INDEX

Page No
Module A International Banking
Foreign Exchange 2
Forex Risks and Derivatives 11
Correspondent Banking 13
Letter of Credit 19
Exports 23
Imports 29
Foreign Trade Risks and ECGC 33
Exim Bank 36
Reserve Bank of India , FEMA and FEDAI 37

Module B Risk Management

Risk and Capital , Capital adequacy Ratio 47
Types of Risks, Tier-I& II Capital & Risk Weighted assets 49
BASEL-I, II & III 52
Credit Risk & Credit Risk Mitigates 56
Operational Risk 66
Market Risk 70
Supervisory Review Process and Market Discipline 73
Risk Weights on NPAs and Off Balance Sheet Items 73
Questions for Practice 74
LCR & NFSR 81
Module C Treasury Management
Concept of Treasury 86
Treasury Products 89
Funding and Regulatory Aspects 98
Treasury Risk Management 101
Derivative Products 104
Treasury and ALM 108
Module D Balance Sheet Management
3rd Schedule 111
Asset Classification 115
Liquidity Management 122
Interest Rate Risk Management 124
RAROC 128
Case Studies 130
Module - A

International Banking
Forex, Exports, Imports, DGFT, RBI, LC, FEDAI etc.

2020
 International Banking
Buy and Sell If the net result of transaction is incoming of Foreign currency, it is Buy
Maxim transaction otherwise, if foreign exchange outgoes, it is Sell transaction.
Foreign Exchange Buy Low Sell High (Direct Quotations)
Buy rate is also called Bid Rate and Sell Rate is called Offer Rate.
Foreign It includes all Currency, deposits, Credits and Balances payable in Foreign
Exchange & currency. It also includes Drafts/TCs, LCs and Bills of Exchange payable in Buy High Sell Low (Indirect Quotations)
Foreign Foreign currency. In nut shell, all claims payable abroad is Foreign When Local Currency is fixed, bank will like to have more foreign
Currency Exchange. currency while buying and give less foreign currency while selling.
Direct and Direct Rates
On the other hand, Foreign Currency is narrow term which includes hard Indirect Rates Foreign Currency is fixed ---say 1USD = INR 55.70
currency say Pounds, Dollars etc. Indirect Rates
Forex Market It comprises of individuals and entities including banks across the globe Local currency remains fixed---say Rs. 100 = 1.93 USD.
without geographical boundaries. Forex market is dynamic and it operates (The Term Home Currency Quotations are Direct Rates)
round the clock. Exchange rate of major currencies change after about At present, following 4 currencies are quoted in Indirect mode:
every 4 seconds (i.e. 15*60*24= 21600 changes per day). It opens from EURO, GBP, AUD and NZ$
Monday to Friday except in Middle east countries where it is closed on Suppose 1USD = 55.70. Rate changes and now 1USD = 55.80. It means
Friday and opens on Saturday and Sunday. Dollar has improved and Rupee has become cheaper.
Global Forex market handles turnover of approx. 5100 billion USD$ per Forward Rates It is required when currency is exchanged after few months/days.
day, out of which 2% relates to trade and remaining 98% relates to Buy Transactions :
investments and speculations. (Premium is Spot Rate (+ ) premium OR ( - ) Discount
Exchange Rate When settlement of funds and exchange always added and ( Lower premium is added OR Higher discount is deducted )
mechanism of currency takes place_________ Discount is Sale Transactions:
TOD rate or Cash Rate Same day (it is also called ready rate) always deducted Spot Rate (+ )Higher premium OR (-) Lower discount
TOM Rate Next working day from Spot Rate to
Spot Rate 2nd working day (48 hours) arrive at Forward (So that currency may become cheaper while buying and dearer while
Forward Rate After few days/months Rate) selling
If Next day or 2nd day is holiday in either of the two countries, the
settlement will take place on next day. For example Spot deal is In India, Forward Contracts are available for Maximum period
stuck on 23rd Dec. 25th is Christmas Day and 26th is Sunday. Under of 12 Months and are decided by market forces of Demand and Supply)
such circumstances, value date will be 27th i.e. Monday.
There are two types of rates- Fixed and Floating. Floating rates are Example of Euro 1 = USD$1.3180/3190
determined by market forces of Demand and Supply. India Forward rates Forward differentials:
switched to Floating exchange rates regime in 1993. 1M = 15/18, 2M= 30/37, 3M=41/49
Card rates are calculated at beginning of each day based on current (Direct Quotations
market rates. when currency is Calculate 2M Bid rate and 3M Offer rate
Factors Fundamental reasons at premium) 2M Bid rate
determining Balance of Payment (Surplus leads to stronger home currency) ( It implies that the we have to quote bid rate of Euro)
Exchange rates GDP rates (High growth rate leads to rise in imports and weaker Formula of Direct Quote will apply.
home currency). 2M Bid rate = 1.3180+.0030 = 1.3210 (Lower premium is added in lower
Fiscal & Monetary policy (Lower taxes lead to high growth) spot rate)
Interest rates (In short run, high interest rates attracts overseas
capital and local currency appreciates). 3M Offer Rate
Political issues (Political stability leads to Economic growth). (It implies that we have to quote Sale rate of Euro)
Surplus of Foreign currency makes local currency stronger Formula of Direct Quote will apply
Technical reasons : Freedom on capital movement brings FDI and 3M Offer rate = 1.3190+.0049=1.3239 (Higher premium is added in
local currency becomes stronger. higher spot rate)
Speculations: It provides depth and liquidity to the market and sometimes
acts as a cushion. In this way, local currency becomes stronger in
exchange of Foreign currency.

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 Indirect Quotes What is Bank Formula is :
Suppose, in the above example, if situation is like this that we have to Spread?
quote Buy Rate of USD (instead of Euro), then this will be indirect Selling Rate Buying Rate___ *100
quotation. We will like to buy more USD for 1 Euro. Then Maxim Buy High, (Selling Rate + Buying Rate)/2
Sell Low will apply i.e. 1Euro = USD 1.3190
Forward Rates Euro 1 = USD$1.3180/3190 Suppose Equation is 1 USD = 44.57/44.68
when Currency Forward differentials:
is at Discount 1M = 24/19, 2M= 26/20, 3M=33/25 (It implies Discount) 44.68 -44.57*100
44.625
Find out 2 Month Bid rate
2M Bid rate = 1.3180-.0026 = 1.3154 (Higher Discount is deducted in = .11/44.625*100 = .2465%
Lower spot rate)
Cross Rates Suppose, In India, 1USD=42.8450/545 and in UK, 1USD=.7587/.7590
2M Offer Rate = 1.3190-.0020 = 1.3170 ((Lower Discount is deducted in where two EURO. The customer intends to remit Euro and he desires to know 1 Euro
Higher spot rate) markets are = ? INR.
Exchange involved and
Margin Exchange margin is deducted while buying and added while selling. one of them is We will Sell USD to buy Euro in International Market and then, we will Sell
Cross Rates Suppose bank has to Quote GBP against INR, but in India, GBP is not international Euro to our customer.
quoted directly. In India, market Calculation
It is an exchange 1USD =48.10 and GBP/USD is quoted as 1GBP= USD1.6000. Sell rate of 1USD = .42.8545 (Direct Quote)
rate between two Therefore 1 GBP = 48.10X1.6 = 76.96 (Sell High i.e. While selling USD, get more INR)
currencies
computed by An Import bill of GBP 100000 has to be retired. Rates are: Sell Rate of Euro (Indirect Quotes)
reference to a third 1 GBP=1.5975/85 USD
currency, usually
i.e. 1USD=.7587 (Sell Low Buy High)
1USD = 48.14/15 INR
the US dollar TT margin =.20% .7587Euro = 1USD = INR 42.8545
Here Cross selling rate of both currencies will apply. 1 EURO = 42.8545/.7587 = 56.48
Bank has to remit GBP. GBP/USD Quote is available in International In India, there is Full Convertibility of Current Account transactions.
market whereas USD/Rupee Quote is available in local market. Bank will Example Where one currency is bought and another currency is sold
sell USD to buy GBP and then GBP will be sold to customer. A wants to remit JPY 100.00 million at TT spot with margin @.15%. Given
USD/INR at 48.2500/2600 and in Japan USD/JPY = 90.50/60
While selling USD, bank will Quote Higher Rate i.e. 1 USD = 48.15
While selling GBP, bank will Quote Higher Rate i.e. 1 GBP = 1.5985 USD Solution:
We will buy Japanese Yen and sell USD and then, JPY will be sold to the
1 GBP = 1.5985 USD = 1.5985*48.15 = 76.9675 + Margin@.20% = customer. The rate to be applied is:
77.1214 (say 77.1225) 48.2600/90.50 = .533260 per JPY
Per Unit and 100 All currencies are quoted as per unit of currency whereas the following Rate per 100 JPY = 53.3260 + Margin @.15%(.0799) = 53.4059 (say
Unit Quotes currencies are quoted as 100 units of Foreign currency: 53.4050)
Japanese Yen
Indonesian Rupiahs
Kenyan Schilling.
TT Rates and Bill Rates
Belgian Francs
Spanish Peseta
Following 4 types of buying and selling rates are important:
Intervening Currencies in India
1. TT Buying rate
US Dollar
British Pound
2. Bill Buying rate
3. TT Selling rate
4. Bill Selling rate

In Interbank market, exchange rate is quoted up to 4 decimals in multiples of 0.0025. e.g.

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1USD=53.5625/5650 Solution
Bill Buying rate of August will be applied.
For customers the exchange rate is quoted in two decimal places i.e. Rupees and paisa. E.g. 1 Spot Rate----34.75 Less discount .60 = 34.15
USD =Rs. 55.54. Less Exchange Margin O.15% i.e. .0512 =34.0988 Ans.
( Transit period is rounded to next month since currency will be cheaper as it is buy transaction)
Amount being paid or received will be rounded off to nearest Rupee.
TT Buying Rate Q. 3
It is required to calculate when our Nostro account is already credited or Issue of DD on New York for USD 25000. The spot Rate is IUSD = 34.3575/3825 IM forward
being credited without delay e.g. Receipt of DD, MT, TT or collection of rate is 34.7825/8250
Foreign bills. This rate is used for cancellation of Forward Sales Contract. Exchange margin: 0.15%
Calculation
Spot Rate Exchange Margin Solution:
TT Selling Rate will Apply
Bill Buying Rate Bill Buying rate is applied when bank gives INR to the customer before Spot Rate = 34.3825 Add Exchange margin (.15%) i.e. 0.0516
receipt of Foreign Exchange in the Nostro account i.e. Nostro account is TT Selling Rate = Spot Rate + Exchange Margin = 34.4341 Ans.
credited after the purchase transaction. In such cases.
Examples are: Q. 4
Export Bills Purchased/Discounted/Negotiated. On 12th Feb, received Import Bill of USD-10000. The bill has to retired to debit the account of
Cheques/DDs purchased by the bank. the customer. Inter-bank spot rate =34.6500/7200. The spot rate for March is 5000/4500. The
Calculation exchange margin for TT selling is .15% and Exchange margin for Bill selling is .20%. Quote rate
Spot Rate + Forward Premium (or deduct forward discount) Exchange to be applied.
margin.
TT Selling Rate Any sale transaction where no delay is involved is quoted at TT selling rate. Solution
It is desired in issue of TT, MT or Draft. It is also desired in crystallization of Bill Selling Rate will be applied.
Export bills and Cancellation of Forward purchase contract. Spot Rate + Exchange margin for TT Selling + Exchange margin for Bill selling =
Calculation 34.7200+.0520+.0695 = 34.8415 Ans.
Spot Rate + Exchange Margin
Bill Selling Rate It is applied where handling of documents is involved e.g. Payment against Forward Contract Due date and Transit period
Import transactions: (Bill Buying Rates and Bill Selling Rates)
Calculation If due date after adding transit period and forward period falls in a particular month
Spot Rate + Exchange Margin for TT selling + Exchange margin for Bill
Selling Buy Transactions
Quote rates applicable to lower month (if currency is at premium) and same month (if currency
Examples is at discount) due to the reason that currency becomes cheaper and Buy low and Sell High
Q. 1
Bank received MT of USD 5000 on 15th Sep. The Nostro account was already credited. What Sale Transactions
amount will be paid to the customer: Spot Rate 34.25/30. Oct Forward Differential is 22/24. Quote rates applicable to Same month (if currency is at premium) and lower month (if currency
Exchange margin is .80% is at discount) due to the reason that currency becomes dearer and Buy low and Sell High
Forward contracts can be booked by Resident Individuals up to USD1lac.

Solution
TT buying Rate will be applied Buy Spot Rate on 16.07.2012 is 1 USD = 34.6850/7275
34.25 - .274 = 33.976 Ans. Transactions- Spot August = 4000/4200, Spot Sep = 7500/7700, Spot Oct = 1.05/1.07
Currency at Spot Nov =1.40/1.42
Q. 2 Premium Transit Period = 25 days , Exchange Margin = 0.15%
On 15th July, Customer presented a sight bill for USD 100000 for Purchase under LC. How
much amount will be credited to the account of the Exporter. Transit period is 20 days and Transit Period is Calculate Forward Buying Rate of 3 M Usance bill.
Exchange margin is 0.15%. The spot rate is 34.75/85. Forward differentials: rounded off to
Aug: .60/.57 Sep:1.00/.97 Oct: 1.40/1.37 lower month in Due date of realization of Bill = 16.7.2012 + 3M + 25 days = 9.11.2012
which due date By Rounding Transit period to lower month, Oct Rate will be as under:
falls 34.6850+1.05 - .0536 (exchange margin) = 35.6814

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Buy On 22.7.2013, At present there are about 90 ADs which include all PSBs, Foreign
Transactions- Spot Rate is 35.6000/6500 Forward 1M=3500/3000 2M=5500/5000 Banks, Pvt. Banks and All India Financial institutions.
Currency at 3M=8500/8000
Discount Transit Period ----20 days Exchange Margin = 0.15%. Forward Point Spot Rate
Find Bill Buying Rate & 2 M Forward Buying Rate Calculation Euro 1 = US$1.3180
Transit Period is 3 Month Forward Rate
rounded off to Solution Euro 1 = US$1.3330
same month in Bill Buying Rate (Ready) : Bill Date +20 days = 11.8.2013 Forward Point = 1.3330 1.3180 = 150 points
which due date Spot Rate = 35.6000 Less Forward Discount 1M (0.3500) Less Exchange
falls Margin 0.15% (0.529) Arbitrage & It consists of purchase of one currency in one center accompanied by
i.e. 35.6000-.3500-.0529(0.15% of 35.2500) = 35.1971 Forward Point immediate resale against same currency at other center.
Calculation Example:
2 M Forward Buying Rate: = Transaction date +2M +20 days =11.10.13 Let us borrow from one center and lend at other center at higher rate. In
3 Month Forward Buying Rate will be applied. USA, rate of interest is 6% whereas in Germany, rate of interest is 3% for
Spot Rate = 35.6000 Less Forward Discount of 3M (.8500) Less Exchange EURO. We will borrow from Germany and lend in USA where
Margin (.0521) 1EURO =1.5 USD
i.e. 35.6000-.8500-.0521(0.15% of 34.7500) = 34.6979 Ans.
Forward Point Calculation for 3 Months
Cancellation of
Deal Cancellation of Buy contract is done at TT selling rate and cancellation of Spot Rate x Interest rate difference x Forward Period
Sale contract is done at TT buying rate. 100 x Nos. of days in a year

Example = 1.5 x 3 x 90
A bank purchased export bill of USD 50000 at Rs. 42.66, which was dishonored for non- 100*360
payment. How much amount will be recovered from exporter, if Spot rate is 42.2000/3000. =0.01125
Exchange margin is 0.15%.
Solution 3 month swap rate = 1.5 + 0.01125 = 1.5112
TT selling rate will be applied to recover the amount Calculation of Interest Differential
TT Selling rate= Spot rate +Exchange margin
=42.3000+0.06345 = 42.36345= 42.3625 (Rounding off to nearest .0025) Forward Points x Nos. of Days x 100
2118125 --------------Ans. Forward Period x Spot Rate

Value Date It is date on which payment of funds or entry to an account becomes = 0.01125 x 360 x 100 =3%
effective. Under TT transaction, value date is same. In other spot and 1.5 x 90
forward contracts, Value Date is the date when Nostro Account is actually
credited. Value date is also date when actually settlement takes place.
Forward Premium or Discount are generally based on Interest Rate
Arbitrage It consists of purchase of one currency in one center accompanied by Differentials as well as Demand and Supply of Currency.
immediate resale against same currency at other center.
Per Cent and Per 1% is on part of 100 whereas per mille is 1 part of thousand
Mille
Authorized Authorized dealers are called Authorized Persons. The categories are as Some additional examples
Dealers under: Ex.1
AP category 1 -----AD banks, Fis dealing in Forex transactions- all types of Calculate TT selling rate for GBP/INR, if USD/INR is 43.85/87 & GBP/USD is 1.9345/49. A
Current Account and Capital account transactions. margin of 0.15% is to be loaded.
AP category 2-----Money changers authorized to sell and purchase Solution ; TT selling rate of GBP/INR
Foreign currency notes, TCs and Handle remittances. These are called 1 GBP = 1.9349 USD
FFMCs (Full Fledged Money Changers). These are Coop. Banks, RRBs. = (1.9349 *43.87)+Margin 0.15%
AP category 3----Only purchase of Foreign currency and Travelers =84.8841+.1273=85.0114 INR 85.0114-------------------------Ans.
Cheques. T

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Ex.2 Forex Dealing It is a service branch which deals Buying and Selling Operations of the
A foreign correspondent intends to fund his Vostro Account maintained with Mumbai branch of Room bank. It manages Foreign currency Assets and Liabilities and also
SBI. What rate will be quoted if 1 USD = 44.23/27 and margin is 0.08% operations manages Nostro accounts.
Solution : TT buying rate will quoted
44.23-.035 = 44.195 ---------------------------------------Ans. A dealer has to maintain two positions:
1. Funds position
Ex.3 2. Currency Position
If Swiss Franc is quoted as USD = CHF 1.2550/54 and in India, USD =INR43.50/52, how much Currency position can be Overbought or Oversold. It is called Open
INR will exporter get for his export bill of CHF 50000. position. Hedging is done to square off the open position.
Solution :
Swiss Franc will be bought from customer and sold for USD in overseas market and USD will be Mid Office deals with Risk Management.
bought in local market.
Rate will be as under: Back Office takes care of settlement and Reconciliation.
1 USD = 1.2554 CHF and 1USD=INR 43.50
1CHF=43.50/1.2554 = 34.6503
Amount as paid to exporter = 34.6503*50000=17,32,515/- ----------------Ans. FOREX RISKS AND DERIVATIVES
Ex.4
If Swiss Franc is quoted as USD = CHF 1.2550/54 and USD =INR43.50/52, how much INR will Foreign Exchange Risk (Transaction Exposure, Translation Exposure and
Importer pay for his import bill of CHF 50000. Exchange Risks Operational Exposure)
Solution : Settlement Risk
Swiss Franc will be sold to the customer after it is bought against USD in overseas market. Liquidity Risk
For this purpose, we will have to buy USD from local market i.e. Buy rate and Sell the same in Country Risk or Sovereign Risk
the international market to buy CHF. CHF will then be sold to the customer. Interest Rate Risk or Gap risk
Operational Risk
1 USD = 1.2550 CHF and 1USD=INR 43.52
Legal Risk
1CHF=43.52/1.2550 = 34.6773
Buyer Risk, Seller Risk and Shipping Risk.
Amount to be received from Importer = 34.6773*50000
=17,33,865/- ----Ans. ICG (Internal Overnight Limit Maximum exposure a bank can keep overnight
control Day Light Limit : Maximum exposure a bank can expose at any time during
Q.5 What rate will be quoted for repatriation of FCNR deposit (spot rate or TT rate) guidelines of a day.
Ans. No rate as the amount is to be paid in Foreign currency itself. RBI Gap Limit: Maximum inter-period say a month exposure which a bank can
keep.
Counter party limit
Q. 6 (Cancellation of Contract)
Country limit
An Export customer
Dealer limit
delay in realization of export bill, the customer intended to cancel forward contract before due
Stop Loss limit
date and book fresh contract of 1M Forward. How much amount will be paid to the customer
Settlement limit
and at what rate, the fresh contract will be booked.
Deal Size limit
Spot Rate = 45.2000/2200 1M Forward = .0800/.1000
Net Overnight Open Position Limit (NOOPL) should not exceed
TT Selling and Buying Margin is 0.20%
25% of total capital.
Solution
Day Light limit of Ads is 5 times the Net Overnight Position Limit or
1. Contract will be cancelled at TT selling rate i.e. 45.2200+.0904(.20%) = 45.3104
existing Intra Day Open Position limit whichever is higher.
Amount which should have been paid if original contract is honored
Aggregate Gap limit (AGL) should not exceed 6% of total capital.
=45.60*10000=456000
CCIL Clearing Corporation of India Limited is the institution created for clearing
Amount which should have been recovered in the event of cancellation of
and settlement of Forex deals amongst Primary dealers. It mitigates
contract = 45.3104*10000=453104
settlement Risks.. Both counter parties should be members of CCIL. It
Difference of amount to be paid to customer = 456000 453104 = 2896/- handles USD/INR deal settlements with netted amounts.
Derivatives Instruments which reduce risk to an accepted level by future coverings are
2. Contract will be booked at 1M Forward Buying Rate
called derivatives. Popular derivatives are:
Spot Rate + 1M premium Margin (0.20%)
1. Forward Contracts
=45.2000 + .0800 - .0905 = 45.1895
2. Futures

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 3. Options Conditions of Swap Deal:
4. Swaps There should be simultaneous buying and selling of same foreign
Forward It is a derivative product in which seller agrees to deliver goods on some currency of same value for different maturities.
Contract future date at fix price. The Quantity and delivery date is fixed as per The deal should be concluded with the understanding between the
requirements suited to the party. These are OTC products. banks that it is Swap Deal.
Forward differentials are calculated on the basis of difference in interest Buying and Selling is done at same rate. Only Forward margin
rates of countries of currency. enters into the deal as a Swap difference.
Currency with lower interest would be at a premium and currency with Example:
higher interest will be at a discount in future. PNB approaches UCO bank to quote its Swap rate for spot to 3months.
Futures It is a derivative product that is based on agreement to buy or sell an asset UCO bank has to sell spot and buy forward. Swap deal is at forward
at certain price in Future. differential of Rs. 1.40/1.35. UCO bank will sell spot and buy forward at a
Futures are standardized contracts with regard to quantity and Delivery discount of Rs.1.40 (Higher discount at purchase). Swap Difference will be
date only. The delivery is not must. Margin is kept each day and it is at Discount of Rs.1.40.
adjusted. These Futures are traded in Exchanges,

Difference between Futures and Forward Contracts CORRESPONDENT BANKING

Forward Contract Futures
It is OTC (Over the Counter) Product It is Exchange traded product
It can be for any odd amount It is always for Standard amount Correspondent Banking
It can be for any Odd period It is always for Standard period
Delivery is essential Delivery is not must It is a relationship between two banks which have mutual accounts with each other:
Margin is not essential It is based on Margin requirement and
Marked to market Nostro accounts
Options Option is Right to buy or sell an agreed quantity of currency or commodity E.g. SBI Mumbai maintaining USD account with City Bank, New York
without obligation to do so. The buyer will exercise the option if market (Only AD Cat. & Cat 2 can open Nostro accounts).
price is in favor or otherwise option may be allowed to lapse. Vostro accounts
E.g.. City Bank New York maintains Rupee account with SBI Ludhiana.
Call Option Loro account
Right to buy at fixed price on or before fixed date. E.g. City bank referring to Rupee account of Bank of America with SBI Mumbai.
Put Option Mirror account ---- It is replica of Nostro account to reconcile.
Right to sell at fixed price on or before fixed date.
Final day on which it expires is called maturity. What is Swift?
CALL OPTION; Society for Worldwide Interbank Financial Telecommunications. There are 11000 members of
If Strike price is below the spot price, the option is In the money. the society. Financial messages are sent through Swift. The messages are automatically
If Strike price is equal to the spot price, the option is At the money. authenticated through BKE (Bilateral Key Exchange). It is operational 24 hours and 365 days.
If Strike price is above the spot price, the option is Out of money. Swift has now introduced new system of authentication system wherein banks are required to
PUT OPTION have authentication key exchanged between them through a set format by use of RMA
(Relationship Management Application). This is called BIC or Bank Identifier Code).
If Strike price is more the spot price, the option is In the money.
If Strike price is equal to the spot price, the option is At the money.
If Strike price is less than spot price, the option is Out of the money. CHIPS New York
American Option Clearing House Inter Bank Payment System.
Option can be exercised on any day before expiry. CHIPS is major payment system in USA with 49 members. The participants use the system
European Option throughout the day for sending and receiving electronic payment instructions. These are netted
Option can be exercised on maturity only. at end of the day and net position is debited or credited to Nostro account of Federal Reserve.
Swap Foreign Exchange transactions where one currency is sold and purchased It is used for Foreign Exchange Inter bank settlements and Euro Dollar Settlements.
Transactions - for another simultaneously.
Swap Deal may involve: FEDWIRE -USA
1. Simultaneous purchase of spot and sale of forward or vice versa. It is US payment system being operated by Federal Reserve Bank having membership of more
2. Simultaneous sale and purchase, both forward but for different than 9000. It handles majority of domestic payments. All US banks maintain account with

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Federal Reserve Bank and are allotted ABA numbers to identify senders and receivers of NRE Deposit Only non-resident Indians can open following NRE accounts with banks:
payments. Accounts Fixed Deposits & Recurring Deposits
SB and CA Deposits
CHAPS London
Clearing House Automated Payment System The other features are:
It is UK based Settlement System. It handles receipts and Payments in UK. Deposits are held in Indian currency.
It has 20 member banks and 4500 Indirect members. The Principal and Interest both can be repatriated.
Account holder bears the risk of fluctuations in currency rates.
TARGET Account will be opened with proceeds from abroad.
The full form of TARGET is Trans-European Automated Real-Time Gross Settlement Express Funds originating in India cannot be deposited.
Transfer System. It is Euro Payment System which comprises of 20 national RTGS systems
No lien is permitted to be marked against SB deposits.
working in EUROPE. At present, name of system is Target2. It process high value payments
Joint account with Indians can be opened as Former or
across Europe. The name of present system is TARGET2.
Survivor.
RTGS-plus Cheque book and IBS allowed.
RTGS plus has over 60 participants. It is a German Hybrid clearing system and operating as a Nomination in favor of NRI/Resident Indian allowed.
European oriented RTGS and Payment system. It has over 90 members. Interest Income is exempt from Income Tax, Gift Tax or Wealth Tax.
TOD allowed up to Rs. 50000/- for maximum 2 weeks.
Account can be operated in India through mandate/P/A basis also.
RTGS & NEFT in India Loans against FDR to 3rd parties allowed provided NRI is personally
Real Time Gross Settlement is a payment system for Interbank transfer with minimum Rs. 2.00 present for documentation.
lakh. This system is managed by IDRBT, Hyderabad, which connects all banks to Central server Interest rates Have since been deregulated by RBI..
maintained by RBI. The network is INFINET (Indian Financial Network) FCNR- B FCNRB accounts can also be opened by NRIs. The conditions of NRE
Timings are: 8:00AM to 8:00PM accounts deposits as explained above are also applicable on FCNR-B deposits with
the following additional features:
NEFT (National Electronic Fund Transfer) is mainly used for low amount transactions. However, Only FD 1-5 years tenure can be opened.
there is no minimum and maximum limit. The timings are: 8:00AM to 7:00PM. There are 23 half The amount is kept in Foreign Currency and repaid in the Foreign
yearly batches daily. The time period is B+2. Currency.
Account can now be opened in any convertible currency.
Who is Resident A person who resides in India for more than 182 days during preceding No exchange risk for the customer. The bank bears the risk.
Indian? Who is financial year is Resident Indian. A person who is not resident is Non- Interest on the basis of 360 days in a year
Non- Resident Resident. Half yearly intervals of 180 days
Who is NRI? A person who is citizen of India but resides outside India owing to: Interest exemptions from I.T.
Employment, Business, vocation-------indicating indefinite period of Operating by P/A not permitted.
stay outside. The amount of Principle and Interest is freely repatriable
Work abroad on assignment with Foreign Govt., UNO, and IMF etc. Joint account with Indians can be opened as Former or
Deputation officially. Survivor.
Study abroad. The rate of interest and tenor applicable to these accounts will be
PIO - Persons of PIO is a person who is citizen of any other country (Except Pakistan and decided by Reserve Bank of India with LIBOR as base.
Indian Origin Bangladesh), but he at any time:
Held Indian Passport; or SNRR SNRR (Special Non-resident Rupee Account)
He or his grand-parents or grand grand-parents were Indian citizens (Special Non- Any person resident outside India, having business relations in India can
by virtue of constitution of India or under Indian Citizenship Act, resident Rupee open SNRR account in Indian Rupees with AD for the purpose of putting
1955; or Account) proceeds from India.
The person is spouse of Indian Citizen. CA type and no interest is paid.
OCB Overseas OCBs are firms, Cos, Society owned directly or indirectly to the extent of at- Tenure of account should commensurate with term of contract or
Corporate least 60% by NRIs. period of operation in India.
Bodies It also includes overseas trusts where at-least 60% irrevocable beneficial Maximum tenure is 7 years.
interest is held by non-residents directly or indirectly. Balance in the account is eligible for repatriation.
Transfer from NRO to SNRR account is prohibited.

14 15
 All transactions are subject to taxes payable in India. Such account will be treated as resident bank account
Pakinstan and Bangladesh national require prior approval of RBI. Cheques, instruments, remittances, cash, card belonging to the NRI
Rupee Loans Demand Loan or Overdraft is allowed against FDR. There is no maximum close relative shall not be eligible for credit to this account
against limit of loan against pledge of FDR . The loan proceeds will be credited to The NRI close relative shall operate such account only for and on
NRE/FCNRB NRO account. The loan can be availed for : behalf of the resident for domestic payment
FDRs Personal purpose. Where due to any eventuality, the non-resident account holder becomes
Investment. the survivor, it shall be categorized as NRO account.
Purchase of property.
The loan can be repaid : Investments by NRIs are allowed to invest in India on Repatriation basis as well as on Non-
From proceeds of abroad NRIs in India Repatriation basis. NRI can purchase Equity Shares, Preference shares
From NRE/FCNR account and Convertible Debentures in Indian companies subject to conditions
From local resources through NRO account. under following categories:
NRO accounts Non-Resident Ordinary are Rupee accounts and can be opened: 1. Foreign Direct Investments.
By NRIs for deposit of Income earned in India. 2. Portfolio Investment
An NRO account, 3. Purchase and Sale of Shares on Non-Repatriation basis.
By any person resident outside India (other than a person resident
is a savings, FD, 4. Purchase of other securities of Indian Companies.
in Nepal and Bhutan). Foreigners coming to India for temporary
RD or current 5. Exchange Traded Derivatives.
stay can open NRO account, maintain it for 6M and can convert it
account held in Ceiling of Purchase of shares by NRI/PIO
India for the NRIs to
into foreign currency after completion of stay provided no local
manage their funds are credited to the account.
Deposit may be held jointly with residents (Former or Survivor) Any individual NRI/PIO 5% of Paid capital of Co
income earned in
All NRIs/PIOs taken together 10% of Paid up capital of Co.
India. Hence, it is a Currency of Deposit is Indian Rupees
good way for Non Repatriable except for the following in the account - 1) Current
account holders to Besides above, NRIs are permitted to invest in:
income 2) Up-to USD 1 Million per financial year.
deposit and Units of UTI and Mutual Funds
Existing accounts of residents are converted to NRO category
manage their
consequent upon their becoming NRIs. Company Deposits
accumulated rupee Share in Proprietorship firm/partnership firm provided the firm is not
funds. TDS called withholding Tax is applicable at 30% + Service Tax
+Education Cess. engaged in Agriculture and Plantation activity or Real Estate
business.
Prior permission of RBI is required to open NRO account of
Pakistani national. However permission is not required for Acquiring of Immovable property not being Agriculture, Plantation
opening NRO account of Bangladeshi citizen having valid Visa or Farm House.
and Passport. NRI can acquire IP by way of :
NRO Account of Foreign student can be opened on the basis of Purchase out of funds received in India
Passport and Visa provided declaration of local address is given By way of gift from resident in India or outside India.
within 30 days and address is verified. Till then, deposit cannot be in By way of Inheritance from a person resident outside India.
excess of amount equivalent to USD 1000. The Income from the property or sale proceeds of the property can be
Now, bank can open one NRO account for Citizen of Pakistan repatriated outside India up to monetary limit of USD1 Million per financial
without RBI approval, belonging to minority community in those year provided all the applicable taxes are paid.
countries and residing in India and who have been granted Long NRIs can invest in Govt. securities, treasury bills on non-
Term Visa by CG. repatriation basis.
However, NRI cannot invest in Small saving Schemes including
Non-Resident Non-resident account holder if returns to India for permanent stay, his PPF.
returning to NRO/FCNR account is converted either into either Resident account Or Loans to NRIs NRI can avail the following loans:
India RFC (Resident Foreign Currency Account). 1. Rupee Loans in India
- Up to up to any limit subject to prescribed margin.
Resident It has been decided that AD banks may include an NRI close relative - For personal purpose, contribution to Capital in Indian
Accounts (relatives as defined in Section 6 of the Companies Act, 1956) in existing / Companies or for acquisition of property.
Operation Either new resident bank accounts as joint holder with the resident account holder - Repayment of loan will be either from inward remittances or
or Survivor with on from local resources through NRO accounts.
non- resident - Loan cannot be used for relending or for agriculture/plantation
activities.

16 17
 2. Foreign Currency Loans in India
- Against security of funds in FCNR-B deposits.
- Maturity of loan should not exceed due date of deposits.
- Repayment from Fresh remittances or from maturity proceeds of
deposits.
- Premature withdrawal of deposits not allowed.
3. Loans to 3rd Parties provided
- There is no direct or indirect consideration for NRE depositor
agreeing to pledge his FD.
- Margin, rate of Interest and Purpose of loan shall be as per RBI
guidelines.
- The loan will be utilized for personal purpose or business
purpose and not for re-lending or carrying
Agriculture/Plantation/Real estate activities.
- Loan documents will be executed personally by the depositor
and Power of attorney is not allowed.
4. Housing Loans to NRIs : HL can be sanctioned to NRIs subject to
following conditions:
- Quantum of loan, Margin and period of Repayment shall be
same as applicable to Indian resident.
- The loan shall not be credited to NRE/FCNR account of the
customer.
- EM of IP is must and lien on assets.
- Repayment from remittance abroad or by debit to NRE/FCNR
account or from rental income derived from property.
Foreign Portfolio Portfolio Investor registered with SEBI is called RFPI (Registered Foreign
Investment Portfolio Investor ) instead of FII and QFI.
Scheme for
RFPIs
Individual investment limits for RFPI is below 10% of paid up capital
of the company or paid up value of each series of convertible
debentures issued by Indian Company.
Aggregate Investment limit for RFPI is below 24% of paid up capital
of the company or paid up value of each series of convertible
debentures issued by Indian Company.
The limits are within FDI sectoral caps.
RFPI can open SNRR (Special Non-resident Rupee account) and
also Foreign Currency account with AD bank.
RFPI can
Purchase/Sale of shares and debentures
Purchase of Govt. Securities
Invest in Exchange traded derivatives
Through Regd. Brokers
Amount is routed through designated branch.
Only delivery based transactions
Investment on Repatriation basis can be made out of inward
remittances or out of NRE/FCNR deposits.
18
LETTER OF CREDIT
Documentary LC is a document:
Letters of Credit
(LC) Carrying undertaking to pay to the seller
Upon presentation of documents evidencing shipping of goods.
In compliance with terms and conditions.
ILC is Inland Letter of Credit and FLC is Foreign Letter of Credit. The
parties to LC are as under:
Applicant Buyer or Importer
Beneficiary Seller or Exporter
Issuing Bank It is opening Bank which ultimately pays on
out
Advising Bank or Bank in Exporter Country through which LC is
Notifying Bank advised. It acts as agent without responsibility to
pay unless it confirms.
Negotiating Bank Bank in Exporter Country which makes payment
or Nominated Bank to exporter or accepts Bill of Exchange.
Confirming Bank
also if it adds confirmation. This bank will be
responsible for default, if any.
Reimbursing Bank The bank which reimburses the negotiating
bank. (Usually, it is the bank having Nostro
account of Opening Bank.
UCP 600 It is a publication of ICC (international Chamber of Commerce). ICC is
Uniform Custom situated in Paris. It does not apply by default. There must be special
and Practice of mention in LC about applicability of UCPDC 600. It has 39 articles. Some
Documentary of the important are here under:
Credit
Negotiating Bank/Issuing Bank gets Reasonable time for
acceptance/refusal of Documents which is 5 Banking days after
presentation.
Bank to deal with documents and not with goods. Bank not to check
quality of the goods. However shipping documents must contain the
particulars of commodity shipped which should match with LC.
Bank is not concerned with underlying contract of buyer and seller.
Courts refrain from passing injunction on complaint of importer
regarding any discrepancy of goods.
If word about is written in LC, amount of Bill may differ from LC
amount ±10% (Tolerance limit)
In such cases, quantity of Bill may differ from LC specification ±5%
(Tolerance limit).
Documents are original if it carries original signatures, stamp mark
and label of issuer.
Documents must be presented for negotiation within 21 Calendar
days from date of Shipment. It becomes stale thereafter.
If the documents are presented after 21 days, banks can handle
19
 without RBI permission, if satisfied with the reasons. Crystallization of It is incumbent upon the issuing bank to make payment immediately.
If expiry of LC falls on Public holiday, under such situations Foreign In case of sight documents, the issuing bank can hold documents for
documents can be submitted on Preceding banking day. It cannot currency maximum period of 10 days. In case the bill is not retired or paid within this
be extended under any circumstances. Liability period, the issuing bank will crystallize the liability on 10th day at Bill
Term beginning, middle and end of the month means 1-10, 11-20 & Selling rate or the rate at which the contract was booked (whichever is
21 to last day of the month. higher)
DOCDEX (Documentary Credit Dispute resolution Expertise) is one As per latest directive, this period will be decided by each individual bank
of the options available to parties of LC to resolve their disputes. and make policy in this regard
Types of LC LC Type Features
Revocable It is an LC which can be amended or cancelled In case of Usance bill, Forex liability will be crystallized on due date into
without consent of all parties. UCPDC 600 does not Indian Rupees at Bill Selling rate or Contracted Rate (which is higher)
allow issue of such LC. Inco Terms Ex-Works
Irrevocable It is LC which cannot be cancelled or amended (International Exporter says that goods can be picked up from Factory. Exporter will not
without consent of all parties. Commercial pay the freight. The transport cost and risk will be borne by the Importer.
Confirmed LC If confirmed by some bank in exporter country. Terms)
Transferable LC It can be transferred in Full or part by advising bank at FCA (Main Freight Paid by Buyer)
the request of issuing bank. ONLY ONCE Free Carrier means seller hands over the goods to first Carrier.
Red Clause LC It enables the beneficiary to avail pre-shipment credit
FAS (Main Freight Paid by Buyer)
. Free alongside ship i.e. Goods will be delivered by exporter to shipping co.
Green Clause Besides pre-shipment, Corresponding bank can allow
FOB (Main Freight Paid by Buyer)
Letter of Credit advance for storage and shipment.
Free on Board (Say FOB Mangalore) means Goods will be loaded on
Revolving LC Where bills are negotiated and LC is automatically
ship/Aero plane (main carriage still unpaid by the exporter)
renewed.
Back to Back LC Beneficiary Uses LC to open another LC in favor of
DAP: Delivery at Place
local suppliers.
DAT: Delivery at terminal
Standby LC It is issued in lieu of Guarantee. It is substitute of
guarantee and is used in countries like US where CFR (Cost and Freight Paid by Seller)
guarantees are not used. Seller will pay cost and freight till destination
Sight, Sight LC is payable on demand whereas Acceptance CIF (Cost, Insurance and Freight paid by Seller)
acceptance or LC is payable on due date after usance period. LC The cost, Insurance and Freight will be borne by seller.
Deferred which is not accompanied by Bill of exchange and is
Other related UCPDC does not apply by default. It is required to be mentioned on
Payment Credit payable on certain future date is called DP credit. guidelines LC.
If nothing is mentioned, LC will be Irrevocable, non-transferable. Shipping Documents can be dated prior to the date of LC. It means
LC covers the shipping done prior to the issue of letter of credit. But,
Documents under LC the shipping done after expiry of LC is not permitted.
1. Bill of exchange. On or about date means ±5 Calendar days. If it is mentioned on LC
2. Invoice that date of credit is on or about 31.12.2013. This implies that date
3. Transport Documents: Bill of Lading & Airway Bill of expiry of LC can be after 5 calendar days after 31.12.2013.
4. Insurance Documents (Insurance is done at 110% of CIF value) ISBP (International Standard Banking Practice ) for examination of
5. Certificate of Origin Documents under LC is ICC publication which provides important
guidance for examination of documents under LC.
Short Bill of Lading: Which does not carry detailed terms and conditions URR-725 (Uniform Rules for Bank to Bank Reimbursement) is also
Thorough Bill of Lading covers entire voyage with several modes of publication of ICC which prescribes responsibilities of Issuing bank,
transport claiming bank, re-imbursing bank and other related parties as
Straight Bill of Lading is issued directly in the name of consignee. incorporated in LC.
Clause Bill of Lading: It bears super imposed clause that declared Insurance Policy should be in the same currency as the LC.
defective condition of Goods. Insurance claim is payable in currency of applicant.
Clean Bill of Lading: It has no such super imposed clause declaring
goods or packaging as defective.

20 21
Case Studies on Case-Study -1
LC ABC Ltd received LC in their favour for exports to UK. The expiry date of
credit is on or about 30th July, 2014. Owing to delay, the exporter
presented shipping documents on 3rd Aug, 2014. What is the position of
Negotiating Bank?
Solution
The documents can be accepted. The reason is that expiry date of LC is on
or about 30th July. As per Article 3 of UCPDC, On or About is interpreted
as that an even can occur during a period of 5 calendar days after the
specified date (both start and end date included). The presentation of
shipping documents is well within stipulated period.
Case Study 2
Dena Bank issued LC of USD 75000 on 5.1.2014 in favour of XYZ, London.
Last date of shipping is 15.1.14 and last date of negotiation is 31.1.14.
Goods were shipped on 2.1.14 14
Documents of shipping were presented with London Bank
(Negotiating bank) on 14.1.2014.
Documents were negotiated on 16.1.14. The documents were sent
to Dena bank (Issuing bank/Opening bank) for reimbursement by
London Bank,
The opening bank narrated the following deficiencies and returned the
negotiating documents.
1. Date of LC is 5.1.14 whereas the goods were shipped on 2.1.14.
2. Date of Invoice is 3.1.14 whereas date of packing list and inspection
certificate is 31.12.13.
Solution
The return is not justified on the following grounds:
1. As per Article 14 of UCPDC, Documents under LC can be dated
prior to the Issue of LC. But these cannot be dated later than date of
presentation.
2. There is no justification for objection no. 2 raised by the opening
bank.
As such, There is no option with the opening bank except to honor the
commitment and pay the LC.
Case Study 3
Issuing Bank received documents under LC from Negotiating bank on
22.12.2013. The documents were forwarded to the applicant for
acceptance on next day. On 29.12.2013, applicant pointed out that
insurance policy was in currency different than as mentioned in LC. 25th
Dec was holiday and 27th Dec was Sunday. The opening bank informed the
discrepancies to Negotiating bank and sought directions of exporter. The
Negotiating bank objected that opening bank could have pointed out
discrepancy within 5 days which has already been lapsed and therefore
Opening bank must pay now.
Solution
Article 16 of UCPDC states that Issuing Bank gets 5 banking days to
determine discrepancy, if any. 25th Dec, 26th Dec and 27th Dec has to
excluded and therefore the claim of Negotiating bank is not tenable.
22
EXPORTS
RBI and DGFT RBI controls Foreign Exchange and DGFT (Directorate General of Foreign
Trade) controls Foreign Trade. Exim Policy as framed in accordance with
FEMA is implemented by DGFT. DGFT functions under direct control of
Ministry of Commerce and Industry. It regulates Imports and Exports
through EXIM Policy.
On the other hand, RBI keeps Forex Reserves, Finances Export trade and
Regulates exchange control. Receipts and Payments of Forex are also
handled by RBI.
IEC - Importer One has to apply for IEC to become eligible for Imports and Exports. DGFT
Exporter Code allots IEC to Exporters and Importers in accordance with RBI guidelines
and FEMA regulations. EXIM Policy is also considered before allotting IEC.
Export All exports (physically or otherwise) shall be declared in the following Form.
Declaration 1. Softex form---meant for export of software.
Form 2. SDF/EDF (Statutory Declaration Form/ Export Declaration Form)----
replaced GR form in order to submit declaration electronically.
EDF is submitted in duplicate with Custom Commissioner who puts its
stamp and hands over obne copy to exporter
Exemptions
Trade Samples, Personal effects of travelers and Central Govt.
goods and Aircrafts/Engines spare parts for overhauling
Gift items having value up to Rs. 5.00 lakh per exporter.
Goods with value not exceeding USD 1000 value to Myanmar.
Goods imported free of cost on re-export basis
Goods sent for testing.
Imported goods found defective for replacement or found surplus
ADs may consider waiver for export of goods free of cost for export
promotion up to 2% of average annual exports of previous 3 years subject
to ceiling of Rs. 1.00 crore for Status Holder Exporters.
As per latest directives, submission of SDF has been dispensed with
only if exports are taking place on EDI ports. . However, mandatory
statutory requirements contained in EDF have been subsumed in
Shipping bill format.
Prescribed Time The time norms for export trade are as under:
limits
within 21 days from date of shipment.
Time period for realization of Export proceeds is has been reduced
to 9M for all types of exports including exports to SEZ (Special
23
 economic zones), SHE (Status Holder Exporters) and 100%EOUs. The proceeds of exports can be got deposited by exporter in any of the
Previously, the time period was 12Months for SEZs and SHEs. following account:
For, Exports to Warehouse established outside India, as soon as it 1. Overseas Foreign Currency account.
is realized and in any case within fifteen months from the date of 2. Diamond Dollar account.
shipment of goods 3. EEFC (Exchange Earners Foreign Currency account)
After expiry of time limit, extension is sought by Exporter on ETX DDA _ diamond Diamond Dollar account can be opened by traders dealing in Rough and
Form. The AD can extend the period by 6M. Dollar accounts Polished diamond or Diamond studded Jewellary with the following
conditions:
However, reporting will be made to RBI on XOS Form on half yearly basis
in respect of all overdue bills not realized within due date. 1. With track record of 2 years.
2. Average Export turnover of 3 crores or above during preceding 3
Direct Dispatch AD banks may handle direct dispatch of shipping documents provided licensing years.
of Shipping export proceeds are up to USD 1 Million
Documents the exporter is regular customer of at least 6 months AND DDA account can be opened by the exporter for transacting business in
Full Value of Exports stands received. Foreign Exchange. An exporter can have maximum 5 Diamond Dollar
accounts.
Advance Exporters may receive advance payments from their overseas importers EEFC Exchange Earners Foreign Currency accounts can be opened by exporters.
Payments provided: 100% export proceeds can be credited in the account which does not earn
Shipment is made within 1 year from receipt of advance. interest but this amount is repatriable outside India for imports (Current
Rate of interest payable should not exceed LIBOR+100 bps. Account transactions).
Documents are routed through AD from which advance was routed.
Pre-shipment Packing credit has the following features:
Refund of Refund of export proceeds can be considered by AD provided the exporter
Finance or
Export proceeds submits evidence of re-import on account of poor quality, trade dispute etc.
Packing Credit 1. Calculation of FOB value of order/LC amount or Domestic cost of
SD must exercise due diligence, verify bonafides and obtain certificate of
production (whichever is lower).
DGFT from exporter that no incentives were received from DGFT at the
2. IEC allotted by DGFT.
time of exports or incentives received if any have been surrendered. The
3.
Ad must also obtain certificate that goods will be re-imported within 3
4. He should
months from date of remittance.
5. There must be valid Export order or LC.
Prescribed Exporter will receive payment though any of the following mode:
6. Account should be KYC compliant.
Method of Bank Drafts, TC, Currency, FCNR/NRE deposits, International 7. Normally up to 180 days at concessional rates. Presently, it is
payment and Credit Card. But the proceeds can be in Indian Rupees from Nepal available up to 270 dats.
Reduction in and Bhutan.
export proceeds Export proceeds from ACU countries can be settled in ACU/EURO Liquidation of Pre-shipment credit
or ACU/Dollar. A separate Dollar/Euro account is maintained which Out of proceeds of the bill.
is denominated as ACU Dollar or ACU EURO.
Out of negotiation of export documents.
ACU Asian Clearing Union was formed in Tehran, Iran in 1974 and it Out of balances held in EEFC account
comprises of following 9 countries as members. Out of proceeds of Post Shipment credit.

India, Bangladesh, Bhutan, Myanmar, Iran, Pak, Srilanka, Nepal and
Maldives.
Exporters may be allowed to reduce the export proceeds with the following:
Reduction in Invoice value on account of discount for pre-payment
of Usance bills (maximum 25%)
Agency commission on exports.
Claims against exports.
Write off the unrecoverable export dues up to maximum limit of 5%
of export value. SHE can write off up 10% of total exports during
previous calendar year.
Post Shipment Post shipment finance is made available to exporters on the following
Finance conditions:
IEC accompanied by prescribed declaration on GR/PP/Softex/SDF
form must be submitted.
Documents must be submitted by exporter within 21 days of
shipment.
Payment must be made in approved manner within 6 months.
Normal Transit Period is 25 days. The margin is NIL normally. But
in any case, it should not exceed 10% if LC is there otherwise it can
be up to 25%.
Credit can be granted for maximum 9 months (inclusive of NTP) in

24 25
 case of Usance Bills Export of Credit can be provided to exporters of all 161 tradable services covered
Concessional rate of interest is allowed to the exporter up to services under GATS (General Agreement on Trade in services) where payment for
Notional Due Date or Value date whichever is earlier up to such services is received in Forex. The provisions applicable to export of
maximum 90 days. goods apply to export of services.
Types of Post Shipment Finance:
Export Bills Purchased for Sight bills and Discounting for Usance
bills.( These bills are not covered under LC) Gold Card All exporters in Small and Medium Sector with good track record are
Export bills negotiation. (These bills are covered under LC) Scheme eligible to avail Gold Card Scheme. The conditions are :
Advance against bills sent for collection. 1. Account should be classified as Standard assets for the last 3
years.
Discrepancies of Documents 2. Limit is sanctioned for 5 years.
Late Shipment, LC expired, Late presentation of shipping documents, Bill 3. There is provision of 20% Standby limit.
of Lading not signed properly, Incomplete Bill of Lading, Clause Bill of 4. Packing Credit is allowed in Foreign currency.
Lading , Short Bill of Lading or Inadequate Insurance. 5. Concessional rate is allowed for 90 days initially which can be
extended for 360 days.
Advance against Un-drawn Balance 6. Bank may waive collateral and provide exemption from ECGC
Undrawn balance is the amount less received from Importers. Bank can Guarantee schemes.
finance up to 10% undrawn amount up to maximum period of 90 days. Star Export As per Foreign Trade Policy, Star Export Houses are exporters who Excel.
Houses Category FOB Value of Exports in USD
Advance against Duty Drawback One Star Export House 3 million
Duty drawback is the support by Government by way of refund of Two Star Export House 25 million
Excise/Custom duty in case the domestic cost of the product is higher than Three Star Export House 100 million
the Price charged from the importer. This is done to boost exports despite Four Star Export House 500 million
international competition. Bank can make loan to exporter against Duty Five Star Export House 2500 million
Drawback up to maximum period of 90 days. Factoring and Factoring is financing and collection of Receivables. The client sells
Forfaiting Receivables at discount to Factor in order to raise finance for Working
Concessional rate of interest is allowed up to NDD (Notional Capital. It may be with or without recourse. Factor finances about 80%
Due Date) in case of Demand Bill and Usance Bill. and balance of 20% is paid after collection from the borrower. Bill should
carry LR/RR. Maximum Debt period permitted is 150 days inclusive of
Export Credit in PCFC is pre-shipment credit in Foreign Currency and PSFC is post- grace period of 60 days. Debts are assigned in favour of Factor. There are
Foreign shipment credit in Foreign Currency. This is additional window for providing 2 factors in International Factoring. One is Export Factor and the other is
Currency finance in any convertible currency. It is applicable only in cash exports. Import Factor. Importer pays to Import factor who remits the same to Export
GATS Credit can be afforded to exporters of all the 161 services covered under Factor.

applicable to export of goods apply mutatis mutandis to export of services.
Crystallization of Consequent upon non-realization, Conversion of Foreign Exchange liability
Overdue Bills into Rupees is called crystallization. It is done on 30th day from notional
due date at prevailing TT selling rate or Original Bill Buying Rate
(Whichever is higher).
Forfaiting is Finance of Export Receivables to exporter by the Forfaitor. It
is also called discounting of Trade Receivables such as drafts drawn under
LC, B/E or PN. It is always No Recourse Basis (i.e. without recourse to
100% payment to exporter after deducting applicable discount. Maximum
period of Advance is 180 days.

DA Bills Pre-shipment & Post-shipment Finance

Notional due date is calculated in DA Bill by adding normal period of transit
i.e. 25 days in the Usance period. 30th day is taken from notional due date.
DP Bills
30th day after Normal Transit Period
If 30th day happens to be holiday or Saturday, liability will be
crystallized on the following working day.
Policy has been liberalized and crystallization period will be decided
by individual banks.
Q. 1
Received order of USD 50000(CIF) to Australia on 1.1.11 when USD/INR Bill Buying Rate is
43.50. How much pre-shipment finance will be released considering profit margin of 10% and
Insurance and freight cost@ 12%. Contribution from borrower is 25%.
Solution
FOB Value = CIF Insurance and Freight Profit (Calculation at Bill Buying Rate on 1.1.11)
= 50000X43.5 = 2175000 261000(12%) 191400(10% of 1914000) = 1722600
Pre-shipment Finance = FOB value - 25% (Margin) = 1722600-430650=1291950.Ans.

26 27
Q. 2 :What will be amount of Post-shipment Finance under Foreign Bill Purchased for USD
45000 when Bill Buying rate on 31.3.11 (date of submission of Export documents) is 43.85 IMPORTS
Solution
45000X43.85 = 1973250 Ans. Imports Pre- AD1 banks are to ensure that Imports are in accordance with:
Q. 3: Period for which concessional Rate of Interest is charged on DP bills Solution requisites Exim Policy
25 days .Ans. RBI Guidelines
Q. 4 If the above said bill remains overdue for 2 months, what will be date of crystallization? FEMA Rules
Due Date of Bill will be 31.3.11 + 25 days = 25.4.2011 Goods are as per OGL (Open General list).
The bill will be crystallized on 24.5.2011 i.e. on 30th day from due date. Ans. Importer is having IEC (Import Export Code) issued by DGFT.
Q. 5 : On 8th Sep, an exporter tenders a demand bill for USD 100000 drawn on New York. The Imports The following are essential elements of Imports:
USD/INR quote is as under: Formalities & 1. An importer before remitting proceeds exceeding USD 5000 must
Spot---------USD 1 =34.3000/3500 Time limit for submit application on Form A-1 to the Authorized Dealer.
Spot Sep-------------------6000/7000 import payment
Spot Oct--------------------8000/9000 (AS PER LATEST DIRECTIVES OF RBI, FORM A-1 IS NO MORE
Spot Nov------------------10000/11000 REQUIRED NOW)
Transit Period is 20 days and Exchange margin 0.15%
Calculate Rupee payable to the customer. Customer wants to retain 15% in Dollars 2. AD banks can issue LC on the basis of License and Exchange
Interest @13% has to be charged on INR liability of the customer. Control Copy.
Solution
Since, the currency is at premium, the transit period will be rounded off to the lower month Remittance against imports should be completed within 6 months from
(i.e. NIL). And the rate to the customer will be based on Spot Rate. If interest rate is 13%, how date of shipment. For Capital goods, period is 3 years.
much interest will be recovered from the Exporter Any delay beyond 6 months will be treated as Deferred
Spot Buying rate = 34.3000 Payment arrangement and the same will be treated as
Less Exchange Margin = 0.0515 Trade Credit up to 3 years.
34.2485 or 34.25 per dollar.
Amount in Indian Rupee = 85000(85% of 100000) x 34.25 = 2911250/-
AD Category I banks can consider granting extension of
Interest will be charged on 2911250/- @ 13% for 20 days = 20738/-.
Q. 6 time for settlement of import dues up to a period of 6
On 26th Aug, an exporter tenders for purchase a bill payable 60 days from sight and drawn on months at a time (maximum up to the period of three years)
New York for USD 25650. The dollar rupee rate is as under: irrespective of the invoice value for delays on account of
Spot----------------------1USD = 34.6525/6850 disputes about quantity or quality or non-fulfillment of terms
Spot Sep--------------------------------1500/1400 of contract; financial difficulties and cases where importer
Spot Oct---------------------------------2800/2700 has filed suit against the seller.
Spot Nov--------------------------------4200/4100
Spot Dec--------------------------------5600/5500 While considering extension beyond one year from the date
Exchange Margin is 0.15%, Transit Period is 20 days. Rate of Interest is 13%. An amount of Rs. of remittance, the total outstanding of the importer does not
500/- on account of Out of Pocket expenses has to be charged. exceed USD one million or 10 per cent of the average import
What will be the exchange rate payable to the customer and Rupee amount payable? remittances during the preceding two financial years,
Solution whichever is lower.
Notional due Date = 20+60 days from 26th Aug i.e. 14th Nov. Since, the currency is at discount,
the period will be rounded off to the same month). Obviously, the discount of Nov will be more Cases not covered by the above instructions / beyond the
and it will make the Buy Rate Lower. above limits, may be referred to the concerned Regional
Dollar/Rupee market spot Buying Rate = 34.6525 Office of Reserve Bank of India.
Less Discount for August to November = 0.4200 Advance AD Banks may remit advance payment of Imports subject to following
34.2325 Remittances conditions:
Less Exchange Margin @.15% .0513 Up to USD 200000 or equivalent after satisfying about nature of
= 34.1812 transaction, trade and standing of Supplier. For services, the limit is
Rupee Amount payable to exporter = 25650 X 34.18 = 876717-00 USD 500000.
Less Interest for 80 days @ 13% = 24980-00 In excess of 2,00,000 USD, an irrevocable Standby LC or
Less out of pocket expenses = 500-00 Guarantee from a bank of international repute or a guarantee from
851237-00 bank in India, if such guarantee is issued against Counter guarantee

28 29
 of International bank outside India.
The requirement of guarantee may not be insisted upon in case of
remittances above USD200000 up to USD 50, 00,000 (5 million)
subject to suitable policy framed by BOD of bank. The AD should be
satisfied with track record of the exporter.
Approval of RBI is required only if Advance remittance exceeds
USD 50,00 000 or equivalent.
Advance remittance will be made direct to overseas supplier or his
bank.
Physical imports must be made within 6 months from date of
Remittance. For Capital goods, the period is 3 years. If it is Non-
Physical Imports, a certificate from CA that Software data has
been received, may be obtained.
Evidence of In case of all imports, irrespective of the value of foreign exchange remitted
Imports / paid for import into India, it is obligatory on the part of the AD Category I
bank through which the relative remittance was made, to ensure that the
importer submits BoE number, port code and date for marking evidence of
import under IDPMS
It is credit extended by Overseas suppliers to Importer normally beyond 6
months..
Up to 1 year for Current Account Transactions
Up to 3 years for Capital Account Transactions
Monetary Limit is USD 20 million (Revised 50 million) per transaction
under Automatic route and beyond 50 million under Approval route. For
Oil/Gas/refinery and Marketing monetary limit is Rs. 150 million per
transaction.
It is credit arranged by Importer from Banks/FIs outside countries. Banks
dit with period of Maturity:
Up to 1 year for Current Account Transactions
Up to 5 years for Capital Account Transactions
All-in Cost The present Ceilings for all-in-
Ceiling credit, as fixed by RBI is as under:

AD Category I bank may accept, in lieu of Exchange Control Copy of Bill Benchmark rate + 250 bps
of Entry for home consumption, a certificate from the Chief Executive
Officer (CEO) or auditor of the company that the goods for which These ceilings include management fees, arrangement fees etc.
remittance was made have actually been imported into India provided :-
Crystallization of In case the importer fails to make payment,
The amount of foreign exchange remitted is less than USD Foreign Crystallization of Foreign Exchange liability into Indian Rupees is done on
1,000,000 or its equivalent and Currency 10th day at Bill selling Rate or Original Bill Selling rate (whichever is
The importer is a company listed on a stock exchange in India and Liability into INR higher)
whose net worth is not less than Rs.100 crore as on the date of its
last audited balance sheet, or, the importer is a public sector In case of Retirement of Import Bill
company or an undertaking of the Government of India or its The crystallization is done at current Bill Selling Rate on the following dates
departments. DP Bill: On 10th Day from date of receipt of Import Bill.
DA Bill: On Actual Due Date.
On operationalization of IDPMS, all outstanding import remittances,
Irrespective of the amount involved, will be reported into the system by Example On 12th Feb, a customer has received an Import bill for USD 10000/-. He
banks and submission of a separate BEF statement would be discontinued asks you to retire the bill to the debit of the account. Considering Exchange
from a date, to be notified separately. margin 0.15% for TT sales and 0.20% on Bill Selling Rate. What amount
Import Finance Importer can avail finance from banks/FIs in the shape of : will be debited to the account? Spot rate is 34.6500/34.7200
1. Letter of Credit Spot march = 5000/4500
2. Import Loans against Pledge/Hypothecation of stocks.
3. Trade Credit Supplier Credit or Buyer Credit. Rate applied will be Bill Selling Rate
4. Spot Rate = 34.7200
Add Margin for TT selling (0.15%) = 0.0520
Trade Credit If the Import proceeds are not remitted, within 6 months, it is treated as TT selling Rate = 34.7720
Trade Credit up to the period 3 years. Importer must be resident of India. Add margin for Bill selling@ 0.20% = 0.0695
Bill Selling Rate = 34.8415
There are two types of Trade Credit: Rs. 348400/- (10000X 34.84) Ans.
1. Suppliers Credit
2. Buyers Credit IDPMS & EDPMS IDPMS (Import Data Processing and Monitoring System)
It is IT based system of processing all import transactions. And monitoring
thereof. Custom authorities, DGFT, Banks and RBI use this common

30 31
 platform to monitor all Import transactions.
FOREIGN TRADE RISKS AND ECGC
EDPMS (Export Data Processing and Monitoring System)
It is IT based system of processing all Export transactions. And monitoring Risks in Foreign trade risk may be defined as Uncertainty or Unplanned events with
thereof. Custom authorities, DGFT, Banks and RBI use this common International financial consequences resulting into loss. Types of Risks are as under:
platform to monitor all Import transactions. Trade 1. -Acceptance or non-payment
2. - shipping or Shipping of poor quality goods or
RATES TO BE APPLIED IN FOREIGN EXCHANGE TRANSACTIONS delay.
Nature of transaction Rate to be applied 3. Shipping Risk: Mishandling, Goods siphoned off, Strik e by potters or
Encashing Foreign currency Currency Buying rate wrong delivery.
Encashing Traveler Cheques TC Buying rate 4. Other Risks:
Issue of Draft in Foreign currency TT Selling rate - Credit Risk
Payment of draft where Nostro account TT Buying rate - Legal Risk
stands credited already - Country Risk
Cancellation of DD TT Buying Rate - Operational Risk
Purchase of Export Bill Bill Buying rate - Exchange Risk
Purchase of Sight Bill i.e. DP under FOBP Bill Buying 5. Country Risk
Discounting of Usance Bill i.e. DA under Spot rate - Exchange Provision of risk is made if Exposure to one country is 1% or more of total
FUBD Margin + Forward assets. ECGC has the list of Country Risk Ratings which can be referred to
Premium by the Banks and the banks can make their own country risk policy.
Payment of Imports Bill Selling Risk Export Credit and Guarantee Corporation provides guarantee cover for risks
Repatriation of NRE deposits TT selling Classification which can be availed by the banks after making payment of Premium.
of Countries ECGC adopts classification of risk. The list is updated and published on
Repatriation of FCNR deposits No rate
quarterly basis. The latest classification is as under:
Crystallization of Overdue Export Bills on TT Selling rate or
1. Insignificant Risks A1
30th day after Notional due date Original Bill buying rate
2. Low Risk A2
Whichever is higher
3. Moderately Low Risk B1
Crystallization of LC liability on 10 th day Bill Selling rate or
4. Moderate Risk B2
Contracted rate
5. Moderately High Risk C1
Whichever is higher
6. High Risk C2
Retirement of Import Bill Bill Selling rate
th 7. Very High Risk D
Crystallization of Import bill on 10 day If Bill Selling rate or
there is default by the buyer Contracted rate 15 countries including Afghanistan, Iraq, Lebanon, Libya, Ukraine, Yemen,
Whichever is higher Congo, Africa Restricted Cover Group- where
Cancellation of Forward Purchase TT selling rate revolving limits are approved by ECGC and these are valid for 1 year.
Contract on 7th working day after due date
Foreign bill returned Unpaid TT selling rate The other 8 countries with D rating (North Korea, Palestine, Sudan, Syria
Cancellation of Forward Sales Contract TT buying rate Venezuela, Western Sahara, South Sudan and Zimbabwe are placed in
on 3rd Working Day after due date - where specific approval is given on case to
case basis by ECGC.

The other 217 countries are in open list.

ECGC _ Export ECGC was established in 1964. Export Credit and Guarantee Corporation
Credit and provides guarantee cover for risks which can be availed by the banks after
Guarantee making payment of Premium. Its activities are governed by IRDA.
Corporation The functions of ECGC are 3 fold:
1. It rates the different countries.
2. It issues Insurance Policies.
3. It guarantees proceeds of Exports.
Types of Policies:
1. Standard Policies

32 33
 It provides 90% cover for exporters for short term exports in case
failure of buyer to make payment due in 4 months.. These cover
Commercial and Political Risks. The different types of Policies are:
- Shipment (Comprehensive Risk) Policy to cover
commercial and political risks from date of shipment.
- Shipment (Political Risks) Policy- from date of shipment
- Contracts (Comprehensive Risk) Policy for both commercial
and Political risks from date of Contract.
- Contracts (Political Risks) Policy from date of contract.
These policies do not cover risk of exchange rate fluctuation, commercial
disputes regarding fitment and quality of goods, failure of buyer to obtain
import authorisation from authorities and failure of exporter to fulfil terms of
export contract or negligence on his part.
2.
A small exporter is defined whose anticipated total export turnover
for the period of 12 M is not more than 50 lac. The policy is issued
to cover shipments 24 M ahead.
Coverage is 95% where loss is due to commercial risks.
Coverage is 100% where loss is due to political risks.
The policy provides cover against Commercial risks and Political
risks covering insolvency of the buyer , failure of the borrower to
make payment due within 2 months
failure to accept the goods due to no fault of exporter.
3. Specific Shipment Policy Short term
It provides cover for both Commercial and political risks Failure to
pay within 4M. It covers short term credit not exceeding 180 days of
PC & PS credit.. These policies can be obtained by exporters who
are not covered by above said comprehensive risk policies.
4. Exports Specific Buyer Policy
This is buyer wise short term policy which covers both Commercial
risks and political risks involved in export of goods on short term
credit to a particular buyer. Policy can be invoked on failure to pay
within 4M
The other Policies are Bu
(exporters who pay minimum 10 lac premium to ECGC are eligible) and
Consignment export Policy, IT enabled Services Policy for Single Customers
& Policy for SME sector.
Financial ECGC issues following types of Guarantees for the benefit of Exporters:
Guarantees Packing Credit Insurance
ECIB (WT-PC) Exporters Credit Insurance for Banks (whole Turnover
Packing Credit)
This policy is issued to banks to guarantee export risks:
- For all exporters
- Minimum 25 accounts should be there.
- Minimum assured premium is Rs. 5.00 lac.
- Period of cover is 12M.
- The claim is payable if there is default of 4 Months.
34
- Premium for fresh covers is 7.50 paisa Per Rs. 100 Per month. It is
calculated on average outstanding.
- Percentage of cover ranges from 75% to 90%
- If due date of export proceeds is extended beyond 360 days,
approval of ECGC is required.
- Claim is to be filed within 6M of report of default to ECGC.
ECIB PC for individual exporters. The advance should be categorized as
Standard Asset. The period of coverage is 12M and %age of cover is 66-
2/3 %. The premium is 12 paisa% per month on highest outstanding.
th
- Monthly declaration by banks before 10 .
- Approval of Corporation beyond 360 days PC.
- Report of default within 4M from due date.
- Filing of claim within 6M of the report.
ECIB (WT- PS) Whole Turnover Post Shipment Credit Policy
- It is a common policy for all exporters.
- Advances against export bills are covered.
- Premium is 8.5 paisa % per month.
- Cover is usually 75 to 90%
- Filing of claim within 6M of the report
ECIB-PS-- for individual exporters
Export Finance When banks make advance to exporters against export incentives
Guarantee receivables like Duty Drawback etc. The cover available is 75% and the
premium ranges from 7 paisa onwards.
Exchange The cover is available for payment schedule over 12 months up to maximum
Fluctuation period of 15 years. Cover is available for payments specified in USD, GBP,
Risk Cover EURO, JPY, SWF, AUD and it can be extended for other convertible
Scheme currencies.
The contract cover provided a franchise of 2% Loss or gain within range of
2% of reference rate will go to the account of the exporter. If the loss
exceeds 2% , the ECGC will make good the portion of loss in excess of 2%
but not exceeding 35%.
The other guarantees are:
- Export Performance Guarantee
- Export Finance (Overseas Lending) Guarantee.
Transfer guarantee cover to the confirming bank in India.
Maturity ECGC provides full-fledged Factoring Insurance services. It facilitates
Factoring purchase of account receivables. It provides up to 90% finance against
approved transactions. It follows up collection of sales proceeds. Exporters
of good track record and dealing on DA terms having unexpected bulk
orders are eligible to apply.
Common Notice of Default
Guidelines Notice of default must be served within a period of 4 months from due date
or 1 month from date of recall.
Lodging of Claim
The claim should be filed with ECGC within maximum period of 6 months
from date of lodging of Default Notice.
35
 EXIM BANK RESERVE BANK OF INDIA

Exim Bank its Exim Bank (Export/Import Bank) was established in 1981 with the objective RBI controls RBI is empowered to
functions of financing Import Export Trade especially on Long term basis. The Foreign Control and regulate Foreign Exchange Reserves
functions of Exim bank are as under: Exchange Supervise Foreign Exchange dealings
Offering Finance for Exports at competitive rates. Maintain external value of Rupee
Developing alternate financial solution FERA was replaced by FEMA in the year 1999.
Data and Information about new export opportunities. FEMA The important FEMA guidelines with regard to Foreign exchange are as
Respond to export problems and pursue Policy solutions. provisions under:
The finance activities of Exim bank consist of : 1. No drawl of exchange for Nepal and Bhutan
1. Arranging Supplier 2. If Rupee equivalent exceeds Rs. 50000/-, payment by way of
2. Consultancy and Technical services for exporters crossed Cheque.
3. Pre-shipment credit over 6 months 3. During visit abroad, one can carry foreign currency notes up to USD
4. Setting up of EOU in EPZ (Export Processing Zones) 3000 or equivalent. For Libya and Iraq, the limit is USD 5000 and
5. Finance for DTA (Domestic Tariff Area) units exporting minimum the entire amount for Iran and Russian states.
25% of annual sales. 4. Indian citizens can retain and possess foreign currency up to USD
6. Finance for Import of Computer System and Development of 2000 or its equivalent. (For coins, there is no limit)
Software. Plant and Machinery and Technical up-gradations etc. 5. Unspent currency must be surrendered within a period of 180 days
7. Services for Overseas Investments. after arrival in India.
8. Line of Credit to exporters on the basis of which they receive export Release of Foreign Exchange for Individuals
orders. Purpose of Visit Previous Present Guidelines
EXIM Bank performs following functions for Commercial Banks: Guidelines
Export Bills Rediscounting Usance period should not exceed 180 USD or its equivalent Per Financial Year
days. Personal/Tourism 10000 per fin year USD 250000
SSI Export Bills Rediscounting. Business Purpose 25000 per visit USD 250000
Refinance of Export credit Seminars/conferences 25000 per visit USD 250000
Refinance of TL to EOU, Software Capital goods up to 100% Employment/Immigration 100000 USD 250000
Participates with banks in Issuance of Guarantees. Studies 100000 per USD 250000
Besides above, the EXIM bank arranges Relending facilities for Overseas academic year
Banks, sanctions direct credit to foreign importers and arranges line of Medical 100000 USD 250000
credit for foreign importers. Donations/Gifts 5000 per donor per USD 250000
DPG (Deferred It is normally beyond 6M and meant for SHE (Status Holder Exporters) year
Payment only. Consultancy services 100000 per project USD 250000
Guarantees Banks can approve proposals up to 25 crore. Debit Credit As per BTQ as USD 250000
Above 25 crore up to 100 crore are referred to EXIM bank. above
Above 100 crore proposals will be considered by Inter institutional Working *AD can release Foreign Exchange 60 days ahead of journey
Group consisting of members from RBI, FEDAI, ECGC and EXIM. Overall limit is USD 250000 if exchange is required for more than
Other services Besides above, the EXIM bank provides assistance for : one purposes.
of EXIM bank 1. Project Exports export of Engineering goods on Deferred Payment Release of Foreign currency for other than individuals
terms Donations per remitter/per donor up to 250000 USD in a financial
2. Turnkey Projects- supply of equipment along with related services year.
like design, detailed engineering etc. Consultancy services : Maximum USD 10 lac per project for
3. Construction Projects infrastructure and USD 100000 per project for others.
4. Funded facilities. One can send Gift to Corporate Clients abroad up to USD 5000 at
EXIM Bank is nodal agency designated by GOI to manage Export one time but not exceeding USD 250000 per financial year.
Marketing Fund (EMF) which consists of loan made available to India by Form A2 is required if transaction amount is exceeds USD 25000.
World bank to promote International Trade.
Contravention of Fema guidelines may attract penalty of 10000/- with
additional penalty of 2000/- per day if contravention continues.

36 37
LRS (Liberalized The scheme is meant for Resident Indians individuals (including Minors). currency notes up to Rs. 25000/-
Remittance They can freely remit up USD 250000 per financial year in respect of any Any person Resident Outside India (Not being citizen of Pak and
Scheme) current or capital account transaction without prior approval of RBI. The Bangladesh)
precondition is that the remitter should have been a customer of the bank a) May take outside India currency up to Rs. 25000/-
for the last 1 year. PAN is mandatory. Form A2 is required to be submitted b) May bring into India currency notes up to 25000/-
to RBI, If remittance exceeds USD 25000. For remittance up to $25000, (Previously, the limit was Rs. 10000/-)
Form A2 can be retained by bank itself. Any amount can be taken out while going to Nepal and Bhutan in any
denomination. ( Notes ABOVE 100 denomination up to Rs. 25000/- only
Not Applicable are allowed)
The scheme is not applicable for remittance to Nepal, Bhutan, Pak, Restrictions Customer is required to furnish PAN No.
Mauritius or other counties identified by FATF. If rupee equivalent is 50000/- and above, the entire payment has to
The scheme is not meant for remittance by Corporate. be made by way of crossed cheque or DD.
Banks should not extend loan facility for capital account RETURNS TO Following important returns are submitted to RBI
transactions. BE SUBMITTED R- Returns Forex Operations (Fortnightly)
Beneficiary should not be Resident Indian. TO RBI BAL statement Balance in Nostro/Vostro account
Latest Guidelines STAT 5 Transactions in FCNR B accounts
The limit can be used by Residents for acquiring property abroad. (Fortnightly)---Since discontinued
The limit can be used for opening Foreign Currency accounts STAT 8 Transactions in NRE/NRO accounts
abroad. (Fortnightly) )---Since discontinued
The scheme should not be used for making remittances for any Trade Credit Statement
prohibited or illegal activities such as margin trading, lottery etc., as XOS O/S Overdue Export bills
hitherto. BEF Import Remittance effected but Bill of Entry
Resident individuals have now been allowed to set up Joint not submitted for >3M.
Ventures (JV) / Wholly Owned Subsidiaries (WOS) outside India for ETX Form Seeking relaxation from RBI after expiry of
bonafide business activities outside India within the limit of USD 9M when export proceeds are not received.
250000. NRDCSR . Consolidated statement on Non-resident
The limit for gift in Rupees by Resident Individuals to NRI close deposits
relatives and loans in Rupees by resident individuals to NRI close IBS International Banking Statistics Qtly
relatives shall accordingly stand modified to USD 250000 per containtaing all International Assets and
financial year. Liabilities.
Resident Individual is permitted to lend to NRI/PIO close relative Statement of Monthly
subject to the condition that the loan is interest free and with Remittances under LRS
minimum maturity of 1 year under LRS of 250000 USD per FEMIS- Daily data on Foreign Exchange Dealing
financial year. Room operations.
PAN No. is compulsory for all transactions irrespective of amount. RFC accounts Resident Foreign Currency account is opened by Indian residents who
Remittance beyond $250000 requires prior permission of RBI. were earlier NRIs and Forex is received by them from their overseas dues:
Remittance of It means remittance of funds out of: The accounts can be opened as SB/CA/FD type.
Assets Bank deposits/Company deposits Proceeds are received from overseas.
PF Balance/Superannuation of funds Out of Monetary benefits accruing abroad
Insurance claim or Maturity proceeds The funds are freely repatriable.
Sale proceeds of Shares Minimum amount is USD 5000.
Sale proceeds of property. RFC- D accounts Resident Foreign Currency (Domestic) accounts are opened:
Indian Residents, NRIs and PIOs can remit proceeds of assets out of India By Indian residents who visit abroad: and
up to USD 1 Million per financial year without approval of RBI. In excess Bring with them Foreign Exchange;
of USD 1 million, prior approval from RBI is required. As honorarium, gift etc.
Import and Any person resident in India Unspent money can also be deposited.
Export of Indian a) May take outside India (other than Nepal and Bhutan) currency These are CA nature accounts and no interest is paid.
Rupees notes up to Rs. 25000/- or
b) May bring into India (from country other than Nepal and Bhutan)

38 39

FEDAI Foreign Exchange Dealers Association of India
Foreign Exchange association of India is a non-profit body established in 1958 by RBI. All public
sector banks, Private Banks, Foreign Banks and Cooperative banks are its members. The
functions of FEDAI are:
Forming uniform rules
Providing training to bankers; and
Providing guidance and information from time to time.
Who publishes prime rates for major currencies in India on monthly basis?
Ans. FEDAI
The important rules are:
1. Export Transactions Forex liability must be crystallized into Indian rupees on 30th day
after expiry of NTP at TT selling rate(Notional Transit Period) in case of Sight bills and
on 30th day after notional due date in case of Usance bills. The rule has since been
relaxed and bank can frame its own rule for nos. of days for crystallization.
2. Concessional rate of interest is applied up to Notional due date or up to value date of
realization of export dues (whichever is earlier)
3. Import Transactions: For retirement of Import bills whether under LC or otherwise, Bill
selling rate or Contracted selling rate whichever is higher, will be applied.
DP Bills (sight) are retired after crystallization on 10th day after receipt.
DA Bills are retired (crystallized) on Due Date.
4. All Foreign Currency bills under LC, if not retired on receipt, shall be crystallized into
Rupee liability on 10th day after date of receipt of documents at Bill Selling Rate or
contracted rate whichever is higher.
Normal Transit Period is:
-
Export through Bills in Foreign Currencies 25 Days (General)
Exports to Iraq under United Nations 120 Days
Guidelines
Exports to Russia under L/C where 20 Days
reimbursement is provided by RBI
Export Bills drawn in Rupees under Reimbursement provided at centre of
Letters of Credit (L/C) negotiation ----3 Days
Reimbursement in India at centre different
from centre of negotiation 7 days
Reimbursement provided by banks
outside India---20 Days
Export Bills in Rupees not under Letter of 20 Days
Credit
Compensation on Delayed payment:
Authorized dealers will pay or send information to the beneficiary within 2 working days from
date of receipt of credit advice. In case of delay, interest @ 2% over SB rate will be paid to
beneficiary. Bank will also re-imburse amount on account of reverse exchange movement.
In the event of delay in payment of interbank foreign currency funds, interest@2% above Prime
rate of currency to be specified by the bank, shall be paid by defaulting bank.
In the event of delay in payment of Rupee Settlement funds, interest at 2% above NSE MIBOR
ruling on each day will be paid.
40
Forward Contracts
Exchange contracts will be for definite amount and period.
Contracts must state first and last date of contracts e.g. from 1-31 Jan or from 17th Jan to
16th Feb.
For contracts up to 1 month, option period for delivery may be specified.
In case of extension of contract, previous contract will be cancelled at TT Buying rate or
TT selling rate as the case may be.
Overdue contracts are liable to be cancelled on 3rd (Third) working day after maturity
date if no instructions are received. The contracts must state first and last date of the
contract.
Banks can allow resident individuals to book forward contracts up to 100000 USD with
the condition that these are on deliverable basis.
Banks are now free to fix their own rates of commission and margin etc.
Hours of Interbank office transactions is 9:00 am to 5:00 PM. However cross currency
transactions are permitted during extended working hours. Saturday will not be treated
as working day. If due date is known holiday (Holiday known before 3 days), contact
will become due on succeeding day. If due date is suddenly declared holiday, contract
will become due on preceding day.
In the event of contravention of FEMA guidelines, RBI may impose upon AP up to 3 times of
contravention amount. If amount is not quantifiable, up to 2.00 lac and up to 5000/- per day is
imposed, if the contravention continues.
ECBs External Commercial Borrowings
External Commercial Borrowings (ECBs) are loans in India made by non-resident lenders in
foreign currency to Indian borrowers. They are used widely in India to facilitate access to foreign
money by Indian corporations and PSUs (public sector undertakings).
Revised ECB guidelines: The salient features of the new framework are as under:
Merging of Tracks: Now, there will be two tracks as under:
1. Foreign Currency denominated ECB
2. Rupee Denominated ECB
Eligible Borrowers: This has been expanded to include all entities eligible to receive FDI.
Additionally, Port Trusts, Units in SEZ, SIDBI, EXIM Bank, registered entities engaged in micro-
finance activities, viz., registered not for profit companies, registered
societies/trusts/cooperatives and non-government organizations can also borrow under this
framework.
Recognized Lenders: The lender should be resident of FATF or IOSCO compliant country.
Multilateral and Regional Financial Institutions, Individuals and Foreign branches / subsidiaries
of Indian banks can also be lenders.
Forms of ECB
Loans including bank loans, floating/ fixed rate notes/ bonds/ debentures, Trade credits
beyond 3 years; FCCBs; FCEBs and Financial Lease.
41
 Minimum Average Maturity Period (MAMP): financial year either in INR or any convertible foreign currency or a
ECBs in general 3 years combination of both.
In case of FCY denominated ECB, companies are required to mandatorily
ECBs raised from foreign Equity Holders 5 years hedge 70 per cent of their ECB exposure in case average maturity of ECB is
and utilized for specific purpose less than 5 years.
Borrowings by NBFC permitted for WC and general purposes having MAM up
ECB raised for 10 years to 7 years.
ECM having MAM up to 7 years can be availed by eligible borrowers for
WC purposes repayment of Rupee loans availed domestically for Capital Expenditure.
Repayment of Rupee loans availed EC ECM can be availed by eligible borrowers for repayment of Rupee loans
domestically for purposes other than availed domestically for Capital Expenditure in Mfg. and Infra structure if
capital expenditure classified as SMA-2 or NPA under any OTS.
on-lending by NBFCs for the same
purpose FCCB & FCEB FCCB (Foreign Currency Convertible Bonds)
ECBs up to 50 Million USD per financial 1 Year These are special category of bonds issued in different currency from
year by Mfg. Sector
home country. These are Quasi debt instruments tradable on stock
exchanges and convertible into shares.
All in Cost Ceiling FCEB (Foreign currency Exchangeable Bonds)
Benchmark rate (6 M LIBOR Rate) + 450 bps FCEBs are exchangeable into equity share of another company, to be
called the Offered Company, in any manner, either wholly, or partly or on
End-uses (Negative list) The negative list, for which the ECB proceeds cannot be utilized, the basis of any equity related warrants attached to debt instruments.
would include the following ADRs American Depository Receipts are Receipts or Certificates issued by US
a) Real estate activities. American Bank representing specified number of shares of non-US Companies.
b) Investment in capital market. Depository Defined as under:
c) Equity investment. Receipts These are issued in capital market of USA alone.
d) Working capital purposes except from foreign equity holder. These represent securities of companies of other countries.
e) General corporate purposes except from foreign equity holder. These securities are traded in US market.
f) Repayment of Rupee loans except from foreign equity holder. The US Bank is depository in this case.
g) On-lending to entities for the above ADR is the evidence of ownership of the underlying shares.
Unsponsored ADRs
Limit and leverage It is the arrangement initiated by US brokers at their own. US Depository
All eligible borrowers can raise ECB up to USD 750 million or equivalent banks create such ADRs. The depository has to Register ADRs with SEC
per financial year under auto route. (Security Exchange Commission).
Further, in case of FCY denominated ECB raised from direct foreign equity Sponsored ADRs
holder ECB liability-equity ratio for ECBs raised under the automatic route
cannot exceed 7:1. However, this ratio will not be applicable if outstanding the USA. It chooses single Depository bank. Registration with SEC is not
amount of all ECBs, including proposed one, is up to USD 5 million or compulsory. However, unregistered ADRs are not listed in US exchanges.
equivalent.
Issuance of Guarantee, etc. by Indian banks and Financial Institutions: GDRs Global Global Depository Receipt is a Dollar denominated instrument with
Issuance of any type of guarantee by Indian banks, All India Financial Depository following features:
Institutions and NBFCs relating to ECB is not permitted. Receipts 1. Mainly traded in Stock exchanges of Europe.
ECB framework is not applicable in respect of the investment in Non- 2. Represents shares of other countries.
Convertible Debentures in India made by Registered Foreign Portfolio 3. Depository bank in Europe acquires these shares and issues
Investors.
Loan Registration Number (LRN): Any draw-down in respect of an ECB 4. GDRs do-not carry voting rights.
should happen only after obtaining the LRN from the Reserve Bank. 5. Dividend is paid in local currency and there is no exchange risk for
AD Category-I banks are permitted to allow Startups to raise ECB under the issuing company.
the automatic route with minimum average maturity period will be 3 years. 6. Issuing Co. collects proceeds in foreign currency which can be used
The borrowing per Startup will be limited to USD 3 million or equivalent per locally for meeting Foreign exchange requirements of Import.

42 43
 7. Overseas capital as at the close of the previous quarter or USD 10 million (or its
in OTC market London and private placement in USA. equivalent), whichever is higher, as against the existing limit of 50 per cent
8. It can be converted in underlying shares. (excluding borrowings for financing of export credit in foreign currency and
IDRs Indian Indian Depository Receipts are traded in local exchanges and represent capital instruments).
Deposits security of Overseas Companies. Borrowings can be from Banks/FIs outside India.
Receipts Purpose of borrowings is Packing credit or Post shipment credit.
CDF (Currency CDF is required to be submitted by the person on his arrival to India at the Borrowings by Resident Individuals may borrow up to USD 250000 or equivalent from
Declaration Airport to the custom Authorities in the following cases: Resident close relatives outside India subject to the following conditions:
Form) 1. If aggregate of Foreign Exchange including foreign currency/TCs Individuals Minimum maturity period is 1 year.
exceeds USD 10000 or its equivalent. Loan is free of interest.
2. If aggregate value of currency notes (cash portion) exceeds Crystallization of RBI has advised that AD will crystallize i.e. convert foreign currency deposit
USD 5000 or its equivalent. Inoperative (with fixed maturity date) into INR, if remains in-operative for 3 years from
Foreign date of maturity.
Form A1 Form A1 is meant for remittance abroad to settle imports obligations. It is Currency If a deposit account has not been operated for 10 years, the amount will be
Form A2 and not required if value of imports is up to USD 5000. Now, as per latest Deposits transferred to DEAF.
Form A3 directives of RBI, Form A-1 is not at all required for any kind of imports. Rupee Current Account transactions are payments due in connection with foreign
Convertibility in trade, services and short term banking and credit facilities, interest on loan,
Form A2 is meant for remittance abroad on account of any purpose other Current Account remittances and expenses in connection with foreign travel, medical care,
than Imports. It is not required if remittance is up to USD 25000. & Capital education etc. Rupee is fully convertible in such type of transactions.
Account
Form A3 is meant for remittances abroad in Inter bank Vostro account Transactions But Rupee is partially Convertible in Capital Account transactions. These
within 5 working days. The form is submitted by remitting bank to transactions are FDI, ODI, ECBs, Raising Foreign Currency Loans,
beneficiary bank. Transfer of Property or other Assets outside India, Loans to persons
LIBOR Rate & London Interbank Offering rate is the rate fixed at 11 am (London time) at residing outside India & Maintenance of Foreign Currency Account in India.
Other Rates which top 16 banks in London offer to lend funds in interbank markets. In nut shell, if a transactions creates long term liability or asset in India, it is
Capital Account transaction. Rupee is partially convertible in capital
MIBOR- Mumbai Inter Bank Offered Rate account transactions as there are certain restrictions in capital account
MIFOR- Mumbai Interbank Forward Rate transactions.
EURIBOR Euro Inter-bank Offered Rate
TIBOR Tokyo Inter-bank Offered Rate Which of the currencies is not freely convertible?
SIBOR Singapore Inter-bank Offered Rate Ans.----Indian Rupees
Interest on Banks are free to decide lending rates on export credit or above MCLR
Export Credit & Interest Equalization Scheme for Rupee Pre-shipment and Post- LOU/LOC - Letter of Undertaking and Letter of Comfort cannot be issued as per RBI
Interest shipment Credit directives dt. 13.3.2018.
Equalization Rate of Interest Equalization is 3%.pa.
Scheme Banks are to pass on benefit upfront
Eligible exports should meet the criteria of minimum processing of NRI working in London remits GBP 100000 for opening account in India:
G
2015-2020. He can open any of the three - NRO, NRE or FCNR account.
Benefit of Interest is available up the date of repayment or up date Exchange rate will be TT Buying Rate for opening NRE Account.
beyond which export credit becomes overdue. If he prefers to place money in Foreign Currency, FCNR account will be opened. Exchange Risk
The scheme is applicable on export of products covering 416 tariff will be borne by bank.
He can exercise nomination in favour of NRI or Indian resident in all types of accounts.
items including Merchant Exports.
NRI can appoint any indian resident as attorney to operate the account.
Interest Equalization Scheme on pre & post shipment Rupee Export Credit,
If he return to India for permanent stay, his accounts will be converted either to Resident a/c or
increased from 3% to 5% in respect of MSME (Manufacturing sector) RFC a/c.
only. The amount in RFC account can be repatriated abroad provided minimum stay abroad was 1
Foreign It has been decided to liberalize this facility further. year.
Currency Accordingly, AD Category - I banks may henceforth borrow funds from He can raise Demand loan when he executes documents personally.
Borrowings by their Head Office, overseas branches and correspondents and overdrafts in
ADs from Nostro accounts up to a limit of 100 per cent of their unimpaired Tier I

44 45
Module - B

RISK MANAGEMENT
RISKS and CAPITAL

46
 Risk Management
Risk Pricing Risk Premium is added in the interest rate because of the following:
Necessary Capital is to be maintained as per regulatory
requirements.
Risk and Risk is possible unfavorable impact on net cash flow in future due to Capital is raised with cost.
Capital uncertainty of happening or non-happening of events. Capital is a For example there are 100 loan accounts with Level 2 Risk. It means
cushion or shock observer required to absorb potential losses in future. there can be average loss of 2% on such type of loan accounts: Risk
Higher the Risks, high will be the requirement of Capital and there will Premium of 2% will be added in Rate of Interest.
be rise in RAROC (Risk Adjusted Return on Capital). Pricing includes the following:
Types of Risks Risk is anticipated at Transaction level as well as at Portfolio level. 1. Cost of Deploying funds 2. Operating Expenses
Transaction Level 3.Loss Probabilities 4. Capital Charge
Credit Risk, Market Risk and Operational Risk are transaction level risk Risk Credit Risk can be mitigated by accepting Collaterals, 3 rd party
and are managed at Unit level. Calculation guarantees, Diversification of Advances and Credit Derivatives.
Portfolio Level Interest rate Risk can be reduced by Derivatives of Interest Rate
Liquidity Risk and Interest Rate Risk are also transaction level risks but Swaps.
are managed at Portfolio level (aggregate level). Forex Risk can be reduced by entering into Forward Contracts and
Futures etc.
Risk Measurement Diversification of Advances
1. Based on Sensitivity Business Year1 2 3 4 5 Total Mean sd
It is change in Market Value due to 1% change in interest rates. The interest rate gap is A
sensitivity of the interest rate margin of Banking book. Duration is sensitivity of Investment (Cash 10 3 4 8 11 36 7.20 3.26
portfolio or Trading book. flow)
Risk = sd/mean = 3.26/7.20 = .45 i.e. 45%
2. Based on Volatility: If we make advances to different types of business with different Risk
It is common statistical measure of dispersion around the average of any random variable percentage, the overall risk will be reduced through diversification of
such as earnings, Mark to market values, losses due to default etc. Portfolio.
Banking Book, Banking Book
Statistically Volatility is Standard deviation of Value of Variables Trading Book It includes all advances, deposits and borrowings which arise from
Calculation and Off Balance Commercial and Retail Banking. These are Held till maturity and
Example 1 : We have to find volatility of Given Stock price over a given period. Volatility Sheet Items Accrual system of accounting is applied. The Risks involved are:
may be weekly or monthly. Suppose we want to calculate weekly volatility. We will note Liquidity Risk, Interest Rate Risk, Credit Default Risk, and Operational
down Stock price of nos. of weeks. Risk.
Let Mean Price = 123.62 and Trading Book
Variance (sum of Squared deviation from mean) / Number of options = 82.70 (given) It includes Assets which are traded in market.
(extracted from weekly Stock prices). Volatility is nothing else but Standard Deviation. These are not held till maturity.
The positions are liquidated from time to time.
These are Mark- to market i.e. Difference between market
Volatility over Time Horizon T = Daily Volat
price and book value is taken as profit.
Example 2
Daily Volatility =1.5% Trading Book comprises of Equities, Foreign Exchange
Holdings and Commodities etc.
These also include Derivatives
Volatility will be more if Time horizon is more. The Risks involved are Market Risks. However Credit Risks and
Liquidity Risks can also be there.
3. Downside Potential (Best Method to measure Risk) Off Balance Sheet Exposures
It captures only possible losses ignoring profits and risk calculation is done keeping in view The Off Balance sheet exposures are Contingent Liabilities,
two components: Guarantees, LC and other obligations. It includes Derivatives also.
1. Potential losses 2. Probability of Occurrence. These may form part of Trading Book or Banking Book after they
The measure is more relied upon by banks/FIs/RBI. VaR (Value at Risk) is a downside become Fund based exposure.
Risk Measure. Banks using propriety models must compute VaR daily, using 99th percentile
with time horizon of 10 trading days using historical observation of last one year.

47 48

Types of Risks
1. Liquidity Risk
It is inability to obtain funds at reasonable rates for meeting Cash flow obligations.
Liquidity Risk is of following types:
Funding Risk: It is risk of unanticipated withdrawals and non-renewal of FDs which
are raw material for Fund based facilities.
Time Risk: It is risk of non-receipt of expected inflows from loans in time due to
high rate NPAs which will create liquidity crisis.
Call Risk: It is risk of crystallization of contingent liabilities.
2. Interest Rate Risk
Risk of loss due to adverse movement of interest rates. Interest rate risk is of
following types:
Gap or Mismatch Risk: The risk of Gap between maturities of Assets and
Liabilities. Sometimes, Long term loans are funded by short term deposits. After
maturity of deposits, these liabilities are get re-priced and Gap of Interest rates
between Assets and Liabilities may become narrowed thereby reduction of profits.
Basis Risks: Change of Interest rates on Assets and Liabilities may change in
different magnitudes thus creating variation in Net Interest Income.
Yield Curve Risk: Yield is Internal Rate of Return on Securities. Higher Interest
Rate scenario will reduce Yield and thereby reduction in the value of assets.
Adverse movement of yield will certainly affect NII (Net Interest Income).
Embedded Option Risk: Adverse movement of Interest Rate may result into pre-
payment of CC/DL and TL. It may also result into pre-mature withdrawal of
TDs/RDs. This will also result into reduced NII. This is called Embedded Risk.
Re-investment Risk: It is uncertainty with regard to interest rate at which future
cash flows could be re-invested.
3. Market Risk
Market Risk is Risk of Reduction in Mark-to-Market value of Trading portfolio i.e.
equities, commodities and currencies etc. due to adverse market sensex. Market
Risk comprises of:
- Price Risk occurs when assets are sold before maturity. Bond prices and Yield
are inversely related.
- IRR affects the price of the instruments.
- Price of Other commodities like Gold etc,. is also affected by the market trends.
- Forex Risks are also Market Risks.
- Liquidity Risk or Settlement Risk is also present in the market.
4. Credit Risk or Default Risk
Credit Risk is the risk of default by a borrower to meet commitment as per agreed
terms and conditions. There are two types of credit Risks:
Counter party Risk: This includes non-performance by the borrower due to his
refusal or inability.
Country Risk : When non-performance of the borrower arises due to constrains or
restrictions imposed by a country.
5. Operational Risk
Operation Risk is the risk of loss due to inadequate or Failed Internal procedures,
people and the system. The external factors like dacoity, floods, fire etc. may also
49
cause operational loss. It includes Frauds Risk, Communication Risk,
Documentation Risk, Regulatory Risk, Compliance Risk and legal risks but
excludes strategic /reputation risks.
Two of these risks are frequently occurred.
Transaction Risk: Risk arising from fraud, failed business processes and inability
to maintain Business Continuity.
Compliance Risk: Failure to comply with applicable laws, regulations, Code of
Conduct may attract penalties and compensation.
Other Risks are:
1. Strategic Risk: Adverse Business Decisions, Lack of Responsiveness to business
changes and no strategy to achieve business goals.
2. Reputation Risk ; Negative public opinions, Decline in Customer base and litigations
etc.
3. Systemic Risks ; Single bank failure may cause collapse of whole Banking System
and result into large scale failure of banks.
4. Settlement Risk: In 1974, closure of HERSTATT Bank in Germany posed a threat
for the entire Banking system. This happened when it could not pay dues in
settlement. This is called Settlement Risk.. Risk of Settlement that arises due to
time zone differences is known as HERSTAT Risk.
Strategic Risk & Reputational risk are equivalent to Operational Risk. Settlement Risk will
lead to Credit Risk.
Case Study (Risk Identification) - Interest Rate Risk
PCR bank has granted a Term Loan of Rs. 2.00 crore to a reputed corporate client for 6
years at BR+2% .
The above said loan is funded by bank with low interest FD of Rs. 2.00 crore @7%
whose maturity is 4 years.
The loan is carrying floating rate of interest whereas FD is carrying Fixed rate of interest.
There are
Q. 1 If rate of interest is reduced on both Loan and FD during first 4 years, which type of
risk, the bank is exposed to:
a) Funding Risk b) Embedded Option Risk c) Basis Risk, Gap or mismatch Risk
Q. 2 Rate of interest at the end of 4 years may be different on Fixed Deposit
a) Re-investment Risk b) Embedded Option Risk c) Basis Risk, Gap or mismatch Risk
Q.3 There is possibility that Company may pre-pay the loan or depositor may withdraw
deposit pre-maturily. Which type of risk, the bank is exposed to:
a) Re-investment Risk b) Embedded Option Risk c) Basis Risk, Gap or mismatch Risk
Q.4 With Quarterly repayment of loan, the repayment amount has to be deployed by the
bank elsewhere at different rate of interest. Due to this bank is exposed to
Re-investment Risk b) Embedded Option Risk c) Basis Risk, Gap or mismatch Risk
50

Case Study (Risk Identification) - Liquidity Risk
PCR bank has granted a Term Loan of Rs. 20.00 crore to a reputed corporate client for 7
years repayable in 84 Equal monthly installments with moratorium of 12 months.
The above said loan is funded by bank with low interest FD of Rs. 10.00 crore for 5
years, 5 crores for 3 years and 5.00 crore for 2 years. There is also One Bank Guarantee
of 60 lac.
Q. 1 If FD is withdrawn before maturity or is not renewed on maturity, bank will require
new source to fund the loan, which type of risk, the bank is exposed to:
a) Funding Risk b) Call Risk c) Time Risk. D) Gap or mismatch Risk
Q. 2 If loan installment is not paid in time
a) Funding Risk b) Call Risk c) Time Risk d) Gap or mismatch Risk
Q.3 If Bank Guarantee is invoked and borrower is unable to pay.
a) Funding Risk b) Call Risk c) Time Risk d) Gap or mismatch Risk
Q.4 There is maturity mismatch between TL and FD, this can result into:
a) Credit Risk b) Market Risk c) Liquidity Risk d) Operational Risk
Q. 5 If there is default by the borrower in repayment of loan, it will be called
a) Credit Risk b) Market Risk c) Liquidity Risk d) Operational Risk
Exchanges such as Stock Exchange or Commodity Exchange mitigate Counter-
party Risk.
Banks impose Penalty of certain % on Prepayment of Loan/limit. This is done to
mitigate Embedded option Risk.
Sanction of loan by bank, Besides major portion of Credit risk, bank also incurs
Interest Rate risk, Liquidity Risk and Operational Risk.
Banking Book Assets and Liabilities are NOT exposed to Market Risk.
Risk of worsening of Credit Rating is called CREDIT SPREAD RISK.
Which type of Risk is taken care of in RTGS Settlement Risk.
51
BASEL-I, II & III
BASEL I Bank for International Settlements (BIS) is situated at Basel (name of
(back-ground) the city in Switzerland). Moved by collapse of HERSTATT bank, BCBS
Basel Committee on Banking Supervision consisting of 13 members
of G10 met at Basel and released guidelines on Capital Adequacy in
July 1988. These guidelines were implemented in India by RBI w.e.f.
1.4.1992 on the recommendations of Narsimham Committee. The basic
objective was to strengthen soundness and stability of Banking system
in India in order to win confidence of investors, to create healthy
environment and meet international standards.
BCBS meets 4 times in a year. Presently, there are 28 members.
BCBS does not possess any formal supervisory authority.
BASEL II The Committee on Banking Regulations and Supervisory Practices
released revised version in the year 2004. These guidelines have been
got implemented by RBI in all the banks of India. Parallel run was
started from 1.4.2006. In banks having overseas presence and foreign
banks (except RRBs and local area banks. Complete switchover has
taken place w.e.f. 31.3.2008. In banks with no foreign branch,
switchover took place w.e.f. 31.3.2009.
Distinction
between Basel I Basel I measures credit risks and market risks only whereas Basel II
and Basel II measures 3 types of risks i.e. Credit Risk, Operational Risk and
Market Risk. Risk weights are allocated on the basis of rating of the
borrower i.e. AAA, AA, A, BBB, BB and B etc. Basel II also recognized
CRM such as Derivatives, Collaterals etc.
BASEL III BASEL-III was implemented in India w.e.f. 1.4.2013.
Under Basel-III, Capital will include the following:
1. Tier - I Capital (Going concern concept)
2. Tier - II Capital (Gone Concern Concept)
Tier-I Capital consists of:
a) Common Equity Tier - I (CET-I)
b) Additional Capital Tier I (AT-I )
CET I (Common Equity Tier-I ) : Core Capital It includes as under:
Paid up equity capital (Common shares)
Share Premium (Stock surplus)
Statutory Reserves
Capital Reserve
Other disclosed free reserves
Investment Fluctuation Reserve (Without ant ceiling)
Revaluation Reserve at discount of 55%
Foreign currency transaction reserve at a discount of 25%
Balance in PL account
Qtly profit after incremental provision of NPAs
Common Shares issued by subsidiaries of bank (Minority
interest).
52
 Two ways to 1. By raising more capital. Raising Tier I capital will dilute the equity
AT-I (Additional Capital) : It includes the following improve CRAR stake of existing investors including Govt. Raising Tier II Capital is
Perpetual Non-Cumulative Preference Shares (PNCPS). definitely a costly affair and it will affect our profits.
Share premium on instruments issued in AT-I 2. Reduction of risk weighted assets by implementing Risk mitigation
Innovative perpetual Debt Instruments (PDI). Policy.
.
Amount of PNCPS along with PDI cannot exceed 1.5 % of Risk (Parallel run of Basel-II & Basel-III till 31.3.2017)
Weighted Assets. Beyond this limit, the amount will be included in Tier-
II Capital. Banks can also issue PDI and PNCPS with call option which
be exercised with prior approval of RBI only if the instrument has run for BASEL III Calculation of Capital
at least 5 years.
Minimum Capital Requirement will be calculated as under:
Tier II Capital consists the following: The below mentioned %age has been fully implemented from 31.3.2019
Redeemable Cumulative Preference shares,
Redeemable non-cumulative Preference shares %age of RWAs AS PER BASEL
General Provisions & Loss reserves up to 1.25 % of Credit Minimum CET-I (Common Equity) 5.5% 4.5%
RWAs, if Standardized approach (0.6 % if IRBA approach) Max. AT-I (Additional Tier-I) 1.5% 1.5%
Debt Capital instruments Minimum Tier - I Capital 7.00 % 6.00%
Stock Surplus resulting into issue of above said securities. Maximum Tier-II Capital 2.00 % 2.00%
Minimum CRAR 9% 8.00%
(Under BASEL-II, Tier -2 Capital cannot be more than 50% of total CCB Capital Conservative Buffer in 2.5% 2.5%
capital or we can say Tier 2 Capital cannot be more than 100% of the form of Common Equity(Tier I )
Tier-1 Capital) Countercyclical Capital Buffer within 0-2.5%of RWAs
range of (Yet to be implemented)
Regulatory Adjustments/Deductions: Following adjustments have to Leverage Ratio (Minimum Standard) 4.5% 4.5%
be applied to Regulatory Capital at both solo and consolidated level. It is ratio of Outside Liabilities/Net Worth
i.e. Capital & Reserves
Goodwill and all intangible assets,
DTA (Deferred Tax Assets) Common Equity Tier-1 Capital Ratio = CET-1/ Risk Weighted Assets
Cash flow Hedge reserve Tier-1 Capital Ratio = Tier-1 Capital / Risk Weighted Assets
Shortfall in stock of provisions for expected losses. Total Capital Ratio ( CRAR) = Eligible Total Capital / Risk Weighted Assets
Gain on related securitization transactions. Leverage Ratio = Capital Measure / Exposure Measure
Investment in own shares
Investment in Capital of Banking, Financial and Insurance (Risk Weighted Assets = RWAs for Credit, Market and Operational Risk)
entities. Capital Conservation Buffer in the form of Common Equity Tier-I.
Countercyclical Capital Buffer within the range of 0-2.5% of RWAs will also be in the
Calculation of Capital funds ( Tier I & Tier II) form of Common Equity. It will be implanted as per national requirements.
CRAR (Capital --------------------------------------------------------------------------------- X 100 Leverage Ratio prescribes minimum standard of 4.5% of Tier I Capital compared
to Risk Credit Risk Weighted Assets + Market RWAs + Operational RWAs with Total Exposure. Total Exposure includes Balance Sheet Items and Non-
Weighted Asset Balance sheet items as well as 10% of un-availed limits even if there is
Ratio) Minimum requirement of CRAR is as under: unconditional cancellable undertaking.
As per BASEL-II recommendations 8% D-SIBs (Domestic Systemically Important Banks) are those whose failure can
As per RBI guidelines 9% disrupt the whole system. These are SBI, ICICI & HDFC. These banks need to
Banks undertaking Insurance business +1% provide additional CET-1 @0.6% (SBI) & 0.2% for other banks.
New Private Sector Banks 10%
Local Area banks 15% Advances against NSC/KVC/FDs/LIC 0%
. Risk Weights Claims on RBI, DICGC, CGTMSE, CGFSEL etc. 0%
on Different Claims on Domestic Sovereign i.e. Central Govt. 0%
Assets/Loans Guarantees & Loans Guaranteed By Central
Govt.

53 54
 Claims on ECGC 20%
State Govt. Guarantees & Loans Guaranteed By 20%
State Govt. Credit Risk
Balance with other scheduled banks having CRR 20%
at least 9%
Secured loan to staff 20% Credit Risk is the risk of default by a borrower to meet commitment as per agreed terms
Other Staff loans -not covered by retirement dues 75% and conditions. In terms of extant guidelines contained in BASEL-II, there are three
Loans upto 1.00 lac against Gold/Silver 50% approaches to measure Credit Risk given as under:
Mortgage based securitization of assets 77.5%
Credit Cards/Loan against Shares & Capital 125% 1. Standardized approach
Market Exposure 2. IRB (Internal Rating Based) Foundation approach
Personal Loans and Consumer Loans 100% 3. IRB (Internal Rating Based) Advanced approach
Claims secured by NBFC-non-deposit taking 100%
(other than AFCs) 1. Standardized Approach
Exposure to Corporate AFC, NBFC-IFCs (More 150% RBI has directed all banks to adopt Standardized approach in respect of Credit Risks.
than 200 Crore Under standardized approach, risk rating will be done by credit agencies. Following
Agencies are approved for external rating:
Venture Capital 150%
Commercial Real Estates (CRE) 100%
1. CARE 2. FITCH India (New name India Rating.) 3.CRISIL 4. ICRA 5. Credit
Commercial Real Estate (Residential Housing) 75%
Analysis and Research Limited. 6. INFORMERICS 7. Brickwork
Education Loans 75%
8. SMERA (For SME units) and 9. Onicara (also for SME units)
Other Retail Loans 75% Bank may also use International agencies like Fitch, Moody & Standard and Poor
SME Loans 75%
Other loans (Agriculture, Exports) 100% Risk weights prescribed by RBI are as under:

Risk Weight on Housing Loan Long term Rating Risk Weight Short Term Rating
Latest guidelines of RBI are as under: AAA 20% A1+
Loan Category LTV Ratio Risk Weight Provision on AA 30% A1
Standard A 50% A2
Asset BBB 100% A3
Up to 30 lac < 80 35% 0.25 % BB, C & D 150% A4 & D
>80 < 90 50% Unrated 100% Unrated

Above 30 up to 75 lac < 80 35% External Risk rating is required for total exposure (FB & NFB) Rs 10 crore and
above. It is exempted up to 25 crore for MSME borrowers with aggregate
Above 75 lac LTV < 75 50% exposure up to 25 crore provided the same is secured by 75% Cash Collateral.
rd
House will be treated as CRE
2. IRBA Internal rating Based Approach
exposure. At present all advances of Rs. 10.00 crore and above are being rated from external
agencies in our bank.
IRBA
Three Pillars of Pillar I Minimum Capital Requirement nt. It has two variants (Foundation and
BASEL-II Pillar II Supervisory Review Process advanced). Bank will do its own assessment of risk rating and requirement of Capital will be
Pillar III Market Discipline calculated on
Probability of default (PD)- It measures the likelihood that borrower will default.
Loss given default (LD) It measures proportion of exposure that will be lost in
case of default
Exposure of default (ED) It measures the facility that is likely to be drawn in the
event of default.
Effective maturity. (M) It measures the remaining economic maturity of Exposure.

55 56
Bank has developed its own rating module system to rate the undertaking internally. The
internal rating is being used for the following purposes: Last Nos. of Present Rating
Rating Accoun
1. Credit decisions ts
2. Determination of Powers BBB C Default
3. Price fixing C 30 5 20 5

Credit Risk Management Department (CRMD) is responsible for implementing the Risk %age of AAA rated borrowers remained in the same rating:35/50 = 70%
Identification and Risk mitigate strategies. At the end of observation period, number of AAA rated borrowers = 40
%age migration of borrowers from A to default category 2%
Risk Identification %age migration of borrowers from BBB to default category 40/200*100=20%.
Which rating module the regulator will advise to rigorously follow up ---BBB
Credit risk has two components:
(maximum default)
1. Default risk
Number of Default borrowers at the end of period: 1+2+40+5= 48
2. Credit Spread Risk or Downgrade risk
Credit Risk at portfolio level is of following two types:
1. Systemic risk
2. Concentration risk due to non- diversification
score makes forecast about financial health of the company within 12 months.
This model combines following 5 ratios to predict the financial position:
Z = 1.2 X1 + 1.4 X2 + 3.3 X3 +0.6 X4 +1.0 X5
Rating Migration
Rating migration is change in the rating of a borrower over a period of time when rated on
the same standard or model.
Here 1= Working Capital / Total Assets Ratio
2=Retained earnings / Total Assets Ratio
Rating Migration of loan accounts based on internal rating of HSBC between 31.3.11 &
3=Earnings before Interest and Tax / Total Assets Ratio
31.3.12 is as under:
4 = Market Value of Equity / Book Value of Long Term Liabilities Ratio
Last Nos. of Present Rating
5=Sales/Total Assets ratio
Rating Accoun
ts
Higher the value of Z, lower will be default risk. A firm with less than Z score 1.81 should be
AAA AA+ AA A+ A BBB C classified as High Risk borrower.
AAA 50 35 8 2 2 1 1 1
Credit Metrics- Model of Scoring
Last Nos. of Present Rating JP M
Rating Accoun volatility is computing by tracking probability that borrower may migrate from one rating to
ts another. It focuses on estimating volatility in value of assets caused by variation in quality
AAA AA+ AA A+ BBB C Default of assets.
AA+ 50 5 30 7 5 1 1 1
What is Ripple Effect?
Last Nos. of Present Rating Systemic risk is the risk that a default by one bank will create a RIPPLE EFFECT that leads
Rating Accoun to defaults by other Fis and threatens stability of financial system.
ts
A+ A BBB C Default What is Cooke Ratio?
A 100 10 80 6 2 2 CRAR is also known as Cooke Ratio. It is Capital/Risk Weighted Assets. Minimum 9% is
the requirement for Indian banks.
Last Nos. of Present Rating
Rating Accoun
ts
A+ BBB C Default
BBB 200 10 120 30 40

57 58
Example -1 How to Calculate RWAs and Capital Charge in respect of Credit risk

XYZ bank has provided the following figures in respect of advances: 1st Step : Calculate Fund Based and Non Fund Based Adjusted Exposure
Rating AAA AA A BBB BB B CCC 2nd Step: Deduct Allowable Reduction after applying haircuts
3 year .04% .15% .30% 1.10% 6% 25% 40% 3rd Step : Apply Risk Weights as per Ratings
5 year .10% .40% .60% 2% 10% 35% 45% 4th Step: Calculate Risk Weighted Assets
5th Step : Calculate Capital Charge
Other Information is as under:
Base Rate of the bank = 11% for AAA category Ist Step: Calculate Fund Based and Non Fund Based Exposure:
Load factor = 1% for AA , 2% for A, 3% for BBB and 4% for BB accounts.
Load factor for additional maturity over 3 years = 0.5% Example:
Fund Based Exposure
Bank has given loan of Rs. 400 lac to A rated Company for 5 years, out of which 2 Nature of loan Limit Outstanding Undrawn portion
year period has already lapsed and there has been no default. Present outstanding is CC 200 100 100
300 lac. Bills Purchased 60 30 30
EAD (Exposure at Default) = 100% and Packing Credit 40 30 10
LGD (Loss Given Default = 50% Term Loan 200 40 160
Find the expected loss on this account? Total 200
Out of Undrawn portion of TL, 60 is to drawn in a year and balance
Solution: beyond 1 year.
It will be solved as under:
EAD X Probability of default X LGD = Adjusted Exposure:
100% Outstanding(Unrated) = 200
300,00,000 X .30% X 50% = Rs. 45000 Ans. 20% of Undrawn CC, BP & PC (140*20/100) = 28
20% of Undrawn TL (1 yr) (60*20/100) = 12
50% of Undrawn TL (>1Yr) (100*50/100) = 50
Exposure FB limits 290
Example -2
Non Fund Based Exposure
PLR bank has provided the following figures in respect of advances: Type of NBF Exposure CCF Adjusted
Rating AAA AA A BBB BB B CCC Exposure
3 year .05% .20% .40% 1% 5% 20% 50% Financial Guarantees 90 100% 90
5 year .8% .30% .70% 1.8% 8% 40% 60% Acceptances 80 100% 80
Bank has given loan to A category borrower with repayment schedule of 4 years out of Standby LC 50 100% 50
which 1 year has lapsed and there has been no default. O/s 400 lac, EAD 100% and LGD Clean LC 50 100% 50
is 50%. Find Expected loss on this account. Unconditional Take out finance 100 100% 100
Performance Guarantee 80 50% 40
Solution: Bid Bonds 20 50% 10
Expected Loss = EAD*PD*LGD Conditional Take out finance 50 50% 25
= 400*100%*.4%*50%
Documentary LC 40 20% 8
=80000 ---------Ans
Exposure FB limits = 453

Total Exposure = 290000+453000 = 7,43,000

59 60
2nd Step: Allowable Reduction after adjusting CRMs (Credit Risk Mitigates)
Reduction from adjusted exposure is made on account of following eligible financial
collaterals:
Eligible Financial Collaterals.
Deposits being maintained by a borrower under lien.
Cash (including CDs or FDs), Gold, Govt Securities, KVP, NSC, LIC Policy, Debt
Equity and convertible bonds are no more eligible CRMs.
Other Examples
No. 1:
1. Exposure----------------------------------------- 100 lac with tenure 3 years
2. Eligible Collateral in A+ Debt Security -----30 lac with Residual maturity 2 years
3. Hair cut on Collateral is 6%
4. Table of Maturity factor shows hair cut as 0.25 for remaining maturity of 2 years.
Calculate Value of Exposure after Risk Mitigation?

Formula for Deposits under lien: C*(1-Hfx) X Mf Solution:

Value of Exposure after Risk Mitigation =
(C=Amount of Deposit; Hfx =0 (if same currency), Hfx = 0.08 (if diff currency) Mf = Current Value of Exposure Value of adjusted collateral for Hair cut and maturity mismatch
Maturity factor).
Value of Adjusted Collateral for Hair cut = C*(1-Hc) = 30(1-6%) = 30*94% = 28.20
Formula for Approved Financial collaterals: C*(1-Hc-Hfx) *Mf ) - E*He Value of Adjusted Collateral for Hair cut and Maturity Mismatch = C* (t-0.25)
(T-0.25)
Haircuts(He Haircut for Exposure & Hc-Haircut for Collateral) = 28.20*(2-.25)/(3-.25) = 17.95
Haircut refers to the adjustments made to the amount of exposures to the counter party ( Where t = Remaining maturity of Collateral T= Tenure of loan )
and also the value of collateral received to take account of possible future fluctuations in
the value of either, on account of market movements. Standardized Supervisory Haircuts Value of Exposure after Risk Mitigation = 100-17.95= 82.05 lac.
for collateral /Exposure have been prescribed by RBI and given in the said circular.
No. 2
Capital Requirement for collateralized transaction An exposure of Rs. 100 lac is backed by lien on FD of 30 lac. There is no mismatch of
E* = max { 0, [E X (1+He) C X (1-Hc- Hfx) } ] maturity.
E* - exposure value alter risk mitigation
E Current value of exposure for which coll. Qualifies Solution:
C = current value of collateral received Hair Cut for CRM i.e. FDR is zero.
Hfx = Haircut appropriate for currency mismatch between collateral and exposure. Hence Value of Exposure after Risk Mitigation is 100 lac 30 lac = 70 lac.
E* will be multiplied by the risk weight of the counter party to obtain RWA amount.
Computation of CRAR
Illustrations clarifying CRM In a bank ; Tier 1 Capital = 1000 crore
In the case of exposure of Rs 100 (denominated in USD) having a maturity of 6 years to a Tier II Capital = 1200 crore
BBB rated (rating by external credit rating agency) corporate borrower secured by collateral RWAs for Credit Risk = 10000 crore
of Rs 100 by way of A+ rated corporate bond with a maturity of 6 years, the exposure Capital Charge for Market Risk = 500 crore
amount after the applicable haircut @ 12%, will be Rs 112 and the volatility adjusted Capital Charge for Op Risk = 300 crore
collateral value would be Rs 80, (after applying haircut @ 12% as per issue rating and 8% Find Tier I CRAR and Total CRAR.
for currency mismatch) for the purpose of arriving at the value of risk weighted asset &
calculating charge on capital. Solution:
RWAs for Credit Risk = 10000 crore
There is an exposure of Rs 100 to an unrated Corporate (having no rating from any RWAs for Market Risk = 500/.09 = 5556 crore
external agency) having a maturity of 3 years, which is secured by Govt. Securities outside RWAs for Op Risk = 300/.09 = 3333 crore
the main index having a market value of Rs 100. The haircut for exposure as well as Total RWS = 10000+5556+3333 = 18889 crore
collateral will be 25%. There is no currency mismatch in this case. The volatility adjusted Tier I Capital = 1000 crore
exposure and collateral after application of haircuts works out to Rs 125 and Rs 75 Tier II Capital can be up to maximum 1000 crore
respectively. Therefore, the net exposure for calculating RWA works out to Rs 50. Total Capital = 2000 crore
Tier I CRAR = Eligible Tier I Capital /Total RWAs = 1000/18889=5.29%
Total CRAR = Eligible Total Capital /Total RWAs = 2000/18889 = 10.59%
for exposure and collateral would be zero. There is no maturity mismatch. Adjusted
exposure and collateral after application of haircuts would be Rs 100 and Rs 125 We may conclude that Tier I Capital is less than the required level.
respectively. Net exposure for the purpose of RWA would be zero

61 62
 Credit Risk Mitigates
It is a process through which credit Risk is reduced or transferred to counter party. CRM
techniques are adopted at Transaction level as well as at Portfolio level as under:
At Transaction level:
Obtaining Cash Collaterals
Obtaining guarantees from Sovereign entities (BIS, IMF, European Cental Bank as
well as from ECGC, CGTMSE, CGTFSEL, banks, PDs with lower RW than the
counterparty.
At portfolio level
Securitization
Collateral Loan Obligations and Credit Linked Notes
Credit Derivatives
What is LRM?
It is Loan Review Mechanism used to evaluate quality of loans and bring improvement in
credit administration.
1. Securitization
It is process/transactions in which financial securities are issued against cash flow
generated from pool of assets. Cash flow arising from receipt of Interest and Principal of
loans are used to pay interest and repayment of securities. SPV (Special Purpose
Vehicle) is created for the said purpose. Originating bank transfers assets to SPV and it
issues financial securities which are called PTC (Pass Through Certificates).
2. Collateral Loan Obligations (CLO) / Collateralized Debt Obligation (CDO)
It is also a form of securitization. Through CLO, bank removes assets from Balance Sheet
and issues tradable securities. They become free from Regulatory Capital.
Collateralized loan obligations (CLOs) are a form of securitization where payments from
multiple middle sized and large business loans are pooled together and passed on to different
classes of owners in various classes.. A CLO is a type of collateralized debt obligation.
It allow banks more often to immediately sell loans to external investor/lenders so as to
facilitate the lending of money to business clients and earn fees with little to no risk to
themselves.
3. Credit Derivatives
It is managing risks without affecting portfolio size. Risk is transferred without transfer of
assets from the Balance Sheet though OTC bilateral contract. These are Off Balance Sheet
Financial Instruments. Credit Insurance and LC are similar to Credit derivatives. Under a
Credit Derivative PB (Protection buyer) enters into an agreement with PS (Protection
seller) for transfer of risks at notional value by making of Premium payments. In case of
delinquencies, default, Foreclosure, prepayments, PS compensates PB for the losses.
Settlement can be Physical or Cash. Under physical settlement, asset is transferred
whereas under Cash settlement, only loss is compensated.
63
Credit Derivatives are generally OTC instruments. ISDA (International Swaps and
Derivatives Association) has come out with documentation evidencing such transaction.
Credit Derivatives are:
1.Credit Default Swaps
2.Total Return Swaps
3.Credit Link Notes
Credit Default Swaps
It is a transaction in which PB pays a premium to PS in return of protection against credit
event experienced on reference obligation. i.e. insolvency, default etc.
Total Return Swaps
In Total Return Swap, PB swaps with PS, total return on an asset by making payment of
premium. It covers both credit risk and market risk. The coupon capital depreciation is also
covered by PS by making premium by PB.
Credit Linked Notes
A credit linked note (CLN) is a form of funded credit derivative. It is structured as
a security with an embedded credit default swap allowing the issuer to transfer a specific
credit risk to credit investors. This eliminates a third-party insurance provider.
It is issued by a special purpose company or trust, designed to offer investors par
value at maturity unless the referenced entity defaults. In the case of default, the
investors receive a recovery rate.
The trust will also have entered into a default swap with a dealer. In case of default,
the trust will pay the dealer par minus the recovery rate, in exchange for an annual
fee which is passed on to the investors in the form of a higher yield on their note.
The purpose of the arrangement is to pass the risk of specific default onto investors
willing to bear that risk in return for the higher yield it makes available. The CLNs
themselves are typically backed by very highly-rated collateral, such as U.S.
Treasury securities.
CLO differs from CLN (Credit link notes in the following manner.
CLO provide credit Exposure to diverse pool of credit where CLN relates to single
credit.
CLO result in transfer of ownership whereas CLN do not provide such transfer.
CLO may enjoy higher credit rating than that of originating bank.
Example:
A bank lends money to a company, XYZ, and at the time of loan issues credit-linked notes bought
by investors. The interest rate on the notes is determined by the credit risk of the company XYZ. The
funds the bank raises by issuing notes to investors are invested in bonds with low probability of
default. If company XYZ is solvent, the bank is obligated to pay the notes in full. If company XYZ
goes bankrupt, the note-holders/investors become the creditor of the company XYZ and receive the
company XYZ loan. The bank in turn gets compensated by the returns on less-risky bond
investments funded by issuing credit linked notes.
64
SPV Special Purpose Vehicle Operational Risk
It is fund created by Securitization Companies to acquire/purchase non-performing assets.
The Fund manages the assets for the purpose of realization or holds them as investments
till maturity. SPV issues consideration of transfer price to the Originator bank in the form of Operational Risk is the risk of loss resulting from
cash, debentures, bonds as mutually agreed. Inadequate or failed internal processes, people and system.
External events such as dacoity, burglary, fire etc.
SPV is created by SCRC (Securitization and Reconstruction Companies. These companies It includes legal risks but excludes strategic /reputation risks.
raise resources from QIBs (Qualified Institutional Buyers). Security Receipt is issued to Identification
QIBs by SCRC in lieu of amount contributed by them. Actual Loss Data Base
RBIA reports
Risk Control & Self Assessment Survey
Example: Key Risk indicators
Scenario analysis
OBC made loan to a corporate whose particulars are as under: Four ways to manage Risk
Loan Repayabl Credit Value of RW to A Hair cut Hair Cut Prevent
amount e after Rating Cash category on on Reduce
Collateral Collateral Exposur Transfer
e Carry/Accept
Operation Three approaches have been defined to measure Operational Risk at the
10 crore 3 years A 10 crore 50% 6% 0%
al Risk branches/offices of the bank:
Measurem 1. Basic Indicator approach
ent 2. The Standardized approach
Question Answer 3. AMA i.e. Advanced measurement approach
Value of Collateral after Hair cut 10 (1-06) = 9.40 crore Basic 15% of Average positive gross annual income of previous 3 years will be
Value of Exposure after Credit Risk 10-9.40 = .60 crore Indicator requirement of capital. To start with banks will have to adopt this
Mitigation Approach approach and huge capital is required to be maintained.
Value of RWAs .60*50/100 = .30 crore The All banking activities are to be divided in 8 business lines. 1) Corporate
Standardi finance 2) Trading & Sales 3) Retail Banking 4) Commercial Banking 5)
zed Asset Management 6) Retail brokerage 7) Agency service 8) Payment
approach settlement
Within each business line, Capital requirement will be calculated as
Risk Weight on Exposures Covered by Guarantees
under:
Credit Risk is reduced, if the exposure is backed by Guarantee of Soverign, DICGC,
By multiplying the average gross income generated by a business over
ECGC, CGTMSE, CGFSEL and entities with minimum rating AA(-) by approved rating
previous 3 years by a ranging from 12 % to 18 % depending
agencies in India. The guaranteed amount will be adjusted against exposure with
upon industry-wise relationships as under:
currency mismatch and maturity mismatch as under:
Retail Banking, Retail Brokerage and Asset Management-----------12%
Adjusted Guaranteed amount = G X (1-Hfx) X Mf
Commercial Banking and Agency Services-----------------------------15%
Corporate, Trading and Payment Settlement----------------------------18%
The guaranteed portion is to be assigned RW as per rating of guarantor (20% for AAA,
Advanced Capital requirement is calculated by the actual risk measurement system
30% for AA)
Measurem
ent using quantitative and qualitative criteria. Our bank has started measuring
approach actual losses and estimating future losses. Minimum 5 year data is
required for a bank to switch over to AMA.

How to calculate RWAs for Operational Risk?

RWAs for Operational Risk = Capital Charge (If required CAR is 9%)
.09

65 66
Operational Low risk-------------2
Risk Events Cause based Medium Risk------3
People oriented losses due to negligence, incompetence, lack High Risk--- -----4
of awareness etc. Very High Risk----5
Process oriented losses due to business volume, less staff,
organization complexity, lack of supervision etc. For Calculation, following formula is used:
Technology oriented failure of system etc.
External causes: Floods, natural disasters etc. Estimated level of Operational Risk = {Estimated probability of
Effect Based occurrence x Estimated potential financial impact x Estimated impact of
Claim cases in court settled against the bank. internal control} ^0.5
Penalties due to non-compliance
Tax penalties ^0.5 implies Under root of whole
Write off
Example:
Delayed interest
Probability of occurrence = 2
Event Based
Probability of Financial impact = 4
Internal and External Frauds Impact of Financial control = 50%
Dacoity, Burg alary etc.
Damage to assets Solution
Business disruption. [ 2x4x(1- 2 (Low) Ans.
Employment practices and workplace safety.
In case financial impact of Internal Control is 20%
Operational It is a term used in measurement of Operational Risk on the basis of Solution would be:
Risk - scenario estimates. [ 2x4x(1- ---------Ans.
Scenario Banks use scenario analysis based on expert opinion in conjunction AMA Question: Probability of Occurrence : 4
Analysis with external data to evaluate its exposure to high severity events. Estimated Potential Financial impact =4
level of Impact of Internal controls = 0%
In addition, scenario analysis is used to assess impact of deviations
Operational
measurement framework to evaluate potential losses arising from Risk and Solution:
operational risk loss events. Impact of { Probability of occurrence x Potential financial impact x Impact of
Internal internal controls } ^0.5
Operational Insurance cover, if available can reduce the operational risk only when Control 4 Ans.(High Risk)
Risk Mitigation AMA is adopted for estimating capital requirements. The recognition of
insurance mitigation is limited to 20% of total Operational Risk Example for Balance sheet figures of ABC bank are as under:
Capital Charge calculated under AMA. calculation of
Capital Charge Ist year (R . in 2nd Year (Rs.
ORMC (Operational Risk Management Committee) under ORMD for operational cr res) crores)
(Operational Risk Management Division) is formed at bank level to Risk Net Profits 120 150
record, report and prevent Operational Risks at Branch level. Provisions 240 290
Staff exp nses 280 320
Practical Under AMA approach, Estimated level of Operational Risk is calculated Other operating expenses 160 240
Example AMA on the basis of:
approach 1. Estimated probability of occurrence Other Income 320 460
2. Estimated potential financial impact Calculate Capital Charge for Operational Risk and RWAs as per
3. Estimated impact of internal control. Basel Norms.
Capital Charge for Operational Risk is calculated as under:
Estimated Probability of Occurrence : This is based on historical Gross Income *15/100
frequency of occurrence and estimated likelihood of future occurrence. Gross Income = Net Profit + Provisions + Staff expenses + Other
Probability is mapped on scale of 5 as under: operating expenses
Negligible risk -----1

67 68
 Ist year = 120+240+280+160= 800 crore
2nd Year = 150+290+320+240=1000 crore
Average Gross Income = (800+1000)/2 = 900 crore
Capital for operational Risk = 900*15/100 = 135 crore
Risk Weighted Assets for Operational Risk =
135/.08 = 1687.50 Crore (as per BASEL norms)
Or 135/.09 = 1500 crore (as per RBI norms)
For calculation of Capital charge under Basic Indicator approach, Gross income
is defined as net interest income plus net non-interest income. However, it is
gross of provisions, operating expenses, Extra ordinary expenses, Profits/losses
from sale of securities.
Figures for any year in which annual gross income is negative or zero should be
excluded from both the numerator and denominator when calculating the
average
69
Market Risk
It is simply risk of losses on Balance sheet and Off Balance sheet items basically in
investments due to movement in market prices.
It is risk of adverse deviation of mark to Market value of trading portfolio during the period.
Any decline in the market value will result into loss.
Market Risk involves the following:
1. Risk Identification
2. Risk Measurement
3. Risk monitoring and control
4. Risk mitigation.
ALCO: Assets Liability Management Committee meets at frequent intervals and takes
decisions in respect of Product pricing, Maturity profiles and mix of incremental assets and
profiles, Interest rate, Funding policy, Transfer pricing and Balance Sheet Management.
Market Risk measurement
Measurement of Market Risk is based on:
1. Sensitivity measurement
2. Downside potential measurement
Sensitivity Measurement
Change in market rate of interest has inverse relation with Value of Bonds. Higher interest
rates lower the value of bond whereas decline in interest rate would result into higher bond
value. Also More liquidity in the market results into enhanced demand of securities and it
will lead to higher price of market instrument. There are two methods of assessment of
Market risk: 1. Basis Point Value 2. Duration method
1. Basis Point Value
This is change in value of security due to 1 basis point change in Market Yield. Higher the
BPV higher will be the risk.
Example
Face Value of Bond = 100/- Bond maturity = 5 years
Coupon Rate = 6%
Market price of Rs. 92/- gives yield of 8%
With fall in yield from 8% to 7.95%, market price rises to Rs. 92.10
Difference in Market price = 0.10
Difference Yield = 0.05%
BPV = Diff in Market price/Difference in Yield
BPV = 0.10/0.05 = 2 paisa per Rs. 100 i.e. 2 basis points per Rs. 100/-
If Face value of the Bond is 1.00 crore, BPV of the bond is Rs. 2000/-
Now, if the yield on Bond declines by 8 bps, then it will result into profit of Rs. 16000/-
70
(8x2000). BPV declines as maturity reaches. It will become zero on the date of maturity. Back Testing
It is a process where model based VaR is compared with Actual performance. It tells us
whether results fall within pre-specified confidence bonds as predicted by VaR models.
2. Duration method
Duration is the time that a bond holder must wait till nos. of years (Duration)to receive Stress Testing
Present Value of the bond. It seeks to determine possible change in Market Value of portfolio that could arise due to
non-normal movement in one or more market parameters (such as interest rate, liquidity,
e.g. 5 year bond with Face Value of Rs. 100 @ 6% having McCauley Duration 3.7 years. It inflation, Exchange rate and Stock price etc.). Four test are applied:
means Total Cash Flow of Rs. 130 to be received in 5 years would be discounted with 1. Simple sensitivity test;
Present Value which will be equivalent as amount received in 3.7 years. The Duration of If Risk factor is exchange rate, shocks may be exchange rate ±2%, 4%,6% etc.
the Bond is 3.7 Years. 2. Scenario test
It is leading stress testing technique. The scenario analysis specifies the shocks if
Formula of Calculation of McCauley Duration = possible events occur. It assesses potential consequences for a firm of an extreme.
It is based on historical event or hypothetical event.
Modified Duration = Duration 3. Maximum loss
1+Yield The approach assesses the risks of portfolio by identifying most potential
Approximate % change in price = Modified Duration X Change in Yield combination of moves of market risks
4. Extreme value theory
Example The theory is based on behavior of tails (i.e. very high and very low potential
A bond with remaining maturity of 5 years is presently yielding 6%. Its modified duration is values) of probable distributions.
5 years. What will be the McCauley Duration. Risk Management and Control
Market risk is controlled by implementing the business policies and setting of market risk
Modified Duration = Duration/ 1+YTM limits or controlling through economic measures with the objective of attaining higher
Duration = Modified Duration x (1+YTM) RAROC. Risk is managed by the following:
= 5 x 1.06 = 5.30 Ans. 1. Limits and Triggers
2. Risk Monitoring
Downside Potential measurement 3. Models of Analyses.
It captures only possible losses ignoring profit potentials. It integrates sensitivity and
volatility with adverse affect of Uncertainty. Calculation of Capital Charge of Market Risk

This is most reliable measure of Risk for Banks as well as Regulators. VaR is the method
to calculate downside potential.
Value at Risk (VaR)
It means how much can we expect to lose? What is the potential loss?. Banks using
propriory models must compute VaR daily, using 99th percentile with time horizon of 10
trading days using historical observation of last one year. Capital Charge for the bank will
The Basel Committee has two approaches for calculation of Capital Charge on Market
Risk as under:
1. Standardized Duration approach
2. Internal Risk Management approach
Under Standardized approach, there are two methods: Maturity method and duration
method. RBI has decided to adopt Standardization duration method to arrive at capital
charge on the basis of investment rating as under:

business days. Investment rating Capital Required

AAA to AA 0%
Let VaR =x. It means we can lose up to maximum of x value over the next period say A+ to BBB
week (time horizon). Confidence level of 99% is taken into consideration. Residual term to maturity
Up to 6M .28%
Example Up to 24M 1.14%
A bank having 1 day VaR of Rs. 10 crore with 99% confidence level. It means that there is More than 24 M 1.80%
only one chance in 100 that daily loss will be more than 10 crore under normal conditions. Unrated 9.00%
Rated BB and Below 13.5%
VaR in days in 1 year based on 250 working days = 1 x 250 == 2.5 days per year.
How to Calculate RWAs, if Capital Charge is given:
100 RWAs for Market Risk = Capital Charge (If required CAR is 9%)
.09

71 72
Pillar II SRP has two issues:
Supervisory 1. To ensure that bank is having adequate capital. Risk Weight on NPAs
Review Process 2. To encourage banks to use better techniques to mitigate risks.
(SRP) SRP concentrates on 3 main areas: a) Risk weight on NPAs net of specific provision will be calculated as under:
Risks not fully captured under Pillar -1 i.e. Interest Rate Risks,
Credit concentration Risks, Liquidity Risk, Settlement Risks, When provision is less than 20% of NPA o/s ---- 150%
Reputational Risks and Strategic Risks. When provision is at least 20% of NPA o/s ---- 100%
Risks not at all taken care of in Pillar -1. When provision is at least 50% of NPA o/s ---- 50%
External Factors.
This pillar ensures that the banks have adequate capital. This process Category Provision Rate Criteria Risk Weight
also ensures that the bank managements develop Internal risk capital Substandard 15% Provision is less 150%
(Secured) than 20%
risk profile and capital environment. Central Bank also ensures through Substandard 25% Provision is at-least 100%
supervisory measures that each bank maintains required CRAR and (Unsecured) 20%
components of capital i.e. Tier I & Tier II are in accordance with Doubtful (DI) 25% Provision is at-least 100%
BASEL-II norms. RBIA and other internal inspection processes are the (Secured) 20%
hniques. Doubtful (DI) 100% Provision is at-least 50%
(Un-Secured) 50%
Every Bank will prepare ICAAP (Internal Capital Adequacy Assessment Doubtful (D2) 40% Provision is at-least 100%
Plan) on solo basis which will comprise of functions of measuring and (Secured) 20%
identifying Risks, Maintaining appropriate level of Capital and Doubtful (D3) 100% Provision is at-least 50%
Developing suitable Risk mitigation techniques. Piller 2 also requires (Secured) 50%
supervisory authorities to ask bank to prepare Supervisory Review and Doubtful (D2) 100% Provision is at-least 50%
Evaluation process (SREP). (Un-Secured) 50%

Pillar III Market discipline is complete disclosure and transparency in the
Market balance sheet and all the financial statements of the bank. The
Discipline disclosure is required in respect of the following:
Capital structure.
Components of Tier I and Tier II Capital
Assessment of Credit Risks, Market Risk and Operational Risk.
Credit Aspects like Asset Classification, Net NPA ratios,
Movement of NPAs and Provisioning.
Frequency of Disclosure
Banks with Capital funds of Rs. 100 crore or more will make
interim Disclosures on Quantitative aspects on standalone basis
on their respective websites.
Larger banks with Capital Funds of Rs. 500 crore or more will
disclose Tier-I capital , Total Capital, CAR on Quarterly basis on
website.
Off-balance sheet items
Off-balance sheet items have been bifurcated as follows:
i) Non-market related off-balance sheet items
ii) Market related off-balance sheet items
There is two-step process for the purpose of calculating risk weighted assets in respect of
off-balance sheet items:
a) The notional amount of the transaction is converted into a credit equivalent factor by
multiplying the amount by the specified Credit Conversion Factor (CCF)
b) The resulting credit equivalent amount is then multiplied by the risk weight
applicable to the counter party or to the purpose for which the bank has extended
finance or the type of asset whichever is higher.
Where the off-balance sheet item is secured by eligible collateral or guarantee, the credit
risk mitigation guidelines will be applied.
Non-market related off-balance sheet items:
Off balance sheet items like direct credit substitutes, trade and performance related
contingent items and commitments with certain draw downs are classified under Non-
market related off-balance sheet items. The credit equivalent amount is determined by
multiplying the contracted amount of that particular transaction by the relevant CCF.
Non-market related off-balance sheet items also include undrawn or partially
undrawn fund based and non-fund based facilities, which are not unconditionally
cancellable. The amount of undrawn commitment is to be included in calculating the off-

73 74
balance sheet items. Non-market related exposure is the maximum unused portion of the
commitment that could be drawn during the remaining period of maturity. In case of term Suppose impact of 1% change of interest rate (Price) = 6000/-
loan with respect to large project to be drawn in stages, undrawn portion shall be calculated Daily Volatility = 3% : Confidence level is 99%
with respect of the running stage only. Probability of occurrence at 99% confidence level is 2.326
Defeasance period = 1 day
VaR = 6000x3x2.326 = 41874/-
RBI guidelines on CCF (Credit Conversion Factor) Duration and Duration is the time that Bondholder must wait for a number of years
Modified (duration) to receive Present Value of Cash Inflows i.e. period in which
Direct Credit Substitutes CCF Duration PV of Cash Inflows equals Actual Cash outflows..
General Guarantees (including Standby LCs), 100%
Acceptances Formula of calculating Duration
Transaction related contingent items (Performance 50%
bonds, Bid bonds, Warranties, Indemnities, Standby
LC relating to particular transaction
Short Term LC (Documentary) for Issuing bank as well 20%
as confirming bank For example:
5 years bond of Rs. 100 @ 6% Coupan rate and gives Duration of 3.7
years. It means Total Cash flow of Rs. 130/- would be equivalent to
receiving Rs. 130/- at the end of 3.7 years.
Modified Duration = Duration / 1 + Yield
CREDIT RISK Fixed Assets : 500 Crore Govt. Securities : 5000 crore
Capital Charge on Un-availed limit How to find Standard Assets
Risk Weighted Retail ---3000 crore
Capital Charge on Undrawn limits is calculated as under: Assets? HL (Less than 30 lakh & LTV above 80%) -------2000 crore
Other loans 10000 cr
20% on Undrawn CC limit Sub-Standard Assets
20% on Undrawn TL limit (which is to be drawn in a year) Secured ----500 crore Unsecured -----150 crore
50% on Undrawn TL limit (which is to be drawn beyond a year) Doubtful (DAI) --------------------------------800 crore

Example Solution:
In the case of a cash credit facility for Rs.100 lakh (which is not Retail----------------3000*75/100 = 2250 crore
unconditionally cancelable) where the availed portion is Rs. 60 lakh, the un-availed HL---------------------2000*50/100=1000 crore
portion of Rs.40 lakh will attract a Credit Conversion Factor (CCF) of 20% (since the Other loans---------10000*100/100 = 10000 crore
cash credit facility is subject to review / renewal normally once a year). The credit Gsec------------------5000*0/100=0
equivalent amount of Rs.8 lakh (20% of Rs.40 lakh) will be assigned the appropriate SS Secured----------500*150/100=750 crore
risk weight as applicable to the counterparty / rating to arrive at the risk weighted SS Unsecured ------150*100/100=150 crore
asset for the unavailed portion. The availed portion (Rs.60 lakh) will attract a risk Doubtful D1 --------800*100/100=800 crore
weight as applicable to the counterparty / rating. Total RWAs = 2250+1000+10000+750+150+800 = 14950 crore
In compliance of the new guidelines banks have advised all the branches for: OPERATIONAL
i) Insertion of Limit Cancellation Clause in loan documents RISK Ist year 2nd year
ii) Levying of Commitment Charges How to find Net Profit 120 crore 150 crore
Risk Weighted Provisions 240 crore 290 crore
VaR (Value at Value at Risk is how much can we expect to lose? What is potential Assets? Staff Expenses 280 crore 320 crore
Risk) loss? Other Oper. 160 crore 240 crore
We can lose maximum up to VaR (value at Risk) over a given time at a expenses
given confidence level. Gross Income 800 crore 1000 crore
Average Income 1800/2=900 crore
Calculation of VaR Capital Charge 900*15/100=135 crore
Market Factor Sensitivity X Daily Volatility X Probability at given RWAs (assuming Capital Charge/8% = 135*100/8 =
confidence level BASEL rate of 8%) 1687.50 crore

75 76
Capital Charge LC within Retail portfolio -------------------1000 crore (AAA rated How Tier I Capital = 100+300+400 + 135 ( 300*45/100) = 935 Crore
on Off Balance securities) calculations will Tier-II Capital = 175 (1.25 % of Credit RWAs or Rs. 200 crore) +300 =
Sheet Items Standby LC (As Financial Guarantee)-----500 crore (A rated Co.) be made under 475 Cr
How to find Standby LC particular transaction-------200 crore (AA rated Co) BASEL-III Total Risk Weighted Assets = 19000
Risk Weighted Performance Bonds & Bid bonds---------1000 crore (Unrated Co.) Capital Adequacy Ratio = Tier-I + Tier-II/ RWA = 1410/19000 = 7.42%
Assets? Financial Guarantees------------------------400 crore (AA rated Co.)
Confirmed LC for Imports------------------100 crore (AAA rated Co.) Minimum CET-I (5.5% of RWAs) = 19000*5.5% = 1045 Cr
Off Balance Sheet CCF Adjusted RWAs Maximum AT-I (1.5% of RWAs) =19000*1.5% = 285 Cr
Exposure Exposure Minimum Tier-I Capital Ratio = 19000*7% = 1330 Cr
LC Retail Portfolio 20% 1000*20% = 200 200 *20% Maximum Tier-II Capital = 19000*2% = 380 Cr
(AAA rated) crore =40 crore CCB required in the shape of Tier-I = 19000*2.5%= 475 Cr

Standby LC (As 100% 500*100% = 500 500*50%

Financial Guarantee) crore =250 crore Practical Examples
(A rated) Ex.1
Standby LC 50% 200*50%=100 100*30% If daily volatility of a Security is 2%, how much will be monthly volatility?
particular transaction crore =30 crore Solution
(AA rated) 10.95% Ans
Performance Bonds 50% 1000*50%=500 500*100% Ex.2
& Bid bonds crore =500 crore If per annum volatility is 30% and nos. of trading days per annum be 250, how much will be
(Unrated) daily volatility?
Financial Guarantees 100% 400*100%=400 400*30% Solution
(AA rated) crore =120 crore Annual Volatility = Daily Volatility *
Confirmed LC for 20% 100*20%=100 20*20% 30 = Daily Volatility *15.81
Imports crore 4 crore Daily volatility = 30/15.81 = 1.90% Ans.
Total RWAs 40+250+30+500+120+4=944 crore Ex.3
Capital Required = 944 *9%= 84.96 crore If 1 day VaR of a portfolio is Rs. 50000/- with 97% confidence level. In a period of 1 year of
Tier-I and Tier II RWAs --- Credit Risks = 14000 crore 300 trading days, how many times the loss on the portfolio may exceed Rs. 50000/-.
Capital RWAs ----Market Risk =2000 crore Solution
CRAR RWAs ----Operational Risks = 3000 crore 97% confidence level means loss may exceed the given level (50000)on 3 days out of
(As per BASEL- Tier I Capital 100.
BASEL-II Paid up Capital--------------------------------------------- 100 crore If out of 100 days loss exceeds the given level on days =3
guidelines) Free Reserves ---------------------------------------------300 crore Then out of 300 days, loss exceeds the given level = 3/100*300 =9 days. Ans.
Perpetual non-Cumulative Preference Shares -----400 crore Ex.4
A 5 year 5% Bond has a BPV of Rs. 50/-, how much the bond will gain or lose due to
Tier-II Capital increase in the yield of bond by 2 bps
Provisions for contingencies ---------------------------200 crore Solution
Revaluation Reserve--------------------------------------300 crore Increase in yield will affect the bond adversely and the bond will lose.
Subordinate Debts-----------------------------------------300 crore Since BPV of the bond is Rs. 50/-. Increase in yield by 2 bps will result into loss of value of
Bond by 50*2=100.
Ex.5
1 day VaR of a portfolio is Rs. 50000/- with 90% confidence level. In a period of 1 year (250
Solution days) how many times the loss on the portfolio may exceed Rs.50000/-
Tier I Capital = 100+300+400 = 800 crore
Tier-II Capital = Provisions 200 crore (Max 1.25% of Credit RWAs i.e. Ans. 90% confidence level means on 10 days out of 100, the loss will be more than Rs.
175 crore)+ ( Revaluation Reserves @ discount of 55% i.e. 50000/-.
300*45/100) + Subordinate Debts i.e. 300 crore Out of 250 days, loss will be more than 50000/- on 25 days Ans. It means, out of 250
=175 + 135 + 300 = 610 crore days, loss will not exceed on 225 days.
Total Capital = 800 + 610 = 1410 crore
CAR = 1410/19000*100 = 7.42 %

77 78
Ex.6 1. Find out change in Basis Point Value of Bond for 1 basis point
Given; change in yield for 9% GOI Bonds
RWAs for Credit and Operational Risks 1200 Cr
RWAs for Market Risks 100 Cr BPV = Difference in Market Price / Difference in Yield
Common Equity Tier-I Capital 85 Cr =(109.80-107.60) / (8.40-8.20) = 2.20 / 20 = 11 paisa per Basis Point
CCB 25 Cr
PNCPS/PDI 35 Cr 2. Find out Price of 9% Bonds, if there is decrease in yield by 100
Eligible PNCPS/PDI 21.25 Cr
bps
Eligible Tier-I Capital 106.25 Cr
Tier-II Capital available 25 Cr
Change in price for 1 basis point change in yield = 11 paisa
Tier-II Capital Eligible 28.33 Cr
Excess of AT-I eligible for Tier-II 3.33 Cr. Change in price for 100 basis point change in yield = .11*100 = 11 Rupees---Ans
Total eligible Capital 134.58 Price of Bond will increase by Rs. 11/-

3. Profit, if 9% Bonds are sold on 31.3.2014

Q. Minimum Common Equity CET-I Capital to support Credit and Operational
Risks Market Price Cost
Ans. 1200*5.5% = 66 Crore 219600- 215200 = 4200/-
Q. Max Additional Tier-I (AT-I) capital to support Credit and Operational Risks
Ans. 1200*1.5% = 18 Crore
Q. Maximum Tier-II Capital to Credit and Operational Risks LATEST GUIDELINES
Ans. 1200*2% = 24 Crore Treatment of Revaluation reserves :
Q. Total Capital to support Credit and Operational Risks Revaluation reserves arising out of change in the
Ans. 66+18+24 = 108 Crore consequent upon its revaluation may, at the discretion of banks, be reckoned as CET1
Q. Minimum CET-I available to support Market Risks capital at a discount of 55%, instead of as Tier 2 capital
Ans. 85-66 = 19 Crore
Q. Maximum AT-I to support Market Risks Treatment of deferred tax assets (DTAs)
Ans. 21.25 18 = 3.25 Crore Deferred tax assets (DTAs) associated with accumulated losses and other such
Q. Maximum T-II Capital within total to support market risks assets should be deducted in full from CET1 capital.
Ans. 28.33 24 = 4.33 Crore The amount of DTAs which are to be deducted from CET1 capital may be netted
Q. Total Eligible Capital to support Market Risks with associated deferred tax liabilities (DTLs) provided that:
Ans. 19+3.25+4.33 = 26.58 Crore The amount of DTAs which is not deducted from CET1 capital (in terms of para
(ii) above) will be risk weighted at 250% as in the case of significant investments
CET1 capital.
Ex.7

PCR Bank has investment in Bonds as on 30.09.2013 as under:

Face Value Yield Price Cost
9% GOI 2000 8.40 107.60 215200
Bonds
11% GOI 2000 8.80 110.50 221000
Bond
Position as on 31.3.2014 is as under:
Face Value Yield Price
9% GOI 2000 8.20 109.80 219600
Bonds
11% GOI 2000 8.60 113.30 226000
Bond

79 80
 LCR & NFSR under Basel-III How to calculate LCR
Ist. Step Total Level 1 Assets (100% factor)
2nd step---Total Level 2A Assets (85% factor)
Liquidity Coverage Ratio is a new concept adopted under BASEL-III. It aims at
3rd Step---Total Level 2B Assets (50% factor)
ensuring that banks have sufficient High Quality Liquid Assets to survive an acute stress
scenario lasting for 30 days. LCR will be implemented in a phased manner from
HQLA= Level 1 Assets + Level-2A Assets + Level 2B Assets Adjustment of 15% Cap
1.1.2015 and its 100% implementation will be up to 1.1.2019.
Adjustment of 50% Cap
It will be applicable on Indian banks on standalone basis including foreign branches. In
foreign banks, framework to be applicable for Indian operations only.
Total NET Cash flow = Expected Cash Outflow - Expected Cash Inflow for subsequent
30 calendar days.
HQLA (High Quality Liquid Assets)
LCR (Liquidity Coverage Ratio) = Stock of HQLA
These are assets which can be easily converted into cash with no loss or little loss of
Total net cash outflow over next 30 days
value. There are two categories:
> 100%
1 Level-1 These are included in HQLA without any limit or haircut.
Assets: Following are Level-1 assets:
Cash including Cash reserves in excess of CRR. Concept of Tier III Capital (Not applicable in India)
Banks may at the discretion of the National Authority, employ 3rd tier of Capital
Govt. securities in excess of minimum SLR requirement. consisting of short term subordinate debts for the sole purpose of meeting a proportion
of capital requirements for market risks.
Marketable securities issued/guaranteed by foreign Tier I Capital (Minimum of 28.5%) that is required to support market risks.
sovereigns with zero risk weight

2 Level 2 Assets These are included in HQLA subject to maximum 40% of

overall stock of HQLA after applying haircut. Level-2 assets are
further divided in 2 parts:
RATING OF BANKS
Banks are rated on a 5 point scale known as CAMELS as under:
Level-2A assets are included after applying 15% hair cut. The
C Capital Adequacy Ratio
examples of these assets are: A Asset Quality
M Management Effectiveness
Marketable securities guaranteed by sovereigns/PSEs E Earnings
with 20% Risk Weight. L Liquidity
S System and Control
Corporate bonds whose valuation is readily available
with AA rating or above Foreign banks are rated as under:
C Capital Adequacy Ratio
Commercial Papers not issued by banks/PDs/FIs with A Asset Quality
minimum AA rating L Liquidity
C Compliance
3 Level- 2B These are included in HQLA after applying 50% haircut. These S System and Control
assets should comprise not more that 15% of total HQLA. The
examples of these assets are:
PCA (prompt Corrective Action)
Marketable securities guaranteed by sovereigns/PSEs
It relates to taking corrective action promptly where bank faces weakness in respect of
with Risk Weight above 20% up to 50%. CAR, Net worth or profits. Follwing are the Trigger Points:
CAR (Capital Adequcy Ratio) Less than 9%
Common Equity shares not issued by banks/FIs/NBFC/
Non Performing Assets Net NPAs over 10%
and included in Nifty/Sensex index Return on Assets Below 0.25%

81 82
 NSFR (Net Stable Funding Ratio)
It aims at promoting medium to long term structural funding of assets and activities of the
banks. RBI proposes to make this ratio applicable to banks in India from 1.1.2018. The
objective of this ratio is to ensure that banks maintain stable funding profile for their
assets and off balance sheet items.
Available Stable Funding (ASF) X100 = 100% and above
Required Stable Funding (RSF)
Other funding (secured and unsecured) not included in the categories above with
residual maturity of not less than six months and less than one year, including
funding from central banks and financial institutions.
Net Stable Funding Ratio =
Available Stable Funding (ASF) X100 > 100% i.e. 100% and above
Required Stable Funding (RSF)

Long-term or "structural term assets" means RSF (Required Stable Funding)

Assets with Zero RSF Factors
Assets assigned a 5% RSF factor
Assets assigned a 15% RSF factor
Assets assigned a 50% RSF factor
Assets assigned a 65% RSF factor
Assets assigned an 85% RSF factor
Assets assigned a 100% RSF factor
Cash, Bank Balance and Balance with
RBI
Level 1 assets as defined in LCR
Level 2A assets as defined in LCR
Level 2B assets as defined in LCR
residential mortgages with a residual
maturity of one year or more that would
qualify for a 35% or lower risk weight
Other unencumbered performing loans
that do not qualify for the 35% or lower
risk weight under and have residual
maturities of one year or more.
100% of loans longer than one year

Available Stable Funding (ASF)

Liabilities and capital instruments receiving a 100% ASF

The total amount of regulatory capital and Total amount of any capital instrument
not included that has an effective residual maturity of one year or more .
The total amount of secured and unsecured borrowings and liabilities (including
term deposits) with effective residual maturities of one year or more.

Liabilities receiving a 95% ASF factor

Stable Term deposits with residual maturities of less than one year provided by
retail and small- and medium-sized entity (SME) customers.

Liabilities receiving a 90% ASF factor

Less Stable Term deposits with residual maturities of less than one year provided
by retail and SME customers.

Liabilities receiving a 50% ASF factor

Funding (secured and unsecured) with a residual maturity of less than one year
provided by non-financial corporate customers;
Operational deposits
Funding with residual maturity of less than one year from sovereigns, public
sector entities (PSEs), and multilateral and national development banks; and

83 84
MODULE - C

Treasury Management

2020
 Treasury Globalization and Growth : Rapid Economic growth is not possible without free capital flows
i.e. Overseas Companies invest in India and Domestic Companies invest outside India.
Exchange of technology and human resources has been made possible only after liberalization
after 1990.
Concept of Treasury
Overseas operations of a bank include Portfolio investment,
It deals with short term fund flow (i.e. Securities with up to 1 year maturity) except part of SLR
Direct Investment,
requirement. Previously, Liquidity Management was main function of Treasury. But now, it
ECB
includes all Trading and Investment activities in financial markets.
Issue of Equity and Debt Capital in Global market
Treasury has become profit center for all the banks Mergers and Acquisitions
It also plays important role in ALM (Asset Liability Management) Payment of technology, and
Receipt of Interest, fees and dividend etc.
Functions of Integrated Treasury
RBI has permitted large movement of capital though
Integrated Treasury refers to integration of the following:
Automatic route
1. Money Market
Approval Route
2. Security Market or Capital Market
3. Forex Market Impact of Globalization
Why Treasury has become so important 1. Interest rates are influenced by global trends
2. Exchange rates become volatile and affect GDP as well as Markets of Stock and
Rupee is freely convertible on account of Current Account transactions. In Capital
Commodity.
account transactions, it is convertible to a larger extent. Therefore, banks are free to
3. Institutional Structure has changed. SEBI, IRDA, CCIL, NSDL and CIBIL have come up.
operate in FDI, ECB and ODI.
4. There is widespread use of Swaps, Forwards and Options.
Banks source funds from Global markets and invest in Domestic currency or vice versa.
5. Rupee Derivatives are also available in the market.
Banks invest in Equity and Debt Market.
Use of Derivatives with reference to forex market as per requirement of our corporate Banks can Borrow and Invest Outside India through Overseas Correspondents in Foreign
customers. Currency up to 100% of Tier 1 Capital or USD 10 Million (whichever is higher)

Role of Treasury
Treasury as Profit Centre Due to following:
Liquidity Management : Managing short term funds besides maintaining CRR and SLR
Proprietary Positions: Trading in Currencies, Securities and other financial instruments 1. Inter- bank market is free from Credit risk and requires little capital allocation.
including Derivatives. 2. Treasury activity is highly leveraged. The risk ranges from 2% to 5%.
Risk Management: Bridging Asset Liability mismatches and managing Risks through 3. Operational costs are low.
Derivative tools.
Sources of Treasury Profit
Treasury Manages 3 books:
1. Forex Business
1. ALM Book Buy Low and Sell High
2. Merchant Book Position is generally squared on daily basis.
3. Trading Book Stock of currency is not generally kept.

ALM book deals with Internal Risk Management. Merchant Book deals with Client related
Derivatives. Trading Book deals sales and purchase of financial instruments for bank itself.

86 87
 2. Money Market
Banks lend surplus funds in Money Market and borrow the same when required. Interest
is earned.
3. Investment in Govt. Securities and Other Securities
Treasury profit is earned by investment in G-sec and other securities in Debt and Equity
Market.
4. Interest Arbitrage
If interest rates are in favour, banks borrow from centers having low rate of interest and
lend at other centers where rate of interest is high. This is called Arbitrage.
5. Trading in market
It is speculative activity. Banks trade in securities and currencies. Swap transactions are
also done to increase profits of the bank.
Organization Structure
In every bank, General Manager is CTO (Chief Transaction Officer) who reports direct to CEO.
There are four sections at HO:
1. Dealing Room : Chief Dealer is Head. There are separate dealers for Forex Operations,
Money market operations and Security Operations. For corporate, separate dealer is
appointed who deals with securities in Secondary as well as Primary market.
2. Mid-Office: It provides MIS, implements Risk Management system and monitors
exposure limits and Stop Loss Limit.
3. Back Office: This office is responsible for verification and settlement of deals,
confirmation of deals with counterparts, book-keeping of all deals and Maintaining
Nostro accounts.
4. Investment Office: This office deals with Primary Issues . Minimum marketable
Investment is Rs. 5.00 crore.
88
Treasury Products
Treasury Products are of 3 types:
Products of Forex Market
Products of Money Market
Products of Security Market
Forex Market Products: It is virtual market without boundaries, highly volatile and liquid and
most transparent. It includes the following products.
1. Spot Trades: Currencies are generally bought and sold at spot rates when payment and
settlement takes place on 2nd working day. Cash and Tom rates are quoted at discount
from Spot rate.
2. Forward Trades : Purchase or sale of currency at future rates. Exchange takes place
after few days/months. Importers and Exporters cover risks by Forward trades. Forward
rates are arrived at on the basis of interest rate differentials of two currencies.
3. Swaps: Foreign Exchange transactions where one currency is sold and purchased for
another simultaneously is called Swap. Swap Deal may involve: Simultaneous purchase
of spot and sale of forward or vice versa. It may also involve Simultaneous sale and
4. Investment in Foreign Currencies: If forex is surplus with bank, it makes investment.
Surplus arises from profits of treasury business, overseas operations, forex borrowings,
NRE, FCNR and EEFC deposits. Investment can be of following 3 types:
Interbank loans- normally not more than 1 year
Short term investments in T-bills and CPs issued by multinational agencies
Some Correspondent banks offer automatic investment facility in Nostro
Accounts subject to minimum balance.
5. Foreign Currency Loans: Banks extend WC loans in foreign currency and for this
purpose, clearance of Treasury is required.
6. Rediscounting of Foreign Bills : Treasury refinances the Foreign currency bills
purchased/negotiated by another bank. The advance covers Usance period 15-360
days.
Money Market Products : Money market products relate to raising and deploying short
term resources with maturity Maximum 1 year. The money market products are:
1. Call Money: It refers to Overnight placement. It needs to be repaid on Next Working
Day. O/N MIBOR Rate is the indicative rate. Non bank players (FIs/MFs) are not
eligible to participate.
89
 2. Notice Money: It is placement of funds beyond overnight up to maximum period of CD can be issued by FIs for 1-3 years.
14 days.
3. Term Money: It deals with placement of funds in excess of 14 days up to 1 year. Practical Example: How to calculate Issue price of CP (Face Value Rs. 100) carrying
1 to 6 month products are very common. maturity of 1 year. Rate of return in the market is 10%

Present Value = Future Value / 1+r

Banks can borrow in Call Money Market up to 100% of Capital on daily = 100/1.10
average basis. But during any day in previous fortnight, the borrowing can be = 90.90
up to 125%. Banks can lend also in call money market up to 25% of capita What will be annualized yield of a treasury bill with face value of Rs. 1.00 lac with
on daily average basis l. On any day, this cap is 50% of Capital funds. maturity after 85 days and is being traded at Rs. 98000/-.
Cooperative banks can borrow up to 2% of their aggregate deposits. For
Annualized Yield = Face Value Maket Price *365/85
Lending, there is no limit.
Market Price
PDs are allowed to borrow up to 225% of their Net Owned Funds whereas
lending limit is 25% of Net Owned Funds.
= (100000-98000) *365/85
Other Money Market Products: 98000
=2000*365/85 = 0.0876 = 8.76%
1. Treasury Bills: 98000
These are issued by Govt. of India through RBI in denomination of 1.00 lac and 3. LAF Repo and Reverse Repo (Repurchase Option)
further in multiples. It is Lending and Borrowing money for short term period (1 day to 1 year)
Tenure is 91Days, 182 Days and 364 Days. Under Repo, RBI purchases securities with commitment to sell at a later date in order to
These are issued at Discount in auction. Inject Liquidity. Presently, Govt. securities are dealt with. All Repo transactions are
Banks and PDs participate in the auction. ted
The auction is also available to all financial players (FIs/MFs/Corporate). companies. But the market is yet to be activated.
Auction takes place on Wednesday every week in case of 91 days bills. Under Reverse Repo, RBI sells securities with a commitment to buy at a later date in
It takes place on Wednesday every Fortnight in case of 182 D and 364 D bills. order to Contain Liquidity.
Repo and Reverse Repo transactions are generally conducted for Overnight period
2. Commercial Papers & 3. Certificates of Deposits through Auction Twice Daily. The minimum Bid is Rs. 5.00 crore and its multiples.
Margin is normally 5%. Margin is called Hair cut.
CP and CD Commercial Papers CP:
CP is issued by Corporate with Net Worth minimum 4 Latest Repo Guidelines as per Monetary policy dt. 3.6.2014
Crore, Rating min. A3 and availing WC limit from any
bank. Cap of Overnight Repo reduced from 0.5 % to 0.25% of NDTL
CP is issued with tenure 7 Days to 1 year. Continuation of Term Repo up to 0.75% (cap) of NDTL under 7 days to 14 days
CP is issued in multiples of Rs. 5.00 lac term repos.
CP is Promissory Note and is Negotiable and also attracts
Stamp Duty. 4. CBLO : Collateralized Borrowings and Lending Obligations:
It is fairly active in Secondary market. It is money market instrument launched by CCIL. Borrower can deposit G-sec with CCIL
It is in Demat form and the price is less than Face Value. and borrow funds from others who have surplus funds subject to re-purchase of
Certificate of Deposit CD
securities. The tenure is 1 day to 1 year.
CD is issued by banks
CD is issued with tenure 7 Days to 1 year. Borrowing Limits in Money Market
CD is issued in multiples of Rs. 1.00 lac.
CD is Promissory Note and is Negotiable and also attracts Participant Borrowings up to Lending up to
Stamp Duty. Scheduled Commercial 125% of Capital funds 50% of Capital funds
CD is not very active in Secondary market. Banks (Fortnightly average not to (Fortnightly average not to
Both are Zero Coupon Bonds always issued at discount. exceed 50% of capital funds) exceed 25% of capital funds)

90 91
Co-operative Banks 2% of their aggregate deposits No limit Green Bonds: Exim Bank issued Green Bonds to fund green projects in India in 2015. This
of March prev. year
Primary Dealers 225% of Net Owned Funds of 25% of Net Owned Funds
March prev. year 4. Equities: It is Share Capital issued by both Private sector and Public sector Companies
to raise funds from public. The people who invest are called Shareholders:
CMB (Cash Management Bills)---These are new short term instruments (With maturity less Bank can invest subject to limit exposure set by RBI for Capital Market
than 91 days) issued by Govt. to meet short term cash flow mismatches. CMB is just like a SEBI has full control and these are traded in Stock Exchanges.
Treasury Bill. The tenure of the bill depends upon short term requirement of Govt. The bills are Derivative products are also available.
issued at a discount through auction through press release. Investment in CBM by SCBs qualify If offered by Company, it is called Primary Market. If purchased through Stock
for statutory requirement of SLR. Exchanges, it is called Secondary market.
Security Market Products
Equity Share Preference Share
Securities constitute Shares, Debentures, Bonds, and Govt Securities etc. The various types of It is permanent capital and is not It may be redeemable or non-redeemable.
securities are: redeemed. It forms part of Tier-I Capital. If redeemable, forms part of Tier-II Capital
Dividend is paid out of profits after making Preference is given while paying dividend.
1. Govt. Securities payment to Preference Share-holders. Unpaid dividend can be carried forward.
This is why these are called Cumulative
These are issued by PDO (Public Debt Office) of RBI.
Preference shares.
Price is determined in auction The Company, if liquidated, pays to Equity Preference Shares are given preference
There is active trading in Secondary market. Shares at last. for payment at the time of liquidation.
If Yield rate is more than coupon rate, these are issued at a discount. These carry Voting Rights. arry Voting rights.
Open Market Operations are conducted by GOI to maintain liquidity position. Generally Preference Shares are
SLR requirements are met by banks by investing in HTM securities. Cumulative and Redeemable.
2. Corporate Debt Papers Domestic and Global Markets Rupee is fully convertible on account of Current Account
transactions and partially on account of Capital Account transactions. Interaction between
These are medium and long term Bonds and Debentures issued by Corporate
Domestic and Global markets takes place in respect of following:
and FIs.
These are non-SLR securities. 1. FII Investments: These are made by way of FDI (Foreign Direct Investments) and
These form part of Tier II Capital. Portfolio Investments. FDI is for Long term Project related investment whereas Portfolio
Yield is more than that of Govt. Securities. Investment related to Investment in Equity and Debt Market. In some areas, FDI is 100%
3. Debentures and Bonds: Both are Debt instruments and form part of Tier-II Capital. whereas it is up to 74% in other areas.
SEBI has control over issuance and redemption.
Debenture Bond 2. ADR/GDR
Issued by Corporate in Private sector Issued by institutions in Public sector American Depository Receipts are Receipts or Certificates issued by US Banks
It is Secured by Floating charge It is not secured representing specified number of shares of non-US Companies.
Provisions of Company Law applies It is governed by Indian Contract Act
It can be transferred through registration It is negotiable instrument Global Depository Receipt is a Dollar denominated instrument which is traded in
It can be convertible or non-convertible Bond, if given option can be European Markets but represents Securities of non-European Companies.
convertible into equity shares.
It can be 3. ECB (External Commercial Borrowings
Zero Coupon Bond, Perpetual Bond, ECBs External Commercial Borrowings
Floating Bond, Deep Discount & Converible
Bond External Commercial Borrowings (ECBs) are loans in India made by non-resident
Masala Bonds: IFC issued Masala Bonds in International markets to fund Infrastructure lenders in foreign currency to Indian borrowers. They are used widely in India to facilitate
projects in India in 2014. These are rupee denominated. access to foreign money by Indian corporations and PSUs (public sector undertakings).

92 93
Revised ECB guidelines: The salient features of the new framework are as under: applicable if outstanding amount of all ECBs, including proposed one,
is up to USD 5 million or equivalent.
Merging of Tracks: Now, there will be two tracks as under: Issuance of Guarantee, etc. by Indian banks and Financial
Institutions: Issuance of any type of guarantee by Indian banks, All
1. Foreign Currency denominated ECB India Financial Institutions and NBFCs relating to ECB is not
2. Rupee Denominated ECB permitted.
ECB framework is not applicable in respect of the investment in
Eligible Borrowers: This has been expanded to include all entities eligible to receive Non-Convertible Debentures in India made by Registered Foreign
FDI. Additionally, Port Trusts, Units in SEZ, SIDBI, EXIM Bank, registered entities Portfolio Investors.
engaged in micro-finance activities, viz., registered not for profit companies, registered Loan Registration Number (LRN): Any draw-down in respect of an
societies/trusts/cooperatives and non-government organizations can also borrow under ECB should happen only after obtaining the LRN from the Reserve
this framework. Bank.
AD Category-I banks are permitted to allow Startups to raise ECB
Recognized Lenders: The lender should be resident of FATF or IOSCO compliant under the automatic route with minimum average maturity period will
country. Multilateral and Regional Financial Institutions, Individuals and Foreign be 3 years. The borrowing per Startup will be limited to USD 3 million
branches / subsidiaries of Indian banks can also be lenders. or equivalent per financial year either in INR or any convertible foreign
currency or a combination of both.
Forms of ECB In case of FCY denominated ECB, companies are required to
Loans including bank loans, floating/ fixed rate notes/ bonds/ debentures, Trade credits mandatorily hedge 70 per cent of their ECB exposure in case average
beyond 3 years; FCCBs; FCEBs and Financial Lease. maturity of ECB is less than 5 years.
Minimum Average Maturity Period (MAMP):
ECBs in general 3 years
4. Foreign Currency Funds of Banks
Banks can use FCNR deposits for the purpose of Investing outside India as well as for
ECBs raised from foreign Equity Holders 5 years
domestic lending in foreign currency. They are also permitted to borrow/invest in
and utilized for specific purpose overseas market within a ceiling of 100% of Unimpaired Tier 1 Capital with minimum
USD10 million.
ECBs up to 50 Million USD per financial year 1 Year
5. ODI (Overseas Direct Investment)
by Mfg. Sector Corporate can invest in Joint Venture/Subsidiary units outside India from Rupee
resources subject to cap of 4 times of Net worth i.e. 400% of Net worth.
This way, Indian Companies can have global presence.
All in Cost Ceiling
Benchmark rate (6 M LIBOR Rate) + 450 bps Any financial commitment exceeding 1 billion USD in a financial year would require prior
permission of RBI even within overall limit of 400% of Net Worth.
End-uses (Negative list) The negative list, for which the ECB proceeds cannot be It has been decided that Proprietorship concerns and Unregistered Partnership firms can
utilized, would include the following also participate in ODI up to 10% of average export realization of previous 3 years or
a) Real estate activities. 200% of Net Owned funds of the firm provided:
b) Investment in capital market. 1. It is Status Holder Exporter and KYC compliant
c) Equity investment. 2. It has proven track record i.e. exports outstanding does not exceed 10% of average
d) Working capital purposes except from foreign equity holder. export realization of previous 3 years.
e) General corporate purposes except from foreign equity holder. 3. There is no adverse notice of any govt. agency.
f) Repayment of Rupee loans except from foreign equity holder.
g) On-lending to entities for the above LRS (Liberalized Remittance Scheme)
The scheme is meant for Resident Indians individuals. They can freely remit up to USD
Limit and leverage 250000 per financial year in respect of any current or capital account transaction without
All eligible borrowers can raise ECB up to USD 750 million or prior approval of RBI. The precondition is that the remitter should have been a customer
equivalent per financial year under auto route. of the bank for the last 1 year. PAN is mandatory.
Further, in case of FCY denominated ECB raised from direct foreign Not Applicable
equity holder ECB liability-equity ratio for ECBs raised under the The scheme is not applicable for remittance to Nepal, Bhutan, Pak, Mauritius or
automatic route cannot exceed 7:1. However, this ratio will not be other counties identified by FATF.

94 95
 The scheme is not meant for remittance by Corporate. Foreign Banks in wholly owned 100%
Latest Guidelines subsidiary
The scheme should not be used for making remittances for any prohibited or Telecom, Education, RE, NBFC, Films, 100%
illegal activities such as margin trading, lottery etc., as hitherto. Hotel & Tourism Sector
Resident individuals have now been allowed to set up Joint Ventures (JV) / Private Sector banks 74%
Wholly Owned Subsidiaries (WOS) outside India for bonafide business activities Credit Information Companies, Coal, 74%
outside India within the limit of USD 250000 Airports, Direct to Home, Mining of
The limit for gift in Rupees by Resident Individuals to NRI close relatives and Diamond
loans in Rupees by resident individuals to NRI close relatives shall accordingly Retail- Multi brand & Trading 51%
stand modified to USD 250000 per financial year. Defense Sector 49%
PAN No. is compulsory for all transactions irrespective of amount. Insurance Sector 49%
RBI has clarified that Scheme can now be used for acquisition of IP (Immovable Power Exchanges & Stock Exchanges 49%
Property) outside India. Public sector Banks 20%
. A citizen/Entity of Pakistan may participate in FDI with prior approval of
MSF Marginal Standing Facility Government.
The banks will use Marginal Standing Facility to borrow overnight money from RBI only ODI It has now been decided:
when they have exhausted all other existing channels like Collateralized Borrowing and (Overseas
Lending Obligations (CBLO) and Liquidity Adjustment Facility (LAF). The features of the Direct a) To restore ODI up to 400% of Net Worth. Any financial
scheme are as under: Investment ) commitment exceeding 1 billionUSD in a financial Year would
The eligible entities can avail overnight, up to 2% of their respective require prior approval of RBI even within overall limit of 400% of
NDTL outstanding at the end of the 2nd preceding fortnight. Net worth.
For the intervening holidays, the MSF facility will be for one day except on
Fridays when the facility will be for 3 days or more, maturing on the b) Any ODI in excess of 400% of the net worth shall be considered
following working day. under the Approval Route by the Reserve Bank of India.
The facility is available on all working days in Mumbai, excluding FPIs FPIs are now allowed access to :
Saturdays between 3.30 P.M. and 4.30 P.M. (Foreign Currency futures
Requests will be received for a minimum amount of Rs. One Crore and in Portfolio Exchange traded currency options
multiple of Rs. One Crore thereafter. Investors For the purpose of hedging currency risk arising out of market value of
MSF will be undertaken in all SLR-eligible transferable Government of their exposure to Indian Debt and Security market.
India dated Securities/Treasury Bills and State Development Loans
(SDL). UP TO USD 10 MILLION or equivalent without having to establish
A margin of 5% will be applied in respect of GOI dated securities and Treasury Bills. In existence of any underlying exposure.
respect of SDLs, a margin of 10 per cent will be applied.
Beyond USD 10 million, FPI will have to establish underlying exposure.
FDI (Foreign Direct Investment)
PRESENT RATES AT A GLANCE
Foreign direct investment (FDI) is a direct investment into production or business in a
country by an individual or company in another country, either by buying a company in Present Rate
the target country or by expanding operations of an existing business in that country. w.e.f. 21.2.2019
Foreign direct investment is in contrast to portfolio investment which is a passive Repo 5.15 %
investment in the securities of another country such as stocks and bonds. Reverse 4.90 %
Repo
FDI Limits in different sectors are as under: MSF 5.40 %
%age of Net Owned Bank Rate 5.40 %
Capital CRR 4%
Civil Aviation & Domestic Airlines 100% SLR * 18.25%
Railways, Construction, Mining of Gold 100%
and Silver
Retail Single brand 100% by FIPB
Courier Service, Electricity & Power 100%

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 Funding and Regulatory Aspects
Broad Money (M3) includes currency in circulation, Demand and Time Liabilities of Banks and
Post Office SB accounts. Narrow money (M1) includes Currency in circulation, Demand
Liabilities of Banks and other deposits with RBI. M3 is 3-4 times than M1.
Money is impounded by RBI to reduce multiplier effect by means of CRR and SLR.
Cash Reserve Ratio (Presently 4% of DTL)
Banks have to maintain cash balance equal to 4% of DTL with RBI.
There is No minimum and No ceiling limit.
No interest is paid by RBI.
Non-maintenance of CRR attracts penalty @ 3% above Bank rate on 1st day and 5%
above bank rate from 2nd day.
It is calculated as fortnightly average.
However daily cash balance should not fall below 90% of the amount required.
Statutory Liquidity Ratio (Presently 19.25% of DTL)
2. NEFT (National Electronic Fund Transfer) is mainly used for low amount
transactions. However, there is no minimum and maximum limit. The facility is available
24X7 basis on all days in a year. There are 48 half yearly batches daily from 00:30 to 00
Hours. . The time period is B+2.
3. Negotiated Dealing System (NDS): It is an electronic platform which facilitates sale
and purchase of Govt. securities. Auctions are made and trading is done electronically.
Banks, PDs, Insurance Cos., MFs and FIs are members. Improved version of NDS
called OM (Anonymous Order matching system) takes care that identity of counter party
is not disclosed till offer is accepted.
4. FX Clear: It is Forex Dealing system developed by CCIL. CCIL provides straight
through processing (STP) between banks for USD/INR transactions and settlement in
made in Indian Rupees.
5. NSDL and CDSL: National Securities Depository Ltd. (NSDL) and Central Depository
Services India Ltd.(CDSL) provide a settlement platform for shares and other securities
in the Secondary market. These institutions also maintain Demat accounts.
NEW RTGS SYSTEM EFFECTIVE FROM 14.7.2014; Two new features have
been added:

1. Hybrid System
Banks have to maintain liquid funds in the form of cash, gold and un-encumbered Govt.
securities @19.25 % of DTL. Offsetting after every 5 minutes.
There is no floor limit. However, ceiling limit is 40%. The transactions with normal priority would be settled in off-setting mechanism
Non-compliance attracts penalty @ 3% above Bank rate on Ist day and 5% above bank within maximum 2 attempts.
rate from 2nd day. It is computed as on last Friday of 2nd preceding fortnight every month. Maximum time a transaction would be in normal queue is 10 minutes.
RBI will reduce SLR by 0.25% every quarter commencing from 1.1.2019 till it If transaction with normal priority is unable to be settled on offsetting mode within
reaches at 18% from present rate of 19.5%. 10 minutes, it would be automatically converted to Urgent.
2. Future Value Transactions; Value Dated transactions would enable the
What Constitutes DTL?
customers/participants to initiate RTGS transactions 3 working days in advance for
Demand deposits (CA, SB, Margin money for LC and Overdue FDs)
Time Deposits (FD and RD). setting in RTGS on Value Date.
Overseas borrowings
Foreign outward remittances in transit. UPI (Unified This is advance version of IMPS which facilitates Interbank/Within bank
Accrued Interest and credit balance of Suspense account. Payment Payments/Collections. All accounts with same mobile number are connected.
Exemptions Interface) Procedure is as under:
Capital, Reserves and Surplus Create Virtual address (VA) e.g. abc@pnb
Net Interbank borrowings, Credit balance in ACU Dollar accounts, Transactions in VA is communicated to sender and amount is remitted.
CBLO and CCIL Account Number/IFSC/MMID is not to be disclosed.
Refinance from NABARD, SIDBI, NHB and RBI. App can be downloaded by non-customers also.
DTL in respect of Off-shore banking units. Service is available on all days 24 hours.
Mobile Banking IMPS Immediate Payment 24 Hours service
Payment and Settlement System Service
1. RTGS (Real Time Gross Settlement) is a payment system for Interbank transfer Three Types of Payments through IMPS (Max amount allowed Rs. 50000/- per day)
with minimum Rs. 2.00 lac. This system is managed by IDRBT, Hyderabad, which 1. P2P (Peer to Peer) ----Interbank transfer of funds using MMID (Mobile Money Identifier)
2. P2A (Peer to Account ) -----Interbank transfer of funds using IFSC
connects all banks to Central server maintained by RBI. The network is INFINET (Indian
3. P2M (Peer to Merchant) ----For e-commerce transactions
Financial Network). Timings are: 7:00AM to 6:00PM (R41) and 7:00 AM to 7:45 PM (R42). 4. P2PM (Peer to Peer Merchant)

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 BHIM (Bharat Interface for Money)
Bharat Interface for Money (BHIM) is an app that lets make simple, easy and quick payment
transactions using Unified Payments Interface (UPI). It enables direct bank to bank payments
instantly and collect money using mobile number and Payment address. The application is
launched by NPCI.
Benefits of BHIM:
Single App for sending and receiving money and making merchant payments
Go cashless anywhere anytime
Added security of Single click 2 factor authentication
Seamless money collection through single identifiers, reduced risks, real time
Mobile no. or Name used to create VIRTUAL PAYMENT ADDRESS (VPA)
Best answer to Cash on Delivery hassle
Send and collect using VIRTUAL PAYMENT ADDRESS (VPA) or A/c no & IFSC
Payments through single app in your favourite language.
24X7, 365 days instantaneous money transfer
Revised Transfer Limits (Sending and Collecting) :
1.Maximum amount is Rs. 25000/- per transaction and Rs. 50000/- per Day.
2. Maximum amount per week is Rs. 200000/- and per month is Rs. 1000000/-.
However minimum amount is Rs. .01
There is limit of 10 transactions per account per bank.(Send money and Collect money).
New User can initiate 5 collect requests through all his accounts linked to registered
mobile.
There is no restriction for P2M and P2PM transactions
There are no charges for making transaction through BHIM
Your account need not be enabled for mobile banking to use BHIM. Your mobile
number shall have to be registered with the Bank.
Currently, BHIM supports linking of one Bank only. At the time of account set-up,
one can link your preferred bank account as the default account. In case you want to
link another bank account, one can go to Main menu, choose Bank Accounts and
select default account.
Visit Profile option and set virtual payment address (VPA)s (2 virtual payment
address (VPA)s are allowed per user 1. mobno@upi, 2. name@upi)
QR code feature is available, by using Scan and Pay option send and collect money
anytime.
(Limit of P2P Collect Transaction Value : Max 5000/- per transaction)
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Treasury Risk Management
Why Treasury is risky?
Treasury is risky because of the following:
1. High Leverage- Value of transaction is very high say 100 crore and 1% adverse
movement may result into loss of 1.00 crore.
2. There is sole discretion of Treasury Department to sell, buy or keep open position.
3. Transactions are confirmed and irrevocable.
Risks involved in the Treasury are mainly:
Market Risk It consists of Liquidity risk, Exchange rate risk, Interest rate risk, Equity
risk and Commodity risk
Take an example:
We borrow from Money market and invest in 5 year G-securities. If Bond prices come
down, we are not willing to sell the bond, but loan has to be repaid. This may lead to
shortage of funds which is called Liquidity Risk.
Liquidity Risk is translated into Interest Rate Risk when funds have to be arranged at
higher rate. Mismatch between Assets and Liabilities also lead to Interest Rate Risk.
Fluctuation of exchange rates due to many domestic and international factors can lead
to Currency Risk.
Risk of fluctuation in market price of Shares and Bonds is called Equity Risk whereas
Risk of Fluctuation in market price of Commodities such as Gold, Silver etc. lead to
Commodity Risk.
Credit Risk It is risk of default by counter party due to various reasons such as Buyer
Risk, Seller Risk, Country Risk and Sovereign Risk.
Types of Control are:
1. Organizational Control
Segregation of Front, Back and Mid office for effective monitoring and control.
2. Internal Control
Setting up of limits like Deal Size limit, Open Position limit, Stop loss limit, Day light limit
and Overnight limit
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 2. Duration or Macaulay Duration
3. Exposure Ceiling Limit
Exposure limit of counterparty is fixed on the basis of Credit Rating. Ideally all deals Duration is the period during which Present Value of Outflows become equal to the Present
should take place DVP Delivery Vs Payment and there is no risk. But ideal position is Value of Inflows.
not there always. Bonds carry coupon rate. If rate of return is higher than coupon rate, Value of Bond falls.
RBI has imposed a ceiling of 5% of Total Business in a year for Individual broker Effective rate of Bond is called Yield.

Measurement of Risk Duration is Weighted Average measure of life of Bond where time of receipt of cash is
weighted by Present Value of Cash Flow.
There are two methods to measure Risk:
It is expressed in number of years during which PV of the bond equals the market price.
1. Value At Risk (VaR)
Formula is :
2. Duration Approach
Duration (Macaulay Duration) =
1.VaR (Value at Risk) It is statistical measure indicating worse movement of market rate
over given period of time under normal market conditions. Modified Duration = Duration
1+ Yield
For example: Overnight VaR of 45 bps for USD/INR at 95% confidence level. If spot rate is
46.00, there are only 5% chances that the rate will be worse than 45.55 (46.00-0.45). Another formula is :
Another Example is: If Overnight VaR of 1 year G-Sec is 0.35%, the current yield of 7.75% is %age change in Price of Bond = Modified duration X Yield change
expected to fall/rise not more than 0.35% by tomorrow.
Practical Example:
VaR is based on Volatility. A bond having duration of 8 years is yielding 10% at present. If yield increases by 0.60%, what would
Volatility is sd calculated from mean observations over a period of time. be impact on price of bond.
VaR is suggested for shorter period.
Modified Duration = Duration/(1+Yield) = 8/(1.10) = 7.27
Practical Example: %age change in Price of Bond = Modified duration X Yield change
= 7.27 X (0.60%)
-Sec portfolio has 100 day VaR at 95% confidence level is 4% based on yield. What = 4.36% (Negative)
is worst case scenario over 25 days.
Ans. = -4.36% (Bond Price will fall by 4.36%
Solution:

Q. A zero coupon Bond issued for 5 years. What is its duration?

* Square root of 100 Ans: 5 years (Because No interest is payable on Zero Coupan Bonds).

4 = One day VaR*10 Q. A Bond has option to be convertible in 5 Years. What option is this?
Ans. Embedded option
One day VaR = 4/10 = .40

25= 2%

In worst case scenario, yield will increase and Market Value of the Bond will fall. Hence,
Answer is 2% increase in yield in 25 days.

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 Derivative Products
OPTIONS

Option is a contract to buy or sell currency, bonds or Equity on future date. The party has right
The market may be financial market dealing in forex, bonds and equities as well as commodity
to exercise option but there is no obligation.
market dealing with underlying commodities like Gold, Silver etc.
Option is Right to buy or sell an agreed quantity of currency or commodity without obligation to
Derivatives refer to Future Price based on Spot Market. Two types of Products are as under:
do so. The buyer will exercise the option if market price is in favor or otherwise option may be
1. OTC Products allowed to lapse.
These are Over The Counter products which include Forward Contracts and Options.
These are structured and offered by Banks/FIs. These derivatives offer contracts with There are two types of Option: 1. Call Option 2. Put Option
date, amount of terms fixed as per requirement of the client. Price is quoted by
banks/FIs after adding margin. Settlement is made by physical delivery. Counterparty Call Option Right to buy at fixed price on or before fixed date.
Risk is always present.
2. Exchange Traded products Put Option Right to sell at fixed price on or before fixed date.
These include Futures traded on organized exchanges. Size of the contract is Final day on which it expires is called maturity. The pre-fixed rate is called Strike Rate.
standardized. Price is transparent. The exchanges collect margin based on Mark to CALL OPTION;
Market price. Physical delivery is not must. There is no counter party risk. If Strike price is below the spot price, the option is In the money (ITM)
If Strike price is equal to the spot price, the option is At the money.(ATM)
Types of Derivatives If Strike price is above the spot price, the option is Out of money.(OTM)
1. Forward Contracts PUT OPTION
2. Futures If Strike price is more the spot price, the option is In the money.
3. Options If Strike price is equal to the spot price, the option is At the money.
4. Interest Rate Swaps If Strike price is less than spot price, the option is Out of the money.
5. Currency Swaps American Option
Option can be exercised on any day before expiry.
European Option
Forward Contracts Option can be exercised on maturity only.
(In India, only Europian type of options are used)
It is a deal to buy or sell Shares, Commodity or Foreign Exchange at a contracted rate with
desired maturity. Forward rate is the interest rate differentiation of two currencies. If Interest
rate is high in a country, its currency will be cheaper. Plain Vanilla Option
It is an option without any conditions. It is ideal for Hedging.
Futures Zero Cost Option
It is Exchange traded product. The seller agrees to deliver a specified security, currency or It does not attract any premium. There is risk of holder i.e. importer to pay higher rate if market
commodity on specified date at a fixed price. Currency Futures are traded in EURO, GBP, JPY, rises beyond certain level.
Embedded Option
CHF, AUD & CAD.
The bond holder is given option to convert its debt into equity.
Forward Contract Futures
Other features of an Option Contract
It is OTC (Over the Counter) Product It is Exchange traded product
Option is based on Notional amount as only exchange difference is settled.
It can be for any odd amount It is always for Standard amount
Price of Option is much smaller than the Notional Value.
It can be for any Odd period It is always for Standard period
The premium depends upon Volatility of the underlying product.
Delivery is essential Delivery is not must
Margin is not essential It is based on Margin requirement and Longer the maturity, costlier will be the option.
Marked to market
Practical Question:
Contract size of USD/INR is USD 1000. The settlement takes place in INR.
Mr. Naresh purchases a Put option for 300 shares of A with strike price of Rs. 2000/- having
EURO/INR/GBP is traded in cross currency rates. maturity of 2 months at Rs. 50/-. On maturity, shares of A were priced at Rs. 1900/-. What is
Future of INR is allowed with Contract size minimum Rs. 2.00 lac based on 7% synthetic profit/loss for the individual transaction:
10 year G-Sec.

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Solution:
Naresh will prefer to exercise option by selling at strike price of Rs. 2000/-. He will receive Rs.
600000/- (2000*300) minus Rs.15000(50*300) i.e. 585000/-
At the same time, naresh can buy from market @1900 i.e. net payment of 300*1900=570000/-
Profit = 585000-570000=15000/-
Interest Rate Swaps (IRS)
It is OTC product. It deals with exchange of Interest flows on an underlying assets and liability.
For Example: A company is paying interest on 5 years Debentures @7%. In market, rate of
interest is declining, company will be losing notionally. But its notional loss can be covered only
if the Interest rate is linked to market rate of interest. The Company enters into Interest rate
swap with bank with the terms that Fixed rate of interest on Debentures will Swap 3M T-bills
@5%. The fixed rate of 7 % on Debentures will be swapped with T+2%. After every 3 months,
bank will pay (notionally) to the company @ T-bills+2%.
Assuming that in the next quarter, 90 days T-bill rate is 4%, the Company will notionally lose
1%. Under such circumstances, company will receive from the bank @1%. This will neutralize
the loss of interest @1% (notional) on account of fall in the market interest rate.
Vice versa, company will pay to the bank @1%.
FRA (Forward Rate Agreement)
It is Forward Interest rate which is an over-the-counter contract between parties that determines
the rate of interest to be paid or received on an obligation beginning at a future start date. The
contract will determine the rates to be used along with the termination date and notional value.
On this type of agreement, it is only the differential that is paid on the notional amount of the
contract.
For a basic example, assume Company A enters into an FRA with Company B in which
Company A will receive a fixed rate of 5% for one year on a principal of $1 million in three years.
In return, Company B will receive the one-year LIBOR rate, determined in three years' time, on
the principal amount. The agreement will be settled in cash in three years.
If, after three years' time, the LIBOR is at 5.5%, the settlement to the agreement will require that
Company A pay Company B. This is because the LIBOR is higher than the fixed rate.
Mathematically, $1 million at 5% generates $50,000 of interest for Company A while $1 million
at 5.5% generates $55,000 in interest for Company B. Ignoring present values, the net
difference between the two amounts is $5,000, which is paid to Company B.
Currency Swaps
It is exchange of cash flow in one currency with that of another currency. Two types of currency
swaps are there: Currency Only Swap & Principal Only Swap. Currency Swaps are used to
mitigate exchange risks for meeting Principal or Interest obligations.
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Example: An investor in Germany needs INR to Invest in India. On the other hand, Reliance in
India needs Euro to acquire a Co. in France. German Investor will raise Euro funds at low rates
and Reliance India will raise Rupee loans at low rates from India. Two parties will Swap Loans
with Bank as financial intermediary.
Principal Only Swap allows the borrower to pay interest in USD. But payment of
Principal is made in home currency. As such risk fluctuations in respect of Principal are
eliminated.
Coupon Only Swap allows the borrower to pay interest in INR. Whereas Principal
amount is hedged by using some other derivative.
P+I Swap is there when borrower eliminates Currency risks as well as Interest Risk. The
risk is zero. Borrower will pay Principal + Interest in Domestic currency to settle Foreign
Currency borrowings. The swap cost is included in rupee interest rates.
RBI Guidelines on Risk Exposure
1. Banks and Counter parties will sign agreement known as ISDA (International Swap
Derivative Association) Master Agreement which is standardized by SDA (Swap
Derivative Association). The agreement is cleared by FIMMDA (Fixed Income Money
Market and Derivatives Association) and FEDAI.
2. RBI allowed MIFOR (combination of LIBOR and Forward Premium) for Inter-bank
dealings only.
3. RBI permitted banks under ISDA agreement to opt for dual jurisdiction.
4. Ceiling for Forward Contract for Designated Importers and Exporters is 100% of
previous year s exports or average of 3 years exports (whichever is higher). The ceiling
is 50% for other Importers and Exporters.
5. Fema allows AD-Categori-I banks to become clearing and trading members of exchange
traded currency option market of recognized stock exchanges, which fulfill the following
prudential requirements:
Minimum Networth-----500 crore; Minimum CRAR -------10%
NPA level maximum---3% Net profits during last 3 years.
6. FBIL (Financial Benchmark India Pvt. Ltd.)---This is independent body set up by
FIMMDA and FEDAI. It provides benchmark rates of the following on daily basis except
on Saturday/Sunday and Public hilodays:
MIBOR for 14 days, 1 month & 3 months ; FC Rupee OptionsVolatilities of 5 tenures
Certificate of Deposits (FBIL-CD); Treasury Bills (FBIL-Tbill)
The rate is announced at 10:45 AM.
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 Treasury and ALM
ALM refers to risk management to avoid mismanagement between Assets and Liabilities. The
risk of Liquidity and Interest rates, if not controlled may result into negative spread and can
cause loss to bank. Therefore ALM manages two risks : 1. Liquidity Risk & 2. Interest Rate Risk.
Liquidity Risk and Interest Rate Risk
We borrow from Money market and invest in 5 year G-securities. If Bond prices come down, we
are not willing to sell the bond, but loan has to be repaid. This may lead to shortage of funds
which is called Liquidity Risk.
Liquidity Risk is translated into Interest Rate Risk when funds have to be arranged at higher
rate. Mismatch between Assets and Liabilities also lead to Interest Rate Risk.
Role of ALM to mitigate Liquidity Risk
Liquidity Gap arises when there is difference between souses and uses of funds. RBI has
prescribed Time bands to measure Liquidity Gaps. These are 10 maturity buckets:
Next Day, 2-7 days, 8-14 days, 15-28 days, 29-90 days, 91-180 days, 181 365 days
1-3 years, 3-5 years, Above 5 years.
(Major portion (around 85%) of SB and CA Balances are kept in 1-3 year bucket for
purpose of maturity profile)
ALM measures the gap between Uses and Sources between above said Time bands.
RBI has also prescribed limits of maximum negative mismatch as under:
Next Day -------5%
2-7 Days------10%
8-14 Days -15%
15-28 Days--20%
ALM takes steps to meet shortfall as a contingent measure at a reasonable rate.
Interest rate Gap leads to erosion of NII (Net Interest Income) due to difference between
earnings and payments.
ALM has the following role to play:
Treasury establishes a link between Core banking and market operations to manage
risks.
Treasury earns profits by managing funds out of mismatches.
Treasury hedges residual risk in Forex market.
Treasury monitors exchange rates and interest rate movements in the market.
Use of Derivatives in ALM
Derivatives are used to hedge high value individual transactions.
For Example: Medium Term Loan of 3 Years is funded by Deposit of 3M because 3M deposit is
cheaper and NII is increased.
108
Bank may swap 3M interest rate into fixed rate into Fixed rate for 3 years. Bank may
also swap Fixed interest rate on loan into floating rate linked to T-bill rate. If 3M deposit
rate is T+1% and 3Year interest rate on loan is T+3%, there will be NII@2%.
Bank may arbitrage Forex. It can buy USD funds at cheaper rate (say 3%) and invest in
rupee loan at 6.5%. The spread can be 3.5%
Risks of Derivatives: Derivatives are not free from risks. Two risks involved in Derivatives are:
1. Residual risk i.e. basis risk.
2. Embedded Option Risk :There are embedded options in certain bank products. E.g. FD
is paid premature or TL is pre-paid. It affects the ALM policy if pre-mature payments are
large.
Treasury and Credit Risk
There are chances of failure on the part of counter party to meet its obligations especially when
Treasury deals in:
1. Debt Market products such as CPs, Bonds, Debentures etc.
2. Securitization of Credit Receivables when credit receivables are converted into Units
or Bonds which are called PTCs ( Pass-through certificate).
3. SPV Special Purpose Vehicle enables the banks to securitize the Mortgage loans
Credit Derivatives
1. Credit Default Swaps
2. Total Returns Swap
3. Credit Linked Notes
Transfer Pricing
It is important function of ALM. It relates to:
Fixing cost of recourses and return on Assets.
ALM notionally buys and sells deposits and loans of the bank.
Price is paid for buying deposits and price is received for selling loans. This is called
Transfer Pricing.
The prices vary according to the tenure or maturity of deposits and loans.
Deposits are bought by Treasury at a rate arrived at by adjusting hedging cost from rate
of deposit. If bank accepts deposits%7% and cost of hedging is 1%, the deposits will be
bought by Treasury @6%.
Loans are sold to Treasury at transfer cost. For example, 10% loan may be notionally
sold to Treasury @7%. The balance is denoted as Risk premium.
Treasury Division, after implementing the Transfer Pricing takes care of Liquidity Risk
and Interest rate risk.
Run on the bank: When customers lose confidence in the bank
Liquefiable securities: Securities that are readily sold for cash in secondary market.
Sensitivity Ratio: Ratio of Rate sensitive assets to Rate sensitive laibilities.
Risk Appetite: Capacity and Willingness to absorb losses of market risk
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MODULE D

Balance Sheet Management

intel

2020
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 Contingent Liabilities: Schedule 12 These are such type of liabilities which may or may not
arise in future. This figure does not form part of Total of Balance sheet but shown as footnote.
All Banks are governed by Indian Companies Act, 1956 as well as Banking Companies Act, These are also called Off Balance Sheet Items. Such items are as under:
1949. The Banks include Nationalized Banks, SBI and its subsidiaries, Foreign Banks,
Cooperative banks, RRBs and Private Sector Banks. 1. LC & LG as well as co-acceptance of bills.
2. Claims against banks not acknowledged as Debts.
Section 5 of Banking Regulation Act stipulates that Banking is accepting of deposits of money 3. Liability for partly paid up Investments.
from public for the purpose of lending or investment. The deposits are repayable on demand or 4. Outstanding Forward exchange contracts.
otherwise by cheque, draft or otherwise. 5. Bills Rediscounted.

3rd Schedule : For

Other Important provisions of Banking Regulation Act Profit and Loss Account of _____Bank for the year _________

Section 8 prohibits the banks to engage in trading activities. Incomes Schedule Amount
Interest earned: It includes interest on Term 13
Section 9 restricts the banks to hold Immovable property beyond a period of 7 years
Loans, Cash Credit, Demand Loan, OD and
except for own use. Rebate on Bills Purchased and Discounted
Section 29 stipulates that Balance Sheet of a Banking Company will be prepared on It also includes Income from Investments
Other Income : It includes Commission, 14
Brokerage, Profit on sale or revaluation of assets
Section 30 states that Balance sheet must be audited by qualified auditors. and Misc. Income
Expenditure
Section 31 & 32 3 copies of Balance Sheet & PL account will be submitted to RBI
Interest Expanded 15
within 3 months from end of the period. This period can be extended by another 3
Operating Expenses 16
months by RBI. Provisions and Contingencies --
Profit or Loss for the year
period of 6 months. Appropriations
Sec 17 states that at-least 20% of profits will be transferred to Statutory Reserve by all Transfer to Statutory Reserves (
the banks. Presently this limit has been raised to 25% by RBI. Transfer to Other Reserves
Transfer to other Reserves
3rd Proposed Dividend
Balance carried forward to Balance sheet
Balance Sheet of _____Bank as on _________ Total

Capital and Liabilities Schedule Amount Statutory Reserve requirement is minimum 20% of Profits. However RBI has
Capital 1 prescribed that banks will maintain 25% of Profits as Reserve.
Reserves and Surplus 2 (Sec 17 of Banking Regulation Act, 1949)
Deposits 3
Borrowings 4 Schedule 17 Additional Disclosure
Other Liabilities and Provisions 5 Following additional disclosures are required as foot-note in the Balance sheet:
Assets 1. Non-performing Assets
2. Movement of provisions held towards NPA
Cash and Balance with RBI 6
3. Movement of provisions held towards depreciation on Investments.
Balances with Banks and Money at call 7 4. Asset Classification Standard Assets, Sub-standard Assets, Doubtful Assets & Loss Assets.
and shot Notices 5. Income Recognition and Provisioning
Investments 8 6. Investments SLR and Non- SLR. Further these are to be classified in 3 categories; Held Till
Advances 9 Maturity, Held for Trading and Available for Sale.
Fixed Assets 10 7. Provision for Depreciation
Other Assets 11 8. Repo and Reverse Repo transactions.
9. CDR Restructuring
Total

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 10. Profit per Employee It is calculated as under:
11. Maturity pattern and ALM (Asset Liability Management) NIM = NII (Net Interest Income)
12. AS-17 Segment Reporting
13. AS-18 Related Party Disclosure Average Total Assets
14. AS-21 Consolidated Financial Statements 3. Economic Equity Ratio
It is comparison of Sh
It is calculated as under:
ALM (Asset Liability Management

ALM refers to risk management to avoid mismanagement between Assets and Liabilities. The risk of
Liquidity and Interest rates, if not controlled may result into negative spread and can cause loss to bank. Total Assets
Therefore ALM manages two risks : 1. Liquidity Risk & 2. Interest Rate Risk.
Practical Example
Liquidity Risk and Interest Rate Risk
We borrow from Money market and invest in 5 year G-securities. If Bond prices come down, we Expenses Incomes
are not willing to sell the bond, but loan has to be repaid. This may lead to shortage of funds Interest Paid 10 Interest Earned 170
which is called Liquidity Risk. Establishment expenses 35 Other Income - operational 110
Provisions 75
Liquidity Risk is translated into Interest Rate Risk when funds have to be arranged at higher Operating Expenses 120
rate. Mismatch between Assets and Liabilities also lead to Interest Rate Risk. Gross Profit 40

Significance of ALM Total 280 Total 280

Total Liabilities are 2000 crore out of which Capital is 400 crore
Market is Volatile. The rate fluctuations affect the NII and ultimate profits
are affected. Find NII (Net Interest Income), NIM and Economic Equity Ratio

Rapid innovations of products are taking place. Most products affect risk NII= 170-10 = 160
profile of the bank.
NIM = NII/ Total Assets = 160/2000= 8%
Regulatory Environment also expects from banks compliance of Basel
Economic
norms which cannot be undertaken without ALM.
= 400/2000= 20%
Management also recognises ALM mechanism as innovative job.
Find out Capital Charge on Operational Risk and Risk Weighted Assets for Operational
Risk.
Objectives of ALM
Capital Charge on Operational risk is 15% of average gross positive income of previous 3 years.
Objectives of ALM are two fold In the instant case, only 1 year study is given.

1. Profitability through Price matching Therefore Capital charge for Op risk = 15% of 280 = 42 crores
2. Ensuring Liquidity through maturity matching.
RWAs for Operational Risk = 42*100/9 = 467 crores
ALM techniques are so designed to manage various risks and the parameters are:

1. NII Net Interest Income

The impact of volatility on short term profit is measured by NII.
NII = Interest Income Interest Expenditure
2. NIM Net Interest Margin
It is comparison of NII with Average Total Assets

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 Asset Classification Non- Financial reasons for account becoming NPA
1. Stock Statement not received for 3 Months.
(The outstanding in the account based on drawing power calculated from stock
One of the important recommendations of Narsimham Committee was to adopt International
statements older than three months, would be deemed as irregular. A working capital
Accounting Practices and Accounting Standards with an objective of bringing transparency in
borrowal account will become NPA if such irregular drawings are permitted in the
the Balance Sheet.
account for a continuous period of 90 days)
2. Limit is overdue for renewal for 6 M.
The major source of Income in the banks is in the from Interest on loans, which is booked
initially and recovered later on i.e. on Accrual basis. If the same is not recovered within
Up-gradation of NPA into Standard Category
reasonable time, the Income should not be recognized as per International Standards.
The account is upgraded on same day when the recovery is made.
Narsimham Committee suggested as under:
Implications of Accounts after becoming NPA
1. Interest is not charged and not credited to Income head.
1. Classification of assets into 4 categories:
2. Interest accrued and credited to Income account but not recovered during corresponding
Standard Assets: The loan account which is not NPA.
previous year will be reversed.
Sub-standard Assets: The loan account which is classified as NPA.
3.
Doubtful assets: The loan account which remains NPA for >1year Asset Classification Borrower wise and not Facility wise
Loss Assets: The loan account in which security is not available. It means if one account of the borrower is classified as NPA, other accounts will also be
How and when the account becomes NPA? treated as NPAs even if these are regular.
Advances under Consortium
Type of Account Period Each bank will take view of transferring account to NPA category on the basis of its own
TL becomes NPA if Interest/Principal remains Overdue More than 90 days recovery.
CC/OD becomes NPA if it remains out of order More than 90 days
The account is treated as out of order: if Takeout Finance: Account is treated as NPA from actual date of it becoming NPA and not from
Outstanding balance is continuously above DP date of taken over.
There are no credits in the account for >90 days Advances under rehabilitation approved by BIFR / TLI: Banks canot upgrade these
Credit is not enough to cover interest during same period accounts for a period of one year. They will continue to be classified as sub-standard/doubtful
Bill becomes NPA if it remains Overdue for More than 90 days as the case may be.
Agriculture Loan account becomes NPA if overdue After 2 crop seasons
In case of Long duration crops After 1 crop season
PROVISIONING NORMS
KCC Account will be treated as NPA if it is out of order:. A KCC account will be treated as out
of order in the following circumstances:
In terms of Monetary policy 2011-12, the revised norms of provisioning are as under:
There are no credits in the account continuously for two crop seasons/one crop season Standard Assets
(as the case may be) as on the date of balance sheet.
The outstanding remains continuously in excess of the limit for two crop seasons/one Classification Rate of provision
crop season (as the case may be) as on the date of balance sheet. Direct SME and Direct Agriculture & 0.25%
The credits in the account are not sufficient even to cover the interest debited in respect Housing Loans
of the account for two crop seasons/one crop season (as the case may be). General including DCCO revised up to 2 0.40%
years
Asset Classification Commercial Real Estate (RH) 0.75%
Loan Account remains in Sub-standard category for 1 year Commercial Real Estate 1%
Loan becomes Doubtful after remaining 1 year in D1 category for 1 year Teaser Housing Loans 2%
Substandard category). D2 category for next 2 years Restructured accounts classified as 5%
(The account is transferred to Doubtful category directly if D3 category beyond 3 years after standard advances:
security loss is 50% or above) it became doubtful
Loan becomes Loss Asset If Loss of security is either 100%
or 90% or more.

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Non-Performing Assets
Sub-standard Advances:
Secured Exposures
Unsecured Exposures (abnitio unsecured)
Unsecured Exposures in respect
Infrastructure loan accounts
Doubtful Advances Unsecured Portion
Doubtful Advances- Secured Portion
For Doubtful up to 1 year
For Doubtful>1 year and up to 3 years
For Doubtful >3 years
Loss Assets : These are identified by auditors 100%
where security is eroded up to 90%
Some Important Equations:
1. Net NPAs = Gross NPAs (Provision +DICGC/ECGC cover).
2. Provisioning Coverage Ratio = NPA Provision X 100
Gross NPAs
3. Provisioning Coverage Ratio should not be less than 70% of Gross NPAs as per bank
15% guidelines.
25% 4. Amount of ECGC/DICGC guarantee cover must be excluded while calculating provision
of 20% in respect of Doubtful assets. But in case of Sub-standard assets, this cover need not to
be deducted.
5. In case of Doubtful Assets, Secured portion and Un-secured portion (Security reduced
100% subsequently) will be segregated and provision will be calculated accordingly.
6. Advances against NSCs/KVPs/FDs/LIC Policies need not to be classified as NPAs
provided adequate margin is available. However, advances against Gold and Govt.
Securities are not covered under the exemption.
GOVT. GUARANTED ACCOUNTS
25% STATE GOVT: It will be declared NPA as in other loan cases.
40% CENTRAL GOVT: Continued to be Standard Assets till repudiation of guarantee by the
100% Central Govt. However interest would not be taken into income unless actually received
Exposure in Weak Accounts
All irregular/weak accounts shall henceforth be classified as Special Mention Assets
(SMA) with sub-categories as under;

CRILIC (Central Repository of Information on Large Credit): Banks have report credit Sub-Category Basis for Classification
information including classification of accounts as SMA on all their borrowings having aggregate SMA-0 Principal or interest overdue up to 30 days
fund-based exposure of 5 crore (50 million) and above. For non-reporting to CRILIC, bank is SMA-1 Principal or interest overdue between 31-60 days
subjected to enhanced provisioning norms as under: SMA-2 Principal or interest overdue between 61 days to 90
days
Secured SS up to 6M--------------15%, 6-12 M------------25%
Practical Examples
Unsecured SS up to 6M----------25%, 6-12 M-----------40% Ex. 1
Account with Outstanding of Rs. 10.00 lac became Out of order on 22.1.11 and it became NPA
Secured DB -1-----------------------40% DB2 & DB3---------------100% on 22.4.2011. The Value of Security at later stage is Rs. 7.00 lac. Calculate Provision as on
31.3.12.
(Non- cooperative borrowers are those who make default, do not provide information and obstruct Solution
sale of securities. Qtly reporting has to be made by banks within 21 days of close of quarter) It is a Sub-Standard Asset as on 31.3.2012.
Provision is 1000000*15/100 = 150000/-
Fraud Cases: Enrite amount has to be provided for irrespective of security.
Ex. 2
Legal Entity Identifier A loan account with outstanding of Rs. 10.00 lac and Value of Security Rs. 6.00 lac was Sub-
standard as on 30.3.2008. What will be provision as on 31.3.2012?
1. RBI has made mandatory for Corporate borrowers having aggregate exposure of 5.00 Solution
crore and above to obtain LEI (Legal Entity Identifier registration and capture the The account will be Doubtful (DI) on 30.3.2009, D2 on 30.9.2010, D3 on 30.3.2012. Provision
will as under:
same in CRILIC. Secured portion = 6.00*100/100 = 6.00 lac
Un-secured portion = 4.00*100/100 = 4.00 lac
Total Provision = 6+4 = 10.00 lac.

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Ex. 3 Ex. 7 Account becomes doubtful on 12th Feb 2008. The Balance is Rs. 6 lac. Value of security is
A loan became Doubtful on 12.2.2009. The outstanding is 6.00 lac. What will be provision on 3 lac. What will be the provision on 31.3.2011?
31.3.2012. Solution
Solution It is D3 Type of account.
The Account will be categorized as Doubtful (D3) as on 12.2.2012. Provision is 100% of 6.00 lac Therefore, provision will be 100% i.e. 6 lac = 6.00 lac Ans.
= 6.00 lac
Ex. 8 NPA o/s : Rs. 10 lac including suspended interest/Derecognized interest Rs. 2 lac.
Security value is Rs. 6 lac. It became NPA on 25th Feb 2008. What would be the provision on
Ex. 4 31.3.2011.
D2 category account has outstanding--10.00 lac, DI/SI ----2.00 lac, Value of security ---6.00 lac It is D2 category account
Solution 4.40 LAC (10-2-6= 2x100%= 2 lac + 40% on 6 lac i.e. 2.40 lac = 4.40 lac) D2
Un- Secured portion = 10-2-6 = 2.00 lac Provision = 2.00 * 100/100 = 2.00 lac
Secured portion = 6.00 * 40/100 = 2.40 lac Ex. 9 A/c became NPA on 2nd January 2008. Balance o/s is 10 lac including Derecognized
Total provision = 2.00 + 2.40 = 4.40 lac interest Rs. 2 lac and ECGC cover of 50%. Value of security is 4 lac. What will be provision on
31.3.2009.
Ex. 5
D2 Category loan is having outstanding 4.00 lac, Value of Security 1.50 lac and ECGC cover It is D1 category account.
50%. Calculate provision as on 31.3.2012. 10 lac 2 lac, DI 4 lac Sec. = 4 lac
Solution ECGC Cover: 4 lac x 50% = 2 lac
Unsecured portion = 50% of (O/s VS) = 50% (4.00 1.50) = 1.25 lac Provision on Unsecured portion
Secured portion = 1.50 lac Unsecured: 4 lac 2 lac = 2 lac x100% = 2.00 lac
Provision on Unsecured portion = 1.25*100/100 = 1.25 lac Provision on Secured portion
Provision on Secured portion = 1.50*40/100 = 0.60 lac Secured: 4 lac x 25% = 1.00 lac
Total provision = 1.25 +0.60 = 1.85 lac. Total Provision: 2 + 1 = 3.00 lac
Ex. 6
A D2 category loan is having outstanding Rs. 6.00 lac. The Collateral Security is Rs. 3.00 lac
and Primary Security is Rs. 2.00 lac. There is also Guarantee of Rs. 10.00 lac. Calculate Strategic Debt Restructuring (SDR): It is the process of Coverting Debt into Equity in a defauting
provision. Company. Management is changed, if needed and in the meantime, suitable buyer of the company is
found. A time period of 18 months is allowed to bank for finding suitable buyers. It requires approval of
JLF (Joint Lending Forum). The decision should be approved by minimum 75% of creditors by value and
Solution
60% by number.
Unsecured portion = O/s Primary Security Collateral = 6.00 2.00 -3.00 = 1.00 lac
Secured portion = 2.00 + 3.00 = 5.00 lac. Sustainable Structuring of Stressed Assets (S4A)
Provision on Unsecured portion = 1.00 *100/100 = 1.00 lac It is process of restructuring Large ticket loans with aggregate exposure of all lenders above 500
Provision on Secured portion = 5.00*40/100 = 2.00 lac crore, where the project is up and running. The loan is divided in two parts Sustainable and
Total provision = 1.00 + 2.00 = 3.00 lac. Un-sustainable. Sustainable part should be at-least 50% or moreof the unsustainable debt
portion. Portion of loan which can be serviced through existing cashflow is called sustainable.
Ex. 7 Unsustainable portion is converted into equity.
Advance portfolio of a bank is as under:
Total advances = 40000 crore, Gross NPAs = 9%, Net NPAs = 2%
INSOLVENCY AND BANKRUPTCY CODE, 2016 (IBC)
Find out 1) Total Provision 2) Provisioning Coverage Ratio
Solution
NPAs = Total Advances *9/100 = 40000*9/100 = 3600 crore The code passed by Parliament in 2016 allows the creditors to acesss viability of a debtor as a
Standard Assets = 40000-3600 = 36400 crore business decision and agree upon a plan for its revival or speedy liquidation.
Provision on Standard Assets = 36400*0.40% = 145.60 crore
Provision on NPAs = 9% - 2% = 7% = 40000*7/100 = 2800 crore Insolvency Resolution Process (IRP) for Companies
1) Total provision = 145.60 + 2800 = 2945.60 crore Default should be atleast Rs.100000/-
Gross NPAs = 40000*9/100 = 3600 crore
IRP can be initiated by financial creditor at NCLT (National Company Law Tribunal).
Net NPAs = 40000*2/100 = 800 crore
Defaulting Debtor, its sharelders or employees can also initiate.
2) Provision Coverage Ratio = Provision on NPAs / Gross NPAs = 2800/3600 = 77%.

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 The code permits banks to push recovery from a company within 180 days with grace Liquidity Management
period of 90 days , if 75% of creditors agree. If resolution plan is rejected or Debtor fails
to meet recovery terms, Corporate Debtor is put into compulsory liquidation..
On NCLT passing order of liquidation, a moratotorium is imposed on all pending legal Banks are required to honour withdrawals from Deposits. Also the banks are supposed to
proceedings against the debtor. disburse loans in time. Liquidity is needed to meet both these requirements. In other words,
Assets of the debtor vest in the estate of liquidator. liquidity is the ability to accommodate decrease in liability as well as funding of increase in
assets.
Insolvency Resolution Process (IRP) for Individuals & Firms
Default should be atleast Rs.1000/- Functions of Liquidity Management:
There are two processes. (a) Automatic fresh start & (b) Insolvency resolution. 1. It defines market place of bank.
2. It enables banks to meet prior loan commitments.
Under automatic fresh start process, Eligible debtors can apply DRT for discharge from
3. It enables the banks to avoid unprofitable sale of assets.
certain debts not exceeding a specified threshold, allowing them to start fresh.
4. It lowers size of default risk premium.
Under Insolvency resolution process, repayment plan is prepared by debtor for approval
from creditors. If approved, DRT passes an order binding both debtor and creditors Liquidity Mismanage may lead to the following:
towards repayment plan. If plan is rejected or fails, Debtor and creditors may apply for
It declines earnings.
bankruptcy order.
It increases NPAs.
Other Important Terms of Act It results in downgrading of rating.
Bankrupt individuals would be barred from contesting elections.
Factors affecting Liquidity
Debtor can be jailed up to 5 years for concealing property or defrauding creditors.
Liquidity is affected by the following:
The entire proceedings will be supervised by Insolvency and Bankruptcy Board of India.
1. Less profits leads to less liquidity
2. Rise in NPAs means less liquidity
Money due to Employees from PPF, gratuity fund will not be included in estate of 3. Deposit concentration in Term Deposits may lead to high liquidity
company or individual. 4. More taxes means less liquidity.

Types of Liquidity Risks

Asset Classification for MSMEs
it has now been decided to temporarily allow banks and NBFCs to classify their exposure, as
per the 180 days past due criterion, to all MSMEs, including those not registered under GST, as
a standard asset, provided
The aggregate exposure does not exceed 25 crore as on 31.5.2018.
A provision of 5 % shall be made.
The additional time is being provided for the purpose of asset classification only and not
for income recognition.
1. Funding Risk: Decrease in deposits due of bad reputation or loss of confidence.
2. Time Risk: Instalments of loan are not forthcoming in time.
3. Call Risk: Non-fund based credit facilities converted into Fund based. Crystallization of
Contingent liabilities like LC/LG turning into Fund Based Loans.
4. Embedded Risk: Adverse movement of Interest Rate may result into pre-payment of
CC/DL and TL. It may also result into pre-mature withdrawal of TDs/RDs. This will also
result into reduced NII. This is called Embedded Risk.
How to manage Liquidity Risk?
1. Developing an organizational structure.
2. Setting of Tolerance level limits.
Limit of cash flow mismatches for tomorrow, next week, next month or next year.
Limit of Loan to Deposit Ratio
Limit of Loan to Capital ratio.

Measurement of Liquidity Risks: Liquidity Risk can be measured in any of the two ways:
1. Stock Approach
2. Flow Approach

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Stock Approach
Following ratios are calculated to measure Liquidity Gap:
Interest Rate Risk Management
Better it is from Liquidity Point of view
Ratio of Core Deposits to Total Assets More the ratio, better it is There is complete deregulation of Interest rates on Fixed Deposits, Recurring Deposits, and SB
Net Loans to Total Deposits Lower ratio is better Deposits above Rs. 1.00 lac. Banks are also free to determine Interest rates on NRE Deposit
Time deposits to Total Deposits Higher ratio is better accounts. This has led to interest rate Volatility resulting into greater Interest Rate Risk.
Volatile Liabilities to Total Assets (Market Lower ratio is better
borrowings are volatile liabilities Adverse movement of Interest rates has direct impact on NII as well as NIM. Market Interest
Short Term Liabilities to Liquid Assets Lower ratio is better. rate also has impact on Present Value of Bonds and Securities. 1% rise in market rate of return
will cause lesser valuation of securities. Also 1% fall in interest rate will cause higher valuation
Liquid Assets to Total Assets Higher ratio is better.
of securities resulting into increase in Mark to Market Price.
Short Term Liabilities to Total assets Lower is desirable
Prime Assets to Total Assets (Prime assets Higher is better
Types of Interest Rate Risk
are Cash, Balance with banks etc.
Following are various types of Interest Rate Risk:
Market Liabilities to Total assets (Market Lower is better
liabilities are Money Market borrowings, Repo 1. Mismatch or Gap Risk
and Inter-bank liabilities This is risk of gap between maturities of Assets and Liabilities. Sometimes, Long term
loans are funded by short term deposits. After maturity of deposits, these liabilities are
Flow Approach: It has 3 major dimensions: get re-priced and Gap of Interest rates between Assets and Liabilities may become
1. Measuring and managing net funding requirements through narrowed thereby leading to reduction of profits.
Maturity ladder 2. Basis Risk
General Market conditions Change of Interest rates on Assets and Liabilities may change in different magnitudes
Bank specific crisis. thus creating variation in Net Interest Income. It tries to explain what will be the %age
General Market crisis. effect on Earnings due to increase or decrease in interest rates by 1bps.
2. Measuring Liquidity over chosen time frames. 3. Net Interest Position Risk
3. Contingency Planning If the bank has more assets than the liabilities, 1% decrease in interest rate will result
into less earnings and more expenditure on account of interest. This will directly affect
RBI guidelines for maturity Buckets: NII and NIM.
All Assets and Liabilities are classified into 10 maturity buckets: 4. Embedded Option Risk
1. Tomorrow Adverse movement of Interest Rate may result into pre-payment of CC/DL and TL. It
2. 2-7 Days may also result into pre-mature withdrawal of TDs/RDs. This will also result into reduced
3. 8-14 Days NII. This is called Embedded Risk.
4. 15-28 Days 5. Yield Curve Risk
5. 29 Days to 3M Yield is Internal Rate of Return on Securities. Higher Interest Rate scenario will reduce
6. 3M to 6M Yield and thereby reduction in the value of assets. Adverse movement of yield will
7. 6m to 1 Year
certainly affect NII (Net Interest Income).
8. 1-3 Years
9. 3-5 Years 6. Price Risk
10. Over 5 years In financial market, when assets are sold before maturity in order to meet liquidity
requirements, loss may occur due to lower selling price.
. 7. Re-investment Risk
It is uncertainty with regard to interest rate at which future cash flows could be re-
invested.

Effects of Interest Rate Risk

Effect on Earnings.
Effect on Economic value of share
Embedded Losses

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Important Points
3. Duration Approach
Interest rate Risk is a type of Market Risk Duration is the time that a bond holder must wait till nos. of years (Duration) to receive
A bank holds a security that is rated A+. The rating of the security migrates to A. What is Present Value of the bond.
the risk that bank will face: Credit Risk
Lower is the rating of the company, higher will be the interest rate on its Bonds. Bond E.g. 5 year bond with Face Value of Rs. 100 @ 6% having McCauley Duration 3.7
with BBB rating will carry higher interest rate than one with AA rating.
years. It means Total Cash Flow of Rs. 130 to be received in 5 years would be
discounted with Present Value which will be equivalent as amount received in 3.7 years.
Measurement of Interest Rate Risk The Duration of the Bond is 3.7 Years.
1. Re-pricing Schedules
All Assets and Liabilities are assigned to Re-pricing time bands according to past Formula of Calculation of McCauley Duration =
judgment and experience of the banks. The schedule distributes Interest Sensitive
Assets, Liabilities and Off Balance Sheet Items into certain number of pre-defined time Modified Duration = Duration
bands.
1+Yield
Under this method, steps are as under:
Ist step---------Adjusted Gap is calculated by netting Interest bearing assets and interest Approximate % change in price = Modified Duration X Change in Yield
bearing liabilities.
2nd step---------Re pricing of assets is done as per the following example
3rd step---------Standard Gap is calculated after deducting Re pricing liabilities from Re 4. Simulation Approach: It involves detailed assessment of potential effects of changes in
pricing Assets. interest rates on earnings and economic value by simulating the future path of interest
rates and their impact on cash flows.
How it is calculated?
A bank has following Assets and Liabilities: Simulation techniques could be
Call Money --------500 crore Static simulation on the basis of existing Assets and Liabilities
Cash Credit -----400 crore Dynamic simulation Detailed assumption about future structure of interest
Cash in hand ---100 crore rate regime.
SB Deposits-------500 crore
Fixed Deposits----500 crore
Current Deposits-200 crore Measures to Control Interest Rate Risk

There is reduction in interest rates by 0.5% in call money, 1% in CC, 0.1% for SB and 1. Reduce Asset Sensitivity
0.8% for FD Extend Investment portfolio maturity, Increase of Floating rate Deposits, Increase of
Fixed Rate lending, and Increase of short term borrowings and Long term Lending.
Calculate Adjusted Gap
Adjusted Gap = (Call Money +CC) (SB+FD) = 900 - 1000 = 100 crore Negative 2. Reduce Liability Sensitivity
Calculate Re pricing Assets
Reduction of Investment portfolio maturity, Increase of Floating rate lending, Increase of
Re pricing Assets = (500*.5) + (400*1) = 250+400=650 crore
Calculate Re pricing Liabilities Long term Deposits and Short term Lending.
Re pricing Liabilities = (500*.1) + (500*.8) = 50+400 = 450 crore
Calculate Standard Gap 3. Control and Supervision
Standard Gap = Re Pricing Assets Re Pricing Liabilities Board and Senior Management of Oversight Interest Rate Risk.
= 650 450 = 200 crore positive Board of Directors must have proper control over Interest rate regime.
2. Gap Analysis Senior Management should be responsible for implementing policy.
Gap is Difference between RSA (Risk Sensitive Assets) and RSL (Risk Sensitive Lines of Authority and Responsibility must be clearly defined.
Liabilities)

If RSA > RSL , it is called Positive Gap or Asset Sensitive Gap.

If RSA < RSL, it is called Negative Gap or Liability Sensitive Gap.

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Practical Example: RAROC (Risk Adjusted Return on Capital)
ABC Bank has following Assets and Liabilities:
SB Deposits 300 crore Cash in Hand------------ 200 crore Profit Planning involves Balance Sheet Management. Higher risk will fetch more profits whereas
lower risk is the cause of lesser profits.
FD Deposits 300 crore Call Money -------------- 300 crore
Risk and Risk is possible unfavorable impact on net cash flow in future due to
CA Deposits 250 crore CC & TL------------------ 240 crore Capital uncertainty of happening or non-happening of events. Capital is a
cushion or shock observer required to absorb potential losses in future.
RSA (Rate Sensitive Assets) = 300+240 = 540 crore Higher the Risks, high will be the requirement of Capital and there will
RSL (Rate Sensitive Liabilities = 300+300 = 600 crore
be rise in RAROC (Risk Adjusted Return on Capital).
Adjusted Gap = RSA-RSL = 540-600 = (60) --------Negative
Suppose Interest rate falls 2% on all assets and liabilities. Liabilities are in excess. Bank
will have to pay less thereby improvement in NII by (60*2/100) i.e. 1.20 Crore
Now, if Interest Rate rises by 2%, bank will have to pay more. Since Negative gap is 60

1. Interest from Loans as well as from Investments

2. Fee Based Income
3. Treasury Income
MODIFIED DURATION GAP (DGAP): Under this section, we have to calculate two things as
under:

1. DGAP = Modified DA W x Modified DL 1. Interest on Demand and Time Deposits

2. Modified Duration of Equity = DGAP x Leverage 2. Staff Expenses
3. Other Operating Expenses
To calculate above, the following values are given in question:
Motive of the bank is to Expand Income and Reduce Expenditure so that Profit can be
Modified DA = Weighted duration of assets (given) maximized. But, in order to Expand Income, more risks have be incurred which requires higher
Capital.
Modified DL = Weighted duration of liabilities (given)
W = RSL / RSA Example:
Leverage = RSA/Equity
Bank has Rs. 1000 crore for Investment in Securities which can be invested under any of the
Practical example following alternative using Basel Norms:
Given in Question : Net Worth = 1500 Cr., T1+T2 Capital = 3500 Cr., RSA = 22500 Cr. Yield Risk Situation 1 Situation 2 Situation 3 Situation 4
RSL = 21000 Cr, Modified DA = 1.80, Modified DL = 1.10 Weight
G-sec 6% 0% 1000 400 300 300
W = RSL/RSA = 21000/22500 = .933 AAA Rated 8% 20% 0 600 300 300
DGAP = Modified DA W*Modified DL = 1.80 - .933*1.10 = 0.77 AA Rated 10% 50% 0 0 400 200
Leverage Ratio = RSA / (Tier 1 + Tier 2) = 22500 / 3500 = 6.428 A Rated 12% 100% 0 0 0 200
Modified duration of Equity = DGAP x Leverage ratio = 0.77*6.428 = 4.949 (Say 4.5) Total 1000 1000 1000 1000
Yield 60 24+48 18+24+40 18+24+20+24
=72 82 =86
%age Yield 6% 7.2% 8.2% 8.6%
RWAs 0 120 60+200 60+100+200
=120 =260 =360
8% Capital 9.60 20.80 28.80
Requirement
as per basel

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 CASE STUDIES 3rd and 4th Module
a given level of Capital.
-interest income can be increased by popularizing 3rd party products and
widening scope of Treasury. Case Study 1 Interest Rate Risk Management

ABC Bank has following assets and liabilities:

Low Cost Deposits must be increased to enhance Profits. Liabilities
Current Deposits-----------500 Crore Cash In Hand----------------------300 crore
SB Deposits-----------------1000 Crore Call Money------------------------- 400 crore
Risk Aggregation and Capital Allocation Term Deposits--------------3000 crore Cash Credit------------------------4000 crore
There is change in interest rates as under:
Through RAROC approach, each Risk is measured to determine both expected and SB----Increase from 3.5% to 4%
Unexpected losses using VaR (Value at Risk). FD---Increase from 7.5% to 8.5%
Call Money------------5 % to 6%
Expected Losses are covered by Reserves and provisions. CC ----------------------12% to 12.5%
Unexpected losses require capital allocation determined on the Principal of Confidence Calculate Adjusted Gap
level, Time horizon, Diversification and Correlation Rate Sensitive Assets Rate Sensitive Liabilities
= 4400-4000 = 400 crore (Positive)
Calculate Re-pricing Liabilities after interest change
SB+FD = (1000*.5) + (3000*1)
How to Calculate RC (Risk Capital) & RAMP (Risk Adjusted Performance Measures? = 500 + 3000 = 3500 crore
Calculate Re-pricing Assets after Interest change.
RC (Risk Capital) = Business Volume * Volatility * Probability Call Money + Cash Credit
=400*1 +4000*.5 = 400+2000= 2400 Crore
RAPM = Profit
Calculate Standard Gap
RC
Standard Gap = Re pricing Assets Re pricing Liabilities
=2400 3500 = 1100 crore (Negative)
Example:
There are two traders One is Forex Trader and the other is Bond Trader. Each is having profit
of 10 Million USD last year. The performance of each can be compared as under:
Case Study 2 ALM (Asset Liability Management)
Deals in amount Volatility Probability Table RC (Risk Capital)
As per RBI guidelines, Buckets are to be classified as under:
at 99% volatility
Capital and Reserves Over 5 year Bucket
Forex Trader $100 Million 12% p.a. 2.33 28 Million
SB Deposits (10% Volatile) & CA (15% Volatile) 1-14 days Bucket
Bond Trader $200 Million 4% p.a. 2.33 18.6 Million
SB & CA Deposits (Core portion) 1-3 year Bucket
Term Deposits Respective Maturity
Forex Trader
RC (Risk Capital) = 100,000,000 x 0.12 x2.33 = 28 Million USD
RAPM = 10/28 = 0.35 A bank has following liabilities:
Capital 4000 crore Reserves 12000 crores
Bond Trader CA 1000 crore SB 4000 crores
RC (Risk Capital) = 200,000,000 x 0.04 x2.33 = 18.6 Million USD FD (1 M) 400 crores FD (1-3 M) 800
RAPM = 10/18.6 = 0.53 FD (3-6 M) 1200 FD (6-12 M) 2000
FD (1-3 years) 1200 FD (3-5 years) 600
Bond Trader has less Risk Capital and Higher Risk Adjusted Performance. Therefore Bond FD (Above 5 years) 800 Borrowings from RBI 40
Trader is performing better. Amount in Less than 14 days bucket
CA = 1000*15% = 150 crore
SB = 4000*10% = 400 crore
Amount in 1-3 year Bucket

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 CA = 1000*85%= 850 crore Items not to be included while calculating CRR = 4400+8600+5200+600=18800
SB=4000*90%=3600 crore Amount of NDTL for calculation of CRAR = 252000-18800 = 233200
FD = 1200 crore CRR = 233200*4/100 = 9328/-
Total=850+3600+1200=5650 crore Minimum balance to be kept on each day (90%) = 9328*90/100 = 8395.20 crore
SLR = 233200*20.5/100 = 47806 crore

Case Study 3 CRR and SLR

How to Calculate Cost of Deposit and Rate of Interest on Advances
Q. A bank having Deposits of Rs. 100/- has to keep CRR @4% and SLR %21%. If average rate
on Deposit (Cost of Deposit ) is 7%.
Calculation of CRR and NDTL What should be the interest rate on loans so that bank may break even ?
Solution:
CRR is calculated @4% of NDTL. It is calculated on the basis of fortnightly average. Minimum Breakeven means = Cost of Deposit = Return on Loans
90% has to be kept on each day. The amount is deposited with RBI and no interest is paid by Total Funds available in bank -----------------100
RBI on this balance. Please see the Liability Less Deposits without income (4+21)---------25
Capital and Liabilities Funds available for lending--------------------- 75
Capital
Reserves and Surplus Cost of Deposits of Rs. 100 = 7
Refinance from NABARD,SIDBI, RBI
Deposits with other banks Now if Investable funds are Rs 75, earning is Rs. 7
Claims from DICGC, ECGC If Investable funds are Rs. 100, earning is ---------7/75*100 = 9.33 %
Demand Deposits (SB and CA)
Time Deposits (FD and RD) It means if funds are deployed @9.33%, only then we cover the cost of funds i.e Break even
Borrowings (Domestic and Foreign) point.
Other Liabilities and Provisions
What is not to be included while calculating CRR?
1. Capital Q. 2 : If rate of interest on loans is 12%, what will be the profit.
2. Reserves
3. Refinance from NABARD, SIDBI, NHB or RBI Yield on Advances = 75*12% = 9.00
4. Deposits with other banks (Maturity 15 days and above) Cost of funds = 7.00
5. Excess provisions for Income tax Profit = 2.00
6. Claims received from DICGC, ECGS, CGTMSE
All other items are included while calculating NDTL.
Example: Case Study 4 Earnings Per share (EPS)
Amount in crores
Capital 4400
Reserves 8600 It is ratio of PAT(Net Profit After tax) and Nos. of Equity Shares
CA Deposits 26000 It is calculated as under:
SB Deposits 82000
EPS = PAT (Profit after Depreciation, Interest and Tax)
Term Deposits (Banks) 5200
Nos. of Equity Shares
Term Deposits (others) 123200
NABARD Refinance 600 1. A company earns PBT (Profit Before Tax) of Rs. 20 crores and PAT Rs. 15 crores. Paid
Bills Payable 200 up Capital of a company is Rs. 10 crore divided into 1 crore shares of Rs. 10 each.
Interest Accrued 80 Market price of share is 150. Find EPS (Earning Per Share).
Borrowings from FIs 800
Suspense Account 120 EPS = PAT/ Nos. of shares = 15 crores/ 1 crore = 15
Subordinate Debts 800
Total Liabilities 252000

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 Case Study 5 Price Earnings Ratio (PE Ratio) Case Study 8 Yield
It is comparison of Market price with Earning per share. It is the return calculated on Face value of share in comparison with Market Value.
It is calculated as under: It is calculated as under:
PE= Market price of share
Earnings Per Share Yield = Dividend (or Interest) X Face Value
1. In the above example, please find out PE Ratio: Market Value
1. 8% Govt. of India security is quoted at Rs. 120/-. Find out current Yield
PE ratio = Market Price/EPS The current yield on the security is:
= 150/15=Rs.10----------------------Ans. Coupon*Face Value/Market price = 8*100/120 = 6.7%---------------Ans.
2. A company with equity capital of Rs. 15 crore makes PBIT of Rs. 25 crore and PAT of 1. Debenture of Rs. 100 carrying 15% coupon rate is quoted in the market at 135. Find
Rs. 5 crore (face value of share is Rs. 10). If PE ratio is 5, what will be the market price Yield or say Current Yield.
of share: Current Yield = 15*100/135 = 11.11%---------------Ans.
EPS = PAT/Nos. of shares = 5 crore / 1.5 crore =5/1.5
PE ratio = Market Price / EPS Case Study 9 How to Find Market Price when Rate of return goes up or Down?
5 = MP *1.5/5
MP = 5*5/1.5 = 16.67-----------------Ans. 1. 12% GOI Security of Rs. 100 is quoted at 120. If interest rate (Yield) goes down by 1%,
Another formula is derived i.e. Market Price of Share = PE ratio X EPS Market Price of Security will be ___?
1st step : Find out Yield
Case Study 6 Book Value of Share Yield = 12*100/120 = 10%
Book Value is Tangible Net Worth of the Company divided by Nos. of Shares 2nd step : Find out Market Price if yield is 9%
It is calculated as under: Yield = Dividend*Face Value/Market Price
9 = 12*100*MP
Equity + Reserves + Profits Intangible Assets MP = 12*100/9 = 133.33-------Ans.
Nos. of Equity Shares 2. 11% GOI Security of Rs. 100 is quoted at Rs. 110. If interest rate (Yield) goes down by
Question: 1%, What will be the Market price of the security?
Equity Share Capital = 10 crore, PBIDT = 30 crore ( Interest = 5 crore, Depreciation = 5 Yield = 11*100/110 = 10%
crore & Tax = 10 crore), Reserves = 30 crore & Long Term Debt = 35 crore. MP if Yield is 9% = 11*100/9 = 122.22 ------Ans.
Company pays 50% dividend and transfers remaining profit to Reserves. Share with Face value
of Rs. 10 is quoted as Rs. 150/- in the market. Case Study 10 Yield on Zero Coupon Bonds and T-bills
Find EPS, Book Value of Share, Return on Net Worth, Debt Equity Ratio & PE ratio & Dividend Zero Coupon Bond does not carry interest but it is always issued at discount. Calculation of
Payout Ratio. discount is done as under:
Solution:
Earnings Per Share = PAT/No of shares = 30-(5+5+10) crore / 1 crore = 10/1 = Rs. 10 On 31st March 2006, 10 year Zero Coupon bond with Yield 7.5% issued. What price should be
Book Value of Share = Equity + Reserves / Nos. of shares = (10+30+5)/ 1 crore = 45 quoted on 31.3.2006?

Return on NW = PAT/NW*100 = 10/45*100 = 22.2%------------------------------Ans. Face Value = 10000 n=10 years r=7.5% i.e. 0.075
Debt Equity Ratio = Long Term Liabilities / Net Worth = 35/45 = 7.9-----------Ans. Present Value = Future Value
PE ratio = MP/EPS = 150/10 = 15 (1+r)^n = 10000/(1+.075)^10 = 4852
Dividend Payout Ratio = Dividend/PAT*100 = 5/10*1=50%
On 31.3.2006, T-bill of Rs. 100000 issued for Rs. 98000/- with maturity date 24.6.2006.
Case Study 7 Pay Out Ratio Find out Yield
Dividend Payout Ratio = Dividend/PAT*100
Dividend Yield Ratio = Dividend/Market Price*100 Yield = Face Value -Price X Nos. of days in a year
i.e. Price Period of Bond
Dividend
Market Price = 100000-98000 X 365
A company declares Rs. 2 dividend on the equity share of Face Value of Rs. 5. The share is 98000 85
quoted in the market at Rs. 80. The dividend yield will be:
2*100/80 = 2.5%.-------------Ans. = 2000/98000* 365/85 = 8.76%---------------Ans.

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 Case Study 11 Bond Value, Current Yield

Bond-1 Bond-2

Face Value 100 100

Annual Coupon 8% 10%

Term to Maturity 3 yrs 4 yrs

Market Price 80 90

Q. 1 Find Current Yield of Bond 2

Solution
Coupon amount X Face Value = 10/90*100 = 11.11%
Market Value
Q. 2 Find YTM of Bond 1 & 2
YTM of Bond 1 = 17.36%
YTM of Bond 2 = 13.41%

Q. 3 Find McCulay Duration of Bond 1

1.76 years
Q. 4
Find Modified Duration of Bond 2

Solution
McCulay duration/1+yield
=3.46/(1+13.41%) = 3.46/1.1341 = 3.05 yrs.
Q. 5 What is %age change in price of Bond 2 if YTM increases by 1%
Expected %age change in price
=Modified Duration x %age change in yield
=3.05 x 1 = -3.05% (Decrease in price of bond)

Q. 6 What is %age change in price of Bond 2 if YTM decreases by 1%

=3.05 x 1 = 3.05% (Increase in price of bond)
Q.7 As an investor, in which bond would you like to invest.
Ans.
Bond 1 (YTM is more)

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