Need of Banking

8/2/2019 Need of Banking

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Alok RustagiKaushik Sadhu

Paresh NemadeSwapnil Deshapnde


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Old scenarioWhy do we have banks ?

To answer this question imagine a situation without

banks existing in society.

What will I do with my surplus units?

Where to go in case I need finance ?

All other intermediaries do not provideliquidity(checking deposits) and surety .


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Can we write off banks ? the theory suggests

liquidity creation,

credit origination, &financial innovation,

without banks issuing claims susceptible to runs

and thus being financially fragile. In breaking upbanks into finance companies and money marketfunds (the so-called "narrow" bank proposals),


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But in doing so we risk throwing the baby out withthe bath water. Thus part of the Faustian bargainthat we have to live with is that periodic banking

disasters will occur and public money will be used.Innovations in regulation and supervision canattempt to reduce the magnitude of the problem,but we should recognize that the alternative ofdoing away with the banks, at least in theforeseeable future, could be much worse.


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A bank can achieve economies of scale

Lower fixed costs relative to its assets .

It will have less need for liquidity.

It will be able to lower its equity ratio without increasingthe danger of insolvency.

Economies of Scope

While economies of scale result from doing more of the

same thing, economies of scope result from doing different,but related, things.(Story of 3 M)(Regulations often standin the way)


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Evolution of Banking 15th Century -------Money changer banks.

13th -17th centuryMerchant banks.

17th

Century -----Bank of Deposits - suspension ofconvertibility.


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Type of banking


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Bank Rate- @ central bank lends fund to commercialbanks

Repo rate -@ RBI lends short term debt to banksagainst securities.

Reverse repo- @ banks kept their short term excessliquidity with RBI.

CRR- Reserve Bank of India(Amendment)Bill,2006

SLR- Minimum proportion of Net Demand and Time

Liabilities.


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Bank Rate 24%

CRR 6%

SLR 7% Repo 8%

Reverse Repo 6%


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Bank Rate 24%

CRR 6%

SLR 7% Repo 8%

Reverse Repo 6%


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Mobilisation of funds across Time

& Space

Surplus Units Deficit Units

Surplus offunds

Users offunds

Flow of funds


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Sources of funds Demand deposit (Current account and savings account

deposit)

Time deposit & term deposit Short term borrowings from other banks and RBI

Equity capital


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Investment of funds Lending short term loan

Loan providing to other banks

Funded to RBI

Lending long term loan

Households- auto loan, home loan, personal loan,Education loan, Corporate loan


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Q: By eliminating the middle man the saver could get a

higher return.Why, then ,do so many people use Bankas a financial intermediary?


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Cost advantage

Time advantage


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How banks earn profits?

Bid/Ask Spread

measured in terms of netinterest income(NII)

and net interestmargin(NIM).


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Risk management Risk involved in banking structure is broadly classified

as

Credit risk.

Market risk.

Operational Risk.

Regulatory Risk.


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Credit Risk

Exposure CeilingsReview/RenewalRisk Rating Model

Risk based scientific pricingPortfolio Management

Loan Review Mechanism


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MARKET RISKMarket Risk may be defined as the possibility of lossto bank caused by the changes in the market variables.

Types of market risk:

Liquidity Risk

Interest Rate Risk

Forex Risk

Country Risk


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Operational risk Banks always live with the risks arising out of human

error, financial fraud and natural disasters. E.g.,

WTC tragedy

Barings debacle


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Other functions performed by

banks as Financial Intermediaries Maturity Transformation

Risk Transformation

Convenience denomination


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Growth Hurdle-NPAA NPA is a loan or an advance where

Interest and/ or installment of principal remainoverdue for a period of more than 90 days inrespect of a term loan

In 2009 Gross NPA of commercial bank was about70k crore

Increasing NPA implies moral hazard problem inbank.


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FACTORS CONTRIBUTING TO NPAs Poor Credit discipline

Inadequate Credit & Risk Management

Diversion of funds by promoters

Funding of non-viable projects

Banks has little freedom to price products and investin their best interest


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IMPACT OF NPAs ON OPERATIONS Drain on Profitability

Impact on capital adequacy

Adverse effect on credit growth Excessive focus on Credit Risk Management


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NPA MANAGEMENT - SOLUTION Sale of NPA to ARC/ SC under Securitization and

Reconstruction of Financial Assets and Enforcementof Security Interest Act 2002 (SRFAESI)

Willful defaulter reported to RBIA NPA is eligible for sale to other banks(Transfer of

risk)`


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Payments System Realization of transaction

Inseparable part of trades and goods.

The primary goal of any national payment system is toenable the circulation of money in its economy.

Payment system is part of business model

Substantial source of income.


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Payment characteristics It is expected safe, secure, sound and efficient

payment and settlement systems for the country

Commonly known as Triple-S + E.


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Efficiency of payments Minimum transaction cost

Competitive Pricing

Integration Stability

Minimizing systemic risk in inter bank paymentsystems


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Types of payment Electronic payment-RTGS,NEFT

Cash payment-Bank branch,ATM

Paper payment- Cheque, Pay order, Demand Draft


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Money Laundering Money laundering is disguising illegal sources of

money so that it looks like it came from legal sources.

The objective of KYC/AML RBI guidelines is to preventbanks from being used, intentionally orunintentionally, by criminal elements for moneylaundering or terrorist financing activities.


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Know Your Customer (KYC)a) Customer Acceptance Policy;

b) Customer Identification Procedures;

c) Monitoring of Transactions;d) Risk Management.


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DFIs Formed by Indian government to lend long term debt

to development work in.

In 1992 Narsimhan committee report suggested toconvert into banks.

Example:HDFC,IDBI,ICICI


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Informational Role of Asset PricesWhat are assets?

Asset prices appear to contain some informationregarding future realizations of inflation and output.

What happens to prices in case of scams bubbles?


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Informational role of asset prices Banks provide many secured loans

They may be backed by different assets such as shares,land etc.

To take loan decision banks need real time data onasset prices.

If asset price is less than loan amount then it will

create problem for banks.


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Regulations As per banking regulation act 1949

Assets of banking company should not be less than75% of its demand and time liabilities.

Liabilities above should not include paid up capital.

Banking company has to report this status at the endof every quarter to RBI


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Managerial IncentivesWorking for self interest creates incentive problem

Measures to avoid this problem

-Employee stock options

-concentrated ownership In India RBI put some guidelines to avoid incentive

problem such as

he should not be director partner in any other trading

commercial firm


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he should not have substantial interest in any otherfirm or be engaged in any other company.

RBI holds right to change the director if it feels it is inpublic interest.


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Basel II Norms

These norms based on three pillars

Minimal capital requirement

Supervisory review process

Market discipline Banks need to maintain 9% CRAR and PSB 12% CRAR

Tier I capital norm is at 6%

Banks require to hold 2% common equity.

Basel III Norms


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New Banking Regulation Eligibility norms

-promoter holding at least 40% for 5 years.

-minimum paid-up capital should be 500 cr. FDI is capped to 49 % for first five years after that 74%

is upper limit.

Min CAR of 12% should be maintained.


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Regarding directors 50% of directors should be totallyindependent.

25% of branches should be in rural sector.

Priority lending as applicable to other domestic banks


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Opportunities Banking penetration is 45% in middle and high

income group

5% in lower income group

Increased use of technology in rural parts providesnew medium to increase penetration

Continuous GDP growth demand more funding from

banks for development


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Challenges To raise the bar of service and speedy redresser of

customer grievances

How to increase rural penetration

Swabhimanyojna

Increase use of technology

Demographical Diversifications


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Fulfill growing demand for finance from infrastructureand real estate sector

More transparency in banking system

Consolidation of KYC Norms.

Increase financial depth.


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Thank You


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Questions?

Need of Banking

Documents

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