2. Overview of the course
Banking sector overview and policy implications
Assessing bank performance and their risk management practices
Liability side management of the balance sheet
Asset side management of the balance sheet
Risk identification and mitigation
Regulatory framework and requirements
BASEL Norms
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3. Learning Outcomes
Upon completion f the course, the student should be able to
Understand the functioning of and FI’s in India (LO -1)
Understand and evaluate the performance of banks with respect to risk and profitability
(LO-2)
Understand and evaluate the regulatory framework and statutory requirements of banks
(LO-3)
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4. Contents
Overview of the banks and FI’s in India – evolution of banking, reforms in the sector, current trends
and challenges
Monetary policy and its implications for banks
Evaluating the performance of banks
Liability side management of the balance sheet
Sources of bank funds
Cost of funds
Asset side management of the balance sheet
Loan pricing and customer profitability analysis
Transfer pricing
Risk management practices in banks
Credit risk / Interest rate risk/ Market risk
Regulatory framework – BASEL norms
Role of NBFC’s/insurance companies/Mutual funds
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8. A Financial System- its stability
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Suppliers of funds Demanders of funds
Financial
Institutions
Financial Markets
Funds
Securitie
s
Deposits
Funds
loans
Loan
contract
Funds
Securities
9. Stability of the financial system
Efficiency in resource allocation/ effectiveness in pricing and managing
financial risks/ ability to withstand shocks
Role of financial system in managing risk
Payment services
Savings
Credit
Market insurance
Trading of assets
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10. Key components of the financial system
Financial institutions
Financial markets
Financial instruments
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11. Segment 1 – Financial Institutions
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Banks NBFI's
Public Sector 1) FI's MF’s/Insurance/MB’s
Private Sector Venture Capital firms
Foreign EXIM/SIDBI/NHB/NABARD/IIFCL/IFCI
RRB's To be set up DFI
LAB's 2) NBFC's An important pillar
Cooperative Credit Institutions
Small Finance Banks 3) PD's Bank PD's
Payment Banks Standalone PD's
13. Segment 2 – Financial Markets and Instruments
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Type Participants Typical instruments
Money Market
Banks, Government and
FI's Call/Notice money; CP; CD’s; Repo;
Capital Market Companies, FI's Equity and bonds
Foreign Exchange Market
Banks and authorised
dealers spot currencies
Government Securities
Market Govt, banks and PD's T bills and bonds
Credit Market Banks and FI's wholesale and retail banking credit
15. VERY IMPORTANT READING- Trend and
Progress in Banking – Annual RBI Report for
2019-20
https://www.rbi.org.in/Scripts/AnnualPublications.aspx?head=Trend%20and%
20Progress%20of%20Banking%20in%20India
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16. Other relevant Readings
https://rbi.org.in/scripts/BS_ViewBulletin.aspx?Id=20201
https://www.rbi.org.in/scripts/FS_Overview.aspx?fn=2755
https://www.rbi.org.in/Scripts/BS_SpeechesView.aspx?Id=1111
https://www.rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=51899
https://www.rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=51832
https://www.rbi.org.in/Scripts/PublicationsView.aspx?id=19975
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17. Financial Structure and its indicators
The meaning of financial structure/changes with time
Bank based financial system
Market based financial system
Indicators of financial structure
Systemwide indicators(no. and types of institutions/growth and trend of major
balance sheet aggregates/ growth of capital and money market
Breadth/coverage of the financial system
Competition/concentration/efficiency( availability of services/3 bank
concentration ratio/ HI/spreads (bid/ask)
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18. Why is financial system important
For intermediation
Channelization of savings
Lowers cost of transaction
Payments and funds transfer
Price discovery/valuation indicator
Liquidity of financial assets
Risk sharing
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19. Regulations for stability
Why regulations
Primary function of a bank
Credit allocation
Avoid banking system misuse
Banking faith
Common investors
Systemic risk
Prior to 1990
Country specific
Focus on capital to assets
But, banking was changing
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20. Regulatory Structure
Ministry of Finance ( Depts of Economic Affairs/Expenditure/Revenue/Investment
and Public Asset Management/Financial Services)
RBI (BPSS and BFS)
NABARD
NHB
SEBI
IRDA
PFDRA
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21. READINGS
IMPORTANT INFO websites
https://www.rbi.org.in
https://www.pfrda.org.in
https://finmin.nic.in
https://www.nabard.org
https://nhb.org.in
https://www.sebi.gov.in
https://www.irdai.gov.in
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22. Regulations for stability
Tools of regulation
Prudential
Regulation of payment and settlement systems
Business products and market regulation
Moral suasion
Some steps towards future regulations
BASEL norms implementation- identifying liquidity risk
International accounting standards
Strengthening CRA’s
Focus on non bank finance companies
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23. Financial
stability
measures
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Mar 2020 Mar 2019
CAR of ScB’s 13% 12.2%
GNPA of ScB’s 8.3% 9.1%
NNPA’s of ScB’s 2.9% 3.7%
Provision CR 65.4% 60.5%
GNPA’s of NBFC’s 6.4% 6.1%
NNPA’s of NBFC’s 3.2% 3.3%
CAR of NBFC’s 19.6% 20.1%
24. The largest banks in the world
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S. No Established HQ Assets
(Trillion
USD)
1 Industrial and Commercial bank of
China
1984 China 3.47
2 China Construction bank Corporation 1954 China 3.02
3 Agricultural Bank of China 1951 China 2.81
4 Mitsubishi Financial Group 2005 Japan 2.63
5 Bank of China 1912 China 2.61
6 JP Morgan Chase 2000 USA 2.5
7 HSBC 1865 UK 2.37
8 BNP Paribas 1848 France 2.19
9 Bank of America USA 2.18
10 Wells Fargo 1852 USA 1.93
25. Changing landscape of the financial system- FinTech
Categorization of FinTech innovations
1. Payments, clearing and settlement services( from barter to current digital modes/ Current innovations ---
VIRTUAL CURRENCY ( its origin and future in India) / E-Rupi
2. https://www.rbi.org.in
3. Reading materialPayment system details.xlsx
4. Deposits and lending – peer to peer lending, crowd funding
5. Market services – smart contract, e aggregators
6. Investment management- Robo advice
7. Data analytics and Risk management
8. LEADING FINTECH FIRMS IN INDIA
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26. Payment and Settlement system in
India
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No
1 Govt Sec Outright/Repo/Triparty repo
Forex
Rupee Derivatives
2
Cr and Debit
Transfers RTGS/AEPS/ECS/IMPS/NEFT/UPI/BHIM/NETC
3 Cards Credit/Debit/POS
4 Prepaid payments Wallets/Cards
5 Paper based CTS
Total payments Sum of all
Retail payments all except for 1
Digital payments 1 to 5
27. FinTech
Leading firms in India
Lendingkart
MoneyTrap
Instamojo
Rajorpay
Paytm
Policybazaar
Shiksha Finance
pineLabs
ZestMoney
ePayLater
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28. Mobile Wallets.. A great innovation
What is a mobile wallet/purpose
Its advantages( one click/accessibility/multiple uses/security)
Some examples – Pay TM, Google pay, amazon Pay….
What is there revenue model ( say Pay TM)
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29. New Trends in crypto space
Defi – decentralized finance
NFT – non fungible token
Polka Dot
Yield farming
WILL CBDC’S BE A REALITY SOON – CENTRAL BANK DIGITAL CURRENCIES
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30. Evolution of the Indian Banking system- key
reforms
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31. The different phases
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Phases Characteristics
Pre independence RBI created in 1935
1947-69
Banking regulation Act of 1949. problems continued in banking.
Nationalization in 1969.
1969-90
High underperformance in banking( regulated interest
rates/high reserve requirements/high NPA's/private banks
disallowed/capital market undeveloped
1991 The crisis and correction
32. The roadmap of banking reforms
Bank nationalization/DFI’s/RRB’s
Recommendations of the Narasimhan Committee (1991)
Structural recommendations (autonomy/independence/consolidation)
Prudential recommendations (CRR/SLR)
Operational recommendations (branch licensing/interest rates/ tribunals for NPA’s
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33. The need for change
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Recommendations of the Narasimhan Committee(1998)
1 Concept of narrow banking for weak banks, else closure
2 Identify 2-3 banks to be given international stature
3 Local banks to be confined to states
4 Depoliticization of banks/ more autonomy
5 Strict implementation of BASEL norms
6 More active role of NBFC’s
34. Select policy reforms since 1991-92
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1993 Guidelines for private players; process of phased reduction of SLR/CRR
1994 Board for Financial Supervision set up
1995 Banking Ombudsman Scheme introduced
2000 LAF introduced
2001 FDI limit increased to 49% in Banks
2002
SARFAESI Act promulgated(Securitization and reconstruction of financial
assets and enforcement of Security Interest) and PMLA( Prevention of
money laundering Act)
2003 Concept of BPLR introduced
2004 FDI limit increased to 74%
2005 NEFT introduced
2006 BC model introduced for financial inclusion
2007 Banks allowed to take pension fund management
2008 Banks code for MSME's introduced
35. Select policy reforms
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2011 Deregulation of SB interest rate; MSF introduced
2012
New bank applications called. Guidelines issued for BASEL
implementation; Mandatory approval from RBI for acquiring 5% stake in
a banking company
2013 RBI power to supersede BOD of a bank
2014 In principal approval to IDFC and Bandhan. PM's JANDHAN jojana
2015 Nayak committee report on PSU's.
Mission Indradhanush( separate posts of of MD and CEO; more hiring
from private sector;setting up of Bank Boards Bureau; Additional
capitalization of 70,000 Cr over the next 4 years;NPA management to
be a key performance indicator)
2016
11 payments bank licence issued( narrow banks/deposits up to 1
lac/50% of their loans to be of small ticket size less than 25 lacs)
36. Select policy reforms…recent
Insolvency and bankruptcy code 2016
Reasons why companies fail/rationale for a sound bankruptcy process
The process( role of creditors/ IP/ Arbitration)
https://www.ibbi.gov.in/legal-framework/act
Bank consolidations (sound rationale or mindless)
Loan rates
Digitalization of services( AI/Analytics/offline services to online)
Security of ATM transactions
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37. Future roadmap for reforms
Role of private sector
Continued focus on FI
Role of niche banks in FI
Support of RRB’s through capitalization
Consolidation based on value creation
Performance indicators for management
Remove interest subsidies and subventions
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38. Innovative new banking Models
Small finance banks
Purpose/capital requirements/prudential norms/transition path
Payment banks
Their business model/ handicaps and challenges
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39. Financial stability indicators for Banks
Capital Adequacy
Asset Quality
Management Quality
Earnings and Profitability
Liquidity
Sensitivity to market risk
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40. RBI – lender
of last resort
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The structure of RBI
Its main functions(readings)
https://www.rbi.org.in
Some influential Central banks of the world
Its “BUSINESS MODEL”
49. Background and BASEL I
Focus on capital classification and RWA
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Risk weight Asset category
0 Cash, gold, claims on OECD Governments
20 Claims on OECD PSU's
50 Residential mortgage loans
100 All other claims
BANK A BANK B
Unsecured loans = 80 Unsecured loans = 20
Secured loans = 20 Secured loans = 80
RWA= 80*1.3 + 20* 1.1 = 126 RWA = 20*1.3+ 80*1.1= 114
Capital required = 10.08 Capital required = 9.12
50. 1996
Amendment
Introduction of the concept of market risk
Recognition of the “trading book” risk
Mark to market concept
Capital to be maintained to be higher of
Previous day VaR
three times the average daily VaR of the preceding 60
days
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51. Dr. Gautam Negi
BASEL II Accord
51
Flaws in BASEL I
All loans in a segment assigned the same
weight
The pillars of BASEL II
Minimum capital requirements( Credit,
market and operational risk)
Supervisory review
Market discipline
52. BASEL III
Final version in 2010. The pillars were
CAPITAL RULES
LIQUIDITY RULES
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53. CAPITAL RULES – capital definition
Tier 1 – share capital and RE
Additional Tier 1 – preferred stock
Tier 2 – Debt with maturity > 5 years
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Tier 1 4.5 % of RWA
Total Tier 1 6% of RWA
Total Capital 8 % of RWA
BASEL III
54. CAPITAL RULES - conservation buffer
An additional buffer of 2.5% of RWA to be maintained in Tier 1 capital
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with buffer
Tier 1 8.5%
Total Capital 10.50%
55. CAPITAL RULES -countercyclical buffer
Excessive credit growth followed by downturn
Varies , 0 – 2.5% at local supervisor discretion
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Normal With Capital buffer With countercyclical buffer
Tier 1 4.5 % of RWA 7% 9.50%
Total Capital 8 % of RWA 10.50% 13%
56. LIQUIDITY
RULES- LCR
Why liquidity risk introduced
New measures introduced
Liquidity coverage ratio (LCR)
Net Stable funding ratio (NSFR)
LCR = High quality liquid assets/Net cash outflow in a 30
day period. To be maintained in excess of 100%
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57. LIQUIDITY RULES
- NSFR
Net Stable Funding Ratio
(NSFR) = Amount of stable
funding/ required amount of
stable funding. To be more
than 100%
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ASF Factor (%) Category
100 Tier 1 and Tier 2 capital
90 "Stable" demand and term deposits
80 "less stable" demand and term deposits
50 wholesale demand and term deposits
0 all other liabilities
RSF factor(%)
0 cash
5 MS with maturity < 1 year
20 Corp bonds with rating higher than AA-
50 Gold, bonds rated A+ to A-
65 residential mortgages
85 retail loans
100 all other assets
58. BASEL III – Off
balance sheet
risks
Focus on risk in derivatives trading
The estimated risk to be added to market risk
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59. G-SIB’s and D-
SIB’s
Additional tier 1 capital to be
maintained
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Bucket
Additional
capital
5 3.50% HSBC/JP
4 2.50%
3 2% Barclays/BNP/Citigroup/Deutsche
2 1.50% 6 banks
1 1.00% 18 banks
60. MANDATORY
BASEL
DISCLOSURES
Qualitative disclosures ( bank’s approach to assessing
capital adequacy)
Quantitative disclosures( for types of risks/ capital
adequacy ratios)
General disclosures for
Credit risk( exposures/industry wise distribution/NPA’s/
maturity breakdown of assets/ RWA’s breakup)
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61. Mandatory Disclosures SBI
https://www.hdfcbank.com/personal/resources/regulatory-disclosures
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62. BASEL IV and beyond
Deloitte Report
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63. Estimating Regulatory Capital
The asset side of the balance sheet of a bank is as below. Its total capital is 400 Cr. The PAT of the bank
for last three years has been 25Cr, 32Cr and 35 Cr. respectively.
Details Amount (Rs. Crore) Risk weights (%)
Cash and Balances with RBI 200 0
Bank Balances 200 20
Investments
Held for trading
Available for sale
Held to maturity
500
1000
500
Govt securities-0
Banks – 20
Others – 100
Advances 2000 100
Other Assets 300 100
Total Assets 4700
Ownership wise break up of investments- Of the total 2000 Cr investments, 1000 Cr is in G Secs, 500 Cr
in Bank bonds and the balance 500 Cr is with other bonds. A further breakup of investments as per maturity
is as below
Investment Value (in Rs. Cr) Type Maturity
G Sec 100 Held for trading <6months
600 Available for sale 6-24 months
300 Held to maturity >24 months
Bank Bonds 100 Held for trading 6-24 months
400 Available for sale >24months
Others 300 Held for trading <6months
200 Held to maturity <6months
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64. Prescribed Capital charge for Market risk (specific risk and general risk)
A) Specific risk capital charge
For investments in government securities -0
For investments in banks to be grouped as below
Details Capital charge (%)
For term to final maturity 6 months or less 0.3
For term to maturity between 6 and 24 months 1.125
For term to maturity exceeding 24 months 1.8
For investments in others – 9%
B) Capital charge for general market risk
Estimated price sensitivity of investments
Counter party Capital charge (%)
Government 0.84
Banks 0.16
Others 2.29
If the bank uses the standardized approach for calculation of capital for credit, market and
operational risk, is it sufficiently capitalized if the required CAR is 9%.
Dr. Gautam Negi 64
70. Key
differentiators
of bank’s
financials
Balance sheet
Sources of funds(short term)/high leverage & low
capital/low FA
Applications of funds – loans and thus risk
Income statement
Interest income major income
Provisions is a large expense
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71. Performance
indicators-
HDFC Bank
Reach – ATM’s/ BC’s/ Customer base/ POS(merchant
acceptance)
Financial Capital
Growth in BS, Retail assets/advances
CAR
Efficiency – Cost to income/ NIM/ PAT/ Spread/ Rupee
earned/ Rupee spent
Resilience – NPA( Gross and Net)/ PCR/ Slippage ratio
Returns – ROC/ROA/EPS
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72. KPI’s- An exhaustive list
Efficiency and control ratios
Liquidity
Risk
Profitability
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73. KPI’s -
Efficiency
Operating efficiency
Cost of funds
Burden ratio
Productivity per employee
Cost per employee
Net interest margin
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74. KPI’s -
Liquidity
Demand deposits/ Total Deposits
Demand Deposits/TA
Credit to Deposit ratio
Short term investments/ TA
SLR/ Total investments
Cash/ Deposits
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75. KPI’s - Risk
Equity Multiplier – TA/Equity
CAR – Equity/RWA
Provisions/TA
Provision Coverage Ratio
NPA’s ( Gross and Net)
RWA/TA
Dr. Gautam Negi 75
76. KPI’s -
Profitability
ROE/ROA
Assets Utilization
Yield on Assets
Cost of funds
EPS
P/E or Price/BV
Spread
Dr. Gautam Negi 76
79. Dr. Gautam Negi
CAMELS/CALCS
APPROACH
79
Capital Adequacy – Tier 1/Tier II Capital
of RWA
Asset Quality – classifications (SM0-
0/SMA-1/SMA-2) and NPA’s/RWA to total
Assets/ NPA’s/ Slippages
Management – competence and
compliance with laws
Earnings – ROA/ROE/Spread/NIM
Liquidity
80. Weights under CAMELS/CALCS
CAMELS CALCS
Capital Adequacy 18 18
Asset Quality 18 18
Management 18
Earnings 10
Liquidity 18 18
Compliance 26
System and control 18 20
Dr. Gautam Negi 80
82. Dr. Gautam Negi
RBI Approach-
Soundness
82
Performance (Assets and earnings) –
credit and deposit YOY growth/
composition of profit/NIM/ROA/ROE
Asset Quality /Risk and Capital
Adequacy – GNPA/NNPA/Sectoral asset
quality/credit quality of large
borrowers/Slippage/PCR/ CAR
Liquidity - LCR
90. FI’s – Soundness and Resilience Report
RBI Report
Dr. Gautam Negi 90
91. Assignment – 10 marks
A comparative performance analysis of two banks based on
ROE Approach
CAMELS approach
Your interpretations
Dr. Gautam Negi 91
95. Interest rate
movements
Nominal and real interest rates
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Country Output Price GDP Inflation
New
GDP Nom G Real G
A 10 10 100 5% 105 5% 0
B 10 10 100 10% 110 10% 0
96. Drivers of
interest rates
Supply and demand for money
Economic growth
Inflation
Government borrowing
Government influence
Global interest rates
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97. Drivers of interest rates
Supply of foreign capital in equity and debt market
Foreign exchange rate
Dr. Gautam Negi 97
99. Commonly followed – floating rate
The concept/ benchmarking/estimation/ approach( multiplicative/additive)
The benchmarks
EXTERNAL BENCHMARK
INTERNAL BENCHMARK
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100. External benchmark
The international benchmark rates
The Indian benchmark rate and role of NSE
The LIBOR scandal of 2012
India’s response and setting up of FBIL
The role of FBIL in India/ rates published by it
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101. MIBOR overnight estimation
Computation methodology
Deals recorded between 9-10 am
Min 10 trades, total volume > 500 Cr, else one hour extended time
Weighted average and SD estimated
Outliers dropped ( mean weighted rate + 3SD
Final volume weighted average and SD up to 2 decimals reported
Rate declared at 10.45 as the MIBOR of the day
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103. Policy rates of RBI
Repo rate
Reverse repo
MSF
Bank rate
Dr. Gautam Negi 103
104. Interest rate on bank liabilities
Savings accounts
Deposit accounts
Fixed income investments( PPF/NSC/Post office schemes)
Coupon interest on bonds
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105. Interest rate movements
Trend towards low interest rates
Interest rates in the “negative zone”
Concept of fixed and floating rates
Negative yield on bonds
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106. Monetary Policy
Goals of the policy (Price stability)
Operating framework (inflation targeting)
The monetary policy process ( role of MPC)
Dr. Gautam Negi 106
107. Discussion Points
Monetary stock, types of money and what do the changing numbers indicate
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110. Discussion Point
Monetary stock as a base of
credit creation
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Rs Crore
Reserve
money Base money 2349715
Narrow
money
Base money + demand
deposits 4125915 1.7
Broad
money
Narrow money + Time
deposits 16799930 7.1
Outstanding bank credit
of ScB 86254 3.566014
Investments of ScB 33184 1.371932
Source: RBI Handbook of statistics
111. Credit creation by banks
Deposits created/ credit creation
Money multiplier/ income multiplier
Dr. Gautam Negi 111
112. Instruments of the monetary policy
Dr. Gautam Negi
Repo rate
Reverse repo rate
MSF
Bank rate
CRR (estimation)
SLR
OMO
MSS
112
The “CORRIDOR” of Repo and Reverse Repo for interest rate management
Do the monetary and fiscal policy complement each other ?
113. CRR Estimation
Reporting every fortnight(Friday)
Function of NDTL = liabilities to others + interbank liabilities
Interbank liabilities are added only if positive
Concept of the maintenance period
Penal interest on non maintenance
Dr. Gautam Negi 113
119. RBI’s response on COVID
Targeted long term repo operations
CRR
MSF
Reduction in policy rate and widening of policy corridor
Dr. Gautam Negi 119
135. Insights from the balance sheet of a bank
Liabilities view of the balance sheet/Why deposits are important
Implications of change in price
The “funding gap” estimated by banks
Dr. Gautam Negi 135
136. Interest on deposits
Deposit insurance
Competition to deposits/ innovative and basket of schemes
Dr. Gautam Negi 136
137. Estimating the cost of deposits
Historical average cost – what it conveys
Marginal cost of deposits – what it conveys
Dr. Gautam Negi 137
138. Dr. Gautam Negi 138
Period of deposit Amount Weight Interest current rate 1 current rate 2
Savings deposits < 1 year 500000 0.3333 0.025 0.03 0.0225
Term deposits 1 year 100000 0.0667 0.03 0.035 0.025
2 year 200000 0.1333 0.035 0.04 0.0325
3-4 years 300000 0.2 0.04 0.045 0.035
> 5 years 400000 0.2667 0.05 0.06 0.045
1500000
Historical rate 0.0363
Marginal rate 1 0.0427
Marginal rate 2 0.0325
139. Using MC and MP
A bank finds that it can attract
the following amounts of
deposits if it offers the following
rates . Management anticipates
being able to invest any new
deposits raised in loans yielding
7%. How far should the bank go
in raising its deposit rate?
Dr. Gautam Negi 139
Rate of interest
offered
Expected volume of new
deposits(lacs)
5% 10
5.25% 15
5.5% 20
5.75% 26
6% 28
141. Another example
ABC bank plans to launch a new deposit campaign next week in hopes of
bringing in from Rs. 100 lacs to Rs.600 lacs in new deposit money which it
expects to invest at a yield of 7.75%. management believes that an offer rate of
5.75% would attract Rs.100 lacs in new deposits. To attract Rs.200 lacs, the
bank would be forced to offer 6.25%. The bank’s forecast also suggests that
Rs.300 lacs will be available at 6.8%, Rs.400 lacs at 7.25% and Rs.600 lacs at
7.65%. What volume of deposits should the bank try to attract to ensure that
marginal cost does not exceed marginal revenue?
Dr. Gautam Negi 141
142. Determinants of cost of deposits
The interest expenses
Deposit insurance paid
Other costs ( administrative + operating)
Service charges received
Reserve requirements
Deposit price =
Dr. Gautam Negi 142
143. An account has an expected balance of Rs.1000, deposit insurance is Rs.0.6 per
year, interest expenses are Rs.10.4, administrative costs are Rs.42.2 and service
charges are Rs.21.50. What is the cost of deposits? Reserve requirements is 10%.
Answer the parts
a. If a demand deposit has an average balance of Rs.100 and the annual cost of all
expenses is Rs.92.52( interest exp plus all other exp), what is the cost of deposit if
the reserve requirements are 10%
b. What annual service charges would be necessary to lower the cost of deposits to
8%
c. What minimum balance would be necessary to lower the cost of deposit to 8%.
Dr. Gautam Negi 143
144. Conditional pricing ….
Dr. Gautam Negi 144
Average Monthly Balance Charges on Services
10000/50000/100000 Cheque leaves/Cash collection/ATM card charges/ ATM
withdrawal charges/ mobile services/ locker services/….
145. A bank offers the following 4
savings accounts with given
details of service provided
against each type of account.
What is the cost of each type of
deposits account? Assume no
interest is earned on the
reserves maintained by the
bank.
Dr. Gautam Negi 145
Min balance 10000 25000 50000 100000
Annual service charges
collected 250 625 1250 2500
Adm exp 500 700 1000 1500
Free ATM transactions 3 5 8 12
Free cheque leaves 10 20 50 100
Locker facility No No Yes Yes
Other operational exp 100 200 400 1000
Cost of each ATM
transaction 100
Cost of each cheque leaf 5
Cost of locker facility 4000
Reserve requirements 5%
146. Dr. Gautam Negi 146
Average Balance 10000 25000 50000 100000
Costs incurred
Adm exp 500 700 1000 1500
ATM 300 500 800 1200
Cheque leaves 50 100 250 500
locker facility 0 0 4000 4000
other op exp 100 200 400 1000
Total costs 950 1500 6450 8200
Received as ser charges 250 625 1250 2500
Net cost 700 875 5200 5700
Money available after adjusting for reserve requirements 9500 23750 47500 95000
Cost of deposits 0.0737 0.0368 0.1095 0.0600
147. Innovative pricing strategies…
Dr. Gautam Negi 147
Innovative pricing strategies
Estimating your returns in deposit accounts- You hold a savings bank account
in SBI. In the last financial year, your account had a closing balance of Rs.2000
for 180 days and Rs.100 for the remaining days of the year. If the bank paid you
an interest of Rs.8.50, what was you return?
148. Funding mix and intro to ALM
Dr. Gautam Negi 148
Equity 55 11% Cash 60 12%
Demand Deposits 50 10% Advances 320 64%
Time Deposits 150 30% Investments 100 20%
Market borrowings 200 40% FA 20 4%
other liabilities 45 9%
500 500
149. Pricing with targeted bank profitability
A bank’s liabilities comprise deposits amounting to Rs.2000 and an equity of Rs.200.
On this liability base, the bank is required to maintain a CRR of 5% and an SLR of 20%.
The bank can earn an average yield of 15% on its loanable funds and the investments will
yield an annual return of 7%. Its fixed expenses including manpower expenses amount to
7% of its deposits. The bank expects to earn a net profit of Rs.20 in the current year. For
simplicity assume no other expenses.
Assuming no taxes, what will be the maximum average rate of interest the bank will be
willing to pay on its deposits.
If the bank is in the tax category of 30%, and it expects a similar PAT of Rs.20, how
much will it have to change the rate offered to depositors.
Dr. Gautam Negi 149
151. Pricing of loans/ floating
rates and Transfer
pricing
Dr. Gautam Negi 151
152. Pricing of Loans
Types of lending
Average break up of loans
Dr. Gautam Negi 152
153. The traditional approach- the fixed rate
Factors considered
The cost of funds (average/marginal cof)
Service costs (employee costs/OH costs/ collections and administrative costs)
The expected profit margin- getting the required return from shareholders
expectations
Default risk premium (estimating from historical data) - A certain profile of
customers has probability of default of .05. For a one-year loan, it has been
estimated that the bank is able to recover 85% of the principal and interest due. The
average rate in the past quoted for this category of customers has been 14%. What
will be the default risk premium for this category of customers?
Dr. Gautam Negi 153
155. Concept of Transfer pricing/ NII division
Assume a bank expects to lend Rs.2000 in the financial year @ 12%. It expects its net
deposits inflow to be Rs.1200 @6%. The shortfall will be raised by ALM at the current
market rate of 9%. Assume ALM transfers the borrowed money to the loan department
@9.2%. How will the NII of the FY be divided among assets department, liabilities
department, treasury department.
Dr. Gautam Negi 155
157. Profitability analysis of segments
A bank wants to compare the performance of its assets, liabilities and treasury
departments at its 2 branches in Noida. Details as below for the previous FY (fig in
lacs)
The shortfall in the loan and deposits of a branch is contributed by the treasury
department which sources from the market at 8.5% and the transfer pricing for branches
is 9%. The total expenses for Branch A for the FY was Rs.35 (Assets – 20, liabilities-
10, Treasury – 5); The total expenses for Branch B was Rs.65(Assets – 40, liabilities –
20, Treasury- 5). Branch A has a total of 6 employees (Assets -2, liabilities -3, treasury-
1) while Branch B has a total of 9 employees (assets -3, liabilities -5, treasury -1).
Dr. Gautam Negi 157
Branch Loans Av lending rate (%) Deposits Av Deposit rate (%)
A 1000 15 600 6
B 2000 14 1400 5
158. Pricing of loans given profitability
Dr. Gautam Negi 158
From the given information of a bank, arrive at a prime rate (base rate) on which the bank would
base the interest rate on loans. (figures in %)
Capital adequacy ratio 10
Reserve requirements(cash) 15
Cost of capital 12
Cost of demand deposits 3
Cost of term deposits 6
Fifty percent of the demand deposits are interest free deposits. Ratio of demand to term deposits
is 1:2. The bank has a credit scoring system to rate borrowers and uses the system to fix lending
rates as given below
Category Rate Proportion
A At prime 0.4
B At prime + 100 bps 0.4
C At prime + 200 bps 0.2
The bank also earns an interest of 3% on 50% of the reserves. The bank’s total working funds
consist of only capital and deposits. The management requires pretax ROA of 4%. What is the
minimum prime rate below which the bank will start making losses.
160. Modes of Credit Delivery
Dr. Gautam Negi 160
Purpose Security Mode of credit delivery
Working Capital Inventory
Book Debts
Receivables
WCL/ CC/ OD/ CP’s/
Letter of credit
Capital expenditure Capital assets Term loans/ syndicate
loans
Consumer loans Assets purchased under
the loan
Short term loans(
AL/PL/HL…)
161. Short term loans
WCL – As per Tandon Committee Recommendations
Cash credit (RBI directives 2018)
OD limits
Bills discounting
CP’s
LC’s and types
Bank Guarantees
Dr. Gautam Negi 161
163. Pricing of loan commitments/CC
A customer is sanctioned a loan with the following details
Sanctioned loan amount Rs. 100000
interest rate of 14% is charged on the used amount.
The upfront fee is .125%
backend fee on the unused amount is 0.25%.
The customer is required to keep a compensating balance equivalent to the
average unused amount.
The reserve requirements of the bank is 10% and the expected take down amount
by the client is 75% of the sanctioned loan amount.
What is the expected return to the bank?
Dr. Gautam Negi 163
164. Pricing of loan commitments
Dr. Gautam Negi 164
An existing customer approaches the bank for a revolving loan facility of 50 lacs@ 13%. The bank is
looking for a targeted return of 14.0% on the transaction. The customer argues for the low rate based on
relationship and the compensating balances he is expected to maintain with the bank. The processing fee
will be 0.15% of the sanctioned loan amount. There will also be a commitment fee of 1% on the unutilized
loan amount. The following services will be used by the client in respect of the loan
Nature of service Number of transactions Cost per transaction (Rs)
Items in transit 15000 0.4
Demand deposit transactions 5000 8
Payment transfers 500 4
Other info expected on customer’s loan and deposits as below
Average loan outstanding 42 lacs
Credit administration costs 1%
Credit risk expenses 1%
Cost of funds 7.5%
Average yield on short term investments 7%
Required reserve ratio 10%
Average demand deposit balance 10 lacs
Based on the info, should the loan be extended. How much compensating balance should the customer
maintain for the loan to be given.
165. Credit Analysis.. individuals
The traditional and current approach
CIBIL and its estimation
Credit history
Credit utilization
Credit mix
Other factors
Dr. Gautam Negi 165
166. Credit analysis… companies
Financial statements analysis ( ratios and cash flows)
The important and evergreen ones (Kamath report)
Analysis of
Manufacturing enterprises
Service enterprises
Tech firms
Dr. Gautam Negi 166
167. Appraisal of Projects
Assessing Non financial risks
Dr. Gautam Negi 167
168. Monitoring and early signals of default
For individuals
For companies
Financial indicators
Behavioural indicators
Industry indicators
Economy indicators
Predicting sickness
Z score
Discriminant analysis
Probability Default Models
Dr. Gautam Negi 168
169. Management of NPA’s
Defining
Types of NPA’s
Provisioning norms
Current status
Corrective action plan
Dr. Gautam Negi 169
170. NPA management
Legal recourse – IBC, its birth and importance
ARC’s – their genesis/ business model/ importance for banks
Dr. Gautam Negi 170
176. Credit risk – scoring models
• Process of scoring
• The economics of the scoring system
• Common scoring models – excel understanding
• z score
• Linear probability models
• Logit models
• Discriminant models
177. Credit analysis – wholesale loans
• Term structure of credit risk and its modeling
• Use of CDS spreads
• Credit rating reports
178. Credit risk – scoring models
• Process of scoring
• The economics of the scoring system
• Common scoring models – excel understanding
• z score
• Linear probability models
• Logit models
• Discriminant models
179. Credit analysis – wholesale loans
• Term structure of credit risk and its modeling
• Use of CDS spreads
• Credit rating reports
181. Valuing life insurance contracts
Mortality tables are used for the calculation of insurance premiums for various term plans. One
such is as given below
Male Female
Age Survival
probability
Life expectancy Survival probability Life expectancy
90 0.16969 4.02 0.28649 4.85
91 0.14112 3.73 0.24892 4.5
92 0.11495 3.46 0.21268 4.19
93 0.09152 3.22 0.17840 3.89
Your bank wants to offer a one-year term insurance plan of Rs.1,00,000 to a man who is
currently aged 90. What should be the break even premium amount. The current interest rate is
4%. Assume the premium to be paid at the start of the policy and payout if any needed to be
paid in the mid of the year.
Now assume you are offering a term insurance plan to a man aged 90 for a two year period.
What should be the break even premium amount.
In the case of a three year term insurance plan for the same person, what would be the break even
premium amount.
182. Applications – Probabilities in banking
Age Probability of dying
40 .011858
41 .012966
42 .01412
The bank wants give the following – For a man aged 40 years term insurance of Rs.5 lac, r is 6% p.a.
What is the Break even premium for the bank if the term insurance is for 1 year, 2 year and 3 years.
Assume the probability of death is in the mid of the year
185. Risk management in banks
Whose responsibility
Functions of ALCO
Dr. Gautam Negi 185
186. Types of risks in banks
Market risk forms
Understanding interest rate risk
Dr. Gautam Negi 186
187. Sources of interest rate risk
Gap or mismatch risk
Basis risk
Options risk
Yield curve risk
Dr. Gautam Negi 187
188. Measuring interest rate risk
Techniques used
Traditional GAP analysis
Duration approach
Simulation
VaR
Understanding Traditional Gap Analysis
Dr. Gautam Negi 188
189. GAP Analysis
Concept of ISA/ISL and process of GAP analysis
Dr. Gautam Negi 189
Overnight 1-7 days 8-14 days 15-31 days 32-60 days 61-90 days
ISA 40 60 80 100 120 150
ISL 30 30 60 90 100 100
10 30 20 10 20 50
190. Protecting
the NII
Dr. Gautam Negi 190
Current rate
Assets Liabilities Assets Liabilities
Rate
sensitive 700 550 0.12 0.1
Fixed rate 250 350 0.14 0.11
Non earning 50 100
1000 1000
191. Protecting
the NII
Dr. Gautam Negi 191
CURRENT RATE
Assets Liabilities Assets Liabilities
Rate
sensitive 700 800 0.12 0.1
Fixed rate 250 100 0.14 0.11
Non earning 50 100
1000 1000
192. Inferences of the GAP analysis
Change in NII = (ISA-ISL)* Delta r
Unequal changes in rates of ISA and ISL
Dr. Gautam Negi 192
193. Suppose interest rates rise such that the average yield on rate sensitive assets increases
by 45 BP and the average yield on rate sensitive liabilities increases by 35BP, what will
be the change in NII of the bank.
Dr. Gautam Negi 193
Assets Liabilities
Amount Av. Rate Amount Av. Rate
Rate
sensitive
550000 7.75 Rate
sensitive
375000 6.25
Fixed
rate
755000 8.75 Fixed rate 805000 7.5
Non
earning
265000 Non
earning
390000
1570000 1570000
195. Classification of portfolio
HTM
HFT
AFS
Valuation of these investments
Shifting among categories
Dr. Gautam Negi 195
196. Returns of the portfolio
Risk of the portfolio
Interest rate risk( price and reinvestment)
Credit risk
Liquidity risk
Other risks
Estimating this risk
Non performing investments
Dr. Gautam Negi 196
197. Investment
portfolio of
HDFC Bank
2020
Dr. Gautam Negi 197
In Rs. Crores
Govt Securities 3230399 82.91%
Other Approved Securities 0 0.00%
Shares 4044 0.10%
Debentures and Bonds 264503 6.79%
Subsidiaries/ JV's 38264 0.98%
Others (CD's/CP's..) 359227 9.22%
TOTAL 3896437
Asset Base 15305112
Inv as % of Assets 25.46%
