Introduction to

Commercial Banking
 Bank
• A bank is a financial intermediary that
accepts deposits and channels those deposits
into lending activities, either directly by loaning
or indirectly through capital markets. A bank
links together customers that have capital
deficits and customers with capital surpluses.

Source: Wikipedia
 History of Banking
• 1786: East India Co. established General Bank
• 1790: Bengal Bank established for Europeans in the same market
• 1791: General Bank became GB of India
• 1809-1843: Presidency bank established consists of 20% of Govt. stake
• 1835: National currency came into existence
• 1861-62: Currency issue became exclusive right of Government and
distributed by Presidency bank
• 1863-1876: Punjab bank established by joint stocks and was private
bank
• 1900: Nationalization came
• 1921: Punjab Bank merged to form Imperial Bank of India
• 1935: RBI established & in 1949 became nationalized
• After 1969: Govt. nationalized 20 banks including SBI (1955)& hold 91%
of business
 Commercial Banking & Functions
Commercial banks are an organization which normally performs certain
financial transactions. It performs the twin task of accepting deposits from
members of public and make advances to needy and worthy people form
the society. When banks accept deposits its liabilities increase and it
becomes a debtor, but when it makes advances its assets increases and it
becomes a creditor. Banking transactions are socially and legally approved.
It is responsible in maintaining the deposits of its account holders
Structure of Indian Banking System

http://www.rbi.org.in/commonman/English/scri
pts/banksinindia.aspx#SBIA
 Regulation for Banking
• The Reserve Bank of India, India's central banking authority, 
was nationalized on January 1, 1949 under the terms of the 
Reserve Bank of India (Transfer to Public Ownership) Act, 1948 
(RBI, 2005b).
• In 1949, the Banking Regulation Act was enacted which 
empowered the Reserve Bank of India (RBI) "to regulate, 
control, and inspect the banks in India."
• The Banking Regulation Act also provided that no new bank or 
branch of an existing bank could be opened without a license 
from the RBI, and no two banks could have common directors.
Banking Data 2019
 Digital Banking
• The last 10 years have witnessed significant increase in the provision of
consumer services through technology. Various technology platform are
introduced like computers, mobile phones, the Internet and self-service
kiosks to service consumers in new ways(Wentzel,2013).

• The market for mobile financial services in India is growing steadily.

With 41 percent of India’s adults financially excluded, which leads to the
need of financial literacy on priority(Kumar& Lal, 2013). This will help
banks to increase their customer base in financially excluded regions
through more convenient and efficient platforms of mobile technology.

• The 2014 Intermedia Financial Inclusion Insight (FII) Survey of 45,000

Indian adults found that 0.3% of adults use mobile money, compared to
76% in Kenya, 48% in Tanzania, 43% in Uganda, and 22% in
Bangladesh(cgap.org).
Growth Drivers in Indian Banking Sector
Government Schemes in Indian Banking
Sector
Types of Risk in Indian Banking Sector
 Risks Faced by Financial Intermediaries

RISKS FACED BY
FINANCIAL
INTERMEDIARIES

ASSET-LIABILITY PORTFOLIO OPERATIONAL

SOLVENCY RISKS
RISKS RISKS RISKS

INTEREST RATE
CREDIT RISKS
RISK

LIQUIDITY RISKS MARKET RISKS

FOREIGN
EXCHANGE RISKS
 ASSET-LIABILITY RISKS
• Interest Rate Risk

• Interest rate risk is defined as the volatility in the earnings or

the value of a financial institution owing to unexpected
changes in interest rates
 ASSET-LIABILITY RISKS

INTEREST
INTEREST INTEREST
INTEREST SPREAD
SPREAD
INCOME LESS COSTS EQUALS
INCOME COSTS

VARIABLE VARIABLE
IN LONG VARIABLE IN SHORT
TERM IN SHORT TERM
TERM
 ASSET-LIABILITY RISKS
• Liquidity Risk

– Liquidity risk is the risk of economic losses resulting from the

fact that the sum of all inflows and the cash reserves of a
financial intermediary on a day are not sufficient to meet its
outflows on that day
– http://derivative-news.fincad.com/derivatives-regula
tions/indonesian-banks-may-face-higher-systemic-liqu
idity-risk-stemming-from-basel-iii-adoption-2653/
 ASSET-LIABILITY RISKS

INFLOWS CASH OUTFLOW LIQUIDITY

RESERVES LESS S

LIQUIDITY
RISK

UNCERTAINTY IN UNCERTAINTY IN UNCERTAINTY IN

 ASSET-LIABILITY RISKS
• Foreign Exchange Risks

– Foreign exchange risk is defined as the volatility in

earnings or value of a financial intermediary caused
by unexpected changes in exchange rates

– http://articles.economictimes.indiatimes.com/2012-
06-29/news/32472618_1_bad-loans-credit-growth-cred
it-risk
 ASSET-LIABILITY RISKS

SHORT LONG POSITION NET

POSITION IN IN CURRENCY A POSITION IN
CURRENCY A CURRENCY A

Exchange rate of
currency A
versus reference
Changes in exchange rate of currency A vis-à-vis a currency
reference currency cause changes in the value of net
position in reference currency terms
NET
POSITION
VALUE IN
REFERENCE
CURRENCY
 PORTFOLIO RISKS

• Credit Risk

– Credit risk is the volatility in the value of a

financial intermediary’s credit portfolio owing
to the reduction in credit quality of credit
counterparties
 PORTFOLIO RISKS

Credit
Credit
Exposureatat
Exposure Probability
Probability Loss
Loss Risk
Risk
default
default ofofdefault
default given
given
(EAD)
(EAD) (PD)
(PD) default
default EQUALS
rate
Combined Combined rate
(LGDR)
(LGDR)
with with
 PORTFOLIO RISKS
• Market Risk

• Market risk arises from the volatility in values of off and on

balance sheet trading positions owing to unexpected changes in
market prices which could be interest rates, equity prices,
commodity prices & foreign exchange risk.

• Difference between Interest Rate risk & Market risk is Market risk
applies only to the trading portfolio of the banks
 PORTFOLIO RISKS

VARIABLEOF
VARIABLE OF
RISK
RISK INTEREST:
INTEREST:
FACTORS:
FACTORS: AFFECT PORTFOLIOVALUE
VALUE
PORTFOLIO
INTERESTRATES,
INTEREST RATES,
EQUITYPRICES,
EQUITY PRICES,

RESULTING IN

MARKETRISK
MARKET RISK
 OPERATIONAL RISK
– The New Basel Capital Accord, 2003 defines operational risk as the risk
of loss resulting from inadequate or failed internal processes, people
and systems or from external events

– In 2005, RBI unveils draft note to manage operational risks. The RBI has
sought to make bank boards primarily responsible for managing
operational risks in banks and such risks should be dealt as a separate
risk management function across the organization. The Reserve Bank of
India has proposed that Indian banks transit to the Basel-II norms for
capital adequacy by March 31, 2007.
 OPERATIONAL RISK

Internal
fraud

Execution,
delivery and External
process fraud
management

Operational
risk
Employee
Business
practices and
disruptions
workplace
and systems
safety

Clients,
Damage to
products and
physical
business
assets
practices
 SOLVENCY RISK
• The risk of insolvency, defined as a situation wherein losses are
large enough to wipe out the capital of a financial intermediary, is
called solvency risk
• Banks need to target the level of solvency risk that their
shareholders are comfortable with and choose their capital level
accordingly

• Capital Management is an area of concern. Ex as per Basel III

Committee norms, Indian Banks need additional 90,000 crore
 SOLVENCY RISK
LEVEL OF INTEREST
RISK ASSUMED

LEVEL OF LIQUIDITY LEVEL OF

RISK ASSUMED OPERATIONAL
RISK ASSUMED
CHOSEN
LEVEL OF
SOLVENCY
RISK LEVEL OF
LEVEL OF CREDIT MARKET RISK
RISK ASSUMED ASSUMED

LEVEL OF
CAPITAL
REQUIRED
THE PROCESS OF RISK MEASUREMENT AND
MITIGATION
Risk Measurement:
· Enlisting basic risk factors and indices to measure them
·Determining magnitudes of exposure of target variables to basic risk
factors.
·Grasping range and likelihood of the possible outcomes

Tool Analysis:
· Analysing tools that can alter risk exposure and
evaluating risk-cost trade-off of each tool.

Exposure Management:
· Selecting a strategy of No Exposure, Selective Exposure or Magnified
Exposure

Performance Evaluation
· Back testing the risk measurement model to evaluate its
performance.