The document outlines various financial banking norms, focusing on risk exposures such as credit, liquidity, market, and operational risks that banks face. It discusses non-performing assets, financial inclusion initiatives, capital adequacy frameworks, and the evolution of banking regulations from Basel I to Basel III, emphasizing the importance of maintaining sufficient capital to absorb risks. Additionally, the document highlights the implications of these frameworks on the Indian banking sector and the ongoing efforts by the Reserve Bank of India to enhance financial stability.

1. Financial Banking Norms
Presented by:-
SHASHWAT SHANKAR
IMB2018017
Under the supervision of
Anurika Vaish

2. Risk Exposure
 Banks in the process of financial intermediation are confronted with various kinds
of financial and non-financial risks :-
 Credit Risk- If you've lend money to someone, then it involves an uncertainty of getting
money back. This uncertainty is Credit Risk.
 Liquidity Risk- The risk that a company or bank may be unable to meet short term
financial demands. This usually occurs due to the inability to convert a security or hard
asset to cash without a loss of capital and/or income in the process.
 Market Risk- The risk that prices (or factors that affect prices, such as interest rates) in
the market of interest will move in a unfavorable direction that disrupts the value of
one’s holdings
 Operational Risk- Operational risk is the prospect of loss resulting from inadequate or
failed procedures, systems or policies.
 Employee errors
 Systems failures
 Fraud or other criminal activity
 Any event that disrupts business processes.

3. Non Performing Assets
 Loans and advances given by the banks to its customers is are an Asset to the
bank.
 A loan (an asset for the bank) turns as NPA when the EMI, principal or interest
component for the loan is not paid within 90 days from the due date.
 Thus a Bad Loan is an asset that ceases to generate any income for the
bank.
NPA of Banking Sector
 The non-performing assets of the banking sector rose sharply to 1.28 per cent
in 2011-12 from 0.97 per cent a year ago due to high interest rate and
slowdown in the economy.

4. Financial Inclusion
 ‘Financial inclusion’ or inclusive financing is the delivery
of financial services at affordable costs to sections of
disadvantaged and low-income segments of society, in
contrast to financial exclusion where those services are
not available or affordable.
 An estimated 2.5 billion working-age adults globally have
no access to the formal financial services.
 The Reserve Bank of India (RBI) set up the Khan
Commission in 2004 to look into financial inclusion
 In the report RBI exhorted the banks to achieve greater
financial inclusion with basic "no-frills“ banking account.

5. Steps taken by Government & RBI
 In India, RBI has initiated several measures to achieve greater
financial inclusion
 Opening of no-frills accounts
 Relaxation on know-your-customer (KYC) norms
 Engaging business correspondents (BCs)
 Use of technology
Financial Inclusion Tax
 On June 25, 2013, CRISIL , India's leading credit rating and research
company launched an index to measure the status of financial
inclusion in India.
 It combines three critical parameters of basic banking services —
 Branch penetration,
 Deposit penetration, and
 Credit penetration

6. Capital
 The basic approach of capital adequacy framework is that a bank should have
sufficient capital to provide a stable resource to absorb any losses arising
from the risks in its business.
 For supervisory purposes capital is split into two categories:
 Tier I and Tier II. These categories represent different instruments’ quality as
capital:
 Tier I Capital consists:
 Equity Capital (Shareholders‘ Funds)
 Disclosed Reserves:
 Premium over shares,
 Retained earnings,
 Legal reserve
 It is a bank’s highest quality capital because it is fully available to cover
losses.

7. Legal Reserve:
 The reserve requirement has two main purposes:
 Risk Management: By requiring that large institutions hold a percentage of their
deposits in reserve, the central bank forces them to self-insure against losses, and
to keep some cash on the asset side of the balance sheet.
 Controlling the money supply: By adjusting reserve requirements, the central
bank is able to influence the velocity of money.
 The two asset categories are:-
 Required Reserve (Vault cash & Reserve deposits )
 Excess Reserve (Reserve for loan purposes)
 Vault Cash (Required Reserve) -Paper bills and metal coins kept on the bank
premises, both the vault and teller drawers.
 To satisfy currency withdrawal demands of depositors.
 Vault cash is not part of the official M1 money supply.

8.  Reserve deposits are the one that regulators require. These are deposits that
banks keep with the Reserve Bank Of India System. Any legal (or total) reserves
over and above those required by regulators are excess reserves.
 These excess reserves are used for loans, which makes them exceedingly
important to the banking industry.
 Tier II capital Consists:
 Undisclosed reserves- They are accepted by some regulators where a bank has made a
profit but this has not appeared in normal retained profits or in general reserves of the
bank.
 Revaluation reserves- is created when a bank has an asset revalued and an increase in
value is brought to account.
 General provisions
 Subordinated debt
 Hybrid Instruments- Have some characteristics of both DEBT and EQUITY. These are
close to equity in nature, in that they are able to take losses on the face value without
triggering a liquidation of the bank
 This capital is less permanent in nature.
 The loss absorption capacity of Tier II capital is lower than that of Tier I
capital.

9. Capital to Risk Weighted Assets
 A measure of a bank's capital. It is expressed as a percentage of a bank's risk
weighted credit exposures.
Risk Weighted Assets
 Risk weighted assets is a measure of the amount of a banks assets, adjusted
for risk.
 It can be arrived simply by multiplying it with factor that reflects its risk.
 The financial crisis of 2007 and 2008 was driven by financial
institutions investing in subprime home mortgage loans that had a far higher
risk of default than bank managers and regulators believed to be possible.
When consumers started to default on their mortgages, many financial
institutions lost large amounts of capital, and some became insolvent.

10. Capital to risk weighted Ratio

11. Why Capital Requirement?
 While bank’s assets (loans & investments) are risky and prone to losses, its
liability (deposits) are certain.
 Assets = External Liabilities + Capital.
 Liabilities (deposits) to be honored. Hence reduction in capital. When capital
is wiped out – Bank fails.
 Bank failures - mainly by losses in assets – default by borrowers (Credit Risk),
losses of investment in different securities (Market Risk) and frauds, system
and process failures (Operational Risk)
Capital Adequacy Ratio (CAR) is the measure of a bank's financial
strength expressed by the ratio of its capital (net worth and subordinated debt)
to its risk-weighted credit exposure (loans).
 Also known as Capital to Risk (Weighted) Assets Ratio (CRAR), is the ratio of a
bank's capital to its risk. National regulators track a bank's CAR to ensure that it
can absorb a reasonable amount of loss and complies with statutory Capital
requirements.

12. Failure of Bretton Woods System
 Bretton Woods System – 1944
 – IMF
 – World Bank
 – System of fixed exchange rates
Under the agreement, countries promised that their central banks would
maintain fixed exchange rates between their currencies and the dollar.
 In 1971, the United States was suffering from massive stagflation. It was
partly a result of the dollar's role as a global currency. In response, President
Nixon started to deflate the dollar's value in gold.
But the plan backfired.
 In 1973, Bretton Woods System led to causalities in German Banking System
and UK’s Banking system with huge amount of foreign exchange exposures
which was more than the capital of the banks.

13. Risk Management through BASEL
committee
 The Basel Committee on Banking Supervision was established in 1974, by the
Bank of International Settlements (BIS). In order to help the banks to
recognize the different kinds of risks and to take adequate steps
 An international organization founded in Basel, Switzerland in 1930 to serve
as a Bank for Central banks.
 As per Basel Committee guidelines issued capital adequacy was considered
panacea for risk management.
 Committee consisting of members from each of the G10 countries. It is
represented by central bank governors of each of the G10 countries.
 Thirteen industrialized Nations that meet on an annual basis to consult each
other on international financial matters.
 It meets regularly 4 times a year.

14. BASEL I:-The Capital Accord
 The Basel I Accord attempted to create a cushion against credit risk.
 The Basel I Accord focused on reducing credit risk, prescribing a minimum
capital risk adjusted ratio (CRAR) of 8percent of the risk weighted assets.
Although it was originally meant for banks in G10 countries, more than 100
countries claimed to adhere to it, and India began implementing the Basel I in
April 1994.
 To measure market risk, banks were given the choice of two options:
 A standardized approach using a building block methodology
 An ‘in-house’ approach allowing banks to develop their own proprietary models to
calculate capital charge for market risk by using the notion of Value-at-Risk
 The norm comprised of four pillars,
 Constituents of Capital,
 Risk Weighting,
 Target Standard Ratio, and
 Transitional and implementing arrangements.

15. Adoption and Implementation of Basel I
Norms by RBI
 Recognizing the importance of Basel Norms, RBI initiated reforming Indian
banking Sector through adopting Basel I norms for Scheduled commercial
Banks in 1992, and its implementation spread over the next three years.
 However, there is a ‘three track’ approach for Basel compliance
 The commercial banks are Basel I compliant with respect to credit and market
risks;
 The urban cooperative banks maintain capital for credit risk as per Basel I and
market risk through surrogate charges;
 The rural banks have capital adequacy norms that are not on par with the Basel
norms.
 It was stipulated that foreign banks operating in India should achieve a CRAR
of 8 per cent by March 1993, while Indian banks with branches abroad should
achieve the 8 per cent norm by March 1995.
 The capital adequacy norm for India’s commercial banks was higher than the
internationally accepted level of 8 percent, i.e. 9 percent.

16. Transition to BASEL II
 Eventually in 2004, the more sophisticated Basel II replaced the risk
insensitive Basel I aiming at ensuring capital allocation, credit risk,
operational risk and market risk.
 It not only deals with CRAR calculation, but has also got provisions for
supervisory review and market discipline.
 Thus, it stands on three pillars:
 Minimum regulatory capital (Pillar 1): This is a revised and extensive framework for
capital adequacy standards, where CRAR is calculated by incorporating credit,
market and operational risks.
 Supervisory review (Pillar 2): This provides key principles for supervisory review,
risk management guidance and supervisory transparency and accountability.
 Market discipline (Pillar 3): This pillar encourages market discipline by developing a
set of disclosure requirements that will allow market participants to assess key
pieces of information on risk exposure, risk assessment process and capital
adequacy of a bank.

17. Adoption and Implementation of Basel II
Norms by RBI
 Commercial banks in India adopt Standardized Approach (SA) for credit risk.
 Banks rely upon the ratings assigned by the external credit rating agencies
chosen by the RBI for assigning risk weights for capital adequacy purposes.
 Banks must disclose the names of the credit rating agencies that they use for
the risk weighting of their assets.
 The establishment of suitable risk management systems in banks and their
review by the supervisory authority (RBI).
 For such comprehensive disclosure, IT structure must be in place for
supporting data collection and generating MIS which is compatible with Pillar
3 requirements.
 The RBI has stated that Indian banks must have aCRAR of minimum 9%,
effective March 31, 2009.

18. Emergence Of BASEL III
 Special emphasis on the Capital Adequacy Ratio
Capital Adequacy Ratio is calculated as:-
CAR = (Tier 1 Capital + Tier 2 Capital) / Risk Weighted Assets
 Reducing risk spillover to the real economy
 Comprehensive set of reform measures to strengthen the banking sector.
 Strengthens banks transparency and disclosures.
 Improve the banking sectors ability to absorb shocks arising from financial and
economic stress.
 While good quality of capital will ensure stable long term sustenance,
compliance with liquidity covers will increase ability to withstand short term
economic and financial stress.
 The essence of Basel III revolves around two sets of compliance:
 Capital
 Liquidity

19. Major Features of BASEL III
 Revised Minimum Equity & Tier 1 Capital Requirements
 Better Capital Quality
 Backstop Leverage Ratio
 Short term and long term liquidity funding
 Inclusion of Leverage Ratio & Liquidity Ratios
 Rigorous credit risk management
 Counter Cyclical Buffer
 Capital conservation Buffer

20. Comparison of Capital
Requirements under BASEL II and BASEL III :

21. Understanding the Indian scenario
 The implementation of Basel III norms commenced in India from April 1, 2013
in a phased manner, with full compliance initially targeted to be achieved by
March 31, 2018 but extended to March 31, 2019.
 In order to strengthen risk management mechanism: “Indian banks should
have minimum Tier-I capital of 7 percent of risk-weighted assets.
 Total capital must be at least 9 percent of risk-weighted assets.
 Besides, it has also suggested for setting up of the capital conservation buffer
in the form of Common Equity of 2.5 per cent of RWAs.
 On aggregate, banks are comfortably placed in terms of capital adequacy, but
a few individual banks may fall short due to implementation of Basel III
norms.
 It is proposed that the implementation period of minimum capital
requirements and deductions from Common Equity will begin from January 1,
2013 and be fully implemented as on March 31, 2018.

22. Basel III: Implications in India

23. Comparison of Capital Requirement

24. History of Banking Sector
 Developed during the British era. British East India Company established three
banks.
 Bank of Bengal-1809
 Bank of Bombay-1840
 Bank of Madras –1843
 These three banks were later amalgamated and called Imperial Bank
Types of Banks
 Central Bank
 The Reserve Bank of India
 Public Sector Banks
 State Bank of India
 Private Sector Banks
 Co-operative Sector

25. References
[1] Allen, Bill, Ka Kei Chan, Alistair Milne, and Steve Thomas (2012), “Basel
III: Is the cure worse than the disease?” International Review of
Financial Analysis, Vol. 25, pp. 159- 166.
[2] Bank for International Settlements (2013), “Report to G20 Finance
Ministers and Central Bank Governors on monitoring implementation of
Basel III regulatory reform”, Bank for International Settlements
publications
[3] Reserve Bank of India (2013), “Reserve Bank of India Annual Report
2013-14”, Reserve Bank of India Publications.
[4] Shah, Mamta (2013), “Basel-3 and its Impact on Indian Banking Sector,”
Journal of Indian Research, Vol. 1, No. 1, pp. 53-58.

26. THANK YOU…!!