Group F _ .pptx

ABC to XYZ: A Journey
& Supervisor’s
Perspective
Group F (Fireballs)

Q.1 -How macro economic environment changes should
prompt the discovery of newer techniques to be adopted
in the annual inspection ?
Adapting to Changing Macroeconomic Environment in
the Indian Banking System

Need for Adapting Inspection Techniques
● Changing Risk Landscape: The evolving macroeconomic environment introduces
new risks and challenges that traditional inspection methods may not adequately
capture. Market dynamics, emerging technologies, and regulatory frameworks can
contribute to new risks.
● Efficiency and Effectiveness: Adopting newer techniques enhances the efficiency
and effectiveness of inspections. It enables banks to identify risks more accurately
& efficiently, ensuring timely risk mitigation and effective resource allocation.
● Regulatory Compliance: Staying up-to-date with regulatory expectations is
essential. Banks need to align their inspection techniques accordingly to remain
compliant.

Macroeconomic Environment Changes
● GDP Growth: The growth rate fluctuated throughout the year, impacting
various sectors, including banking. For example, the growth rate declined
in the first quarter due to the impact of the second wave of COVID-19.
● Inflation Rate: Inflation rates also underwent fluctuations, affecting
consumer spending, investment decisions, and monetary policy measures.
● Interest Rates: RBI adjusted interest rates to manage inflation and
stimulate economic growth. These changes had implications for borrowing
costs, loan demand, and deposit rates.

Innovative Techniques for Annual Inspections
● Data Analytics: Advanced analytics processes large volumes of data
to identify patterns and detect anomalies in banking operations. This
helps in areas such as credit risk assessment, fraud detection, and
customer behavior analysis.
● Artificial Intelligence and ML: AI and ML can automate routine
inspection tasks, enhance risk assessment models, and improve
fraud detection. Examples include chatbots for customer
interactions, natural language processing for document analysis,
and predictive modeling for identifying potential risks.
● Automation: Automating manual inspection processes, such as
document review, data entry, and report generation, improves
efficiency and reduces errors. Technologies such as robotic process
automation (RPA) and workflow management systems facilitate

Q2 : a) What would be your approach towards the adverse event happened to the promoter in this
case study ?
1. Understand the Impact:
- on financial position, risk management practices, reputation, and compliance with regulatory
requirements.
- determining the areas that require closer examination during the inspection.
2. Review Risk Management Framework: Evaluate the effectiveness of the company's risk
management framework in identifying, assessing, and mitigating the risks associated with the adverse
events.
3. Scrutinize Governance and Control Mechanisms:
- to ensure they are robust and capable of identifying and addressing any misconduct or malpractices.
- examining the roles and responsibilities of the Board of Directors, management, and internal audit
function in overseeing and monitoring the company's activities.

4. Assess Compliance with Regulatory Requirements:
- Related to reporting, transparency, and disclosure.
- Ability to adapt to changes in the regulatory environment.
5. Evaluate Business Continuity Planning:
- Its ability to effectively manage and mitigate risks arising from adverse events.
- Examining contingency plans, stress testing, and disaster recovery measures to ensure the company
can withstand and recover from unexpected disruptions.

Q2. b) Would this event materially impact your inspection even though the company did not
default in any kind of its loan commitment?
1. Reputational Risk:
- Even if the company did not default on its loan commitments, the damage to its reputation
can affect customer trust, investor confidence, and relationships with other stakeholders.
- The inspection should consider the impact of reputational risk on the company's business
prospects and its ability to attract funding and customers.
2. Risk Management and Governance:
- The inspection should assess whether the company's risk management framework and
governance structure adequately identify, assess, and mitigate risks associated with such
adverse events.
- It should also evaluate the company's ability to manage and respond to similar situations in
the future.

3. Regulatory Compliance:
- Even if the company did not default on its loan commitments, regulatory authorities
may scrutinize its practices and operations more closely.
- The inspection should assess whether XYZ Finance Limited has complied with all
relevant laws, regulations, and reporting requirements, particularly in relation to the
adverse events.
4. Financial Soundness:
- The inspection should evaluate the financial impact of the adverse events on the
company's profitability, capital adequacy, liquidity, and asset quality.
- It should also consider any potential vulnerabilities or risks that may arise from the
adverse events, such as increased credit risk, funding challenges, or asset quality
deterioration.

5. Risk Assessment:
1. The inspection should review the company's risk assessment
methodologies, stress testing practices, and forward-looking analysis
2. to determine whether the adverse events have introduced new risks or
amplified existing risks.
When adverse events impact the company, the inspection would give more
attention to reputational risk, risk management practices, regulatory
compliance, and the financial impact of those events. In the absence of adverse
events, the inspection would focus more on overall risk assessment, financial
performance, business growth, and compliance with regulatory requirements.

Q3. With the digitalisation of the economy, the scope of information
asymmetry would be reducing day by day . How do you want to
incorporate this extremely important phenomenon in the creation of
checklist to be used for annual audit of RE ?
► Information asymmetry is a situation where one party has more or better
information than the other party in a transaction or a contract.
► In the context of retail loan products, this means that lenders may have
less information than borrowers about their creditworthiness, repayment
capacity, or risk profile.
► This can result in
► adverse selection, where lenders end up lending to high-risk borrowers who are
more likely to default, or
► moral hazard, where borrowers have an incentive to behave irresponsibly after
receiving the loan.

Checklist for annual audit of RE
► Balance sheet and Financial statement audit
► IT Systems Audit : Access Management, Integrity
► Cyber Audit
► Model Checking

Q8. With the reduction of information asymmetry and increased
transparency of doing business arising out of digitalisation of Indian
economy , retail loan products are fraught with risks which may crop
up . Please identify such risks which may crop up in the future and
what should be your instruction to REs to address this situation . As per
your view , is this a known known or known unknown or unknown
unknown scenario and why ?
Risks that may crop up in the future due to digitalisation of retail loan
products
► Cyber risk : Data Breaches, Identity theft
► Operational risk : BCP, system errors
► Credit risk : Model Risk in Digital Lending, Customer selection
► Compliance risk : Privacy, Consumer Protection

Regulators Instructions to RE’s
Regulators should provide clear and consistent guidance and supervision
► To establish and maintain a robust cyber security framework that covers the
identification, protection, detection, response, and recovery of digital assets and
systems from cyber threats
► To ensure adequate operational resilience and contingency planning for digital
platforms and processes that support the delivery of loan products and services.
► To validate and monitor the performance and outcomes of digital lending models
and methods that use alternative data sources, advanced analytics, machine
learning, etc., and ensure their alignment with the credit risk appetite and
policies.
► To comply with the relevant regulations and standards related to data privacy,
consumer protection, cyber security, anti-money laundering, etc., and disclose
the necessary information to customers and regulators about the use of digital
lending practices.

► Providing clear and transparent information to their customers about
their products, services, fees, and terms and conditions, and educating
them about the benefits and risks of digital bankin

Is it known known or known unknown or
unknown unknown scenario and why?

• Data Breaches
• Regulatory Compliance Challenges
• Consumer Protection Issues
• Monopoly Risk
Known
Knowns
• Algorithmic Bias
• Changing Customer Behavior
Known
Unknowns
• New types of cyber threats
• Regulatory changes
Unknown
Unknowns

Q4. Please carry out the analysis of the balance sheet
as shown above and from the analysis give your view
about the appropriateness of this type of balance
sheet during the time of crisis.
Q11. Please analyse both financial statements and
additional information given with respect to
comparable funding cost and post analysis please
prepare your checklists that would address risks
embedded within the RE.

•Assets- the composition and quality of assets, their
liquidity, and any potential risks associated with them
•Evaluate the nature, maturity dates, interest rates, and
terms of the liabilities. Assess the company's ability to
meet its obligations and the overall level of debt.
•Analyze the changes in equity over time, including any
dividends or share repurchases. Look for signs of dilution
or stock issuances that might impact ownership

A.Liquidity : Current Ratio
B.Leverage : D/E Ratio- d to determine the overall level of financial risk a company and its
shareholders face
C.Efficiency : NIM Ratio- a measure of the difference between interest paid and interest
received, adjusted for the total amount of interest-generating assets held by the bank.
D.Profitability : ROE, ROA - how well management is employing the company's total assets to
make a profit.
E.Market value : EPS- indicates how much money a company makes for each share of its

Sources of funds
•Equity capital- no funds raised since 2021, retention ratio
– 61% and 43% in FY 21 and 22
•Long term Non Convertible Debenture- approx. 12%
•Commercial papers- 20%
•Loans from Banks- 52%

FUNDING RISK
•Assessing the company’s ability to raise funds in times of
need at comparable market rates.
•Checklists to address the risk
•Concentration risk- is the NBFC diversifying it’s funding
sources
•Is the NBFC monitoring and maintaining an appropriate mix
of funding instruments (e.g., bank loans, bonds, commercial
paper) to optimize funding costs and mitigate refinancing
risks?

•Interest Rate Risks- The borrowing costs for different funding
sources (loans from banks, commercial paper, and debentures)
have varied over time. Fluctuating interest rates can impact the
cost of borrowing and affect the RE's profitability and cash flows.
•Does the NBFC Monitor and analyze interest rate movements
and their potential impact on funding costs.
•Does the NBFC perform stress testing and scenario analysis to
assess the RE's sensitivity to changes in interest rates.
•Does the NBFC consider hedging strategies such as interest rate
swaps or fixed-rate borrowings to mitigate interest rate risk

•Does the NBFC have robust liquidity management policies and
procedures in place to ensure adequate funding availability? Has
the NBFC developed contingency funding plans and establish
lines of credit to address potential liquidity shortfalls.
•Does the NBFC conduct stress tests to assess its liquidity
position under various scenarios, including adverse market
conditions?
•Does the NBFC monitor and manage the maturity profiles of
borrowings to ensure sufficient liquidity is available to meet
obligations

Question Number 5
Please give your views about the appropriateness of strategy taken by the
company for addressing the negative outcome.
Do you think that this type of strategy would impact your annual inspection
methodology.

Strategy Adopted
1. Replaced Mr Jalan and inducted one retired Executive Director of a Public
Sector Bank
2. Confidence building calls with the investors
3. Changing company name

Question 6
Please give your comment about the management of credit risk by the
Regulated entities through diversification effort.

Shifting of the Business Model
During the year 2000
●Lent about 80% of the debt to
small and medium enterprise
customers through combination
of secured product i.e. Loan
Against Property ( LAP) and
unsecured loans like Business
Loan . Remaining part of debt is
invested in G Sec and about 60%
of the net worth was invested in
Fixed Asset.
During 2021-2022
●Loan portfolio is about 82% and
rest is in the form of investments
. Within the loan portfolio,
currently retail loan comprises of
about 65% and the rest is
corporate loan

Loan Portfolio
Retail Loan(65%)
●Personal Loan
●Business Loan
●Secured SME Loan
●Loan Against Property
Corporate Loan(35%)
●Loan Against Shares
●Infrastructure Loan
●General Purpose Corporate Loan

Retail Loan
Personal Loan(10%)
• Private
companies in
metro and urban
areas
• CIBIL- 740 and
above
• GNPA- 2.50%
• NNPA- 0.75%
• Average Ticket
Size- 15l to 75l
• There is no
internal rating
Business Loan(15%)
• Unsecured Loan
• CIBIL- 650-700
• GNPA- 5.60%
• NNPA- 2.25%
• Average Ticket
Size- 25l to 150l
Secured SME
Loan(30%)
• LTV- 60%
• GNPA- 2.50%
• NNPA- 0.5%
LAP(45%)
• LTV- 55%
• GNPA- 3.50%
• NNPA- 1.75%
• Average Ticket
Size – 4 Cr

Corporate Loan
Loan Against
Property(40%)
• LTV- 50%
• GNPA- 2%
• NNPA-0.5
• There is no internal
rating mechanism
Infrastructure
Loan(30%)
• LTV- 65%
• GNPA- 2.50%
• NNPA- 0.75%
General Purpose
Corporate Loan(30%)
• LTV- 60%
• GNPA-2.25%
• NNPA- 1%
• There is no internal
rating mechanism

Role of Regulator in Managing Credit Risk
●Setting Prudential Regulations
●Conducting Risk Assessments
●Monitoring and Supervision
●Enforcing Regulatory Compliance
●Promoting Transparency and Disclosure
●Crisis Management and Resolution

Advantage to regulated entity from credit
diversification
●Risk Mitigation
●Stability and Resilience
●Enhanced Risk-Return Profile
●Investor Confidence and Reputation

2. Retail Loan Portfolio: -
(a)Personal Loan: Major observations associated: -
(i) Big Average ticket Size :- Average ticket size is 15 lakhs.
(ii) Risk of loan being unsecured vis-à-vis the size of loan may be a
point of concern at the time of future stress in the economy.

(b) Business Loan: Major observations associated: -
(i) 75% of the business loans are given to the borrowers with borderline credit score
between 650-700.
(ii) Comparatively high GNPA and NNPA ratio of 5.6% and 2.25% which may prove to be
riskier as business loans are unsecured.
(c) Secured SME Loan:
(i) Contributes 30% of the total retail loan portfolio which may be a major risk
concentration.
(ii) For majority of the loans, borrowers have already taken working capital limit from the
banks.
(iii) Only 30% of the loan portfolio is assessed based on income model.
(iv) Average yield is 11% which is less compared to other category of retail loans.

(d) Loan against Property: Major observations associated: -
(i) Big Average ticket Size :- Average ticket size is Rs. 400 lakhs.
(ii) High concentration as it constitutes around 45% of loan
portfolio.

3. Points for checklist: -
(i) Rating model developed by the banks for different loan products.
(ii) Portfolio concentration strategy adopted by the bank and whether
current loan portfolio is complying with the same.
(iii) Sectoral concentration strategy adopted by the bank and whether
the bank is complying with the same.

Risk Analysis of Loan Products

Informatics of Loan Products : -
Type of Loan
Product
Category Weightag
e in Loan
Portfolio
Average
Tenure
Vintage
Period
Yield
(per
annum)
Average
Ticket Size
(in Rs.)
Personal Loan Retail 6.5% 4 years 1.5 years 16% 15 lakhs
Business Loan Retail 9.75% 4 years 1.75
years
18% 25 lakhs
Secured SME
Loan
Retail 19.5% 5 years 3.3 years 11.25 % Not
Given
Loan Against
Property
Retail 29.25% 8 years 5 years 14% 4 crores
Loan against Share Corporate 14% 4 years 3 years 14% Not Given
Infrastructure Loan Corporate 10.5% 5 years 1.5 years 13% Large
funding
consortium
loan
General Purpose
Corporate Loan
Corporate 10.5% 3.3 years 3 years 13.50% Not given

Analysis for Asset Liability Mismatch Risk
A. Uses of Funds: -
(i) Weighted Average Tenure of all loans is 5.4 years.
(ii) Weighted Average Vintage Period of all loans is 3.25 years.
(iii) Weighted Average tenure of retail loans is 6.1 years and they
constitute around 65% of total loans and around 53% of total assets.
(iv) Weighted Average tenure of corporate loans is 4.1 years and they
constitute around 35% of total loans and around 28.7% of total
assets.

Analysis for Asset Liability Mismatch Risk: -
B. Sources of Funds: -
● Borrowings constitute around 31% of all the funds raised.
● Loans from banks constitute around 50% of all the funds
raised.
● Funds from Commercial Paper constitute around 19% of all
the amount raised.
● Funds from LT Non-convertible debenture constitute around
12% all the funds.

Analysis for Asset Liability Mismatch Risk: -
(i) The asset-liability mismatch is when the entity has to pay a short-term liability for
which it is undergoing a long-term asset.
(ii) In order to avoid ALM with good buffer, the RE should:-
(a) Focus on raising comparatively longer term funds from the banks and
borrowings since they are the major source of funds to the RE.
(b) Focus on raising long term sources of funds with relatively higher tenor
premium and it can provide long term funds with more premium keeping in
view the competition.
(c) Revisit its strategy towards providing retail loans specially secured SME
Loans and LAP since they have relatively higher tenure and vintage period.
(d) Strategize towards providing more corporate loans since they have relatively
lower tenure and vintage period and good yield.

Q. 10- Please give your comment about sourcing pattern of fund by the RE .
Please recommend additional checklist which you think is necessary to
address issues arising out of such sourcing pattern of fund by any NBFC.

Sourcing Pattern of the RE •RE has used a combination of equity
financing, short term and long term
debt instruments and bank loans for
funding it’s operations.
•Excessive reliance on loans from
banks.
•Borrowings from market at higher
cost.
•Retained earnings form a major
component of equity.
•Personal connections of the promoter
used to raise capital and loans.

Additional Checklist to address issues pertaining to sourcing pattern of funds
•Assess the extent of reliance on a particular funding source or a limited number of lenders/investors.
•Evaluate the risk of losing access to funding if a key source of funds is disrupted or withdrawn.
•Evaluate the ability to maintain sufficient liquidity to meet obligations when they fall due.
•Assess compliance with regulatory guidelines related to capital adequacy, prudential norms, and funding
restrictions.
•Assess the impact of market conditions, such as volatility, liquidity constraints, or adverse economic events, on
the NBFC's ability to source funds.
•Consider the impact of market sentiment on the cost and availability of funding sources.

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