool oI mortgages. Income
Irom the underlying mortgages is used to meet interest and principal repayments.


A derivative instrument derives its value Irom an underlying product. There are basically
three derivatives
a) Forward Contract- A Iorward contract is an agreement between two parties to buy or sell
an agreed amount oI a commodity or Iinancial instrument at an agreed price, Ior delivery on
an agreed Iuture date. Future Contract- Is a standardized exchange tradable Iorward contract
executed at an exchange. In contrast to a Iutures contract, a Iorward contract is not
transIerable or exchange tradable, its terms are not standardized and no margin is
exchanged. The buyer oI the Iorward contract is said to be long on the contract and the
seller is said to be short on the contract.
b) Options- An option is a contract which grants the buyer the right, but not the obligation,
to buy (call option) or sell (put option) an asset, commodity, currency or Iinancial
instrument at an agreed rate (exercise price) on or beIore an agreed date (expiry or
settlement date). The buyer pays the seller an amount called the premium in exchange Ior
this right. This premium is the price oI the option.
c) Swaps- Is an agreement to exchange Iuture cash Ilow at pre-speciIied Intervals. Typically
one cash Ilow is based on a variable price and other on aIIixed one.

Duration (Macaulay duration) measures the price volatility oI Iixed income securities. It is
oIten used in the comparison oI interest rate risk between securities with diIIerent coupons
and diIIerent maturities. It is deIined as the weighted average time to cash Ilows oI a bond
where the weights are nothing but the present value oI the cash Ilows themselves. It is
expressed in years. The duration oI a Iixed income security is always shorter than its term to
maturity, except in the case oI zero coupon securities where they are the same.
Modified Duration

ModiIied Duration ÷ Macaulay Duration/ (1¹y/m), where y` is the yield (°), m` is the
number oI times compounding occurs in a year. For example iI interest is paid twice a year
m÷2. ModiIied Duration is a measure oI the percentage change in price oI a bond Ior a 1°
change in yield.
Non Performing Assets (NPA)

An asset, including a leased asset, becomes non perIorming when it ceases to generate
income Ior the bank.

Gross NPA (Balance in Interest Suspense account ¹ DICGC/ECGC claims received and
held pending adjustment ¹ Part payment received and kept in suspense account ¹ Total
provisions held).
Coverage Ratio
Equity minus net NPA divided by total assets minus intangible assets.
$lippage Ratio

(Fresh accretion oI NPAs during the year/Total standard assets at the beginning oI the

A restructured account is one where the bank, grants to the borrower concessions that the
bank would not otherwise consider. Restructuring would normally involve modiIication oI
terms oI the advances/securities, which would generally include, among others, alteration oI
repayment period/ repayable amount/ the amount oI installments and rate oI interest. It is a
mechanism to nurture an otherwise viable unit, which has been adversely impacted, back to
$ubstandard Assets

A substandard asset would be one, which has remained NPA Ior a period less than or equal
to 12 months. Such an asset will have well deIined credit weaknesses that jeopardize the
liquidation oI the debt and are characterised by the distinct possibility that the banks will
sustain some loss, iI deIiciencies are not corrected.
Doubtful Asset

An asset would be classiIied as doubtIul iI it has remained in the substandard category Ior a
period oI 12 months. A loan classiIied as doubtIul has all the weaknesses inherent in assets
that were classiIied as substandard, with the added characteristic that the weaknesses make
collection or liquidation in Iull, - on the basis oI currently known Iacts, conditions and
values - highly questionable and improbable.
Doubtful Asset

An asset would be classiIied as doubtIul iI it has remained in the substandard category Ior a
period oI 12 months. A loan classiIied as doubtIul has all the weaknesses inherent in assets
that were classiIied as substandard, with the added characteristic that the weaknesses make
collection or liquidation in Iull, - on the basis oI currently known Iacts, conditions and
values - highly questionable and improbable.
Loss Asset

A loss asset is one where loss has been identiIied by the bank or internal or external auditors
or the RBI inspection but the amount has not been written oII wholly. In other words, such
an asset is considered uncollectible and oI such little value that its continuance as a
bankable asset is not warranted although there may be some salvage or recovery value.
ff Balance $heet xposure

OII-Balance Sheet exposures reIer to the business activities oI a bank that generally do not
involve booking assets (loans) and taking deposits. OII-balance sheet activities normally
generate Iees, but produce liabilities or assets that are deIerred or contingent and thus, do
not appear on the institution's balance sheet until and unless they become actual assets or
Current xposure Method

The credit equivalent amount oI a market related oII-balance sheet transaction is calculated
using the current exposure method by adding the current credit exposure to the potential
Iuture credit exposure oI these contracts. Current credit exposure is deIined as the sum oI
the positive mark to market value oI a contract. The Current Exposure Method requires
periodical calculation oI the current credit exposure by marking the contracts to market,
thus capturing the current credit exposure. Potential Iuture credit exposure is determined by
multiplying the notional principal amount oI each oI these contracts irrespective oI whether
the contract has a zero, positive or negative mark-to-market value by the relevant add-on
Iactor prescribed by RBI, according to the nature and residual maturity oI the instrument.

Total income

Sum oI interest/discount earned, commission, exchange, brokerage and other operating
Total operating expenses
Sum oI interest expended, staII expenses and other overheads.
perating profit before provisions
Net oI total income and total operating expenses.
Net operating profit

Operating proIit beIore provision minus provision Ior loan losses, depreciation in
investments, write oII and other provisions.
Profit before tax (PBT)
(Net operating proIit ¹/- realized gains/losses on sale oI assets)
Profit after tax (PAT)
ProIit beIore tax provision Ior tax.
Retained earnings
ProIit aIter tax dividend paid/proposed.
Average Yield
(Interest and discount earned/average interest earning assets)*100
Average cost
(Interest expended on deposits and borrowings/Average interest bearing liabilities)*100
Return on Asset (RA)- After Tax

Return on Assets (ROA) is a proIitability ratio which indicates the net proIit (net income)
generated on total assets. It is computed by dividing net income by average total assets.
Formula- (ProIit aIter tax/Av. Total assets)*100
Return on equity (R)- After Tax

Return on Equity (ROE) is a ratio relating net proIit (net income) to shareholders` equity.
Here the equity reIers to share capital reserves and surplus oI the bank. Formula- ProIit aIter
tax/(Total equity ¹ Total equity at the end oI previous year)/2}*100

Accretion to equity
(Retained earnings/Total equity at the end oI previous year)*100
Net Non-Interest Income

The diIIerential (surplus or deIicit) between non-interest income and non-interest expenses
as a percentage to average total assets.
Net Interest Income ( NII)
The NII is the diIIerence between the interest income and the interest expenses.
Net Interest Margin
Net interest margin is the net interest income divided by average interest earning assets.
Cost income ratio (fficiency ratio)

The cost income ratio reIlects the extent to which non-interest expenses oI a bank make a
charge on the net total income (total income interest expense). The lower the ratio, the
more eIIicient is the bank. Formula: Non interest expenditure / Net Total Income * 100.

Funds and Investment
CA$A Deposit
Deposit in bank in current and Savings account.
High Cost Deposit
Deposits accepted above card rate (Ior the deposits) oI the bank.
Liquid Assets

Liquid assets consists oI: cash, balances with RBI, balances in current accounts with banks,
money at call and short notice, inter-bank placements due within 30 days and securities
under 'held Ior trading¨ and 'available Ior sale¨ categories excluding securities that do not
have ready market.
Funding Volatility Ratio
Liquid assets |as above| to current and savings deposits - (Higher the ratio, the better)
Market Liability Ratio
Inter-bank and money market deposit liabilities to Average Total Assets

Asset Liability Management (ALM) is concerned with strategic balance sheet management
involving all market risks. It also deals with liquidity management, Iunds management,
trading and capital planning.

Asset-Liability Management Committee (ALCO) is a strategic decision making body,
Iormulating and overseeing the Iunction oI asset liability management (ALM) oI a bank.

Banking Book

The banking book comprises assests and liabilities, which are contracted basically on
account oI relationship or Ior steady income and statutory obligations and are generally held
till maturity.
Venture Capital Fund

A Iund set up Ior the purpose oI investing in startup businesses that is perceived to have
excellent growth prospects but does not have access to capital markets.
Held Till Maturity(HTM)
The securities acquired by the banks with the intention to hold them up to maturity.
Held for Trading(HFT)

Securities where the intention is to trade by taking advantage oI short-term price / interest
rate movements.
Available for $ale(AF$)

The securities available Ior sale are those securities where the intention oI the bank is
neither to trade nor to hold till maturity. These securities are valued at the Iair value which
is determined by reIerence to the best available source oI current market quotations or other
data relative to current value.
Yield to maturity (YTM) or Yield

The Yield to maturity (YTM) is the yield promised to the bondholder on the assumption
that the bond will be held to maturity and coupon payments will be reinvested at the YTM.
It is a measure oI the return oI the bond.

This represents the rate oI change oI duration. It is the diIIerence between actual price oI a
bond and the price estimated by modiIied duration.
Foreign Currency Convertible Bond

A bond issued in Ioreign currency abroad giving the investor the option to convert the bond
into equity at a Iixed conversion price or as per a pre-determined pricing Iormula.
Trading Book

Investments in trading book are held Ior generating proIits on the short term diIIerences in
prices/yields. Held Ior trading (HFT) and Available Ior sale (AFS) category constitute
trading book.

Cash reserve ratio is the cash parked by the banks in their speciIied current account
maintained with RBI.

Statutory liquidity ratio is in the Iorm oI cash (book value), gold (current market value) and
balances in unencumbered approved securities.

$tress testing

Stress testing is used to evaluate a bank`s potential vulnerability to certain unlikely but
plausible events or movements in Iinancial variables. The vulnerability is usually measured
with reIerence to the bank`s proIitability and /or capital adequacy.
$cenario Analysis

A method in which the earnings or value impact is computed Ior diIIerent interest rate

London Inter Bank OIIered Rate. The interest rate at which banks oIIer to lend Iunds in the
interbank market.
Basis Point

Is one hundredth oI one percent. 1 basis point means 0.01°. Used Ior measuring change in
interest rate/yield.

Frauds have been classiIied as under, based mainly on the provisions oI the Indian Penal
(a) Misappropriation and criminal breach oI trust.
(b) Fraudulent encashment through Iorged instruments, manipulation oI books oI account or
through Iictitious accounts and conversion oI property.
(c) Unauthorised credit Iacilities extended Ior reward or Ior illegal gratiIication.
(d) Negligence and cash shortages.
(e) Cheating and Iorgery.
(I) Irregularities in Ioreign exchange transactions.
(g) Any other type oI Iraud not coming under the speciIic heads as above.

Asset $ecuritisation

A process by which a single asset or a pool oI assets are transIerred Irom the balance sheet
oI the originator (bank) to a bankruptcy remote SPV (trust) in return Ior an immediate cash
$pecial Purpose Vehicle ($PV)

An entity which may be a trust, company or other entity constituted or established by a
Deed` or Agreement` Ior a speciIic purpose.
Bankruptcy remote

The legal position with reIerence to the creation oI the SPV should be such that the SPV
and its assets would not be touched in case the originator oI the securitization goes bankrupt
and its assets are liquidated.

Credit enhancement

These are the Iacilities oIIered to an SPV to cover the probable losses Irom the pool oI
securitized assets. It is a credit risk cover given by the originator or a third party and meant
Ior the investors in any securitization process.

An entity, usually a bank that actually holds the receivables as agent and bailee oI the
First loss facility

First level oI credit enhancement oIIered to an SPV as part oI the process in bringing the
securities issued by SPV to investment grade.
$econd loss facility

Credit enhancement providing the second or subsequent tier oI protection to an SPV against
potential losses.
Value at Risk (VAR)

VAR is a single number (currency amount) which estimates the maximum expected loss oI
a portIolio over a given time horizon (the holding period) and at a given conIidence level.
VaR is deIined as an estimate oI potential loss in a position or asset/liability or portIolio oI
assets/liabilities over a given holding period at a given level oI certainty. The Iollowing are
the three main methodologies used to calculate VaR: Parametric Estimates Estimates VaR
using parameters such as volatility and correlation. Accurate Ior traditional assets and linear
derivatives, but less accurate Ior non linear derivatives. Monte Carlo simulation- Estimates
VaR by simulating random scenarios and revaluing positions in the portIolio. Appropriate
Ior all types oI instruments, linear and nonlinear. Historical simulation- Estimates VaR by
reliving history; takes actual historical rates and revalues positions Ior each change in the
Commercial real estate

commercial real estate is deIined as 'Iund based and non-Iund based exposures secured by
mortgages on commercial real estates (oIIice buildings, retail space, multi-purpose
commercial premises, multi-Iamily residential buildings, multi-tenanted commercial
premises, industrial or warehouse space, hotels, land acquisition, development and
construction etc.)¨

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