NMIMS

Course: Retail Banking

Internal Assignment Applicable for June 2022 examination

1. Retail Banking is sustainable and over the years, it has grown exponentially.
What are the reasons for its growth? What changes you perceive in coming
years?(10 Marks)

Answer:

Retail banking is when a bank executes transactions directly with consumers, rather
than corporations or other banks. Services offered include savings and transactional
accounts, mortgages, personal loans, debit cards, and cards. Today, retail banking is
being considered as one of the most innovative financial services provided by the
various commercial Public Sector Banks (PSBs), private sector and foreign banks.
Retail banking has a huge potential considering the growing demand for its products
namely, term deposits, consumer durable loans, auto loans, debit card, credit cards,
ATM facilities, insurance, online banking, etc.

The growing sector of retail lending has contributed significantly to the development
of the economy. Like other developed countries, India too, has a developed retail
banking sector which accounts for one-fifth of all banks credit. Retail lending across
the globe has been a showcase of innovative services in the commercial banking
sector. Countries, like China and India, have emerged as potential markets with
changing investment opportunities.

The higher growth of retail lending in emerging economies can be attributed to the
rapid growth of personal wealth, favourable demographic profile, rapid development
in information technology, the conducive macroeconomic environment, financial
market reforms and small micro-level supply side factors. The retail banking
strategies of banks are undergoing a major transformation, as banks are beginning to
adopt a mix of strategies like organic growth acquisition and alliance formation.
Retail banking in India is not a new phenomenon. It has always been prevalent in
India in various forms. For the last few years, it has become synonymous with
mainstream banking for many banks. The typical products offered in the Indian retail
banking segment are housing loans, consumption loans for purchase of durables, auto
loans, credit cards and educational loans.

Following changing consumer demographics have led to the need for expansion of
retail banking activities in India.

INCREASINGLY AFFLUENT AND BULGING MIDDLE CLASS: About 320

million people will be added in the middle-income group in a period of 15 years
approximately.

YOUNGEST POPULATION IN THE WORLD: Changing consumer

demographics indicate vast potential for growth in consumption both qualitatively and
quantitatively, due to increasing affluent with bulging middle class and youngest
people in the world. 70% of Indian population is below 35 years of age which means
that there is tremendous opportunity of 130 million people being added to working
population.

INCREASING LITERACY LEVELS: Due to increase in the literacy ratio, people

have developed a taste for latest technology and variety of products and services. It
will lead to greater demand for retail activities especially retail banking activities.

HIGHER ADAPTABILITY TO TECHNOLOGY: Convenience banking in the

form of debit cards, internet and phone-banking, anywhere and anytime banking has
attracted many new customers into the banking field. Technological innovations
relating to increasing use of credit / debit card, ATMs, direct debits and phone
banking have contributed to the growth of retail banking in India.

CONTINUING TREND IN URBANIZATION: Urbanization of Indian population

is also an important feature influencing the retail banking.
INCREASING CONSUMPTION MINDSET OF INDIANS: Economic prosperity
and the consequent increase in purchasing power have given a fillip to a consumer
boom. During the 10 years after 1997, India's economy grew at an average rate of 6.8
percent and continues to grow at the almost the same rate – not many countries in the
world match this performance. It means that Indian consumers are now shifting from
the tendency of buying more and better quality to new services and products.

DECLINING TREASURY INCOME OF THE BANKS: The Treasury income of

the banks, which had strengthened the bottom lines of banks for the past few years,
has been on the decline during the last two years. In such a scenario, retail business
provides a good vehicle of profit maximisation. Considering the fact that retail’s share
in impaired assets is far lower than the overall bank loans and advances, retail loans
have put comparatively less provisioning burden on banks apart from diversifying
their income streams.

DECLINE IN INTEREST RATES: Finally, decline in interest rates has also

contributed to the growth of retail credit by generating the demand for such credit.

CHANGES IN COMING YEARS

As stated earlier, banking industry has gone through a major revolution in the last few
years. With the rise in competition, the IT revolution, the emergence of Fintech and
non-financial services, and evolving customer expectations has called for adoption of
new strategies and techniques from banks.
Banks are progressing towards the path of digital transformation that promises
better customer experience, lower operating costs, and reduced costs for banking
transactions. Meanwhile, internet and mobile banking are the rapidly emerging trends
in this sector.
Use of AI and voice assistants to provide personalized and contextualized services are
technologically forward innovations and it is expected to change the face of banking
systems.  With biometric technology and KYC, system expects more secure banking
system.
 There is a need of constant innovation in retail banking. In bracing for tomorrow, a
paradigm shift in bank financing through innovative products and mechanisms
involving constant up gradation and revalidation of the banks’ internal systems and
processes is called for.

2. Banks are exposed to different types of risk. Recently banks in Afghanistan faced
crisis due to volatile political and economic turbulence. This resulted in banking
services remaining suspended for a month causing great inconvenience not only
to general trade& services but also to common men whose deposit were frozen in
the banks and withdrawals were rationed/controlled. What are different types of
risks banks are exposed? How to mitigate these risks? (10 Marks)

Answer:

Due to the large size of some banks, overexposure to risk can cause bank failure and
impact millions of people. By understanding the risks posed to banks, governments
can set better regulations to encourage prudent management and decision-making.
The ability of a bank to manage risk also affects investors’ decisions. Even if a bank
can generate large revenues, lack of risk management can lower profits due to losses
on loans. Value investors are more likely to invest in a bank that is able to provide
profits and is not at an excessive risk of losing money.

Financial institutions that are run on the principle of avoiding all risks will be stagnant
and will not adequately service the legitimate credit needs of the community. On the
other hand, a bank that takes excessive risks is likely to run into difficulty.

Credit risk
Credit risk is the most obvious risk in banking, and possibly the most important in
terms of potential losses. The default of a small number of key customers could
generate very large losses and in an extreme case could lead to a bank becoming
insolvent. This risk relates to the possibility that loans will not be paid or that
investments will deteriorate in quality or go into default with consequent loss to the
bank. Credit risk is not confined to the risk that borrowers are unable to pay; it also
includes the risk of payments being delayed, which can also cause problems for the
bank. Capital markets react to deterioration in a company’s credit standing through
higher interest rates on its debt issues, a decline in its share price, and/or a
downgrading of the assessment of its debt quality.

As a result of these risks, bankers must exercise discretion in maintaining a sensible

distribution of liquidity in assets, and also conduct a proper evaluation of the default
risks associated with borrowers. In general, protection against credit risks involves
maintaining high credit standards, appropriate diversification, good knowledge of the
borrower’s affairs and accurate monitoring and collection procedures. In general,
credit risk management for loans involves three main principles:

• Selection
• Limitation
• Diversification

First of all, selection means banks have to choose carefully those to whom they will
lend money. The processing of credit applications is conducted by credit officers or
credit committees, and a bank’s delegation rules specify responsibility for credit
decisions. Limitation refers to the way that banks set credit limits at various levels.
Limit systems clearly establish maximum amounts that can be lent to specific
individuals or groups. Loans are also classified by size and limitations are put on the
proportion of large loans to total lending. Banks also have to observe maximum risk
assets to total assets (see Chapter 2), and should hold a minimum proportion of assets,
such as cash and government securities, whose credit risk is negligible. Credit
management has to be diversified. Banks must spread their business over different
types of borrowers, different economic sectors and geographical regions, in order to
avoid excessive concentration of credit risk problems. Large banks therefore have an
advantage in this respect.

Liquidity risk
Another ever-present risk in banking is the likelihood that customer demand for funds
will require the sale or forced collection of assets at a loss. Banks require liquidity for
four major reasons:
• As a cushion to replace net outflows of funds
• In order to compensate for the non-receipt of expected inflows of funds
• As a source of funds when contingent liabilities fall due
• As a source of funds to undertake new transactions when desirable.

Liquidity risk relates to the eventuality that banks cannot fulfil one or more of these
needs. Banks must ensure that they have a satisfactory mix of various assets or
liabilities to fulfil their liquidity needs. The choice among the variety of sources of
liquidity should depend on several factors, including:

• Purpose of liquidity needed

• Access to liquidity markets
• Management strategy
• Costs and characteristics of the various liquidity sources
• Interest rate forecasts.

Seasonal liquidity requirements tend to be repetitive in extent, duration and timing.

Forecasts of seasonal needs are usually based on past experience. Because seasonal
requirements are generally predictable, only moderate risk is associated with the use
of bought-in forms of liquidity to cover seasonal liquidity requirements. On the other
hand, liquidity requirements relating to cyclical needs are much more unpredictable.
Bought-in funds to provide liquidity needs during booming economic cycles tend to
be costly. Credit demands are high during such periods and liabilitysources tend to
become expensive. They may be limited by the money market’s lack of confidence in
a bank’s ability to repay its obligations and the market may be restricted to only the
larger operators. Large banks with broad access to money market sources have few
problems during such periods, whereas smaller banks tend to rely on their (less costly)
non-bought-in liquid asset holdings.
 The longer-term liquidity needs of banks are more complex than the aforementioned
seasonal and cyclical requirements. If loan growth exceeds deposit growth, banks
must budget for longer-term liquidity.

Interest rate risk

Interest rate risk relates to the exposure of banks’ profits to interest rate changes
which affect assets and liabilities in different ways. Banks are exposed to interest rate
risk because they operate with unmatched balance sheets. If bankers believe strongly
that interest rates are going to move in a certain direction in the future, they have a
strong incentive to position the bank accordingly: when an interest rate rise is
expected, they will make assets more interest-sensitive relative to liabilities, and do
the opposite when a fall is expected. Assets and liabilities can obviously be mixed to
increase or decrease exposures, and techniques such as interest-margin variance
analysis (IMVA) 2 are used to evaluate current and project future exposures. The
impact of interest rate changes in the macro economy on the risk exposure of banks is
a matter of significant concern to both bankers and regulators. For example, a
monetary environment that produces marked interest rate volatility may threaten
banking stability. Because banks engage in maturity transformation, unexpected and
significant market rate changes may lead to an unacceptable number of banks and
other financial institutions encountering difficulties, or even failing. Full awareness of
such costs is needed in order to evaluate policy alternatives. At the same time,
management needs to understand and manage its own exposure to interest rate risk

A successful banker is one that can mitigate these risks and create significant returns
for the shareholders on a consistent basis. Mitigation of risks begins by first correctly
identifying the risks, why they arise and what damage can they cause.

3. Branchless Banking is one-step towards Financial Inclusion Policy of

Government of India.

a. What is the vision of government in this regard? (5 Marks)

Answer:
Financial Inclusion is described as the method of offering banking and financial
solutions and services to every individual in the society without any form of
discrimination. It primarily aims to include everybody in the society by giving them
basic financial services without looking at a person’s income or savings. Financial
inclusion chiefly focuses on providing reliable financial solutions to the economically
underprivileged sections of the society without having any unfair treatment. It intends
to provide financial solutions without any signs of inequality. It is also committed to
being transparent while offering financial assistance without any hidden transactions
or costs.

Financial inclusion wants everybody in the society to be involved and participate in

financial management judiciously. There are many poor households in India that do
not have any access to financial services in the country. They are not aware of banks
and their functions. Even if they are aware of banks, many of the poor people do not
have the access to get services from banks.

Objectives of Financial Inclusion:

 Financial inclusion intends to help people secure financial services and

products at economical prices such as deposits, fund transfer services, loans,
insurance, payment services, etc.
 It aims to establish proper financial institutions to cater to the needs of the
poor people. These institutions should have clear-cut regulations and should
maintain high standards that are existent in the financial industry.
 Financial inclusion aims to build and maintain financial sustainability so that
the less fortunate people have a certainty of funds which they struggle to have.
 Financial inclusion also intends to have numerous institutions that offer
affordable financial assistance so that there is sufficient competition so that
clients have a lot of options to choose from. There are traditional banking
options in the market. However, the number of institutions that offer
inexpensive financial products and services is very minimal.
 Financial inclusion aims to bring in digital financial solutions for the economically
underprivileged people of the nation. It also intends to bring in mobile banking or
financial services in order to reach the poorest people living in extremely remote areas
of the country.

b. Enumerate different technologies used in the banking sector to achieve the aim
of bringing more people under banking ambit? (5 Marks)

Answer:

As these technological advancements continue to disrupt the traditional ways of

banking, we see a whole new spectrum of newer and faster banking solutions. Online
deposits, mobile wallets, e-bill payments, and so on have fundamentally become a
norm for how financial transactions are carried out nowadays. With increased
consumer demand for digital banking services, artificial intelligence is also at the core
of digital banking transformation. These advancements are predominantly followed
by the growth of fintech and neo-banks that are making the entire banking process
more convenient and hassle-free for customers.

Blockchain
To undertake risk management practices, banks are increasingly using blockchain
technology that makes it difficult for hackers to extract confidential information such
as customer bank details. The industry is already experimenting with the technology
by replicating current asset transactions on the blockchain. It helps in improving
efficiency, enhancing security, and making quicker transactions with decreased costs.

Biometrics
As consumer reliance on cash is decreasing, companies such as WhatsApp, Google,
Amazon are coming up with their payment systems. Biometric payments are shaping
the way consumers make payments through their mobile devices. Payments are made
within seconds of scanning their finger or facial recognition technology.

Cloud banking
Most banks have started to move towards cloud-based banking. The cloud allows
banks to synchronise the enterprise; break down operational and data silos across
customer support, finance, risk, and more. This transforms their cost-efficiency and
enables them to provide digital experiences to customers by keeping their legacy
model intact.

Artificial Intelligence and Machine Learning

Banks are extensively implementing AI and ML to offer just-in-time, personalised
services to their customers. AI and ML automate the banking processes and facilitate
better customer services, credit and loan services. They also combat fraud.

The year has seen increased dependence on digital technologies for banking needs.
There still lies a massive potential for banks to fill the gaps to meet their customer
expectations. More businesses are digitising their processes and finding more agile
ways of working and modernising functions by investing in the latest technologies.
Modern banking technologies are helping banks collaborate and integrate their
services with Fintech and neo-banks to offer consumers newer and efficient
technologies.