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DEFINATION A bank is an institution, usually incorporated with power to issue its promissory notes intended to circulate as money (known as bank notes); or to receive the money of others on general deposit, to form a joint fund that shall be used by the institution, for its own benefit, for one or more of the purposes of making temporary loans and discounts; of dealing in notes, foreign and domestic bills of exchange, coin, bullion, credits, and the remission of money; or with both these powers, and with the privileges, in addition to these basic powers, of receiving special deposits and making collections for the holders of negotiable paper, if the institution sees fit to engage in such business."
Types of banks in India 1. Public Banks 2. Private Banks 3. Cooperative Banks
The History of banking in India dates back to the early half of the 18th century. 3 Presidency Banks that were established in the country namely the Bank of Hindustan, Bank of Madras and Bank of Bombay can also be referred to as some of the oldest banking institutions in the country. The State Bank of India that was earlier known as the Bank of Bengal is also one of the oldest in the genre. To know about the types of banks in India, it is necessary that we first comprehend the banking system so as to be able to distinguish about its various types.
All types of Banks in India are regulated and the activities monitored by a standard bank called the Reserve Bank of India that stands at the apex of the banking structure. It is also called the Central Bank, as major banking decisions are taken at this level. The other types of banks in India are placed below this bank in the hierarchy. The major types of banks in India are as follows: Public sector banks in India - All government owned banks fall in this variety. Besides the Reserve Bank of India, the State Bank of India and its associate banks and about 20 nationalized banks, all comprises of the public sector banks. Many of the regional rural banks that are funded by the government banks can also be clubbed in this genre. Private sector banks in India - A new wave in the banking industry came about with the private sector banks in India. With policies on liberalization being generously taken up, these private banks were established in the country that also contributed heavily towards the growth of the economy and also offering numerous services to its customers. Some of the most popular banks in this genre are: Axis Bank, Bank of Rajasthan, Catholic Syrian Bank, Federal Bank, HDFC Bank, ICICI Bank, ING Vysya Bank, Kotak Mahindra Bank and SBI Commercial and International Bank. The Foreign Banks in India like HSBC, Citibank, and Standard Chartered bank etc can also be clubbed here. Cooperative banks in India - With the aim to specifically cater to the rural population, the cooperative banks in India were set up through the country. Issues like agricultural credit and the likes are taken care of by these banks.
Public Sector Banks in India • • • • • • • • • • • • • • • • • • • • Allahabad Bank Andhra Bank Bank of Baroda Bank of India Bank of Maharastra Canara Bank Central Bank of India Corporation Bank Dena Bank IDBI Bank Indian Bank Indian Overseas Bank Oriental Bank of Commerce Punjab & Sind Bank Punjab National Bank Syndicate Bank UCO Bank Union Bank of India United Bank of India Vijaya Bank .
Private Sector Banks in India : • • • • • • • • • • • • • • • • • • • Bank of Punjab Bank of Rajasthan Catholic Syrian Bank Centurion Bank City Union Bank Dhanalakshmi Bank Development Credit Bank Federal Bank HDFC Bank ICICI Bank IndusInd Bank ING Vysya Bank Jammu & Kashmir Bank Karnataka Bank Karur Vysya Bank Laxmi Vilas Bank South Indian Bank United Western Bank UTI Bank .
MONITORING AUTHORITY OF INDIA .
For focussed attention in the area of supervision over nonbanking finance companies. banks. that can be monitored. identifying banks which show financial deterioration and would be a source for supervisory concerns. The primary objective of the off site surveillance is to monitor the financial health of banks between two on-site inspections. Off-site Monitoring As part of the new supervisory strategy. These powers are exercised through on-site inspection and off site surveillance. Subsequently.. holds supervisory discussions and draws up an action plan. i.e. development financial institutions and non-banking financial companies. All these are followed up vigorously. Department of Supervision was further bifurcated in August 1997 into Department of Banking Supervision (DBS) and Department of Non-Banking Supervision (DNBS). certain specified branches are covered under inspection so as to ensure a minimum coverage of advances. i. For dedicated and integrated supervision over all credit institutions. the top management of the Reserve Bank addresses supervisory letters to the top management of the banks highlighting the major areas of supervisory concern that need immediate rectification. asset quality. On site Inspection On site inspection of banks is carried out on an annual basis. management.Department of Banking Supervision The Banking Regulation Act. liquidity and operational health of the bank. This acts as a trigger for timely remedial action. Both these departments now function under the direction of the Board for Financial Supervision (BFS). It is based on internationally adopted CAMEL model modified as CAMELS. Till 1993. respectively. Besides the head office and controlling offices. the Board for Financial Supervision (BFS) was set up in November 1994 under the aegis of the Reserve Bank of India. 1949 empowers the Reserve Bank of India to inspect and supervise commercial banks. While the compliance to the inspection findings is followed up in the usual course. capital adequacy. Indian commercial banks are rated as per supervisory rating model approved by the BFS which is based on CAMELS concept. a new Department of Banking Supervision (DBS) was set up to take over the supervisory functions relating to the commercial banks from DBOD. The Board for Financial Supervision constituted an audit sub-committee in January 1995 with the Vice-Chairman of the Board as its Chairman and two non-official members of BFS as members. earning. liquidity and system and control. The Annual Financial Inspection (AFI) focusses on statutorily mandated areas of solvency. These Departments now look after supervision over commercial banks & development financial institutions and non-banking financial companies. The sub-committees main focus is upgradation of the quality of the statutory audit and concurrent / internal audit functions in banks and development financial institutions. .e. a focussed off-site surveillance function was initiated in 1995 for domestic operations of banks. regulatory as well as supervisory functions over commercial banks were performed by the Department of Banking Operations and Development (DBOD)..
etc. the need for building a strong and efficient banking system comparable to the international standards cannot be gainsaid. A detailed study was carried out so as to ascertain gaps. The objective of this monitoring was to obtain a macro level perspective for evolving monetary and credit policy. constitution of independent audit committee of board. etc. Initiatives and Directions The Reserve Bank has taken several other supervisory policy initiatives. Introduction of concurrent audit system. 1999. creation of a post of compliance officer. The Reserve Bank intends to reduce this periodicity with effect from April 1.During December 1995 first tranche of off-site returns was introduced with five quarterly returns for all commercial banks operating in India and two half yearly returns one each on connected and related lending and profile of ownership. these institutions were brought under the prudential regulation of the Reserve Bank. the monitoring of the financial institutions first started after 1990. This was done through prescribed quarterly returns on liabilities / assets. several steps have been initiated. issued several guidelines to banks and all india financial institutions to enable them to become Y2K compliant. The department as a one time measure. if any. Besides. the Reserve Bank monitors the implementation of recommendations of Jilani Committee relating to internal control systems in banks on an on-going basis during the annual financial inspection of banks. in implementing the 25 core principles of effective banking supervision enunciated by the Bank for International Settlements (BIS). The department monitors cases of frauds perpetrated in banks and reported to it. to assess the quality of assets of the financial system and to improve co-ordination between banks and FIs. control and management for domestic banks. such are some steps. In 1994. appointment of RBI nominees on boards of banks. It is the BFS which evolves policies relating to supervision. source and deployment of funds. The Reserve Bank has adopted more or less. Core Principles Against the backdrop of banking sector reforms in India and the global focus on internal control and supervisory mechanism. appointment of monitoring officers and direct monitoring of certain problem areas in house-keeping.2000. It also attends to appointment of statutory central auditors / branch auditors for all banks and selected all India financial institutions and to complaints against banks. the CAMELS approach for regulation . Corporate Governance With a view to strengthening the corporate governance and internal control function in the banks. Necessary steps have already been initiated to fill in the gaps. The second tranche of four quarterly returns for monitoring asset-liability management covering liquidity and interest rate risk for domestic currency and foreign currencies were introduced since June. In addition the department provides secretarial support to the Board for Financial Supervision and acts as its executive arm. These include quarterly monitoring visits to banks displaying financial and systemic weaknesses. Supervision over FIs On the basis of the recommendations made by an in-house group. so as to make the regulatory as well supervisory system more sound and comparable to international standards.
.. ICICI. Since FIs are vested with developmental role as welland with responsibility of supervision of other institutions. an off-site surveillance system has also been put in place. Exim Bank. IIBI. With a view to having a continuous monitoring and supervision of these FIs. evaluation of their developmental. the division collects from LIC. The newly created division in the department at present supervises and regulates ten select all-India financial institutions viz. NHB. co-ordinating and supervisory role is also undertaken. NABARD. IFCI. IDFC and TFCI. SIDBI.of Fis. Further. IDBI. GIC and UTI information relating to assets and liabilities and flow of funds for the purpose of overall assessment of the impact of the operations of FIs on the total flow of resources in the economy and for compiling new liquidity and monetary aggregates.
One of the primary motives behind this drive was to introduce an element of market discipline into the regulatory process that would reinforce the supervisory effort of the Reserve Bank of India (RBI). Banks are very important for the smooth functioning of financial markets as they serve as repositories of vital financial information and can potentially alleviate the problems created by information asymmetries. the Indian economy went through a process of economic liberalization. From a central bank’s perspective.INTRODUCTION TO THE BANKING REFORMS In 1991. which would operate in an environment of prudential regulation and transparent accounting. the RBI as part and parcel of the financial sector deregulation. reinforces regulatory and supervisory efforts and provides a strong incentive to banks to conduct their business in a prudent and efficient manner and to maintain adequate capital as a cushion against risk exposures. Recognizing that the success of economic reforms was contingent on the success of financial sector reform as well. The banking reform package was based on the recommendations proposed by the Narsimhan Committee Report (1991) that advocated a move to a more market oriented banking system. Consequently. introducing stricter income . Banking sector. is known for the adoption of multidimensional strategies from time to time with varying degrees of success. which was followed up by the initiation of fundamental reforms in the banking sector in 1992. the government initiated a fundamental banking sector reform package in 1992. Market discipline. the world over. among other things. attempted to enhance the transparency of the annual reports of Indian banks by. especially in the financial liberalization phase. such high-quality disclosures help the early detection of problems faced by banks in the market and reduce the severity of market disruptions.
should have a 5 per cent weight for market risk. with the resolve of the government not to fund the DFIs through budget allocations. savings bank accounts & short duration fixed deposits. enhancing the capital adequacy norms. Major Recommendations by the Narasimham Committee on Banking Sector Reforms Strengthening Banking System Capital adequacy requirements should take into account market risks in addition to the credit risks. Now they have taken the route of reverse merger with IDBI bank & ICICI bank thus converting them into the universal banking system. IFCI & ICICI had posted dismal financial results. In the next three years the entire portfolio of government securities should be marked to market and the schedule for the same announced at the earliest (since announced in the monetary and credit policy for the first half of 199899). while the latter on long term lending & project financing. were essentially depending on budget allocations for long term lending at a concessionary rate of interest. commercial banks & development financial institutions were functioning distinctly. DFIs like IDBI. . their very viability has become a question mark. the former specializing in short & medium term financing. Development Financial Institutions (DFIs) on the other hand. Commercial banks were accessing short term low cost funds thru savings investments like current accounts. and by requiring a number of additional disclosures sought by investors to make better cash flow and risk assessments. Infact. The scenario has changed radically during the post reforms period. besides collection float.recognition and asset classification rules. During the pre economic reforms period. government and other approved securities which are now subject to a zero risk weight.
advances covered by Government guarantees. One approach can be that. two alternative approaches could be adopted. This should be made prospective from the time the new prescription is put in place. There should be penal provisions for banks that do not maintain CRAR. Individual banks' shortfalls in the CRAR are treated on the same line as adopted for reserve requirements. which have turned sticky. uniformity across weak and strong banks. an intermediate minimum target of 9 per cent be achieved by 2000 and the ratio of 10 per cent by 2002. RBI to be empowered to raise this further for individual banks if the risk profile warrants such an increase. Asset Quality An asset is classified as doubtful if it is in the substandard category for 18 months in the first instance and eventually for 12 months and loss if it has been identified but not written off. For evaluating the quality of assets portfolio. all loan assets in the doubtful and loss categories should be identified and their realisable value determined. These norms should be regarded as the minimum and brought into force in a phased manner. Risk weight on a government guaranteed advance should be the same as for other advances. Minimum capital to risk assets ratio (CRAR) be increased from the existing 8 per cent to 10 per cent. viz. be treated as NPAs. . Public Sector Banks in a position to access the capital market at home or abroad be encouraged. For banks with a high NPA portfolio. as subscription to bank capital funds cannot be regarded as a priority claim on budgetary resources. Foreign exchange open credit limit risks should be integrated into the calculation of risk weighted assets and should carry a 100 per cent risk weight. These assets could be transferred to an Assets Reconstruction Company (ARC) which would issue NPA Swap Bonds. Exclusion of such advances should be separately shown to facilitate fuller disclosure and greater transparency of operations.
There may be need to redefine the scope of external vigilance and investigation agencies with regard to banking business. Banks and FIs should have a system of recruiting skilled manpower from the open market. Introduction of a general provision of 1 per cent on standard assets in a phased manner be considered by RBI. which should be reduced to 90 days in a phased manner by 2002. As an incentive to make specific provisions. costs and NPSs for higher profitability. GIC and Provident Funds. An alternative approach could be to enable the banks in difficulty to issue bonds which could from part of Tier II capital. 2 lakhs should be deregulated for scheduled commercial banks as has been done in the case of Regional Rural Banks and cooperative credit institutions. There is need to develop information and control system in several areas like better tracking of spreads. . Banks may evolve a filtering mechanism by stipulating in-house prudential limits beyond which exposures on single/group borrowers are taken keeping in view their risk profile as revealed through credit rating and other relevant factors. accurate . Prudential Norms and Disclosure Requirements In India. backed by government guarantee to make these instruments eligible for SLR investment by banks and approved instruments by LIC. they may be made tax deductible. Public sector banks should be given flexibility to determined managerial remuneration levels taking into account market trends. Systems and Methods in Banks There should be an independent loan review mechanism especially for large borrowal accounts and systems to identify potential NPAs. income stops accruing when interest or installment of principal is not paid within 180 days. The interest subsidy element in credit for the priority sector should be totally eliminated and interest rate on loans under Rs.
RBI should totally withdraw from the primary market in 91 days Treasury Bills. Structural Issues With the conversion of activities between banks and DFIs. CPs. eschewing high cost funds/borrowings etc. . There is a need for a reform of the deposit insurance scheme based on CAMELs ratings awarded by RBI to banks. only exception to be made is primary dealers. Non-bank parties are provided free access to bill rediscounts. risk and asset-liability management. The RBI regulator of the monetary system should not be also the owner of a bank in view of the potential for possible conflict of interest. and efficient treasury management. Treasury Bills. Mergers of Public Sector Banks should emanate from the management of the banks with the Government as the common shareholder playing a supportive role. Inter-bank call and notice money market and inter-bank term money market should be strictly restricted to banks. the DFIs should. The minimum share of holding by Government/Reserve Bank in the equity of the nationalised banks and the State Bank should be brought down to 33%. Merger should not be seen as a means of bailing out weak banks. ‘Weak Banks' may be nurtured into healthy units by slowing down on expansion.and timely information for strategic decision to Identify and promote profitable products and customers. CDs. over a period of time convert them to bank. Mergers between strong banks/FIs would make for greater economic and commercial sense. A DFI which converts to bank be given time to face in reserve equipment in respect of its liability to bring it on par with requirement relating to commercial bank. and MMMF.
CAMELS FRAMEWORK .
with which to evaluate a bank's financial condition and to monitor its compliance with laws and regulatory policies. if any. The supervisory . or 5 present moderate to extreme degrees of supervisory concern. This rating system is used by the three federal banking supervisors (the Federal Reserve. A sixth component. Management. In 1994. and Liquidity. (Note that the bulk of the academic literature is based on pre-1997 data and is thus based on CAMEL ratings. A key product of such an exam is a supervisory rating of the bank's overall condition. was added in 1997. the RBI established the Board of Financial Supervision (BFS). The entire supervisory mechanism was realigned to suit the changing needs of a strong and stable financial system. The acronym "CAMEL" refers to the five components of a bank's condition that are assessed: Capital adequacy. the FDIC. while banks with ratings of 3. The ratings are assigned on a scale from 1 to 5. hence the acronym was changed to CAMELS. supervisors gather private information.) Ratings are assigned for each component in addition to the overall rating of a bank's financial condition. 4. which operates as a unit of the RBI. such as details on problem loans. commonly referred to as a CAMELS rating. a bank's Sensitivity to market risk . supervisory concerns. Earnings. Banks with ratings of 1 or 2 are considered to present few. Asset quality.CAMELS FRAMEWORK During an on-site bank exam. and the OCC) and other financial supervisory agencies to provide a convenient summary of bank conditions at the time of an exam.
In addition to the normal on-site inspections. large credits and concentrations. The BFS has also established a sub-committee to routinely examine auditing practices. RBI had set up a working group under the chairmanship of Shri S. and coverage. Padmanabhan to review the banking supervision system. Under off-site system. liquidity and interest rate risks). Reserve Bank of India also conducts offsite surveillance which particularly focuses on the risk profile of the supervised entity. earnings and risk exposures (viz. The Off-site Monitoring and Surveillance System (OSMOS) was introduced in 1995 as an additional tool for supervision of commercial banks. While exam results are confidential. currency. CAMELS ratings are never released by supervisory agencies. connected lending. asset quality. It was introduced with the aim to supplement the on-site inspections. It recommended that the banks should be rated on a five point scale (A to E) based on the lines of international CAMELS rating model. including the CAMELS. although studies show that it does filter into the financial markets. the private supervisory information gathered during a bank exam is not disclosed to the public by supervisors. the public may infer such supervisory information on bank conditions based on subsequent bank actions or specific disclosures. The Committee certain recommendations and based on such suggetions a rating system for domestic and foreign banks based on the international CAMELS model combining financial management and systems and control elements was introduced for the inspection cycle commencing from July 1998. A bank's CAMELS rating is directly known only by the bank's senior management and the appropriate supervisory staff. In 1995. Its mandate is to strengthen supervision of the financial system by integrating oversight of the activities of financial services firms. CAMELS ratings in the supervisory monitoring of banks . even on a lagged basis. quality. All exam materials are highly confidential. Overall. wich focus on supervisory concerns such as capital adequacy. 12 returns (called DSB returns) are called from the financial institutions.jurisdiction of the BFS was slowly extended to the entire financial system barring the capital market institutions and the insurance sector.
given the informational asymmetries in the commercial banking industry. Market prices are generally assumed to incorporate all available public information. is clearly useful in the supervisory monitoring of bank conditions. it must also be of value to the public monitoring of banks. The overall conclusion drawn from academic studies is that private supervisory information. Since banks fund projects not readily financed in public capital markets. For the period between 1988 and 1992.Several academic studies have examined whether and to what extent private supervisory information is useful in the supervisory monitoring of banks. They find that. The authors find that.5 to 3 years). CAMELS ratings in the public monitoring of banks Another approach to examining the value of private supervisory information is to examine its impact on the market prices of bank securities. as summarized by CAMELS ratings. supervisors with direct access to private bank information could . the private supervisory information contained in past CAMEL ratings provides further insight into bank current conditions. even after controlling for a wide range of publicly available information about the condition and performance of banks. they find that a statistical model using publicly available financial data is a better indicator of bank failure than CAMEL ratings that are more than two quarters old. outside monitors should find it difficult to completely assess banks' financial conditions. it decays quickly. Morgan (1998) finds that rating agencies disagree more about banks than about other types of firms. Barker and Holdsworth (1993) find evidence that CAMEL ratings are useful. if private supervisory information were found to affect market prices. In fact. With respect to predicting bank failure. Cole and Gunther (1998) examine a similar question and find that although CAMEL ratings contain useful information. over the period from 1989 to 1995. conditional on current public information. Such private information could be especially useful to financial market participants. Hirtle and Lopez (1999) examine the usefulness of past CAMEL ratings in assessing banks' current conditions. the private supervisory information gathered during the last on-site exam remains useful with respect to the current condition of a bank for up to 6 to 12 quarters (or 1. Thus. as summarized by current CAMEL ratings. As a result.
The holders of commercial bank debt. et al.. Small depositors are protected from possible bank default by FDIC insurance. even if those banks already are monitored by private investors and rating agencies. which is consistent with managers' incentives to publicize positive information while deemphasizing negative information. The direct public beneficiaries of private supervisory information.. they find that supervisors are more likely to uncover unfavorable private information.generate additional information useful to the financial markets. (1998) examine whether private supervisory information would be useful in pricing the subordinated debt of large BHCs. such as cease-and-desist orders. DeYoung. at least by certifying that a bank's financial condition is accurately reported. Furthermore. such as that contained in CAMELS ratings.e. since both are more concerned with banks' default probabilities (i. did not cause deposit runoffs or dramatic increases in the rates paid on deposits at the affected banks. For example. downside risk). The authors use an econometric technique that estimates the private information component of the CAMEL ratings for the BHCs' lead banks and regresses it onto subordinated bond prices. was valued at more than $910 billion at year-end 1998. which probably explains the finding by Gilbert and Vaughn (1998) that the public announcement of supervisory enforcement actions. should have the most in common with supervisors. especially subordinated debt. uninsured depositors could be expected to respond more strongly to such information. These results indicate that supervisors can generate useful information about banks. Jordan.. However. (1999) find that the stock .. As of year-end 1998. Thus. The market for bank equity. such as prohibitions on paying dividends. et al. decline during the quarter after the announcement. which is about eight times larger than that for bank subordinated debt. et al. Jordan. bank holding companies (BHCs) had roughly $120 billion in outstanding subordinated debt. (1999) find that uninsured deposits at banks that are subjects of publicly-announced enforcement actions. would be depositors and holders of banks' securities. They conclude that this aspect of CAMEL ratings adds significant explanatory power to the regression after controlling for publicly available financial information and that it appears to be incorporated into bond prices about six months after an exam. the academic literature on the extent to which private supervisory information affects stock prices is more extensive.
They find that assessments by supervisors and rating agencies are complementary but different from those by the stock market. according to Flannery (1998). Davies. Berger. such as through bank financial statements made after a downgrade. on-site bank exams seem to generate additional useful information beyond what is publicly available. Moreover. The authors attribute this difference to the fact that supervisors and rating agencies. which focuses on future revenues and profitability. This result holds especially for banks that had not previously manifested serious problems.market views the announcement of formal enforcement actions as informative. it is the key parameter for financial managers to maintain adequate levels of capitalization. while supervisors in effect force the release of unfavorable information. That is. This information may reach the public in several ways. (A) Capital Adequacy Capital base of financial institutions facilitates depositors in forming their risk perception about the institutions. as representatives of debtholders. They conclude that CAMEL downgrades reveal unfavorable private information about bank conditions to the stock market. such announcements are associated with large negative stock returns for the affected banks. Focusing specifically on CAMEL ratings. and Flannery (1998) extend this analysis by examining whether the information about BHC conditions gathered by supervisors is different from that used by the financial markets. the limited available evidence does not support the view that supervisory assessments of bank conditions are uniformly better and more timely than market assessments. Berger and Davies (1998) use event study methodology to examine the behavior of BHC stock prices in the eight-week period following an exam of its lead bank. are more interested in default probabilities than the stock market. This rationale also could explain the authors' finding that supervisory assessments are much less accurate than market assessments of banks' future performances. In summary. These results suggest that bank management may reveal favorable private information in advance. besides absorbing unanticipated shocks. it signals that the institution will continue to honor its . However. Also.
According to Bank Supervision Regulation Committee (The Basle Committee) of Bank for International Settlements. which ultimately jeopardizes the earning capacity of the institution. Share of bank assets . A sound capital base strengthens confidence of depositors.obligations. Capital adequacy ultimately determines how well financial institutions can cope with shocks to their balance sheets. the asset quality is gauged in relation to the level and severity of non-performing assets. and interest rate risks—by assigning risk weightings to the institution’s assets. A Capital Adquecy Ratio is a measure of a bank's capital. With this backdrop. This ratio is used to protect depositors and promote the stability and efficiency of financial systems around the world. it is useful to track capital-adequacy ratios that take into account the most important financial risks—foreign exchange. being prime source of banking problems. Also known as ""Capital to Risk Weighted Assets Ratio (CRAR). The most widely used indicator of capital adequacy is capital to riskweighted assets ratio (CRWA). credit. distribution of assets etc. a minimum 8 percent CRWA is required. as losses are eventually written-off against capital. loan default to total advances. Thus. and the health and profitability of bank borrowers— especially the corporate sector. trends in nonperforming loans. Capital adequacy is measured by the ratio of capital to risk-weighted assets (CRAR). The deteriorating value of assets. and recoveries to loan default ratios. It is expressed as a percentage of a bank's risk weighted credit exposures. The solvency of financial institutions typically is at risk when their assets become impaired. directly pour into other areas. (B) Asset Quality: Asset quality determines the robustness of financial institutions against loss of value in the assets. recoveries. so it is important to monitor indicators of the quality of their assets in terms of overexposure to specific risks. adequacy of provisions. Popular indicators include non-performing loans to advances.
deposits as a share of total bank liabilities have declined since 1990 in many developed countries. Even where role of banks is apparently diminishing in emerging markets. The gross non-performing loans to gross advances ratio is more indicative of the quality of credit decisions made by bankers. merit in recognising the importance of diversification in the institutional and instrument-specific aspects of financial intermediation in the interests of wider choice. In this regard. no doubt. Furthermore. while in developing countries public deposits continue to be dominant in banks. An asset. NPA: Non-Performing Assets Advances are classified into performing and non-performing advances (NPAs) as per RBI guidelines. it is useful to emphasise the dominance of banks in the developing countries in promoting non-bank financial intermediaries and services including in development of debt-markets. competition and stability. including the development of financial markets. doubtful and loss assets based on the criteria stipulated by RBI. becomes non-performing when it ceases to generate income for the Bank. whereas these figures are much lower in the developed economies. they continue to play a leading role in non-banking financing activities. than 90 Interest and/or instalment of principal remains overdue for a period of more .in the aggregate financial sector assets: In most emerging markets. In India. the dominant role of banks in financial intermediation in emerging economies and particularly in India will continue in the medium-term. banking sector assets comprise well over 80 per cent of total financial sector assets. as of end-March 2008. However. including a leased asset. One of the indicators for asset quality is the ratio of non-performing loans to total loans (GNPA). An NPA is a loan or an advance where: 1. substantively. and the banks will continue to be “special” for a long time. NPAs are further classified into sub-standard. There is. Higher GNPA is indicative of poor credit decision-making. the share of banking assets in total financial sector assets is around 75 per cent.
(C) Management Soundness Management of financial institution is generally evaluated in terms of capital adequacy. technical competence.days in respect of a term loan. improving recovery-management in India is an area requiring expeditious and effective actions in legal. In addition. institutional and judicial processes. For 2008. A loan granted for long duration crops will be treated as an NPA if the installments of principal or interest thereon remain overdue for one crop season. The account remains "out-of-order'' in respect of an Overdraft or Cash Credit The bill remains overdue for a period of more than 90 days in case of bills (OD/CC). 2.9 per cent is ample testimony to the impressive efforts being made by our banking system. leadership . recovery management is also linked to the banks’ interest margins. earnings and profitability. 4. No doubt. the net NPL ratio for the Indian scheduled commercial banks at 2. purchased and discounted. ability to plan and react to changing circumstances. performance evaluation includes compliance with set norms. This is a key to the stability of the banking sector. There should be no hesitation in stating that Indian banks have done a remarkable job in containment of nonperforming loans (NPL) considering the overhang issues and overall difficult environment. asset quality. and 5. 3. A loan granted for short duration crops will be treated as an NPA if the installments of principal or interest thereon remain overdue for two crop seasons. The cost and recovery management supported by enabling legal framework hold the key to future health and competitiveness of the Indian banks. liquidity and risk sensitivity ratings. The Bank classifies an account as an NPA only if the interest imposed during any quarter is not fully repaid within 90 days from the end of the relevant quarter. In fact.
Furthermore. Things to remember . Efficiency Ratios demonstrate how efficiently the company uses its assets and how efficiently the company manages its operations. for instance. Sound management is one of the most important factors behind financial institutions’ performance. can jointly serve—as. however. it is difficult to judge its soundness just by looking at financial accounts of the banks. efficiency measures do—as an indicator of management soundness. which includes a variety of expenses. It is primarily a qualitative factor applicable to individual institutions. and cannot be easily aggregated across the sector. workers compensation and training investment. Indicators of quality of management. given the qualitative nature of management. Several indicators. reflects the management policy stance. total expenditure to total income and operating expense to total expense helps in gauging the management quality of the banking institutions. In effect. management rating is just an amalgam of performance in the above-mentioned areas. Sound management is key to bank performance but is difficult to measure. however. Nevertheless. This variable.and administrative ability. . The ratio of non-interest expenditures to total assets (MGNT) can be one of the measures to assess the working of the management. such as payroll. are primarily applicable to individual institutions. Asset Turnover Ratio = Revenue Total Assets Indicates the relationship between assets and revenue.
In addition. this determines the capacity to absorb losses. . companies with low profit margins tend to have high asset turnover. The single best indicator used to gauge earning is the Return on Assets (ROA). As noted above. (D) Earnings & Profitability Earnings and profitability. those with high profit margins have low asset turnover . which is net income after taxes to total asset ratio. is examined with regards to interest rate policies and adequacy of provisioning. those with high profit margins have low asset turnover. More specifically. . This ratio is more useful for growth companies to check if in fact they are growing revenue in proportion to sales. Asset Turnover Analysis: This ratio is useful to determine the amount of sales that are generated from each dollar of assets. the prime source of increase in capital base. Companies with low profit margins tend to have high asset turnover. Strong earnings and profitability profile of banks reflects the ability to support present and future operations. it also helps to support present and future operations of the institutions.it indicates pricing strategy.
Chronically unprofitable financial institutions risk insolvency. Calculated by dividing a company's annual earnings by its total assets. However. The assets of the company are comprised of both debt and equity. its ROA is 20%. and build up an adequate level of capital. The formula for return on assets is: ROA tells what earnings were generated from invested capital (assets). another indicator Net Interest Margins (NIM) is also used. Compared with most other indicators.finance its expansion. ROA-Return On Assets An indicator of how profitable a company is relative to its total assets. Both of these types of financing are used to fund the operations of the company. it is best to compare it against a company's previous ROA numbers or the ROA of a similar company. because the company is earning more money on less investment. if one company has a net income of $1 million and total assets of $5 million. the need for high earnings and profitability can hardly be overemphasized. the best and most widely used indicator is Return on Assets (ROA). ROA gives an idea as to how efficient management is at using its assets to generate earnings. unusually high profitability can reflect excessive risk taking. the better. The ROA figure gives investors an idea of how effectively the company is converting the money it has to invest into net income. if . however. Although different indicators are used to serve the purpose. This is why when using ROA as a comparative measure. For example. pay dividends to its shareholders. Being front line of defense against erosion of capital base from losses. ROA for public companies can vary substantially and will be highly dependent on the industry. ROA is displayed as a percentage. for in-depth analysis. The higher the ROA number. Sometimes this is referred to as "return on investment". trends in profitability can be more difficult to interpret—for instance.
. therefore.another company earns the same amount but has total assets of $10 million. but very few managers excel at making large profits with little investment (E) Liquidity An adequate liquidity position refers to a situation. Efficient fund management refers to a situation where a spread between rate sensitive assets (RSA) and rate sensitive liabilities (RSL) is maintained. The most commonly used tool to evaluate interest rate exposure is the Gap between RSA and RSL. it has an ROA of 10%. as mismatching gives rise to liquidity risk. while liquidity is gauged by liquid to total asset ratio. Anybody can make a profit by throwing a ton of money at a problem. It is. the first company is better at converting its investment into profit. generally assessed in terms of overall assets and liability management. where institution can obtain sufficient funds. management's most important job is to make wise choices in allocating its resources. Based on this example. When you really think about it. either by increasing liabilities or by converting its assets quickly at a reasonable cost.
Depth is the volume of transactions necessary to move prices.Initially solvent financial institutions may be driven toward closure by poor management of short-term liquidity. Assets that are often illiquid include limited partnerships. stocks traded in the Stock Exchange or recently issued Treasury bonds. More generally. Indicators should cover funding sources and capture large maturity mismatches. . access to. available lines of credit. The common theme in all three contexts is cash. Resiliency is the speed with which prices return to equilibrium following a large trade. A market is liquid if participants can easily convert positions into cash —or conversely. An institution is said to have liquidity if it can easily meet its needs for cash either because it has cash on hand or can otherwise raise or borrow cash. all relating to availability of. the liquidity of the institution's assets. Examples of assets that tend to be liquid include foreign exchange. thinly traded bonds or real estate. The liquidity of an institution depends on: the institution's short-term need for cash. cash on hand. A market is said to be liquid if the instruments it trades can easily be bought or sold in quantity with little impact on market prices. Kyle (1985) identifies three components of market liquidity: Tightness is the bid-ask spread. A corporation is liquid if it has ready access to cash. but this is an imperfect metric at best. The term liquidity is used in various ways. The institution's reputation in the marketplace—how willing will counterparty is to transact trades with or lend to the institution? The liquidity of a market is often measured as the size of its bid-ask spread. An asset is said to be liquid if the market for that asset is liquid. or convertibility into cash. An asset is liquid if it can easily be converted to cash.
. foreign exchange rates. which will be the focus of this module. It is calculated by dividing the cash held in different forms by total deposit. to total asset ratio (LQD) is an indicator of bank's liquidity. A high ratio shows that there is more amounts of liquid cash with the bank to met its clients cash withdrawals. In general. foreign exchange volatility and equity price risks (these risks are summed in market risk).Cash maintained by the banks and balances with central bank. Market Risk encompasses exposures associated with changes in interest rates. While all of these items are important. banks with a larger volume of liquid assets are perceived safe. Credit deposit ratio is a tool used to study the liquidity position of the bank. the primary risk in most banks is interest rate risk (IRR). equity prices. commodity prices. (F) Sensitivity To Market Risk It refers to the risk that changes in market conditions could adversely impact earnings and/or capital. Risk sensitivity is mostly evaluated in terms of management’s ability to monitor and control market risk. etc.The diversified nature of bank operations makes them vulnerable to various kinds of financial risks. Sensitivity analysis reflects institution’s exposure to interest rate risk. since these assets would allow banks to meet unexpected withdrawals.
particularly in the setting of interest rates and the carrying out of foreign exchange transactions. Conversely. its limited ability to liquidate that position at short notice will . banks are required to monitor and control IRR and to maintain a reasonably well-balanced position. If a trading organization has a position in an illiquid asset. An institution might lose liquidity if its credit rating falls. there is also a need to monitor indicators of equity and commodity price risk. Because of this exposure. it experiences sudden unexpected cash outflows. You can see that in a rising rate environment the impact on the NIM could be devastating as the liabilities reprice at higher rates but the assets do not. when a bank has more liabilities repricing in a rising rate environment than assets repricing. For example. if your bank is asset sensitive in a rising interest rate environment.Banks are increasingly involved in diversified operations. Interest Rate Risk Basics In the most simplistic terms. Liquidity risk tends to compound other risks. your NIM will improve because you have more assets repricing at higher rates. Banks are trying to balance the quantity of repricing assets with the quantity of repricing liabilities. In countries that allow banks to make trades in stock markets or commodity exchanges. Liquidity risk is financial risk due to uncertain liquidity. A firm is also exposed to liquidity risk if markets on which it depends are subject to loss of liquidity. the net interest margin (NIM) shrinks. interest rate risk is a balancing act. or some other event causes counterparties to avoid trading with or lending to the institution. all of which are subject to market risk. An extreme example of a repricing imbalance would be funding 30-year fixed-rate mortgages with 6-month CDs.
Because balance sheets differed so significantly from one organization to the next. we distinguish between different categories of risk: market risk.compound its market risk. Here. If an organization's cash flows are largely contingent. In all but the most simple of circumstances. Suppose a firm has offsetting cash flows with two different counterparties on a given day. such as market risk and credit risk. Should it be unable to do so. liquidity risk has to be managed in addition to market. Construct multiple scenarios for market movements and defaults over a given period of time. Although such categorization is convenient. Liquidity risk compounds other risks. so market risk and credit risk overlap. The distinction between market risk and business risk parallels the distinction between market-value accounting and book-value accounting. Boundaries between categories are blurred. Mark-to-market values are not usually available. the firm will have to raise cash from other sources to make its payment. credit and other risks. it is only informal. It cannot be divorced from the risks it compounds. liquidity risk is compounding credit risk. etc. but the markets are illiquid. For convenience. comprehensive metrics of liquidity risk don't exist. Market risk is exposure to the uncertain market value of a portfolio. Certain techniques of asset-liability management can be applied to assessing liquidity risk. Usage and definitions vary. . Accordingly. Because of its tendency to compound other risks. credit risk. A loss due to widening credit spreads may reasonably be called a market loss or a credit loss. it is difficult or impossible to isolate liquidity risk. There are many instruments for which markets exist. there is little standardization in how such analyses are implemented. it too we default. An important but somewhat ambiguous distinguish is that between market risk and business risk. Business risk is exposure to uncertainty in economic value that cannot be marked-tomarket. The distinction between market risk and business risk is ambiguous because there is a vast "gray zone" between the two. Assess day-to-day cash flows under each scenario. liquidity risk. Regulators are primarily concerned about systemic implications of liquidity risk. If the counterparty that owes it a payment defaults. liquidity risk may be assessed using some form of scenario analysis. Business activities entail a variety of risks.
the Greeks. The focus is on achieving a good return on investment over an extended horizon. Techniques include the careful development of business plans and appropriate management oversight. etc. On a more strategic level. These allow them to identify and reduce any exposures they might consider excessive. book-value accounting is generally used. beta. Long-term losses are avoided by avoiding losses from one day to the next. Increasingly. Business risk is managed with a long-term focus. Do these instruments pose business risk or market risk? The decision is important because firms employ fundamentally different techniques for managing the two risks. Market risk is managed with a short-term focus. so the issue of day-to-day performance is not material. organizations manage market risk by applying risk limits to traders' or portfolio managers' activities. . Each of the above six parameters are weighted on a scale of 1 to 100 and contains number of subparameters with individual weightages.—to assess their exposures.but mark-to-model values provide a more-or-less accurate reflection of fair value. On a tactical level. Some organizations also apply stress testing to their portfolios. value-at-risk is being used to define and monitor these limits. traders and portfolio managers employ a variety of risk metrics —duration and convexity.
operational or compliance weaknesses that give cause for supervisory concern. operational and managerial weaknesses that could impair future viability critical financial weaknesses and there is high possibililty of failure in the near future. serious or immoderate finance. .Rating Symbol A B C D E Rating symbol indicates Bank is sound in every respect Bank is fundamentally sound but with moderate weaknesses financial.