MANAGEMENT OF FINANCIAL

INSTITUTIONS & SERVICES

1
INDIAN FINANCIAL SYSTEM
• Financial system consists of financial markets and financial
intermediaries
• Financial markets comprise of money market, capital market,
forex market, government securities market and credit market.
• While the capital market is regulated by SEBI, all other
markets are regulated by RBI, the central bank.

2
FINANCIAL INTERMEDIARIES IN INDIA

• Commercial banks [about 60% share]

• Urban co-operative banks
• Rural financial institutions
• Non banking finance companies
• Housing finance companies
• Mutual funds
• Insurance companies

3
Banking
• What is banking?
• Why banks exist?
• Challenges in the Indian banking system?
COMMERCIAL BANKING SYSTEM

• Public sector banks [after mergers have reduced]

• Private sector banks
• Foreign banks
• Regional rural banks
• Payment banks- Narrow banks can take deposits but
can not lend
• Small finance banks-Niche banks for financial
inclusion.

5
Performance of banks
2018-2019        

All Scheduled Commericial

Ratios Public Sector Banks Private Sector Banks Foreign Banks
Banks

Cash-Deposit Ratio 5.4 5.5 5.8 5.4

Credit-Deposit Ratio 69.8 88.3 68.2 75.3
Ratio of Priority Sector Advances to total Advances 32.5 30.2 27.2 31.7
Ratio of Interest Income to total Assets 6.9 7.9 5.8 7.2
Ratio of Net Interest Income to total Assets (Net Interest Margin) 2.3 3.3 3.2 2.7
Ratio of Non-interest Income to total Assets 0.9 1.5 1.5 1.1
Ratio of Operating Profits to total Assets 1.5 2.5 2.8 1.9
Return on Assets -0.7 0.6 1.6 -0.1
Return on Equity -11.4 5.4 8.8 -1.9
2014-2015        
Ratios Public Sector Private Sector Banks Foreign Banks All SCBs

Cash - Deposit Ratio 5.46 6.08 5.97 5.60

Credit - Deposit Ratio 76.11 86.36 80.86 78.31
Ratio of Priority Sector Advances To Total Advances 29.31 27.77 27.30 28.89
Ratio of Interest Income To Total Assets 8.12 8.81 6.71 8.18

Ratio of Net Interest Income To Total Assets (Net Interest Margin) 2.34 3.37 3.54 2.64

Ratio of Non-Interest Income To Total Assets 0.91 1.72 1.98 1.15

Ratio of Operating Profits To Total Assets 1.66 2.86 3.36 2.02
Return on Assets 0.46 1.68 1.87 0.81
Return on Equity 7.76 15.74 10.25 10.42
Asset Quality

Mar-16 

Banks Gross NPAs to

  Gross Advances

  Ratio (%)

State Bank of India & Its Associates 6.4

Nationalised Banks 10.7
Private Sector Banks 2.8
Foreign Banks 4.2
Mar-19
Gross NPAs to Gross
Banks
Advances Ratio (%)
Public Sector Banks 11.59

Private Sector Banks 5.25

Foreign Banks 2.99

Non banking financial institutions - NBFI

Three categories of NBFI

• Financial institutions
• Non banking finance companies
• Primary dealers

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FINANCIAL INSTITUTIONS

• All India financial institutions – EXIM bank, NABARD,

SIDBI, NHB
• Investment institutions – LIC, GIC
• State level financial institutions – SFC, SIDC
• Other specialized financial institutions

9
NON BANKING FINANCE COMPANIES
• What are NBFCs?
• NBFC crisis in India.

10
Primary dealers
• Bank PDs – 13
• Standalone PDs – 8
• The 8 stand alone PDs are STCI Primary Dealer Ltd, SBI DFHI
Ltd, ICICI Securities Primary Dealer Ltd., PNB Gilts Ltd,
Morgan Stanley India primary dealer P Ltd, Nomura fixed
income securities P Ltd, Deutsche Securities India P Ltd, and
Goldman Sachs

11
MONEY, MONEY SUPPLY AND MONETARY POLICY

• What is money?
• Money supply is the total quantity of money in the economy.
• Monetary policy marks the management of money supply and its
links to prices, interest rates and other economic variables

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Important concepts in Monetary Policy
• Repo rate
• Reverse Repo Rate
• Liquidity Adjustment Facility
• Marginal Standing Facility
• Bank Rate
• CRR
• SLR
• OMO
• MCLR
Meanings
• Repo Rate-Interest rate at which the RBI provides overnight liquidity to banks against the collateral of under the
LAF.
• Reverse Repo Rate: Interest rate at which the RBI absorbs liquidity, on an overnight basis, from banks against the
collateral under the LAF.
• LAF- Repo and Reverse Repo.
• MSF- SCBs can borrow additional amount of overnight money from the RBI by dipping into their SLR portfolio up
to a limit.
• Bank rate- It is the rate at which the RBI buys or rediscount bills of exchange or other commercial papers.
• CRR- The average daily balance in cash that a bank is required to maintain with the RBI as a share of such percent
of its NDTL.
• SLR-The share of NDTL that a bank is required to maintain in safe and liquid assets, such as, unencumbered
government securities, gold etc.
• OMO- Outright purchase and sale of government securities, for injection and absorption of liquidity, respectively.
• MCLR- Minimum interest rate that a bank can lend at.
MONEY SUPPLY MEASURES
1. Reserve Money (M0): It is also known as High-Powered Money, monetary base, base money
etc.
M0 = Currency in Circulation + Bankers’ Deposits with RBI + Other deposits with RBI
It is the monetary base of economy.
2. Narrow Money (M1):
M1 = Currency with public + Demand deposits with the Banking system (current account,
saving account) + Other deposits with RBI
3. M2 = M1 + Savings deposits of post office savings banks
4. Broad Money (M3)
M3 = M1 + Time deposits with the banking system
5. M4 = M3 + All deposits with post office savings banks

15
How Banks Create Credit-- THE MONEY MULTIPLIER
• Banks, as financial intermediaries, cannot create currency.
• But they can create deposits, which in turn can be lent.
• The operation of the Money multiplier makes Money creation by
banks an iterative process.
• The key variables determining money supply are ‘the monetary base’
and ‘level of leakage’.
• The ‘monetary base’ is represented by the financial liabilities of the
central bank.
• Central bank can control ‘monetary base’ and strongly influences
‘leakage’.
• Central bank sets ‘reserve requirements’ [=leakage], which places a
limit on banks’ ability to create credit.

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Question

• If the required reserve ratio is 8%, the excess reserve ratio is 2%, and the currency-deposit
ratio is 30%, by how much would money supply change if the Fed made open market
sales valued at $40 million?
• -130
• Assume money supply (M) is $1,200 billion, total bank deposits (D) are $800 billion and
the required reserve ratio is 10%. What would the Fed have to do to lower money supply
by 5%? ( Assume banks do not hold excess reserves)
• -24
Question
• Assume that bank deposits are $3,200 billion, the required reserve ratio is 10%,
and currency outstanding is $400 billion. What can the Fed do to decrease the
money supply by $100 million? ( Assume excess reserves are zero)
CENTRAL BANKS’ TOOLS FOR MONETARY POLICY

• Variations in reserve requirements.

• Variations in the bank rate [the rate at which banks borrow
from the central bank].
• Open Market Operations [OMO].

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The CRR and SLR

• CRR is the ‘FRACTIONAL RESERVE’ and is maintained as cash

balances with RBI.
• The SLR is maintained to:
• Facilitate government borrowings through bank investment in
approved securities.
• Provide additional profitability/ liquidity to banking system.

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Case- European central bank decision to bail out Greece

• Should ECB intervene? What are the arguments for and against, and what criteria
should be used to take a decision?
• Does monetary policy influence price stability? How?
Why are banks’ financial statements different?

• A bank’s financial statements are quite different from those of a

firm in any other industry.
• In their roles as financial intermediaries, banks have to take
considerable financial risks, and their financial statements
merely reflect these risks.

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BANKS’ BALANCE SHEET
• ASSETS
• LIABILITIES
• • Cash and balances with
Capital
central bank
• Reserves
• Balances with banks and
• Deposits money at call
• Borrowings • Investments
• Other liabilities and • Loans and advances
provisions
• Fixed assets
• Other assets

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ASSET CHARACTERISTICS: LOANS and
ADVANCES
• Major asset in banks’ balance sheets
• Major source of revenue for banks
• Operational features - different loan covenants, maturities,
interest rates, repayments amounts and modes,
currencies,industries, purposes etc.

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ASSET CHARACTERISTICS:
INVESTMENTS

• Help to earn interest.

• Help to meet liquidity needs.
• Low transaction costs.
• Speculate on interest rate movements and profit on price
changes.

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ASSET CHARACTERISTICS- CASH AND
DUE FROM BANKS
• Vault cash
• Deposits with Central bank [reserve requirements]
• Deposits with other banks
• Cash items in the process of collection [float funds]

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ASSET CHARATERISTICS: FIXED AND
OTHER ASSETS
• Depreciated value of banks’ premises and equipment.
• Interest accrued [receivable].
• Prepaid expenses.
• Non-banking assets acquired in satisfaction of claims.

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LIABILITY CHARACTERISTICS: DEPOSITS

Savings and demand (current) deposits

• No set maturity.
• Low/no cost.
Time deposits
• Set maturity (short term/long term).
• Deregulated interest rates.

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LIABILITY CHARACTERISTICS:
BORROWINGS
• From the central bank.
• Other banks/FIs.
• Commercial papers.
• Bonds
• Other long term borrowings.
• Borrowings from abroad.

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CONTINGENT LIABILITIES

• It is an off the balance sheet item.

• It signifies a ‘possible’ obligation that depends on the
occurrence of some uncertain event.
• In good times, contingent liabilities can generate substantial
income for banks.
• To ascertain banks’ financial condition, contingent liabilities
will have to be analysed.

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BANKS’ INCOME STATEMENTS (India)

INCOME EXPENSES
• Interest earned [advances, • Interest paid
investments, balances with [deposits, RBI/inter
RBI and other banks] bank borrowings]
• Other income [commission, • Operating expenses
exchange, profit on • Provisions
exchange, etc.]
• Taxes

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TYPICAL BANKS’ BALANCE SHEET IN INDIA

Schedule Schedule Assets

06 Cash and bank
01 balances with RBI
02 07 Balances with
banks and money
at call
03 08 Investment

04 09 Advances

05 10 Fixed assets

11 Other assets

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TYPICAL BANKS’ FINANCIAL STATEMENTS IN INDIA –P&L

Schedule Income Schedule Expenses

13 Interest earned 15 Interest

expended

14 Other income 16 Operating

expenses
17 Provisions and
contingencies

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Assessing Banks’ Performance

• Traditional models of bank performance are based on the

Return on Assets [ROA] approach.
• Some others such as CAMELS rating models follow a rating
approach based on various parameters.
• There are also more sophisticated models based on risk rating
criteria

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 CAMELS RATINGS

• CAPITAL ADEQUACY
• ASSET QUALITY
• MANAGEMENT
• EARNINGS
• LIQUIDITY
• SENSITIVITY TO MARKET RISK

35
 Efficiency and Expense control ratio  
Operating Efficiency Total operating expenses/ Total Assets
Cost of funds Total interest expenses/ Total deposits and non deposit borrowings
Efficiency ratio (Cost to income ratio) Non interest expenses/ Net total income
Income productivity per employee Net income after taxes/No of full time employees
Break even volume of incremental cost per employee Cost per employee/Net interest margin
Tax Ratio Tax paid/Total assets
   
   
Liquidity  
Demand Deposits ratio Total Demand Deposits/Total Assets
Non-deposits borrowing ratio Non deposit borrowings/Total assets
Credit asset ratio Total credit extended/ Total Assets
SLR investment-Total investment ratio SLR investments/Total investments
KPI Cash to Demand deposits ratio Cash /Demand deposits
Cash to total deposits Cash /total deposits
   
Risk  
Equity Multiplier Total Assets/Equity
Equity Ratio Equity/Total Assets
Capital adequacy Total Capital/Risk weighted assets
Provision ratio Loan loss provisions/Total assets
Net NPAs to assets ratio Net NPAs/Total Assets
Net NPAs to equity ratio Net NPAs/Equity
   
Profitability  
ROE Net profit/Equity
ROA Net Profit/Total Assets
Profit Margin Net Profit/Total Income
Asset Utilisation Total Income/Total Assets
interest cost to assets ratio Interest expenses/Total assets
Net operating margin Total operating income less total operating expenses/Total assets
Net interest margin Interest income less interest expenses/Total assets
   Bank of Baroda  
Amount in Crore   Bank of Baroda
S.No Items FY19
1 Interest Earned 49974.1093
2 Other Income 6090.9915
3 Total Income 56065.1008
4 Interest Expenses 31290.3004
5 Operating Expenses 11287.9781
6 Employee Expenses 5039.1318
7 Other Operating Expenses 6248.8463
8 Provisions 13053.2998
9 Assets (2019) 780987.4049
10 Assets (2018) 719999.7716
11 Equity (2019) 45941.1
12 Equity (2018) 43394.77
13 Funds (2019) 705891.02
14 Funds (2018) 653886.79
15 No of employees 55754
16 Tax Paid (2019) 2897.0629
17 Cash (2019) 26661.73
18 Deposits (2019) 638689.7172
19 Demand Deposits (2019) 46900.7261
20 Credit (2019) 468818.7362
21 SLR Investments (2019) 162657.56
22 Total Investments (2019) 182298.0818
23 Net NPAs (2019) 15609.5
24 Gross NPAs (2019) 48232.76
25 Gross Advances (2019) 501706.39

26 Restructured Standard Advances (2019) 4096.49

27 Net Advances (2019) 468818.7362
     
     
     
   Bank of Baroda        
Amount in Crore   Bank of Baroda      
S.No Items FY19      
1 Interest Earned 49974.1093 28 Average Equity 44667.94
2 Other Income 6090.9915 29 Average Assets 750493.6
3 Total Income 56065.1008 30 Net Interest Income 18683.81
4 Interest Expenses 31290.3004 31 Operating Income 24774.8
5 Operating Expenses 11287.9781 32 Operating Profit 13486.82
6 Employee Expenses 5039.1318 33 Cost to Income Ratio 45.56234
7 Other Operating Expenses 6248.8463 34 Net Profit/Loss 433.5225
8 Provisions 13053.2998 35 Net Interest margin 2.49
9 Assets (2019) 780987.4049 36 Return on Average Assets 0.06
10 Assets (2018) 719999.7716 37 Return on Average Equity 0.97
11 Equity (2019) 45941.1 38 Average Funds 679888.9
12 Equity (2018) 43394.77 39 Cost of Funds 4.60
13 Funds (2019) 705891.02 40 Operating efficiency ratio 1.504
14 Funds (2018) 653886.79 41 Income productivity per employee 0.78
15 No of employees 55754 42 Net Profit per employee 0.78
16 Tax Paid (2019) 2897.0629 43 Gross Profit per employee 24.19
17 Cash (2019) 26661.73 44 Tax Ratio 0.371
18 Deposits (2019) 638689.7172 45 Cash-Deposit Ratio 4.174
19 Demand Deposits (2019) 46900.7261 46 Cash Demand Deposits Ratio 56.847
20 Credit (2019) 468818.7362 47 Credit Deposit ratio 73.403
21 SLR Investments (2019) 162657.56 48 Credit Asset Ratio 60.029
22 Total Investments (2019) 182298.0818 49 Demand Deposits Ratio 6.005
23 Net NPAs (2019) 15609.5 50 Equity Multiplier 17.000
24 Gross NPAs (2019) 48232.76 51 Equity Ratio 0.059
25 Gross Advances (2019) 501706.39 52 SLR Investments/Total investments 89.226
Restructured Standard
26 Advances (2019) 4096.49 53 Net NPAs ratio 3.330
27 Net Advances (2019) 468818.7362 54 Total Stressed Assets 10.43
      55 Net NPAs to Equity Ratio 33.98
      56 Interest cost to assets ratio 4.169
      57 Net operating margin ratio 1.797
Assets
• Cash in hand
• Consist of total amount of rupee notes and coins held by bank branches / ATMs / Cash deposit machines etc.
• Foreign currency held by a bank would be included under cash in its balance sheet.
• Balances with RBI
• Consist of balances that banks maintain with RBI
• Balances with banks in India
• Balances of banks in their (a) current account/s and (b) other deposit account/s maintained with other banks in India (including cooperative banks)
• Money at call and short notice- With banks and others
• Short term investment of surplus funds
• Money lent for one day is call money- Deals in overnight funds which are repayable on demand.
• Money lend for a period of more than 1 day and upto fourteen days is money at short notice.
• Balances with banks outside India
• Balances with banks outside India
• Investments-As per Banking Regulation Act, 1949, it comprises investments in India as well as investments outside India.
• Investments in India comprise investments in Indian government securities (Central/ State Government securities and Government of India Treasury bills at book
value), other approved securities (as per Banking Regulation Act, 1949), shares/debentures/bonds (not included under other approved securities) of companies and
corporations, investments in subsidiaries/ joint ventures (including those in RRBs), Certificate of Deposits etc.
• Investments in foreign govt. securities, subsidiaries etc.
• A certificate of deposit is a time deposit, a financial product commonly sold by banks and financial institutions etc.
Assets continued………
• Advances: By nature of credit facility, By security arrangements and by sector.
• By nature of credit facility
• Bills purchased and discounted- A negotiable instrument that gives the holder the right to receive stated fixed sums on demand or at a fixed
or determinable future time.
• When a bank negotiates a bill payable on demand (sight bill) and provides funds to the holder, at a fee/ interest, the facility is referred
to as bill purchase.
• When a bank negotiates bill payable after a usance i.e., at a fixed or determinable future time (usance bill) and provides funds to the
holder, at a discount, the facility is referred to as bill discounting.
• Cash credit- A facility, under which a customer is allowed an advance up to the credit limit against the security by way of hypothecation/
pledge of goods etc.
• Overdraft-A facility, under which a customer is allowed to draw an agreed sum (credit limit) in excess of credit balance in their account.
• Term Loans-A loan which has a specified maturity and is payable in instalments. Usually for more than 1 year.
• By security arrangements
• Secured by tangible assets-Advances where all amounts due are covered fully by the value of tangible security (primary as well as collateral
security).
• Covered by banks/govt. guarantees-Advances guaranteed by Indian and or foreign banks, Indian Central/State/ Local government and or foreign
governments, and other recognized institutions such as ECGC etc.
• Unsecured Advances- These are not covered by tangible securities or govt. guarantees etc.
Assets Continued….
• Advances by sector
• Priority sector- Directed lending to agriculture, Micro and small enterprises etc.
• Public sector- Loans and advances to central and state governments etc.
• Banks-Advances to banks (including cooperative banks)
• Others-Advances to corporate sector and others
• Fixed assets- Classified into premises (including land), other fixed assets (furniture and
fixtures), fixed assets under construction.
• Other Assets- Interoffice adjustments, Accrued interest, tax paid, Stationary and Stamps
and Others
• Interoffice adjustments-Inter-office adjustments represent items in transit and unadjusted
items. All connected inter-office accounts should be aggregated.
Liabilities
• Capital
• Reserves and Surplus-Statutory reserves, capital reserves, share premium, investment fluctuation reserves, revenue reserves.
• Statutory reserves-Reserves created out of the profits in compliance with the Section 17 (c) and 11(2)(b) of the Banking Regulation Act,
1949. Transfer to the fund before any dividend is declared.
• Capital Reserves-Capital reserves arise on account of sale of land and premises, revaluation of fixed assets etc.
• Share premium-The excess of the issue price of shares over their face value.
• Revenue Reserves- Any reserves other than capital reserves
• Investment reserves-Provision of depreciation if is in excess of required amount, excess should be credited to P&L account and
equivalent amount to be placed in Investment reserves.
• Balance of profit- Balance of profit carried down.
• Deposits-Demand deposits, Savings deposits and Term deposits.
• Demand deposits- Deposits which are repayable on demand. This includes current deposits etc.
• Savings deposits-A deposit account which is subject to the restrictions as to the number of withdrawals as also the amounts of
withdrawals permitted by the bank during any specified period.
• Term deposits- Deposits received by the bank for a fixed period and which are withdrawable after the expiry of the said fixed period and
shall also include deposits such as recurring etc.
Liabilities continued….
• Borrowings- Borrowings in India and Outside India
• Borrowings in India from RBI, other banks, other institutions etc.
• Borrowings outside India
• Secured borrowings- Borrowings contracted in India or abroad against securities (tangible assets)
• Other liabilities and provisions-Bills payable, interest office adjustments, interest accrued,
subordinate debt etc.
• Bills payable- Instruments issued by banks against money received from customers, which are to
be paid to the customers or as per their orders.
• https://rbidocs.rbi.org.in/rdocs/Content/PDFs/HADEP3003201706125
497E427463BBED2CA0BB98C6B49.PDF
Case- HDFC borrows in the international market
through masala bonds
• Masala bonds- Borrow abroad through bonds denominated in Indian rupees.
• What are the advantages of borrowing through masala bonds for Indian banks and other
institutions?
• What are the disadvantages?
• Advantages:
• Building up foreign investors’ confidence in Indian economy and currency 
• Diversify their bond portfolio
• It helps the corporations to cut down their cost.
• Disadvantages
• Too much of reliance on external debt aided will have a negative impact on the sovereign ratings of India,
and thereby creating a problem in attracting investments to India. 
LIABILITY MIX---FACTORS TO BE
CONSIDERED
• Maturity
• Cost
• Tax implications
• Regulatory framework
• Market conditions

46
TYPES OF BANK LIABILITIES
• The primary source of bank liabilities – deposits –
representing the savings of the economy.
• Other sources of funds – borrowings and equity
capital.

47
BANK DEPOSITS
• Deposits are differentiated by type of customer,
tenure of deposit and cost to bank.
• Based on these criteria, deposits are broadly classified
as transaction accounts/ demand deposits and term
deposits.
• Transaction deposits can be interest bearing or non
interest bearing.

48
DEPOSIT INSURANCE
• A protection for depositors in most countries against
non repayment of deposits by banks.
• Used by governments to enhance the stability of the
banking system, and minimize losses to depositors in
case of bank failure.

49
DEPOSIT INSURANCE - INDIA
• The second country in the world to introduce the
scheme – in operation since 1962.
• DIC – operated by the government
• Upto INR 1 lakh covered.
• Certificates of deposit, government, inter-bank, and
illegal deposits are not covered.

50
PRICING DEPOSITS
• Assumes importance in present deregulated and
competitive environment.
• Banks should have a pricing policy to take into
account cost and availability of funding sources, and
banks’ profitability.
• Better informed deposit pricing for identified
customer segments would generate positive effect on
Net interest margin and Net interest income of banks.

51
Considerations for pricing
• servicing costs versus minimum balance requirements
• deposit volumes and their costs in relation to profits
• lending and investment avenues and compensating
balances
• relationship with customers
• promotional pricing, if new products are being considered
• product differentiation in a competitive market

52
Bank cash flows Explicit prices Implicit prices
Bank costs Interest payments Below cost services [ eg,.,
free cheque book issue]

Gifts to customers More convenience to

customers – branch offices,
ATMs, business hours etc

Bank revenues Service fees – e.g, charges Minimum balance

per cheque issued requirements

Other fees--such as on Restrictions – such as

overdrafts limited cheque writing
privileges

53
 COMMON PRICING
METHODOLOGIES
• Cost plus margin pricing
• Determine deposit rate to adequately cover all costs of offering the service plus a small profit margin
• Unit price charged to the customer per deposit service-->operating expense per unit of deposit service + estimated overhead expense
allocated to deposit function+ planned profit from each deposit unit
• Market penetration deposit pricing
• Aimed at high growth markets to garner larger market share
• High interest rates above market level or customer fees below market standards
• Managers expect larger sources of funds and associated loan and investment opportunities
• Conditional pricing
• Used to attract the type of depositors they want as customers
• Banks will post a schedule of interest rates or fees for deposits based on size of deposits account or activity
• Typically large volume deposits will have higher interest rates or lower fees
• Encourage customers to have high average deposit balances for a given period
• Upscale target pricing
• Carefully but aggressively designed deposit pricing schemes for customers with high level of income net worth
• The customers targeted are price sensitive and would quickly respond to price differentials
• Relationship pricing
• Ensures banks best customers get the best pricing
• Objective is to forge a strong relationship wit customers by selling convenience and prevents customers from moving away only
because of the pricing concerns
• Promoting customer loyalty to the bank
54
 Liquidity Creation
• On balance sheet liquidity- Banks finance illiquid business loans with
transactional or liquid deposits (Bryant 1980; Diamond and Dybvig, 1983).
• Off-balance sheet liquidity creation- Use of derivatives, loan
commitments as well as other similar funds (Holmstrom and Tirole 1998; Kashyap
et al., 2002).
• Illiquid assets are financed through liquid liabilities liquidity creation
takes place
• Banks-->creating liquidity--> Holding long term corporate loans through the use
of saving deposits (Lei & Song, 2013).
• Banks -->destroying liquidity--> Holding marketable securities by issuing
subordinated debt (Lei & Song, 2013).
 Liquidity Creation Process
• First,
  assets, liabilities, equity and off balance sheet activities of respective banks are
classified into liquid, semi liquid and illiquid activities.
• Second, these activities are then given weights based on the theory of liquidity
creation and intuition.
• The weights being 1/2, 0 and -1/2 based on whether liquidity is created, destroyed or
remained unchanged.
• Liquidity creation-->Banks transform illiquid assets like loans into liquid liabilities like
transactional deposits.
• Hence, illiquid assets, liquid liabilities and illiquid off balance sheet activities are given
weights of ½.
• Third, after activities are combined and weighted the liquidity creation is
constructed by including (catfat) and excluding off balance sheet items (catnonfat).
• ………………………………………………………………………………………...(1)
• ……………………….(2)

Illiquid Assets (weight 1/2)
Premises
Other Fixed assets
Capital work in progress
Other assets
Investments in associated companies
Loans to priority sector
Other loans
Liabilities and equity
Liquid liabilities (weight 1/2)
Demand deposits
Savings deposits
Bills payable
 
 
Illiquid Activities(weight 1/2)
Off-balance-sheet activities
Acceptances, endorsements and loan
obligations.
Guarantees on behalf of its constituents
Claims not acknowledged as debts
Other contingent liabilities
Classification of Liquidity
Semi Liquid Assets (weight 0)
Interbank assets
Loans and advances to public sector
Loans and advances to banks
Semi liquid liabilities (weight 0)
Term deposits
Borrowings from RBI
Borrowings from other banks
Semiliquid activities (weight 0)
 
Liquid Assets (weight-1/2)
Cash in hand
Balance with RBI
All investments excluding investments in subsidiaries
or associated companies
Illiquid liabilities (weight-1/2)
Subordinated debt
Perpetual debt
Borrowings from other institutions and agencies
Other borrowings
Other liabilities and provisions
Equity
liquid Activities(weight -1/2)
 Liabilities for partly paid debts
Questions
• When a bank takes in $1 in transactions deposits to fund a $1 business loan. What
happens to the liquidity creation?

• When a bank takes in $1 in transactions deposits to buy $1 in treasury securities.

What happens to the liquidity creation?
ROLE OF INTERMEDIARIES IN
THE FINANCIAL SYSTEM

• Financial intermediaries serve three useful purposes:

• They mitigate the default risk of deficit units when surplus
units lend to them.
• They ensure liquidity of savings by surplus units.
• They lower information costs.

59
RISKS IN LENDING
• Profitable lending is dependent on the bank’s ability:
• To take on and manage credit risk that arises from the
quality of the borrower and his business.
• To contend with the impact of fluctuations in interest and
exchange rates on profits.
• To manage the liquidity risk posed by mismatch in the
maturities of its liabilities and assets

60
WHO NEEDS CREDIT?
• Both ‘demand’ and ‘supply’ sides of the economy need credit.
• Bank credit is the cheapest source of funding.
• On the demand side, consumers need bank finance for basic
needs – housing, consumption, purchase of durables, etc.
• On the supply side, corporates and the government require
funds for manufacturing, trading, services – for day to day
operations, or long term capital investment.

61
CORPORATE AND RETAIL
BANKING
• Bank finance to the demand side is typically called ‘Retail
banking’, ‘financial services’, or ‘mass banking.’
• Bank finance to the supply side is typically called ‘wholesale
banking’, ‘corporate banking’, or ‘class banking.’

62
TYPES OF LENDING
• FUND BASED LENDING – direct lending to borrowers in the
form of loans /advances, based on prime or collateral security.
• NON FUND BASED LENDING – no funds outlay at the time
of entering into an agreement with third party on behalf of
customer.
• May crystallize into fund based advance if customer does
not fulfill terms of contract with third party.
• ASSET BASED LENDING – Based on earning capacity of
asset – includes securitization, project finance, etc.

63
TYPES OF FUND BASED LENDING

• SHORT TERM LOANS

• MEDIUM / LONG TERM LOANS
• REVOLVING CREDITS

64
THE NATURE OF CREDIT
DECISIONS
• Credit decisions are not easy
• They mean risk taking by the bank
• Money should not be lent unless there is good probability that
money will be repaid – default risk
• Collateral [security] is only a control measure
• Borrowing proposition and repayment to be considered in
isolation of security
• The experience and role of credit officers are critical factors

65
THE CREDIT PROCESS
• IMPORTANT INGREDIENTS OF THE CREDIT PROCESS
ARE:
• The Loan policy
• Business development
• Credit analysis / appraisal
• The initial recommendations based on analysis
• Credit administration & Credit delivery
• Credit review and monitoring

66
FINANCIAL APPRAISAL FOR
CREDIT DECISIONS
• Techniques prevalently used are:
• Financial ratio analysis
• Cash flow analysis
• Sensitivity analysis
• Financial ratios are grouped to indicate important aspects of
borrowing firm’s performance:
• Liquidity ratios
• Profitability ratios
• Leverage ratios
• Operating ratios
• Valuation ratios

67
COMPONENTS OF LOAN AGREEMENT

• Structure of credit facilities:

• Amount and nature
• Interest rate and other charges
• Security – prime and collateral
• Repayment terms
• The conditions / covenants for granting and continuing with
credit facilities:
• Affirmative covenants
• Negative covenants
• Events of default

68
LOAN PRICING
• The loan should be priced so as to Maintain ‘spreads’ between
cost of funds and yield on advances to ensure profitability.

69
A BASIC MODEL FOR LOAN
PRICING
COST PLUS LOAN PRICING MODEL
• Loan price = cost of funds +cost of servicing + risk premium +
profit margin

70
CREDIT RISK DEFINED

PROBABILITY THAT A BORROWER WILL FAIL

TO MEET OBLIGATIONS IN ACCORDANCE
WITH AGREED TERMS

71
CREDIT RISK MANAGEMENT
• MEANS..
• Managing risks in individual transactions.
• Managing risks in the credit portfolio.
• Managing the inter relationships between credit risk and
other risks.

72
BASEL COMMITTEE- PRINCIPLES
OF CREDIT RISK MANAGEMENT

 According to the Committee, a comprehensive credit risk

management program will address the following four areas:
 Establishing an appropriate credit risk environment;
 Operating under a sound credit granting process;
 Maintaining an appropriate credit administration,
measurement and monitoring process; and
 Ensuring adequate controls over credit risk.

73
PRUDENTIAL NORMS IN INDIA- LOANS
AND ADVANCES
• The RBI issues detailed guidelines periodically on the following
aspects:
• Asset Classification
• Income recognition
• Provisioning

74
Definition of NPAs
• The RBI defined NPAs as the loans where:
• the interest and/or principal amount remained overdue for a period of more than 90
days (in the case of term loans or bills received or discounted);
• the account remained out of order (in the case of overdraft or cash credit);
• the interest and/or principal remained overdue for two crop seasons (in the case of
short-duration crops) and one crop season (in the case of long-duration crops);
• overdue payments (in the case of derivative transactions) remained unpaid for more
than 90 days; and
• the liquidity facility had remained outstanding for a period of more than 90 days.
ASSET CLASSIFICATION--INDIA
• An asset becomes non performing when it ceases to generate income
for the bank.
• Loan assets are categorized as follows:
• Standard [Performing Assets]
• Non Performing Assets [NPAs]
• Sub-standard (NPA  12 months)
• Doubtful [ if sub standard > 12 months])
• Loss [irrecoverable]

76
PRESENT PROVISIONING NORMS- INDIA –
subject to change
Loan Classification Provision %
Standard Assets 0.25 - 1
Sub standard assets 15
Unsecured exposures (additional) 10
Doubtful Assets (secured)
 1 year 25
1year – 3 years 40
 3 years 100
Doubtful Assets (unsecured) 100
Loss Assets 100

77
Question
• Based on the data given below for bank branch as on 31/03/2019 answer the
following questions:

A/C holder name Balance (Lakh) Security (Lakh) NPA date

Arindam 140 50 30-09-2018
Parth 120 70 30-07-2016
Prapti 180 90 30-06-2017
Ananya 130 100 31-08-2018
Ramesh 180 180 31-07-2015

• What are the provisions required for each one of their account and why?
Solution
• Arindam’s account is in substandard category (less than equal to 12 months)
• Provisioning norm- Secured-15% and unsecured 25%
• Secured- 50 and Unsecured 90
• Provisioning required: 0.15*50+0.25*90=7.5+22.5=30 lakhs
• Parth‘s account is in doubtful 2 category
• Provisioning norm- Secured-40% and unsecured 100%
• Provisioning required: 0.4*70+1*50=28+50=78 lakhs
• Prapti’s account is in doubtful 1 category
• Provisioning norm- Secured-25% and unsecured 100%
• Provisioning required: 0.25*90+1*90=22.5+90=112.5 lakhs
• Ananya’s account is in substandard category
• Provisioning norm- Secured-15% and unsecured 25%
• Provisioning required: 0.15*100+0.25*30=22.5 lakhs
• Ramesh is in doubtful 2 category
• Provisioning required- 72 laks
INCOME RECOGNITION- INDIA
• Based on the record of recovery.
• Income from NPAs not recognized on accrual basis ->only
when it is actually received.

80
 Provisioning Coverage Ratio (PCR)

• The PCR is calculated as the ratio of Provisions (specific +

floating) to Gross NPAs.
• The PCR indicates the funds available with a bank to cover loan
losses.
• RBI stipulates that banks in India should hold a PCR of not less
than 70 per cent.

81
LOAN LOSSES
• Two types of losses are possible in respect of a borrower or
class of borrowers:
• Expected Losses [EL]
• Unexpected Losses [UL]

82
EXPECTED LOSSES [EL]
• These are part of the normal business risks banks carry and can
be provided for.
• EL is a function of three parameters:
• Probability of Default [PD]
• Exposure at default [EAD]
• Loss Given Default [LGD]

83
EXPECTED LOSSES AND CREDIT RISK

• EL can be modelled as EL = PD X EAD X LGD

• Probability of default- likelihood that a default will take
place over a specified time horizon (PD)
• The amount owed by counterparty at the moment of default
is exposure at default (EAD)
• The fraction of exposure which will be lost following a
default event is loss given default (LGD)
• Assume that based on historical performance a bank expects
around 1 percent of its loans to default every year with an
average recovery rate of 50 percent.
• What are expected losses for bank for a credit portfolio of 1000
crores?
84
Question
• A Indian bank recently disbursed a CAD 2 million loan, of which CAD 1.2
million is currently outstanding. According to the bank’s estimation , the
beneficiary has a 1% chance of defaulting over the next year. In case that happens,
the estimated loss rate is 20%. The probability of default and the loss rate have
standard deviations of 6% and 20%, respectively. Determine the expected loss
figures for the bank.
• Sol: 2400
A BASIC MODEL FOR QUANTIFYING CREDIT RISK

• Classifying loans and advances into performing or non

performing would help a bank determine the amount
of provisioning to be made.
• Based on level of NPAs, credit risk can be quantified.
A basic model would be:
• = [PBT / TA] / [total NPA / TA], or
• =PBT/NPA
• If above equation yields 0.3 for a bank, what does it
imply?

86
Numericals
• Tier 1 capital is 500 Rs and Tier 2 capital is 800 Rs. Risk Weighted Assets (RWA)
for credit risk is 5000 Rs and capital charge for market risk and operational risk
200 Rs and 100 Rs respectively. Regulatory CAR is 8%.
• Calculate total risk weighted assets
• Total risk weighted assets=8750
• Calculate CAR for Tier 1 capital
• Ans-5.71%
• Calculate Total CAR
• Ans-11.42%
Market Risk
• The Basel Committee on Banking Supervision defines banks’ market risk as “the risk of
losses in on- and off-balance sheet risk positions arising from movements in market
prices.

• Safety of Capital
• Liquidity
• Diversification of credit risk
VAR- Value at risk
• Tool to measure the risk in an investment in normal circumstances over a given period say day, month, year etc.
• Used to make assessment about possible loss.
• We must know volatility, confidence level and the time period.
• Daily value at risk= VAR= Volatility*Probability (z value)
• One day VAR is 2 lac Rs with 99% confidence level. What does this mean?
• Means-->1 out of 100 chance that daily loss is going to be more than 2 lac Rs in normal trading conditions
• Example- HDFC has investment of R.s. 50 crore, in shares of Reliance Ltd. The daily volatility is 2%. At 99%
confidence level calculate
• Daily VAR
• Weekly VAR
• Monthly VAR (30 days)
• Yearly VAR (250 days)
Solution
•  Sol: At 99 percent confidence interval z value is 2.33
• At 95 percent confidence interval z value is 1.65
• VAR %= 2% *2.33= 4.66%
• VAR amount= 500000000 *4.66%= 23300000
• 23300000 can be lost on a daily basis
• Weekly value at risk:- Daily VAR *= 23300000*2.6457=61644810
• Monthly value at risk:- Daily VAR *= 23300000*5.4772=127618760
• Yearly value at risk:- Daily VAR *= 23300000*15.8113=368403290
Question
• In previous 45 days trading, daily volatility of 1.25% is observed, for an
investment of Rs 5 lacs in the shares of Jaypee limited. At 98% confidence level,
calculate the VAR for the period of one month (assuming 25 trading days in the
month)
• At 98% confidence level z value is 2.06
• Daily VAR (%)= 1.25* 2.06=2.575%
• Daily VAR amount= 2.575*500000=12875
• 25 days VAR= 12875*5= 64375
Discussion
• What is operational risk?
• Why is it important?
• Measurement of operational risk?
• How is size and ownership measured?
• Sample and Methodology
• Results
• GI- Net Profit (Add: Provision, Write Offs, Reserves for contingencies, operating
expenses, Loss on sale of HTM instrument, Loss on sale of property Subtract:
Profit on sale of HTM investment, profit on sale of property, income from legal
settlement, extraordinary income, income from insurance activities)
Question
Beta
  BIA BIA BIA (%) SA SA SA
Year(-
Business Line Year(-3) Year(-2) 1)   Year(-3) Year(-2) Year(-1)
Corporate Finance 20 30 40 18
Trading & Sales 20 30 40 18
Retail Banking 20 30 40 12
Commercial Banking 20 30 40 15
Payments & Settlements 20 30 40 18
Agency Services 20 30 40 15
Asset Management 20 30 40 12
Retail Brokerage 20 30 40 12
         
Abhay Bank  
Capital Requirement          
             
Solution

  BIA BIA BIA Beta (%) SA SA SA

Business Line Year(-3) Year(-2) Year(-1)   Year(-3) Year(-2) Year(-1)
Corporate Finance 20 30 40 18 3.6 5.4 7.2
Trading & Sales 20 30 40 18 3.6 5.4 7.2
Retail Banking 20 30 40 12 2.4 3.6 4.8
Commercial Banking 20 30 40 15 3 4.5 6
Payments & Settlements 20 30 40 18 3.6 5.4 7.2
Agency Services 20 30 40 15 3 4.5 6
Asset Management 20 30 40 12 2.4 3.6 4.8
Retail Brokerage 20 30 40 12 2.4 3.6 4.8
               
Abhay Bank 160 240 320   24 36 48
               
Capital Requirement 240 36          
36              
Question

  31.03.2017 31.03.2018 31.03.2019

Net Profit 1000 1500 2000
Reserves for contingencies 15 20 25
Provisions 10 12 15
Profit on sale of one HTM instrument 5 4 6
Loss on sale of another HTM category 5 4 6
Operating expenses 25 30 35

Calculate capital charge for operational risk under basic indicator approach
  31.03.2017 31.03.2018 31.03.2019
Net Profit 1000 1500 2000
Reserves for contingencies 15 20 25
Provisions 10 12 15
Profit on sale of one HTM instrument 5 4 6
Loss on sale of another HTM category 5 4 6
Operating expenses 25 30 35
Gross Income 1050 1562 2075
Capital Charge 1562.333333 234.35  
Question
Bank A Portfolio Rs Cr RW What is the risk weight of loan
Investment G secs 20000 0 Portfolio?
Investment Shares 2000 125 What is the risk weight of an
MSE Loans 15000 0 Investment?
Corporate Loans (A rated) 50000 50 What is the total risk weight?
What is the minimum required
Other loans 2000 100
capital for CAR?
Cash Balance 5000 0
What is the minimum required CET1?
Balance with banks 1000 20 What is CAR if paid up capital is 5000
Other Assets 6000 100 crore?
Answer
• Risk Weight of loan-27000
• Risk weight of investment-2500
• Risk weight total-35700
• Min capital required- 3213
• minimum required CET1-1963
Question

Standard Loans Amount In (Cr) Rates of provision

Home Loans 4000 0.25%
Farm Credit in agriculture 10000 0.25%
MSE Loans 5000 0.25%
Corporate Loans 5000 0.40%
Restructured Loans 200 5%
Sub-standard secured 400 15%
Doubtful 1 (Sec-500) 800 25%
Doubtful 2 (Sec-300) 500 40%
Doubtful 3 (Sec-200) 300 100%
Total Loans 26200  
Lessons from NPAs crisis in Indian banks---
Article
• Determinants of NPAs in Indian banks?
• Crisis management framework?
• Stakeholder engagement?
• PCA?
• Challenges?
• Recommendations
Corporate Governance Challenges in Indian
Banks
• Corporate Governance?
• Why are banks different?
• Why CG in banks is critical?
• Constituents of CG?
• Why corporate governance in banks is different?
• How board in banks are different from non financial firms?
• Governance challenges for PSBs in India?
• Corporate Governance setup in India?
• Issue management framework?
• Recommendations
Mergers in the Indian Banking Sector: Public
Policy Challenges
• Would you recommend merger of public sector banks. Yes/No. Which option and why?
• Question 1. What are different types of mergers from a market perspective? What were the Narsimham committee
recommendations for bank mergers in India?
• Question 2-What is the difference between voluntary and compulsory mergers?
• Question 3. What is the PCA framework of RBI? Suppose the revised PCA framework levied by RBI was applicable
for banks from 1st April 2016 based on their financials at 31 st March 2016. How does it help in identifying weak
banks?
• Question 4. What are the reasons for consolidation of PSBs in India? How important is size in the context of
consolidation process in Indian PSBs relative to a global perspective?
• Question 5. What is the impact of economies of scale on bank efficiency, productivity and profitability?
• Question 6. What are the consequences of consolidation among PSBs?
• Question 7. What are the consolidation routes for mergers among PSBs? What would you recommend for
consolidation among PSBs?
• Answer 1- From the perspective of markets, mergers can be classified into three types:
Horizontal mergers, vertical mergers and conglomerate mergers.
• Horizontal mergers takes place between banks competing in the same business and
geographical markets.
• Vertical mergers take place between two or more firms involved in different stages of
production or distribution of the same product.
• Conglomerate mergers take place between two or more firms in the unrelated lines of
business.
• The Narsimham committee reforms in 1990s focused on making banking sector more robust
and competitive.
• The committee recommended bank mergers to have a three tier banking structure in India with
three large banks of international standards at the top, 8 to 10 national banks at tier 2 and large
number of regional banks at the bottom.
 Banks PCA Target Weak Bank
STATE BANK OF BIKANER & JAIPUR No
STATE BANK OF INDIA No
STATE BANK OF MYSORE No
STATE BANK OF TRAVANCORE No
ALLAHABAD BANK Yes- NNPAs>6% breaching risk threshold 1 for asset quality
ANDHRA BANK No
BANK OF BARODA No
BANK OF INDIA Yes NNPAs>6% breaching risk threshold 1 for asset quality
BANK OF MAHARASHTRA Yes NNPAs >6% breaching risk threshold 1 for asset quality
CANARA BANK Yes NNPAs>6% breaching risk threshold 1 for asset quality
CENTRAL BANK OF INDIA Yes NNPAs>6% breaching risk threshold 1 for asset quality
CORPORATION BANK Yes NNPAs>6% breaching risk threshold 1 for asset quality
DENA BANK Yes NNPAs>6% breaching risk threshold 1 for asset quality
 
 

IDBI BANK LIMITED Yes NNPAs >6% breaching risk threshold 1 for asset quality
INDIAN BANK No
Yes NNPAs>9% and negative ROA for two years breaching risk threshold 2 for asset quality and
1 for profitability. It also breaches the CRAR requirement which is between <=10.25 and >=7.75.
INDIAN OVERSEAS BANK Highly weak and risky.
ORIENTAL BANK OF COMMERCE Yes NNPAs>6% breaching risk threshold 1 for asset quality
PUNJAB AND SIND BANK No
PUNJAB NATIONAL BANK Yes NNPAs>6% breaching risk threshold 1 for asset quality
SYNDICATE BANK No
Yes NNPAs>9% breaching risk threshold 2 for asset quality. It also breaches the CRAR
requirement which is between <=10.25 and >=7.75 and Tier 1 leverage ratio requirement which is
UCO BANK less than 4. Highly risky.
UNION BANK OF INDIA No
Yes NNPAs>9% breaching risk threshold 2 for asset quality. It also breaches the CRAR
UNITED BANK OF INDIA requirement which is between <=10.25 and >=7.75. Highly risky.
VIJAYA BANK No
Answer 3
Almost half of the public sector banks breach one or more risk thresholds of revised PCA
framework of RBI.
The riskiest banks are Indian Overseas bank and the UCO bank. Indian overseas bank
breaches risk thresholds for asset quality, profitability and capital ratio whereas UCO bank
breaches risk thresholds for asset quality, capital ratio and leverage.
One of the important evaluations that can be done by policymakers using PCA framework is
to find out weak banks for resolution through mergers.
In this case Indian Overseas Bank and UCO bank can be the potential target for resolution.
Answer 4

• Economies of scale and scope- Economies of scale and scope are the most acknowledged reasons for consolidation among
PSBs driven by the insights of having few large banks of international standards. Large sized banks are required to finance the
huge infrastructure needs of the country.

• Mergers among PSBs should lead to synergies and cost savings for these units.
• Shareholder value- As highlighted by SBI Arundhati Bhattarcharya mergers among PSBs should result in benefiting
customers and must lead to greater shareholders value.

• Higher efficiency, market power and better accounting ratios- Another reason for consolidation of PSBs is that it should
result in increasing efficiency, market power and better accounting ratios for public sector banks which are facing issues related
to capital shortage, surging bad loans, low efficiency and poor accounting ratios like ROA, NIM etc. As argued by D. Subba
Rao, ex-governor, RBI, it should serve the interest of minority shareholders and must lead to greater autonomy for PSBs.

• Mergers should lead to technological synergies and geographical complementarity.

• One of the challenges facing the economy is the low credit growth. Mergers among PSBs would give a push to the credit
growth recovery. A revived credit growth would also drive the economic growth through required lending by the PSBs.

• Mergers would also address the issues related to credit quality and skill deficiency in these banks.
• Among other things mergers would also lead to saving lot of wastage, manpower process and branches.
Answer 5
• From the case we can clearly see that bank size and ROA are negatively related
with each other for Indian banks with a correlation figure of -0.12 pointing out
that as size increases profitability of banks decreases. At the same time bank size
is positively related to ROA for Chinese banks supporting the view that large
banks have benefits of economies of scale which drive their performance.
Answer 6 Challenges post Merger
• The consolidation among PSBs will not serve the problem of capital shortage in these units and they would at any cost
need capital infusion by the govt. to provide for the provisions for surging bad loans and also for meeting the capital
requirements under the Basel 3 norms.
• The challenge would also come in the form of redundancies in people and branches for banks.
• The consolidation strategy of merging two weak banks may not create a strong bank. Also, merging a strong bank with
a weak bank may not create a desirable strong bank.
• Employee morale and slowdown in business and productivity may be a critical challenge for PSBs. Employee unions
in these units have already shown resistance to consolidation among these units. Human resources challenge and cultural
unit are the biggest challenges post merger for these banks.
• Due to burgeoning stressed assets in PSBs they are not in a position to consolidate and any such attempt may worsen
their credit position post mergers.
• Some of the listed PSBs are trading at discount as compared to their book value so they may find it difficult to raise
money from the market to finance mergers.
• Mergers or consolidation among PSBs may also lead to reduced or falling recruitment in these units.
• According to ex RBI deputy governor K.C Chakrabarty if the objective is to make financial system efficient mergers
of PSBs will lead to greater inefficient units. He says that what is actually required is the competition among PSBs in
order to make the financial system efficient.
Answer 7- The consolidation routes for mergers among PSBs are as follows:-

•Merger of a strong bank with a weak bank

•Merger of two weak banks

•Merger of large banks with small weak banks

•Merging two large banks

•Merging small banks to create large banks

•Mergers of banks in the same place or geographical reasons

•Merger of banks in different geographical regions

•Merging of banks with same IT platform

•Merger of ailing PSBs with the strong and competitive private banks.

•Govt. of India will not be ready for such mergers as it would not be willing to lose its control over these units which are govt. vehicles
for fulfilling the socio development objectives of the govt. of India. The solution to mergers problem among PSBs is not easy and what is
required is the combination of several approaches. While India needs bigger banks of international standards it is important to ensure
competition in the banking sector. Apart from size other considerations would be to allow private sector to merge with PSBs taking care of
issues related to geographical region, IT integration etc.
IBC
• What is IBC?
• IBC was effective from May 2016. It becomes the single law that deals with insolvency and
bankruptcy by consolidating and amending various laws relating to reorganization and insolvency
resolution.
• It simplifies the process of insolvency resolution.
• What is the need for Insolvency and Bankruptcy Code in India?
• There was no single law dealing with insolvency and bankruptcy in India. The liquidation of companies
and individuals were handled under various Acts such as:
• Sick Industrial Companies Act, The Securitization and Reconstruction of Financial Assets and
Enforcement of Security Interest Act, 2002 (also known as the Sarfaesi Act), Companies Act 2013 etc.
• It led to an overlapping jurisdiction of different authorities like High Court, Company Law Board, Board
for industrial and financial reconstruction  (BIFR) and Debt recovery tribunal.
• This overlapping jurisdictions and multiplicity of laws made the process of insolvency resolution very
cumbersome in India.
Contd…….
• What is the coverage of IBC?
• IBC covers individuals, companies, limited liability partnerships, partnership firms and other legal entities as may
be notified.
• What is the time frame for resolution under IBC?
• The IBC aims at insolvency resolution in a time-bound manner (180 days, extendable by another 90 days under
certain circumstances) undertaken by insolvency professionals.
• What are the four pillars of IBC?
• Insolvency professionals; information utilities; adjudicating authorities (National Company Law Tribunal (NCLT)
and Debt Recovery Tribunal (DRT)); and the Insolvency and Bankruptcy Board of India.
• What is insolvency professional agency?
• It governs & certifies ‘Insolvency Professionals’.
• What are information utilities?
• Information Utilities are professional organizations which would collect, collate, authenticate and disseminate financial
information. They would maintain electronic databases on lenders and also terms of lending.
Contd….
• What is the difference between NCLT and DRTs?
• The NCLT is the forum where cases relating to insolvency of corporate persons will
be heard, while DRTs are the forum for insolvency proceedings related to individuals
and partnership firms.
• What is IBBI?
• Provides regulatory oversight over insolvency professionals, insolvency professional
agencies and information utilities.
• What are the challenges faced by IBC?
• No of appointments of Judicial members
• The number of NCLT benches
• No of trained insolvency professionals etc.
• What are the salient features of the Insolvency and Bankruptcy Code?
• The Insolvency and Bankruptcy Code 2016 is a comprehensive law and covers all individuals,
companies, Limited Liability Partnerships (LLPs) and partnership firms.
• The adjudicating authority is National Company Law Tribunal (NCLT)  for
companies and LLPs and Debt Recovery Tribunal (DRT) for individuals and partnership firms.
• The insolvency resolution process can be initiated by any of the stakeholders of the firm: firm/ debtors/
creditors/ employees. [As on 1st Dec 2017, more than 1000 cases have been filed with the NCLT]
• If the adjudicating authority accepts, an Insolvency resolution professional or IP is appointed. [Out of
the 1000 cases filed, 400 cases have been admitted by the NCLT]
• The power of the management and the board of the firm is transferred to the committee of creditors
(CoC). They act through the IP.
• The IP has to decide whether to revive the company (insolvency resolution) or liquidate it (liquidation).
• If they decide to revive, they have to find someone willing to buy the firm.
• The creditors also have to accept a significant reduction in debt. The reduction is known as a haircut.
• They invite open bids from the interested parties to buy the firm.
• They choose the party with the best resolution plan, that is acceptable to the majority of the creditors
(75 % in CoC), to take over the management of the firm.
Fintech and Banking
• What is fintech?
• Fintech is the use of technology to provide new and improved financial services.
• The (FSB) defines fintech as “technologically enabled financial innovation that could result in new
business models, applications, processes, or products with an associated material effect on financial
markets and institutions, and the provision of financial services.”
• Also adopted by BCBS.
• Explain the usefulness of fintech?
• It lowers the cost of financial services to improve consumer welfare.
• Research shows that fintech has improved the productivity of mortgage lending.
• What are the broad areas covered by fintech?
• It includes (i) credit, deposits, and capital-raising services; (ii) payments, clearing and set tlement services,
including digital currencies; (iii) investment management services (including trading); and (iv) insurance.
• What is the technological backbone of fintech and how is it useful?
• Blockchain technology. It helps in lowering search costs of matching transacting parties, Achieve
economies of scale in gathering and using large data, Achieve cheaper and more secure information
transmission and reduce verification costs.
• Why has fintech become so popular now?
• It is bypassing traditional intermediaries in the offering of financial services.
• It presents a potential threat to traditional financial intermediation.
• What are the three phases of fintech? Explain in detail?
• What are the important questions raised by author in the article?

• Question 1: How should we modify our theories of financial intermediation so as to accommodate banks, shadow
banks, and non-intermediated solutions?
• Question 2: How will credit, deposits and capital raising be affected by fintech? Will P2P platforms replace bank
lending?
• Question 3: On payments, clearing and settlement, what will be the role of cryptocurrencies vis-à-vis fiat money
and private money creation by banks? How will this affect central banks?
• Question 4: How will Blockchain-technology-assisted smart contracts affect financial markets.

1-The theories of financial intermediation will need to be modified by taking into account the objective function of P2P
lenders, by examining their existing contractual arrangements etc.
2- P2P lending will take some market share away from banks, but will not replace bank lending in the near future. P2P
lenders are likely to take risky borrowers, who lack collateral, away from capital constrained banks. Eventually, banks
will either build their own online lending platforms, acquire P2P platforms or partner with P2P platforms, so it unlikely
that the role of banks in the credit and deposit markets and capital raising will diminish significantly.
3-On payment systems, clearing and settlement, cryptocurrencies will grow in popularity but are unlikely to replace fiat
currency. It is likely that central bank digital currencies – which are centralized rather than being decentralized like
Bitcoin – will emerge in the future to replace cash.
4-Fintech will significantly affect trading and insurance. Smart contracts are likely to substantially impact financial
contracting, at both the intensive and extensive margins
• How to measure size of fintech?
• The size of fintech is difficult to ascertain because of varying definitions of fintech.
• However, one useful growth measure to use is venture capital (VC) investment in fintech companies.
• What is P2P lending?
• P2P lending—sometimes referred to as “marketplace lending”— is the loaning of money to
individuals and businesses through online services that directly match lenders with borrowers
without using an intermediating bank.
• What is the breakdown of P2P lending in the US?
• Consumer loans, business loans, invoice trading and mortgage loans?
• What is blockchain?
• Blockchain is a distributed ledger, which means that the ledger is spread among all peers in the
network, with each peer holding the ledger.
• Bitcoin is a virtual currency, i.e., it is a digital computer code that isstored in an electronic wallet in
cyberspace
• Rather, these digital currencies rely on a decentralized form of control, with ownership, security and
verification based on a cryptography-based digital ledger that replaces banks.
• Transactions are stored digitally on a public ledger known as the Blockchain. This removes the need
for a trusted financial intermediary like a bank to verify transactions.
• What is copy trading?
• The term “copy trading” is used typically in forex trading and it refers to the
phenomenon of copying the trades of successful traders.
• Many successful traders provide access to their trades, either for a fee or for free.
• What is Insurtech? Role of fintech in insurance?
• “InsurTech” is the branch of fintech that is dedicated to the insurance sector.
Block chain
• What is blockchain?
• Blockchain is a distributed ledger, which means that the ledger is spread among all peers in the
network, with each peer holding the ledger.
• Bitcoin is a virtual currency, i.e., it is a digital computer code that isstored in an electronic wallet in
cyberspace
• Rather, these digital currencies rely on a decentralized form of control, with ownership, security and
verification based on a cryptography-based digital ledger that replaces banks.
• Transactions are stored digitally on a public ledger known as the Blockchain. This removes the need
for a trusted financial intermediary like a bank to verify transactions.
• Why is it important?
• How does it work?
• Why are banks interested?
• Is it safe?
• Areas where it can be used?
Mutual funds
• What are mutual funds?
• What is Net Asset Value?
• What are the advantages of mutual funds?
• What are ETFs?
• What is the difference between open ended and closed ended funds?
• What are the types of mutual funds?
Insurance
• What is insurance?
• What is the difference between insurance and assurance?
• What is policy?
• What is policy falling due?
• What is premium?
• What is surrender value?
• What are the basic features of insurance contracts?
• What is subrogation?
• What do you mean by warranties?
• What are the benefits of insurance?
• What are the types of insurance products?
• What is the difference between term endowment and term insurance?
Valuation of bank
• The Dividend Discount Model (DDM) is a quantitative method of valuing a
company’s stock price based on the assumption that the current fair price of a
stock equals the sum of all of the company’s future dividends discounted back to
their present value.
• The dividend discount model was developed under the assumption that
the intrinsic value of a stock reflects the present value of all future cash flows
generated by a security.
• At the same time, dividends are essentially the positive cash flows generated by a
company and distributed to the shareholders.
Dividend Discount Model
• The
  dividend discount model was developed under the assumption that
the intrinsic value of a stock reflects the present value of all future cash flows
generated by a security.
• At the same time, dividends are essentially the positive cash flows generated
by a company and distributed to the shareholders.

• --> intrinsic value of the stock

• --> expected dividends per share over the holding period
• -->expected price at the end of the holding period
• --> required rate of return on the stock or cost of equity
• Now
  if we increase holding period of stock to n periods, the intrinsic value
can be rewritten as:

• Investors buy stock for holding it to infinite period or perpetuity

• For this case the intrinsic value can be expressed as the present value of
infinite stream of dividends discounted at the appropriate rate.

• However, dividends cannot be explicitly forecasted to infinity the forecasted

period is generally divided into explicit forecast period and the terminal
period.
• Intrinsic value= Present value of dividends for explicit forecast period+
present value of dividends for terminal period.
•• Intrinsic
  value of a stock is given as:

• Steps:
• Identify the period for which forecasting is to be done
• Forecasts the financial statements to compute expected dividends for the explicit
period
• Determine the terminal value based on the Gordon growth model
• Estimate the present value of dividends for the explicit forecast period and the
present value for the terminal period to arrive at the intrinsic value
• Compare the intrinsic value with the market value to arrive at the investment
decision.