bat 4] Poe the strike PO wise vr to zero OtBerY Ve of an zetl lo *' Ce ae ot the v4! d The expression NEC 1) babii imes al to Sp if Sr ives idends, 8 nen there are no divi ee inte trike price iste rl tio equals the rican price W! ae : od the interest rate ris set equal © f B-S formula is used, the r otf in pe oo oe is usually assumed tO be I sually measur’ normally meas! : i ina year! The number of trading days fan option is 4 so U! ing days in one year ; eee National holidays 9) for shares. The life 0! than calendar days. It is calculated as T years where days until option maturity T Number of trading days OO ———— > 252 2.3.7 Risks in National and International Banking t Objectives: The role of cross border trade in the Indian economy has been increasin: liberalisation and globalisation of the economy. The volume of foreign i increase with the growth of India’s external trade and active participation by al eines consequently, the subject of risks in international banking has assumed i : ion is to acquaint you with the basic concepts of risks in internati nal banki So dealin mre ml ore et with foreign operations and outline all je re ee eae section, a reader should be able to: spprongh toa ote Inderstand risks in banki ‘ «paisa in banking operation, Explain how risks arise in it e in internati 4 «. Undesiaad ga a pas tional banking and who faces th ou cribe various types of risks i } nderstand management of risks in internat in foreign exch F coupon risk-" ife of the o tion di rest rate for a matur; sp jivided by the number ¢ 252 days (365-104 Sundays an, ed using trading days rath. g due to the process of exchange trading in India has been on the arge number of players in the exchange ance. The purpose & scznned with OKEN ScannerJeuUeDs NINO YalM pauUeDs sO) ROLE OF COMMERCIAL BANKING Risk in Banking Risk has clways been present in the banking business, but the discussion on managing the same has gained prominence only recently. Bankers worldwide have come to realise thatthe growing deregulation of the local markets and their gradual integration with the global markets have deepened their anxieties and as a consequence thereto, the sue of risk management has gained new dimension for banks. All commercial transactions carry risk. Banks in the process of financial intermediation are confronted with various kinds of financial and non-financial risks, These risks are highly inter-dependent and events that affect one area of risk can haye ramifications for a range of other risk categories. ‘What is Risk in Banking?: Risk is exposure to uncertainty. There are two components of risk, via, uncertainty ‘and exposure to that uncertainty. Risks in banking may lead to losses in transactions, losing market confidence, i.e, losing confiderce of depositors/shareholders and the general public. Risks in National and International Banking Transactions Risks in international banking transactions can be defined as the unexpected loss from operations that can result from international banking transactions turning adverse due to changes in operating conditions and the foreign currency exposures. International banking transactions also being commercial transactions, face these kinds of risks Risks in International Banking (1) Foreign Exchange Risks— « Unexzected laa rom operations duo fo changes In operating cantons and foreign cureney exposures Not short or fong position na glven currency exposes fo foreign exchange rate risk. ‘6: Transiction exposure when foreln currency denominated recep and payments, ©. Transition exposure atthe tine of alin the accounts; o translate fregn currency assets and abies | © Economic exposure dus to change in future earning power and cash flow pe @ risk on 0 ts exceeds the llabilties a long or over bought | position or vice versa. | Spot rex riskin calculating th present value of assets doesnot equal to prosent value of abitios | Defeut of counterparties or setioment risk requires banks fo take fresh transactions for replacing te failed actions , Time Zone Risk — Time lags in settlements of one currency In one centre and the setlement of another ane ular borrower and portfollo risk related (o entire portfolio ‘counterparty due to possibility of deraults. ne through fixing of counterparty limits and ongoing credit ee‘BANKING AND INSURANCE risks in internation: I o eacies, ete. there are ad ‘Let us try to understan al banking activities. Further, ag ditional risks inherent in inds d the basic features other ourre ind currencies. o ies, there are various K x countries, jountries a! c such ae involved in neat ( isks (1) Foreign Exchange Risks {In international banking rams sks the banks face in suc! oe ange Hk alee emt be defined as the risk a oe pe nt of a in which it hasan OPM Paures and the attendant risks us v ene an the Balance Sheet : expenditure, or an as Cane Bieey Sheet, contracted purchases and sales, foreign currency ency denominated items in ‘the Balance a : : sand sl cn : the osed trading activity 1 denominated receipts and payments, which could fructify the prop‘ : Sree) . Exchange risks arise due to ‘the changes in the value of currencies relative to tt aE Anat shor a So ae ven currency wil expose the player 6 foreign exchange al P&E OTT 4 ose in case the lone Poti weds the dollar labilts, the bank stands to gain from the appreciation OU TO ce risks, related dollar depreciates. Foreign exchange exposure occurs both on forward and spot transa‘ # to currency exposure are commonly connected to transactions and translation exposures. das the risk that the base currency value of a foreign ‘Transaction Exposure: Transaction exposure can be define t : currency denominated transaction will vary with the change in exchange rates during the life of the ti mee xpos arises when a business has foreign currency denominated receipts or payments. The risk here 1S an. Avette rarrwvcat of the exchenge rate from the ime the transaction is budgeted till the time the exposure is extinguished by sale or purchase of foreign currency against the home currency. Translation Exposure: It is also called accounting exposure and concerns the past. It arises from the need to translate foreign currency assets and liabilities into the home currency for the purpose of finalising the accounts for any given period, It can thus, be defined as the risk which will alter the domestic currency value of assets and liabilities in the Balance Sheet, which rise when translated at foreign exchange rates, resulting in a reported gain or loss. sonoE Sttamie Exposure: While transaction an tanelatonexporure ae accounting concepts and can affect the om line directly, economic exposure is more a managerial concept. It can be defined as a change in ful i ~ tu power and cash flow as a result of adjustment ofthe curencies. It ths, represents a change in competitive position: Economic exposure to an exchange rate is the risk that the change in exchange rates is likely to aff ae ‘competitive position in the market and hence, indirectly its profits. ect the ‘company, Let us now look at the different types of risks faced by banks dealin techniques through which these risks can be managed. Exchange Risk on Open and Mismatched Positions: Banks dealing i ‘ ; , ealing in the forei course of ther dealing with exporters, importers and others, buy and sell eureneien aerey ec eanee Market, in the various currencies in which these transactions are denominated. An open position areey wee WP OPER Positions in currency outright and does not square it up by undertaking an offsetting opposi sce When a bank buys or sells ‘When the assets exceeds cm ite transaction, exceed the assets, a short cen heightened in recent years and is one of is the risk arising from a foreign currency It of adverse exchange rate movements ion of the two in an individual se, whenever @ business has an income or currency. Foreign currency exposures the foreign exchange risk have D vations. Foreign exchange risk ig in foreign exchange markets and the long or overbought position is created in that i Gr oversold positon is cronted fa tht curreaeyc bes beck nts snd'when the liabilities Spot forex risk arises when the total present value of th i _ Spot e e assets in any curre of liabilities in that currency. The resultant mismatch between the levels of asses ees “qual the prese; posions in any currency leads toa risk of negative fiancal impact rom exchange abs and Off balance ea pre risks arise when maturity profile of forward purchases differs from may riettations and move a Open forvard postions may led to both exchange and interest rte risks. Gap risks turity profile of forward ve implied interest rates or actual interest rate differentials arising through transaction involvin® ¢© S@¥EtSe eraselen ard contracts, currency swaps, forward rate agreements, etc ‘svolving foreign cuenes es it ee tn iness, ear also face the risk of default of the counterparties or Set] oy loes not cause principal loss, but banks may hav ment ri ot : jt i 1 iy have to undertake fr t risk, ‘or replacing the failed transactions for which banks may incur replacement. sectSActions a net yPe of ich will (@ Scanned with OKEN Scanner tisk,ROLE OF COMMERCIAL BANKING - time age neato uatts, Banks may lso face another risk called time-zone risk or Herstatt risk which aises out of faibexisibav abner yne Currency in one centre and the settlement of another currency in another time-zone. The ‘ith counterparties from another may also trigger sovereign or country risk. ana nett a be nnaged by sting eppopinte iis fr open positions and gap, onring te mata etn y interest rate sensitivity (IRS) for measurement of forex risk exposures, adoption of value at aa roe to measure the risk associated with exposures and adopting clear-cut and well-defined policies for ma ta , division of responsibility between front, middle and back offices. The exchange risk arising out of open short and long positions can be contained within manageable limits by fixing limit on intra-day/overnight open positions in each currency and a limit on aggregate open positions for all currencies taken together. Generally, the above limits, are referred to as Daylight Limit, Overnight Limit and Aggregate Limit. Daylight limit, as the term suggests is the limit on the intra-day open position given to the dealer for dealing during a dealing day or business hours. Overnight limits defines the size of the authorised open position at the close of business hours when the foreign exchange market is closed. The aggregate limit ensures that long and short positions in various currencies do not result in excessive exposures. The size of these limits is usually defined taking into account the risk perception, size of merchant/trading volume, average size of transactions, liquidity and depth of the market, cte. Gap risks arising out of open gaps be contained within manageable limits by fixing suitable gap limits. To ensure that there is no unreasonable mismatch in positions, gap limits may be fixed for each currency, for each forward month. Usually two types of gap limits are fixed — Individual Gap Limit (IGL) and Aggregate Gap Limit (AGL). IGL is the limit which defines net overbought or oversold position for a particular month or forward delivery date/period for an individual currency, whereas AGL is the aggregate of IGLs for all the months or forward periods taken together ignoring the signs, i.e., overbought (+) and oversold (-). Forward Contract: Forward contract is mechanism through which the rate is fixed in advance for purchase or sale of foreign currency at a future date. In such an arrangement the risk of loss which might accrue on account of adverse movement in the rate of exchange is sought to be removed. It enables the exporter who sells goods abroad in terms of foreign currency to determine at once the amount realisable and the importer to determine at once the cost of imports in terms of his own currency. Similarly, it renders debtors and creditors free from the tisk arising through fluctuations in the exchange rate. (2) Credit Risk Credit risk is the likelihood of a borrower’s failure to perform an obligation for full value either when due or at any time thereafter. It can arise from either an inability or part ‘unwillingness to perform in the manner committed. It can arise due to internal factors related to a particular borrower or certain external factors related to any particular industrial sector or economy as a whole. Credit risk arises due to likelihood of failure of a counterparty or borrower to repay its debts in a timely manner. ‘This is a major-risk faced by banks on account of their business activity of granting credit/lending to borrowers (banking book), or investment operations (trading book), or Off-balance Sheet operations, which may be extended to corporates, individuals, other banks, financial institutions and other countries. Credit risk includes counterparty risk (related to @ particular borrower), and portfolio risk (related to entire portfolio). Counterparty risk may be defined as the possibility, that a borrower or counterparty will fail to meet its obligations in accordance with the agreed terms. It may also be reflected in the downgrading of the standing of the counterparty making him more vulnerable to possibility of defaults Portfolio risk arises due to adverse credit distribution, credit/investment concentrations, etc. Credit risk also includes country risk, which is defined as the possibility that a country will be unable to service or repay its debts to foreign lenders in a timely manner. Proper selection of borrowers through sound eredit granting process, adoption of sound credit granting policies and risk gesessment systems, limiting credit concentrations through adoption of prudential limits for different industries! seotors/geographical areas. Controlling rsks through effective loan review mechanism process, adoption of scientific Fisk-reting (for borrowers/credit facility) and risk-based pricing systems, evolving adequate framework for managing xposure in OfFbalance Sheet products, fixing inter-bank and country exposure limits and monitoring portfolio quality san changes/migration therein, ef., are some of the important tols for management of credit risk. The financial aaaaitinn ofthe borrower as well a the values ofthe available collateral are important tools for bankers to Limit the level of credit risk. (@ Scanned with OKEN Scannerxy In international transactions, credit risk aR RETE eredit risk assumes a greater significance when the parties are operating in differen banking ares Charen! Political set up, different currencies and different level of risks. Credit risk in internation the contract, A forclon one patty #0 a foreign exchange transaction is unable or unwilling to meet his obligation unde, partics to the contract val dare raseetion is confirmed by a contract, which stipulates that on a specific date, bom, specific beneficiary, The risk hove. (ac othe specific amount of currency, in designated banks for the account org due date or is unable to cane is nat be counterparty may not be able to execute his side ofthe contract before je defaulting party is uasble ty ep Of the contract on the due date. Failure of execution may arise because the hereinabove through friag (ed: CFedit risk in forex transactions can be managed in the same way as mentioneg sees a ‘ ving of counterparty limits, appropriate measurement of exposures, ongoing credit evaluation Hejiate ee ae ae sound, obeseting Dincedures, Ag e.mensure fr, controlling credit risks, banks generally tuthorised dealer/overseas ym exchange deals are ma se limits dee ed dealer/overseas bank with whom exchange deals are made and these limits are (3) Operational Risk ncn {3s O1 business risks are people and operations related. Operational risk isthe potential for loss caused systems. Onset oF internal controls, the break down in information, processing, settlement or legal compliance Sostetne, eek ual sks broadly relate to human error, systems and procedures for operations, payment and settlement a eed nology, software quality and programing errors, date integrity and loss of data, etc. Data security relating San alee ete Ratess 10 data, processing errors leading to incorrect statements or even worse incorrect settlements It can also result from natural disasters or criminal activities and frauds. The common factor in all these instances is an explicit failure in basic operation controls or processes and the consequences can be substantial financial loss. For effective control of such risks a few measures that can be taken are: Segregation of major functions involved in contracting foreign exchange transactions such as dealing, accounting (back-up) and controls (audit), © Institution of proper information and other support functions. It is only through proper reporting of information on exchange transactions that the risks can be minimised and kept under control. © Proper selection, training and periodical rotation of personnel. © Reconciliation of forex accounts of other banks, ie., NOSTRO/VOSTRO accounts and checks/controls over operations in such accounts. ¢ Institution of system of continuous concurrent audit. © Prompt investigation into losses, problems or operating difficulties and their resolution. ¢ Adoption of sound policies and control systems for forex transactions and checks for compliance of such 70 BANKING AND INSURANCE policies/systems. © Adoption of well-documented manual of instructions and checks to ensure that such instructions are complied. (4) Legal Risk Legal risks also plays a very important role in international banking transactions. Legal risks arise from the legal -acts. It is very important that banks understand these risks and protect themselves. The best way slike ISDA enforceability of contr ant that fo do this would be to insist on exchange of internationally-accepted Master Agreements between the parti: and supported with other relevant documentation. © tarises from legal enforceability of contracts. ‘© To protect from such risks, banks should exchange internationally accepted master agreements . me aaa a pee : de in the Indian economy has been increasing due to the process of liberalisation am agarose tly, the subject of risks in international banking, particularly the natur wh consequen globalisation of the pepnmealicee wath foreign exchange operations has assumed increased importance dimen: sions: le ris . a pu von cary visk. Banks in the process of fianial intermediation are confronted wi All commercial transactions camry 2°. isk ig exposure to uncertainty. There are two components of ris es ee Risks in banking may lead to losses in transactions. Losing mark ity and exposure a (@ Scanned with OKEN ScannerROLE OF COMMERCIAL. BANKING is confidence, i.e., losing confidenc as the une} © of deposi z ie ian srsitors/shareholders and general public. Risk in international banking transactions med Pa perations that can result from international banking transactions turning are various kinds of risks in interationat gr oe foreign currency exposures As in other banking activites, there ountries, other currencies, ete. thers anne astivites. Further, as intemational banking activities involve other counties and currencies such co Revere, tional sks inherent in such transactions on account of exposure to oer Foreign exchange risk is the ri 'gn Exchange, Country, Credit, Operational and Legal Risks. surencies relative to the domestic concen Om @ foreign currency exposure due to the changes in the values of pace tt lomestic currency. Exchange risks related to currency exposures are commonly connected to ‘ransacti jzanslation exposures. Banks dealing in the foreign exchange marke, in the course of their dealing See Saar ease esas gand ell Carre tes aud Geel open poeiigla id eaceis euTeRGee AR and when the liabilities exceed the assets, a short or oversold position is created in that currency, The mismatches/gaps create risks like spot forex risk, forward forex risk, gap risk, ete, Banks also face the risk of default of the counterparties or settlement risk and risks arising out of time-lags in settlement of o u nt me currency in one centre and the settlement of another currency in another time-zone known as time-zone risk. The forex transaction with counter-parties from another country also trigger Baa or country risk. Forex risks can be managed by setting appropriate limits for open positions and gaps suc! as-daylight limit, overnight limit and aggregate limit, individual gap limit (IGL) and aggregate gap limit (AGL), monitoring the maturity and position (MAP) and interest rate sensitivity (IRS) for measurement of forex risk exposures, adoption of value at risk (VaR) and stop-loss approach to measure the risk associated with the exposures and adopting clear-cut and well defined policies for risk control, division of responsibility between front, ‘middle and back offices. Forward contract is.a mechanism through which the rate is fixed in advance for purchase or sale of foreign currency at a future date and enables the exporter and the importer to determine at once the value of transaction in terms of his own currency and renders the debtors and creditors free from the risk arising due to fluctuations in the ‘exchange rate. Credit risk is the likelihood of a borrower's failure to perform an obligation and call arise from either an inability or an unwillingness to perform in the manner committed, due to internal/external factors, Credit risk includes counter- party risk (related to a particular borrower) and portfolio risk (related to entire portfolio). Portfolio risk arises due to adverse credit distribution, credit/investment concentrations, etc, Credit risk also includes country risk, which is defined as the possibility that a country will be unable to service or repay its debts to foreign lenders in a timely manner. Proper selection of borrowers through sound credit granting process, sound credit granting policies and risk assessment systems, prudential limits and sound monitoring systems are important tools for managing credit risk. In international transactions, credit risk assumes a greater significance when the parties are operating in different countries, different political set with different currencies and different level of risks. Credit risk in forex transactions can be managed in the same way as mentioned hereinabove and by fixing of limits for each customer/authorised dealer/overseas bank with whom exchange deals are made and these limits are also reviewed periodically. Dealing in foreign currencies with banks domiciled outside India involves country risk. It may arise due to policies, economic or political conditions prevailing in other countries. Country risk can be mitigated to some extent by fixing country risk limits. It is also necessary to monitor developments in the countries, especially those in the high-risk category periodically. Operational risks the potential for loss caused by the failure/lack of internal controls, the break down in information, processing, settlement or legal compliance systems. Such risks relate to human error, systems and procedures for operations, payment and settlement systems, technology, software quality and programing errors, data integrity and loss of data, etc. These can also result from natural disasters of criminal activities and frauds For effective control of such risks, segregation of major functions involved in contracting foreign exchange such as dealing, accounting (backup) and controls (audit) institution of proper information and other tions, proper selection, training and periodical rotation of personnel, reconciliation of forex account of ‘institution of system of continuous/concurrent audit, etc., should be adopted by banks. also play a very important roe in intemational banking transactions. ie! es ee from the legal ity of contracts, The best way to do this it would be to insist on exchange of intemationally-accepted Master supported with other relevant documentation. (@ Scanned with OKEN Scannerfis BANKING AND INSURANCE Risk management has become very important for banks and itmay be said that inthe present era Of globalisation isk manag as bec: ' it is the most important tool for survival of banks: ;ANKING 2.4 ROLE OF PUBLIC SECTOR IN B. 0 uublie sector banks. This change is brought about by the social responsi ei ‘advances accounted for 92.7, 90.7 and 88.9 per cent respectively and in 2012 it is 72% only. The effort of merging saat puvate sector unite with public sector banks will enhance the rote ofthe public sector banks, Care must be ky to improve the efficiency of banks and inculcate a competitive spirit in them. The major objectives of nationalisation were (@) widening the branch network of banks particularly in the rural and semi-urban areas; (B) greater mobilisation of savings through bank deposits; and () reorientation of credit flows so as to benefit the hitherto neglected sectors such as agriculture, small-scale industries and small borrowers. With a view to achieving these objectives, several steps have been taken since 1969. Some of the importa, measures are — (i) Under successive branch licensing policies, banks were required to open offices in rural and semi-urban areas with a view to increasing the coverage of branch network outside metropolitan and urban areas. (i) Banks were required to lend a certain proportion of the net bank credit for priority sectors which included agriculture, small-scale industries and small business. This proportion was initially fixed at 33 per cent and ‘was later raised to 40 per cent. Under the overall target, subtargets were also laid down for credit to specific sectors such as agriculture and for weaker sections of the society. (iii) With a view to ensuring that deposits mobilised in rural and semi-urban areas were deployed in those areas, banks were required to maintain a credit-deposit ratio of 60 per cent in rural and semi-urban areas. (iv) Specific targets were also laid down for bank participation in poverty alleviation programmes such as IRDP. (v) In determining the lending rate structure of banks, an element of cross subsidisation was built into it. While large borrowers paid higher rates of interest, certain other sectors of the economy paid lower rates of interes (vi) With a view to meeting more effectively the credit needs of the weaker sections in the rural areas, Regional Rural Banks as separate institutions were set up in the mid-seventies. (vii) Formulation of district credit plans and annual action plans was initiated so as to ensure that credit made available by banks were dove-tailed with the developmental plans. (viii) To prevent large borrowers from pre-empting credit from the banking system, the Credit Authorisation Scheme ‘was introduced. (ix) Every bank was asked to formulate a eredit plan for the bank as a whole each year so that the objectives of overall monetary and credit policy could be achieved. By and large, the major objectives of nationalisation have been fulfilled. There has been a dramatic change in the profile of Indian banking. A structural transformation of far reaching significance has occurred in the deployment of ‘commercial bank credit. Banking has thus emerged as an effective catalytic agent of socio-economic changes in the country. 2.5 REFORMS IN THE BANKING SECTOR Prudential norms for income recognition, asset classification, provisioning of delinquent loans, and capital adequacy ‘were introduced. New private sector banks were allowed to enter so as to induce greater competition. Directed credit ‘Was rationalised through a reduction in the number of categories. The liberalisation of branch-licensing policies free’ banks to relocate branches, set up specialised branches, and open new branches without approval of the Reserve Bank (RBI). ‘The limits stipulated for borrowings under certificates of deposit were withdrawn. Interest rate subsidy (@ Scanned with OKEN Scannern ROLE OF COMMERCIAL BANKING on priority sector lending was lowered. Interest rates on the deposit and lending sides were partially deregulated. Government pre-emption of banks’ resources through SLR and the CRR has been brought down in stages ‘© Substantial improvement in financial health of commercial banking in terms of asset quality/capital adequacy and profitability © High spreads and cost of intermediation/need for more efficient ~ productive and competitive set UP. © Allbanks may face difficulties to maintain their capital levels in terms of Basel-lI Accord which Is in effect from 31st March, 2009. Banks are required to maintain 12% capital as per risk weighted assets. ‘© Banks are facing problem of NPAs. Due to weak debt recovery mechanism/non reliability of collateral and poor ‘credit appraisal techniques. As per estimates by the year 2012, commercial banks would have NPA to the extent of 5% of total advances. Although, SERFAESI Act, 2002 has given banks power of recovery for advances ‘exceeding 10 lakh rupees. Actually NPAs were 6.7% at the end of 2011-12. ‘@ Asset liability committee under the chairmanship of bank's Managing Director or Executive Director are responsible for combating various risks. ‘© Means and measures of cooperate governance, The quality of cooperate governance would become critical as competition intensifies. = Consolidation and mergers in banks are getting momentum during 2006 to 2010. Such consolidation was driven by market forces. Now after appointment of Bank Board Bureau in 2016, the road map for consolidation of public sector banks will start to reduce overlapping of operations and unnecessary competition among PS Banks. = Dynamic or forward looking provisioning by banks may useful for circumventing cyclical fluctuations. = Due foderegulation in interest rates, the variable interest rates raises questions on banks in maintaining liquiclty and also to take advantage of profitable deployment of funds = Recovery of NPAs have been possible due to strict adherence to lending norms and credit appraisal procedures = Improvement in capital of PSBs has been due to recapitalisation support from Central Government but should be through internal generation Profitability of banks can improve by diversifying their business into non-fund-based activities. Banks, Insurers, NBFCs need to follow Ind AS from 2018 ‘The government on 18-01-2016 issued the road map for implementation of Indian Accounting Standards (Ind AS) for commercial banks, insurance companies and non-banking financial companies ‘The new accounting standards are converged with globally recognised Intemational Financial Reporting Standards (IFRS). All scheduled commercial banks term-lending refinancing institutions such as Exim Bank, NABARD, NHB and SIDBI, and insurance companies are required to prepare Ind AS-based financial statements for accounting periods beginning from April 2018, with comparatiyes for the periods sending March 31, 2018. ‘Under Ind AS, banks will have to provision for non-performing assets (NPAs) based on the ‘expected loss model’ rather than the existing ‘percentage-based provisioning model’ as prescribed by the RBI. Indian banks do not treat « restructured asset as an NPA, whereas under the IFRS, a restructured asset will be treated as NPA. The new accounting standards have been finalised by the ministry of corporate affairs in consultation with regulator ice Regulatory and Development Authority of India (IRDA) and Pension Fund Regulatory and Developmen cult to say how much the provisioning will increase as it has to be done case-by-case, but it could go u ‘a senior partner of an accounting advisory firm. -are currently struggling to beat the rising tide of bad loans may have to make higher provision dii ged: es" (@ Scanned with OKEN ScannerROLE OF COMMERCIAL BANKING x on priority sector lending was lowered. Interest rates on the deposit and lending sides were partially deregulated. Government pre-emption of banks’ resources through SLR and the CRR has been brought down in stages. ‘Substantial improvement in financial health of f commercial bai f asset quality/capital adequacy and profitability rcial banking in terms of asset quality High spreads and cost of intermediation/need for more efficient - productive and competitive set up. Al'banks may face difficulties to maintain their capital levels in terms of Basel-ll Accord which isin effect from 31st March, 2009. Banks are required to maintain 12% capital as per risk weighted assets. Banks are facing problem of NPAs, Due to weak debt recovery mechanism/non-reliabilty of collateral and poor credit appraisal techniques. As per estimates by the year 2012, commercial banks would have NPA to the extent of 5% of otal advances. Although, SERFAES! Act, 2002 has given banks power of recovery for advances exceeding 10 lakh rupees. Actually NPAs were 6.7% at the end of 2011-12. Asset liability committee under the chairmanship of bank's Managing Director or Executive Director are responsible for combating various risks. ‘Means and measures of cooperate governance. The quality of cooperate governance would become critical as ‘competition intensifies. Consolidation and mergers in banks are getting momentum during 2005 to 2010. Such consolidation was driven by market forces. Now after appointment of Bank Board Bureau in 2016, the road map for consolidation of Public sector banks will start to reduce overlapping of operations and unnecessary competition among PS Banks. Dynamic or forward looking provisioning by banks may useful for circumventing cyclical fluctuations. ‘Due fo deregulation in interest rates, the variable interest rates raises questions on banks in maintaining liquidity and also to take advantage of profitable deployment of funds Recovery of NPAs have been possible due to strict adherence to lending norms and credit appraisal procedures ‘Improvement in capital of PSBs has been due to recapitalisation support from Central Government but should ‘be through internal generation Profitability of banks can improve by diversifying their business into non-fund-based activities. new accounting standards are converged with globally recognised International Financial Reporting Standards ‘s ed commercial banks term-lending refinancing institutions such as Exim Bank, NABARD, NHB surance companies are required to prepare Ind AS-based financial statements for accounting periods '8, with comparatives for the periods sending March 31, 2018. ig to beat the rising tide of bad loans may have to make higher provisions feb © Scanned with OKEN Scannera BANKING AND INSURANCE sind AS would be applicable to both consolidated and individual financial statements,” the government said g statemans “The holding, subsidiary, joint venture or associate companies of banks and insurance companies wou1g Sino be required to prepare Ind AS-based financial statements,” it sei. ‘Urban cooperative banks (UCBs) and regional rural banks (RRBs) will not be required 10 apply Ind AS for the time being and will continue with the existing standards. Needless to say, the competitive framework in the financial sector is also changing fast: A ost ‘of new players arg entering the fray: new private banks, Fils, and AMCs. Besides, banks are expanding it hitherto uncharted areas like cotuumer finance, project finance, advisory services, credit cards and merchant banking sere The development Pana at iastitutions are further challenging the dominance of banks, making inroads into commercia! afd investment banking. NBFCs are also trying to save their sinking ships, and those that manage to survive SY widening their activites, pried’ grow. The growing homogenisation ina hitherto segmented industry is transforming competitive forces, ‘The most significant achievement of the financial sector reforms has been health of the commercial banking sector, in terms of asset quality, capital adequacy _and profi ibility, Despite these improvements, the commercial banking sector continu -10face several challenges. First, jor concern for the banking system has been the high spreads and cost of intermediation. An important challenge for the banking sector, therefore, remains in transforming itself to a more efficient, productive and competitive set uP. ‘Second although the capitalisation level 6f almost all banks operating in India is above the prescribed minimum levels, banks may face difficulties to maintain their capital levels in coming years. The > capital requirement of banks is Jikely to increase with pick-up in credit demand and the implementation of the New Capital Accord sometime in 2006, Which has accorded greater emphasis on risk-sensitivity in credit allocation. Banks ‘would need to consider these “Factors while estimating their capital requirements. ( jepressed capital market conditions and banks’ limited ability to generate sufficient funds internally, maintaining the capital position in line with the prescribed norms would be a major challenge. ‘Third, commercial banks continue to face the problem of overhang of NPAs, attributable, inter alia, to systemic factors such as weak debt recovery mechanism, non-reliability of collateral and poor credit appraisal techniques. Policy measures have yielded mixed results. The recent enactmer “Assets and Enforcement of Security Interest Act, 2002 has increased the momentum for the recovery of NPAs. However, banks need to intensify their efforts to recover their overdues and prevent generation of fresh NPAS. Fourth, in a regulated regime, risks were essentially compartmentalised with various categories of market and credit risks being managed separately, Increasingly, risk is viewed as multidimensional. To enable banks to cope with risks, the Reserve Bank has been engaged in preparing banks for proactive risk management. Banks would need to ‘establish technical systems and management p Ocesses necessary not only to identify risks associated with their activities, but also to effectively measure, monitor and conirol them. Fifth, it is important that financial institutions possess means and measures of corporate governance, The quality of corporate governance would become critical as competition intensifies, ownership is diversified and banks strive to retain their client base. Banks would be required to further improve their internal management systems in terms of housekeeping, audit practices, asset-liability management and systems management to attain international best practi i saa - ddd ecole Sixth, a sound and well-diversified banking system envisages development of a banking sector with a diverse array of well-capitalised and healthy banks. As the dynamics of reforms gathers momentum, the coming yea's likely to witness consolidation in the banki Such consolidation will be driven by market forces in an enabling envi ‘which bring together willing institutions, A related issue is that of ownership of banks. Public sector (PSBs) continue to dominate the Indian banking sector and progressively the ownership needs to be diversified oe them more amenable to market discipline and reduce the possibilty of regulatory forbearance, | Finally, bank lending tends to be procyclical, while the level of NPAs tends to behave in a counter-cysical in a downtum, as the condition of borrowers deteriorates, they tend to be downgraded by ‘banks that extra provisioning has to be set aside, potentially exacerbating the capital shortage. Su tof banks tends to accentuate cyclical fluctuations. In these circumstances, dynamic or forward by banks may be useful for circumventing such outcome. . the marked improvement in the financial (@ Scanned with OKEN Scanner