Bank Fin Mgmt Guide

BANK FINANCIAL MANAGEMENT
1
Indian Institute of Banking & Finance Created by 87288
INTERNATIONAL BANKING
1. Exchange Rates and Forex Business

Introduction:
Cross-border movement of commodities, services, man power and capital is one
of the biggest drivers of the economic activity. This module focuses on understanding the
role of banking in this particular area, which is also known as international banking.
Exchange rates and the business of dealing in foreign exchange are two important
aspects of international banking.
In this unit, you lean about:

The definition and meaning of foreign exchange
The mechanism of the foreign exchange (forex) market
The factors affecting forex rates
The guidelines relating to forex
The factors related to dealing in forex
Foreign Exchange Markets:

A Foreign Exchange (forex or FX) transaction is primarily defined as the
exchange of one currency (or currency equivalent like traveler cheques and drafts) for
another currency by two parties at an agreed price. The ratio at which the currencies are
exchanged is called the exchange rate.
Example:
One US Dollar (USD) can be exchanged for approximately 44.8 Indian Rupees
(INR) as of June 2011. Hence, the exchange rate is denoted as 1USD= 47.6 INR.
Similarly, 1 EUR = 1.4364 USD.
Forex Participants
There are various participants that trade foreign currencies.
Participants Activity
Exporting Companies Convert foreign revenues into domestic revenues
Importing Companies Convert foreign costs into domestic costs
Commercial Banks Help customers in need of forex
Investment Funds / Banks Transfer funds for investments in or out of foreign
countries.
Central Banks Manage reserves and FX Rates. The central bank in India
is the Reserve Bank of India (RBI)
Individuals Make investments and participate in trade.
2
Delivery Time:
As FX trade is generally conducted across different time zones, the settlement
time is an important factor in determining a contract.
There are various ways in which the delivery of FX can be settled.
Spot Basis:
This is when the currencies are delivered on the second day following the day of
the deal / contract. The exchange rate used for this purpose is called the spot exchange
rate.
Example:
If the date of the deal is on September 12, 2011 (Monday), the settlement date
will be on September 14, 2011 (Wednessday, provided all the markets involved are
working on the 12, 13 and 14).
3
Ready / Cash Basis:
This is when the settlements takes place on the same day of the deal.
Example:
will also be on September 12, 2011 (Monday).
Tom Basis:
This is when the settlement takes place the day after the deal is made.
Example:
will be on September 13, 2011. (Tuesday, provided it is a working day for all the markets
involved).
If it so happens that Tuesday is a holiday in either of the two countries, then the
settlement date will be the next working day in both the countries involved.
Forward Basis:
This is when settlement takes place on a future date determined on the day the
deal is made. The exchange rate used for this purpose is called forward rate.
Example:
If the date of the forward deal is September 12, 2011 (Monday), for settlement
date September 28, 2011, it is termed as a forward deal.
Example:
Usually the forward rate is quoted as premium or a discount to the spot rate of the
foreign exchange. The premium or discount can be easily calculated from the market
forward rate and market spot rate.
4
For Example:
Scenario1:
USD is trading at a bid of INR 45.4 and an offer of INR 45.6 in the spot market.
The mid-rate is INR45.5. The three month forward USD is trading at a bid of INR 45.95
and an offer of 46.05. The mid-forward rate is INR 46. The forward premium is Rs.0.5
(46-45.5) for three months. This situation happens when interest rate in India are more
than interest rates in the US.
Scenario 2:
USD is trading a bid of INR 45.2 and an offer of INR 45.3 in the spot market. The
mid-rate is INR 45.25. The three month forward USD is trading at a bid of INR 44.95 and
an offer of 45.05. The mid-forward rate is INR45. the forward discount is Rs.0.25 (45-
45.25) for three months. This situation happens when interest rates in India are more than
interest rates in the US.
5
6
(Ans : B 80INR)
(Ans: C 137.25 INR)
7
8
9
(Ans: C 1.14)
(Ans: D Indian export increase with respect to imports)
10
2. Correspondent Banking and NRI Accounts
Introduction:
11
12
SWIFT
CHIPS
FEDWIRE
13
CHAPS
TARGET
RTGS System in India:

The Reserve Bank of India has implemented the RTGS system for Indian banks.
A detailed explanation is as follows:
Overview:
Example:
14
(Ans: B VOSTRO Account)
(Ans: A)
(Ans: B Bank C will call Bank A’s account with Bank B as a LORO account, as
LORO means ‘his account with them’)
15
16
17
(Ans: B)
(Ans: B)
18
(Ans: B NOSTRO Mirror Account)
(Ans: B RTGS is a real time gross settlement system in the UK for settling
transactions denominated in GBP)
(Ans: A True)
19
3. Documentary Letters of Credit
Introduction:
A Letter of Credit (LC) is a useful instrument for corporate involved in trading.
An LC is made up of several components and various parties could be involved in an LC
transaction.
In this unit, you learn about:

Definition and concept of an LC
Parties involved in an LC transaction
Risks involved in an LC transaction.
The LC Process:
20
Types of Letters of Credit:
There are different types of LCs that are in use in the international market.
21
Risks Relating to LC Transactions:

An LC is one of the most popular methods for the settlement of payment all over
the world. However, there are certain risks to the parties involved when using an LC.
22
23
24
(Ans: A Equity markets risk)
(Ans: D. International Chamber of Commerce)
25
4. Facilities for Exporters and Importers
Introduction:
26
27
Facilities for Exporters

Exporters can access the following facilities
28
29
30
Pre-Sanction:
Post-Sanction:
Special Cases:
31
Post- Shipment Finance:
Post shipment finance is an advance against receivables, which is in the form of
export documents. It involves handling of export documents and sending it to the foreign
bank or buyer. The following are the different types of post-shipment finances.
32
Services
Factoring Mechanism:
Factoring System:
Advantages of Factoring:
33
Features of Forfaiting:
Forfaiting Mechanism:
Costs:
34
Advantages of Forfaiting:
Exchange and Trade Control Guidelines for Importers:

The following are the guidelines for importers with respect to exchange and trade.
35
Import Finance:
Importers can have access to certain facilities from banks like the import letter of
credit and import loans.
36
(Ans: C)
(Ans: A)
37
(Ans: A True)
(Ans: B)
38
5. Risks in Foreign Trade – Role of ECGC
Introduction:
39
40
41
42
43
44
45
46
Transfer Guarantee:
Exchange Fluctuation Risk Cover:
Maturity Factoring:
(Ans: C)
47
(Ans: B)
(Ans: C)
(Ans:A)
48
6. Role of EXIM Bank, Reserve Bank of India, Exchange Control in
India – FEMA, FEDAI and Others
Introduction:
49
50
Financing Programs: Loans to Foreign Governments, Companies and Financial
Institutions:
The lending activities of the EXIM bank to foreign governments, companies and
financial institutions are as follows:
Financing Programs: Loans to Commercial Banks in India

The lending activities of the EXIM bank to commercial banks in India are as follows:
51
Functions of EXIM Bank: Other Services and Programs
The other special services and programs offered by the EXIM Bank are as follows:
52
(Ans: A True)
(Ans: B External Value)
53
54
(Ans: C)
(Ans: A)
(Ans: B)
55
56
57
(Ans: A True)
(Ans: C, Accredited)
(Ans: A True)
58
59
RISK MANAGEMENT
7. Risk and Basic Risk Management Framework
Introduction:
The Difference between Risk and Uncertainty:

There is a small distinction that needs to be made between risk and uncertainty
Uncertainty:
The lack of certainty or predictability of future outcomes can be termed as
uncertainty. Usually, uncertainty is measured by a set of probabilities assigned to a set of
possibilities.
Example: there is a 60% chance the market will double in 5 years.
60
Risk:
Minimum Capital Requirement:
Returns Expected:
61
(Ans: A)
(Ans: C)
(Ans: D)
62
63
64
65
(Ans: A, C & D)
(Ans: C)
66
8. Risks in Banking Business
Introduction:
67
Banking Risks:
The major risks that occur in the banking business or in the financial services are
liquidity risk, interest rate risk, market risk, default or credit risk and operational risk.
Liquidity Risk:
Interest Rate Risk:
Market Risk:
Credit Risk:
68
Operational Risk:
Types of Liquidity Risk:

The liquidity risk in banks may be of the following types:
Funding Risk:
Funding risk arises when net outflows have to be replaced due to unanticipated
withdrawal / non-renewal of deposits.
Time Risk:
A bank may not receive funds on its assets as per expectations, that is, performing
assets can turn into non-performing assets. Time risk arises from the need to compensate
for this non-receipt of expected funds.
Call Risk:
Call risk arises due to the crystallization of contingent liabilities. This risk may
also arise when a bank is not able to undertake a profitable business opportunity when it
arises.
Types of Interest Rate Risk:

The types of interest rate risk faced by the bank are as follows:
69
(Ans: D)
(Ans: A)
(Ans: ABCDE (All of the above) )
(Ans: C)
70
71
9. Risk Regulations in Banking Industry
Introduction:
72
73
74
Three Pillars Concept:

The Basel II Accord is based on three pillars.
75
(Ans: D)
(Ans: B)
(Ans: ABCD (All of the above) )
76
10. Market Risk
Introduction:
77
78
79
80
81
82
Calculation of VaR:
The methods for calculating VaR are described as follows:
83
84
(Ans: B)
(Ans:D)
85
(Ans: C)
(Ans: B) ( PnL = _(1*400+2*300)*3 = Loss of Rs.3000)
(Ans: A&B)
86
11. Credit Risk
Introduction:
Types of Credit Risk:

Credit risk can be of the following types:
87
88
89
90
Transaction Level:
91
Portfolio Level:
Loan Review Level:
92
93
Total Return Swap:
Credit Default Swap:
Credit Linked Note:
Credit Spread Option:
94
(Ans: B)
(Ans: B)
(Ans: C)
(Ans: B) (When the company becomes more profitable, it becomes financially

healthier thus decreasing credit spread risk)
(Ans: A) (Credit linked notes help reduce credit risks because they take the risk off
the balance sheet of the originator and transfer it to a risk taker)
95
96
12. Operational Risk and Integrated Risk Management
Introduction:
97
Operational Risk Classification:
Operational risks can be of the following types:
98
99
100
Real-Time Concern:
Business Challenges:
Cultural Issues:
101
(Ans: A,B,C)
(Ans: C)
(Ans: B)
(Ans: A)
102
103
TREASURY MANAGEMENT
13. Introduction to Treasury Management
Introduction:
104
105
106
(Ans: A)
(Ans: B)
(Ans: A)
(Ans: C)
107
108
14. Treasury Products;

Introduction:
109
Products of the Foreign Exchange Market:
Some of the products of the forex market are as follows:
110
Short – Term Securities:

The securities currently available for placement of short-term funds are shown in
the accompanying figure. These are explained in greater detail in the subsequent points:
111
112
113
114
115
116
117
Debentures and Bonds:

In India, debentures are generally issued by private sector companies whereas
bonds are issued by institutions in the public sector.
Debentures:
Bonds:
118
119
(Ans: B)
(Ans: A)
(Ans: B) (Notice money is the money loaned by a bank that must be repaid within a
period of 14 days)
(Ans: B)
(Ans: A)
( Ans: B)
120
121
15. Funding and Regulatory Aspects
Introduction:
122
Liabilities:
Liabilities can be of the following types:
Demand Liabilities:
Time Liabilities:
Other Demand and Time Liabilities:
123
124
RTGS:
NDS:
FX Clear:
125
Depository Institutions:
NEFT and Online Payments:
(Ans: B)
(Ans: B)
(Ans: A)
(Ans: A)
(Ans: B)
126
127
16. Treasury Risk Management
Introduction:
128
129
Market Risk:
Three main components of Market risk are liquidity risk, interest risk and
currency risk.
130
(Ans: B)
(Ans: A)
(Ans: A)
(Ans: B)
131
(Ans: B)
132
17. Derivative Products
Introduction:
133
134
135
136
137
138
139
(Ans: A)
140
(Ans: C)
(Ans: A)
(Ans: B)
(Ans: A)
(Ans: B)
141
(Ans: A)
(Ans: B)
(Ans: B)
(Ans: A)
142
18. Treasury and Asset Liability Management
Introduction:
143
144
145
146
(Ans: C)
(Ans: B)
147
(Ans: D)
(Ans: C)
148
BALANCE SHEET MANAGEMENT
19. Managing Assets and Liabilities
Introduction:
149
Liabilities of a Bank:
The following components constitute a bank’s liabilities.
150
Assets of a Bank:
Typical components of a Bank’s assets are listed below:
151
Profit and Loss Account of a Bank:
A bank’s profit and loss account consists of income and expenses.
Income:
Expenses:
152
153
(Ans: A)
(Ans: A & C)
154
155
20. Liquidity and Interest Rate Risk Management
Introduction:
156
157
Liquidity Risk Measurement:
Liquidity risk is usually measured using the concept of stock approach of liquidity
or the flow approach of liquidity.
158
159
Sources of Interest Rate Risk:
The various sources of IRR are as follows. There could be other forms of risk
sources but they would mostly be covered in one of the categories detailed below:
Gap Risk:
Basis Risk:
160
Curve Risk:
Option Risk:
Measurement of Interest Rate Risk:

There are a few ways in which the IRR can be measured.
Maturity Ladder:
161
Interest Rate Duration Gap:
Value at Risk:
162
(Ans: A)
(Ans: B)
163
(Ans: B)
(Ans: A & C)
(Ans: A)
164
21. Banking Regulation and Capital
Introduction:
165
Tier-I Capital
166
Tier-II Capital:
Deductions:
(Ans: C)
(Ans: A, C & D)
167
168
22. Basel II – Capital Adequacy, Supervisory Review and Market
Discipline
Introduction:
169
170
171
172
Pillar – I : Minimum Capital Requirement for Credit Risk

Credit risk can be calculated in three different ways.
173
174
175
176
Pillar – I : Minimum Capital Requirement for Operational Risk:

There are three different approaches to calculate operational risk.
177
178
179
180
181
182
183
(Ans: B)
(Ans: C)
(Ans: B)
(Ans: D)
184
(Ans: B)
185
23. Asset Classification and Provisioning Norms
Introduction:
186
187
188
189
Loss Assets and Doubtful Assets:
Substandard Assets:
190
(Ans: C)
(Ans: C)
(Ans: B)
191
24. RAROC and Profit Planning
Introduction:
192
193
Sources of Income – Services and Trading:
In addition to interest derived form lending and investments, fees charged for
services provided and the income form trading form other sources of income for banks.
Fee Based Income:
Trading or Treasury Income:
194
195
(Ans: B)
(Ans: A)
196
(Ans: A & B)
(Ans: B) (EVA= 150-1000*10% = Rs.50 Crore)
197

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BANK FINANCIAL MANAGEMENT

1. Exchange Rates and Forex Business

In this unit, you lean about:

Foreign Exchange Markets:

(Ans: C 137.25 INR)

(Ans: D Indian export increase with respect to imports)

RTGS System in India:

(Ans: B VOSTRO Account)

(Ans: B NOSTRO Mirror Account)

In this unit, you learn about:

Risks Relating to LC Transactions:

(Ans: A Equity markets risk)

(Ans: D. International Chamber of Commerce)

Facilities for Exporters

Exchange and Trade Control Guidelines for Importers:

Exchange Fluctuation Risk Cover:

Financing Programs: Loans to Commercial Banks in India

(Ans: B External Value)

The Difference between Risk and Uncertainty:

Example: there is a 60% chance the market will double in 5 years.

Minimum Capital Requirement:

Interest Rate Risk:

Types of Liquidity Risk:

Types of Interest Rate Risk:

(Ans: ABCDE (All of the above) )

Three Pillars Concept:

(Ans: ABCD (All of the above) )

(Ans: B) ( PnL = _(1*400+2*300)*3 = Loss of Rs.3000)

Types of Credit Risk:

Loan Review Level:

Credit Default Swap:

Credit Linked Note:

Credit Spread Option:

(Ans: B) (When the company becomes more profitable, it becomes financially

14. Treasury Products;

Short – Term Securities:

Debentures and Bonds:

Other Demand and Time Liabilities:

NEFT and Online Payments:

17. Derivative Products

Measurement of Interest Rate Risk:

Pillar – I : Minimum Capital Requirement for Credit Risk

Pillar – I : Minimum Capital Requirement for Operational Risk:

Fee Based Income:

Trading or Treasury Income:

(Ans: B) (EVA= 150-1000*10% = Rs.50 Crore)

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(Ans: B) ( PnL = _(1400+2300)*3 = Loss of Rs.3000)