Name – Sneha Patil

Roll no. – 2018MMS098

Commercial Banking

Finance MMS 2020

Q1. Identify whether the basel accord is based on regulatory capital or balance sheet
capital and illustrate how this has changed over time.

Banks lend to different type of borrower each carries own risk the inter-mediation n activity
exposes the bank to a verity risk. Bank collapsing due to their inability to sustain the risk
exposures reading available therefore bank have to keep certain capital as security against risk

Basel committee has produced norms called Basel norms to tackle the risk. Basel guideline
refer to board supervisory standard formulated by these group of central banks called Basel
committee on banking supervision the purpose of norms to ensure that financial institution have
enough capital on account to meet obligation and unexpected loss.

BASEL I

Introduced in 1988 to focused on credit risk minimum capital requirement fixed 8% of risk
weighted assets. Assets classify and group into 0%, 20%,50%,100%

0bjective

➢ To ensure an adequate level of capital in int4eractio banking system

➢ To create a more level in competitive environment

BASEL II

Introduced in 2004 focused on 3 main area risk, supervisory review, market discipline.

The guidelines were based on three parameters

➢ Banks should maintain a minimum capital requirement 8% of risk assets

➢ Bank were needed to develop and use better risk management techniques inn
monitoring and managing all three-type risk (market, operational, credit risk)
➢ Bank need to mandatorily disclos4e there risk exposure
BASEL III

Introduced in 2010 these guidelines were introduced in response 2008 financial crisis

Objective

➢ Improve the banking sector ability

➢ Improve risk management and governce
➢ Strengthen bank transparency and disclosure based on

Pillar 1 Pillar 2 Pillar 3

Minimum capital Supervisory review Market discipline

requirement process

Basel iii guide to maintain minimum capital 9% of risk assets

Changes in Basel norms

Better capital quality

Capital conservation buffer (2.5%)

Countercyclical common equity

Leverage ratio

Liquidity ratio

Basel norms are based on regulatory capital requirement or capital adequacy based on amount
of capital requirement by its financial regulator4y usually the express I capital adequacy ratio
of equity as percentage of risk assets it pursue banks not take excess leverage of risk.
Q.2 Explain the difference between common equity tier1 Additional capital Tier1 and
Tier 2 regulatory capital Which type if regulatory capital do regulatory prefer and Why?

Common equity capital means the funds of Equity Shareholders. In the sense, the
Equity Share Capital and also includes retained earnings (Profits which are not distributed to
the equity shareholders). It is also referred to as ‘Core Capital’ in BASEL norms.

Tier 1 (Or ‘Core Tier 1’) equity on the other hand, includes the common equity
abovementioned, along with non-redeemable non-cumulative reference equity (or ‘Preferred
stock’).

Tier 2 capital, or supplementary capital, includes a number of important and legitimate

constituents such as Undisclosed Reserves, Revaluation Reserves, General Provisions,
Subordinated Term Debt, etc.

However, each country's banking regulator (RBI in case of India) has some discretion over
how differing financial instruments may count in a capital calculation, because the legal
framework varies in different legal systems.

Capital Conservation Buffer is a limit above the Minimum Capital Requirement. When the
Bank’s capital falls in this range (even if it is above the minimum capital) capital distribution
constraints will be imposed on the bank. This means that the banks cannot issue dividends, etc.,
and will have no option but to retain the earnings resulting in increase of Tier 1 capital.

Q.3 what is the camels Rating system?

The CAMELS Rating System was developed in the United States as a supervisory rating
system to assess a bank’s overall condition. CAMELS is an acronym that represents the six
factors that are considered for the rating. Unlike other regulatory ratios or ratings, the CAMELS
rating is not released to the public. It is only used by top management to understand and regulate
possible risks.

• The CAMELS rating system assesses the strength of a bank through six categories.
• CAMELS is an acronym for capital adequacy, assets, management capability, earnings,
liquidity, sensitivity.
• The rating system is on a scale of one to five, with one being the best rating and five
being the worst rating.
Understanding the CAMELS Rating System
Banks that are given an average score of less than two are considered to be high-quality
institutions. Banks with scores greater than three are considered to be less-than-satisfactory
institutions. The acronym CAMELS stands for the following factors that examiners use to rate
bank institutions
Capital Adequacy
Examiners assess institutions' capital adequacy through capital trend analysis. Examiners also
check if institutions comply with regulations pertaining to risk-based net worth requirements.
To get a high capital adequacy rating, institutions must also comply with interest and dividend
rules and practices. Other factors involved in rating and assessing an institution's capital
adequacy are its growth plans, economic environment, ability to control risk, and loan and
investment concentrations.
Asset Quality
Asset quality covers an institutional loan's quality, which reflects the earnings of the institution.
Assessing asset quality involves rating investment risk factors the company may face and
balance those factors against the company's capital earnings. This shows the stability of the
company when faced with particular risks. Examiners also check how companies are affected
by the fair market value of investments when mirrored with the company's book value of
investments. Lastly, asset quality is reflected by the efficiency of an institution's investment
policies and practices.
Management
Management assessment determines whether an institution is able to properly react to financial
stress. This component rating is reflected by the management's capability to point out, measure,
look after and control risks of the institution's daily activities. It covers management's ability
to ensure the safe operation of the institution as they comply with the necessary and applicable
internal and external regulations.
Earnings
An institution's ability to create appropriate returns to be able to expand, retain competitiveness,
and add capital is a key factor in rating its continued viability. Examiners determine this by
assessing the company's growth, stability, valuation allowances, net interest margin, net worth
level and the quality of the company's existing assets.
Liquidity
To assess a company's liquidity, examiners look at interest rate risk sensitivity, availability of
assets that can easily be converted to cash, dependence on short-term volatile financial
resources and ALM technical competence.
Sensitivity
Sensitivity covers how particular risk exposures can affect institutions. Examiners assess an
institution's sensitivity to market risk by monitoring the management of credit concentrations.
In this way, examiners are able to see how lending to specific industries affects an institution.
These loans include agricultural lending, medical lending, credit card lending, and energy
sector lending. Exposure to foreign exchange, commodities, equities, and derivatives are also
included in rating the sensitivity of a company to market risk.
For each category, a score is given from one to five. One is the best score and indicates
strong performance and risk management practices within the institution. On the other hand,
five is the poorest rating. It indicates a high probability of bank failure and the need for
immediate action to ratify the situation. A higher number rating will impede a bank’s ability to
expand through investment, mergers, or adding more branches. Also, the institution with a poor
rating will be required to pay more in insurance premiums.
Q.4 what is Net interest Margin? Calculate NIM from following information.

Investment returns –Rs. 60,000/- Begining year outstanding loan Rs. 80,000/- year end
outstanding loan Rs. 1,50,000/- interest Rs. 50,000/- give analysis and interpretation.

Answer

Net interest margin (NIM) is a measurement comparing the net interest income a financial firm
generates from credit products like loans and mortgages, with the outgoing interest it pays
holders of savings accounts and certificates of deposit (CDs). Expressed as a percentage, the
NIM is a profitability indicator that telegraphs the likelihood of a bank or investment firm
thriving over the long haul. This metric helps prospective investors determine whether or not
to invest in a given financial services firm. Simply put: a positive net interest margin suggests
that an entity operates profitably, while a negative figure implies investment inefficiency. In
the latter scenario, a firm may take corrective action by applying funds toward outstanding debt
or shifting those assets towards more profitable investments.

• Net interest margin is a profitability metric that measures how much a bank earns in
interest compared to the outgoing expenditures it pays consumers.
• A positive net interest margin indicates a bank invests efficiently, while a negative
return implies investment efficiencies.
• Net interest margin can be calculated by subtracting interest expenses from interest
income, then dividing that figure by the average earning assets.

Calculating Net Interest Margin

Net interest margin may be calculated by the following formula:

𝐼𝑅 − 𝐼𝐸
Net interest margin =
𝐴𝑣𝑒𝑟𝑟𝑎𝑔𝑒 𝑒𝑎𝑟𝑛𝑖𝑛𝑔 𝐴𝑠𝑒𝑡𝑠

where:

IR=Investment returns

IE=Interest expenses

The net interest is calculated as follows:

Net Interest = Investment Returns – Interest Expenses = 60,000 – 50,000 = 10,000

Average earning assets = (Assets at the beginning of the year + Assets at the end of the
year) / 2 = ( 80,000 + 150,000) / 2 = 115,000
Now that we have all the pieces of the equation, we can calculate the ratio like this:

Net interest margin

60,000 − 50,000
0.09% =
115,000

Net Interest Margin = 10,000 / 115,000 = 8.7%

Analysis and Interpretation

The net margin measures how successful an investment manager or company is at making
investment decisions or investing its resources. If this ratio is a negative figure, then it indicates
that the firm or company has not been made effective investment decisions. In other words, the
company lost money on its investments and “earned” a negative margin.

A positive figure, on the other hand, means that the investment decisions were successful and
the fund manager or the company was profitable.

In example the NIM was 8.7 percent. This means that for every Rs.100 of invested assets (loans
to bank customers) the bank made Rs. 9 of income after all interest expenses had been paid.
The bank made good investment decisions this year and used its resources effectively to general
a 9 percent return.

The bank could boast this margin up next by either choosing to charge higher interest rates to
people it loans money to or pay less interest to depositors who have bank accounts at the bank.
Obviously, the bank can’t raise interest rates too high otherwise people will start going to less
expensive banks to receive loans. Likewise, depositors will only keep their money in the bank
if interest rates are high enough. If they fall below a certain amount, depositors might choose
to withdrawal their funds and invest somewhere else.