14-2




                       NARSIMHAN COMMITTEE
                             REFORMS
                               I ...
The Management Of
                Capital

The purpose of this session is to discover why
capital – particularly equity ca...
14-4

              SW Analysis of Indian Banking

                         Strength
      Massive Branch Network

       ...
14-5

              SW Analysis of Indian Banking

                       Weaknesses
      Lack of competition
      Low c...
14-6

              SW Analysis of Indian Banking

                            Weaknesses
      Indifferent attitude of ba...
14-7



                              Recommendations
      Deregulation of interest rates
      Preemption of banks’ reso...
14-8



                              Recommendations
      Internal organisation of banks be left to
      judgment of in...
14-9



                              Recommendations
      Appointment of CMD should be free from
      political interfe...
14-10



                              Recommendations
      Banks should not take into account income from NPA
      wher...
14-11



                              Recommendations
      Criterion for income recognition to be
      recognised by ta...
14-12



                              Recommendations
      Banks to be restructured on the following lines
          3 t...
14-13



               Tasks Performed By Capital

      Provides a Cushion Against Risk of Failure
      Provides Funds ...
14-14



                                 Types of Capital

      Common Stock                                       Minor...
14-15



          Reasons for Capital Regulation


      To Limit the Risk of Failures
      To Preserve Public Confidenc...
14-16


            The Basle Agreement on
         International Capital Standards
      An International Treaty Involvin...
14-17



                                     Tier 1 Capital


      Common Stock and Surplus
      Undivided Profits
    ...
14-18



                                     Tier 2 Capital

      Allowance for Loan and Lease Losses
      Subordinated...
14-19


                    Basle Agreement Capital
                         Requirements

      Ratio of Core Capital (Ti...
14-20



     Calculating Risk-Weighted Assets

      Compute Credit-Equivalent Amount of Each Off-
      Balance Sheet (O...
14-21


       What Was Left Out of the Original
             Basle Agreement
      The Most Glaring Hole with the Origina...
14-22



                                              Basle II
      Aims to Correct the Weaknesses of Basle I
      Thre...
14-23


     Capital Adequacy Categories Based
        on Prompt Corrective Action

      Well Capitalized
      Adequatel...
14-24



              Internal Capital Growth Rate


                                  = ROE X Retention Ratio


        ...
14-25


     Planning to Meet a Bank’s Capital
                  Needs
      Raising Capital Internally
            Divide...
Session4&5
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Session4&5

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Narasimhan committee management of banks and financial institutions

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  1. 1. 14-2 NARSIMHAN COMMITTEE REFORMS I & II McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Bank Management and Financial Services, 6/e
  2. 2. The Management Of Capital The purpose of this session is to discover why capital – particularly equity capital – is so important for financial institutions, to learn how managers and regulators assess the adequacy of an institution’s capital position, and to explain the ways that management can raise new capital.
  3. 3. 14-4 SW Analysis of Indian Banking Strength Massive Branch Network Weaknesses Scarcity of skilled manpower New branches incurred losses for prolonged period specially those in rural and semi-urban centers Customer service deteriorated McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Bank Management and Financial Services, 6/e
  4. 4. 14-5 SW Analysis of Indian Banking Weaknesses Lack of competition Low capital base Low productivity High intermediation cost Technology use minimum No proper risk management system Prudential norms were weak McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Bank Management and Financial Services, 6/e
  5. 5. 14-6 SW Analysis of Indian Banking Weaknesses Indifferent attitude of bank officials at all levels Monitoring by central office becomes difficult in view of large geographical spread Increasing overdue in advances Political interference High degree of directed credit Impounding of huge resources of banks due to high CRR and SLR McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Bank Management and Financial Services, 6/e
  6. 6. 14-7 Recommendations Deregulation of interest rates Preemption of banks’ resources through SLR and CRR to be reduced No further nationalisation of banks Branch licensing to be abolished RBI policy towards foreign banks should be more liberal There should be level playing field between foreign and domestic banks Streamlining and rationalisation of foreign operations of indian banks McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Bank Management and Financial Services, 6/e
  7. 7. 14-8 Recommendations Internal organisation of banks be left to judgment of individual banks Computerisation should be speedier to handle ever growing volumes Individual banks should be free to make their own recruitment Duality of control between RBI and Ministry of Finance should end McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Bank Management and Financial Services, 6/e
  8. 8. 14-9 Recommendations Appointment of CMD should be free from political interference Capital of banks should be raised to 4% by March 1993 8% by March 1996 Of which 50% to be Tier I capital Banks should access capital markets for raising capital McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Bank Management and Financial Services, 6/e
  9. 9. 14-10 Recommendations Banks should not take into account income from NPA where interest remains past due for a period of 180 days Assets should be classified under four categories and provision made as under: Standard Nil Sub-standard 10% of total outstanding Doubtful 100% of security shortfall 20% to 50% depending on the period asset is doubtful Loss asset 100% provision or writeoff McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Bank Management and Financial Services, 6/e
  10. 10. 14-11 Recommendations Criterion for income recognition to be recognised by tax authorities Special tribunals be set up for speedy recovery of bank dues Establishment of Asset Reconstruction Fund Bad and doubtful assets to be transferred to ARF in a phased manner McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Bank Management and Financial Services, 6/e
  11. 11. 14-12 Recommendations Banks to be restructured on the following lines 3 to 4 large international banks 8 to 10 national banks having all India network Local Area Banks operating in specific regions RRBs confined to rural areas The revised system should be market driven and based on profitability considerations and brought about throughout a process of mergers and acquisitions McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Bank Management and Financial Services, 6/e
  12. 12. 14-13 Tasks Performed By Capital Provides a Cushion Against Risk of Failure Provides Funds to Help Institutions Get Started Promotes Public Confidence Provides Funds for Growth Regulator of Growth Role in Growth of Bank Mergers Regulatory Tool to Limit Risk Exposure Protects the Government’s Deposit Insurance System McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Bank Management and Financial Services, 6/e
  13. 13. 14-14 Types of Capital Common Stock Minority Interest in Preferred Stock Consolidated Subsidiaries Surplus Equity Commitment Undivided Profits Notes Equity Reserves Subordinated Debentures McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Bank Management and Financial Services, 6/e
  14. 14. 14-15 Reasons for Capital Regulation To Limit the Risk of Failures To Preserve Public Confidence To Limit Losses to the Central Government Arising from Deposit Insurance Claims McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Bank Management and Financial Services, 6/e
  15. 15. 14-16 The Basle Agreement on International Capital Standards An International Treaty Involving the U.S., Canada, Japan and the Nations of Western Europe to Impose Common Capital Requirements On All Banks Based in Those Countries McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Bank Management and Financial Services, 6/e
  16. 16. 14-17 Tier 1 Capital Common Stock and Surplus Undivided Profits Qualifying Noncumulative Preferred Stock Minority Interests in the Equity Accounts of Consolidated Subsidiaries Selected Identifiable Intangible Assets Less Goodwill and Other Intangible Assets McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Bank Management and Financial Services, 6/e
  17. 17. 14-18 Tier 2 Capital Allowance for Loan and Lease Losses Subordinated Debt Capital Instruments Mandatory Convertible Debt Cumulative Perpetual Preferred Stock with Unpaid Dividends Equity Notes Other Long Term Capital Instruments that Combine Debt and Equity Features McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Bank Management and Financial Services, 6/e
  18. 18. 14-19 Basle Agreement Capital Requirements Ratio of Core Capital (Tier 1) to Risk Weighted Assets Must Be At Least 4 Percent Ratio of Total Capital (Tier 1 and Tier 2) to Risk Weighted Assets Must Be At Least 8 Percent The Amount of Tier 2 Capital Limited to 100 Percent of Tier 1 Capital McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Bank Management and Financial Services, 6/e
  19. 19. 14-20 Calculating Risk-Weighted Assets Compute Credit-Equivalent Amount of Each Off- Balance Sheet (OBS) Item Find the Appropriate Risk-Weight Category for Each Balance Sheet and OBS Item Multiply Each Balance Sheet and Credit-Equivalent OBS Item By the Correct Risk-Weight Add to Find the Total Amount of Risk-Weighted Assets McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Bank Management and Financial Services, 6/e
  20. 20. 14-21 What Was Left Out of the Original Basle Agreement The Most Glaring Hole with the Original Basle Agreement is its Failure to Deal with Market Risk In 1995 the Basle Committee Announced New Market Risk Capital Requirements for Their Banks In the U.S. Banks Can Create Their Own In-House Models to Measure Their Market Risk Exposure Regulators Would Then Determine the Amount of Capital Required Based Upon Their Estimate Banks That Continuously Estimate Their Market Risk Poorly Would Be Required to Hold Extra Capital McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Bank Management and Financial Services, 6/e
  21. 21. 14-22 Basle II Aims to Correct the Weaknesses of Basle I Three Pillars of Basle II: Capital Requirements For Each Bank Are Based on Their Own Estimated Risk Exposure Supervisory Review of Each Bank’s Risk Assessment Procedures and the Adequacy of Its Capital Greater Disclosure of Each Bank’s True Financial Condition McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Bank Management and Financial Services, 6/e
  22. 22. 14-23 Capital Adequacy Categories Based on Prompt Corrective Action Well Capitalized Adequately Capitalized Undercapitalized Significantly Undercapitalized Critically Undercapitalized McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Bank Management and Financial Services, 6/e
  23. 23. 14-24 Internal Capital Growth Rate = ROE X Retention Ratio = Profit Margin X Asset Utilization X Equity Multiplier X Retention Ratio McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Bank Management and Financial Services, 6/e
  24. 24. 14-25 Planning to Meet a Bank’s Capital Needs Raising Capital Internally Dividend Policy Internal Capital Growth Rate Raising Capital Externally Issuing Common Stock Issuing Preferred Stock Issuing Subordinated Notes and Debentures Selling Assets and Leasing Facilities Swapping Stock for Debt Securities Choosing the Best Alternative McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Bank Management and Financial Services, 6/e
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