commercial banking 12
TRANSCRIPT
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Bank is an institution which collects money from
those who have in spare or who are saving it out of
their income; and lend this money out to those who
require it.
All those institutions which are in thebusiness of banking are called financial institutions.
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Banking Systemin India
Scheduled Banks
State Coop.Banks
CommercialBanks
Non-ScheduledBanks
Central Coop.Banks and
primary credit
societies
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CommercialBanks
Public Sector
Banks
SBI &
Associate
Banks(7)
Other
Nationalized
Banks
Foreign BanksPrivate Sector
Banks
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Scheduled banks :- Banks which have been included in
the Second Schedule of RBI Act 1934. They arecategorized as follows:
Public Sector Banks :- E.g.. SBI, PNB, Syndicate
Bank, Union Bank of India etc.
Private Sector Banks :- E.g.. ICICI Bank, IDBIBank, HDFC Bank, AXIS Bank etc.
Foreign Banks :- E.g.. Citi Bank, Standard
Chartered Bank, Bank of Tokyo Ltd. etc.
Non scheduled banks :- Banks which are not included
in the Second Schedule of RBI Act 1934.
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Commercial Banks are those profit seeking institutionswhich accept deposits from general public and advance
money to individuals like household, entrepreneurs,
businessmen etc. with the prime objective of earning
profit in the form of interest, commission etc. Examples of commercial banks ICICI Bank, State
Bank of India, Axis Bank, and HDFC Bank
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Commercial banks are an organisation which
normally performs certain financial transactions. Itperforms the twin task of accepting deposits from
members of public and make advances to needy and
worthy people form the society. When banks accept
deposits its liabilities increase and it becomes a
debtor, but when it makes advances its assets
increases and it becomes a creditor. Banking
transactions are socially and legally approved. It isresponsible in maintaining the deposits of its account
holders.
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A. Accepting deposits
1. Demand or current account deposits- a depositorcan withdraw it in part or in full at any time he
likes without notice. It carries no interest.
2. Fixed deposits- it can be done from 15 days to
few years with high rate of interest which can be
withdrawn at expiry of term.
3. Saving deposits- it is for the purpose of small
saving deposits by salaried people. These depositscarry less rate of interest and money can be
withdrawn through cheques.
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B. Advancing loans
1. Overdraft facility- this facility is provided to thebusinessmen only even if the deposits are less, thetransaction can be done . Banks charge interest on thisfacility.
2. Loans by creating deposits- it can be done in
following ways Cash credit
Demand loans
Short term loans
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The tendency of the commercial banks to make loans
several times of the excess cash reserves kept by the
bank is called creation ofcredit.
Creation of credit means that the commercial banks bytaking in deposits and making loans expand the money
supply.
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The process of 'Credit Creation' begins with bankslending money out of primary deposits. Primary
deposits are those deposits which are deposited in
banks.
In fact banks cannot lend the entire primary deposits
as they are required to maintain a certain proportion of
primary deposits in the form of reserves with the RBI
under RBI & Banking Regulation Act.
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Bank M receives a cash deposit of $2000. This is the cash inhand with the bank which is its assets and this amount is also
the liability of the bank by way of deposits it holds.
Given the reserve ratio of 10 % the bank holds $200 in
reserves and lends $1800 to one of its customers.
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Commercial bank's balance sheet has two main sides
i.e. the liabilities and the assets. From the study of thebalance sheet of a bank we come to know about a
system which a bank has followed for raising funds
and allocation of these funds in different asset
categories. Bank can have others money with it. Itcan be in terms of shareholders share capital or
depositors deposits. This money is the bank's
liabilities. On the other hand bank's own sources of
income leads to generation of assets for bank.
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Liabilities Assets
a. Share Capital a. i. Cash in Hand
b. Reserve Funds ii. Cash with the Central Bank (RBI)
c. Deposits iii. Cash with the other banks
i. Fixed Deposits b. Money at short
ii. Saving Deposits c. Bills and securities discounted
iii.Current Deposits d. Investment of bank
iv. Other Deposits e. Loans and Advances given
d. Borrowings f. Other Assetse. Other liabilities
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Capital Adequacy Ratio (CAR) is a ratio that
regulators in the banking system use to watch bank'shealth, specifically bank's capital to its risk.
Regulators in the banking system track a bank's CAR
to ensure that it can absorb a reasonable amount of
loss.
Regulators in most countries define and monitor
CAR to protect depositors, thereby maintaining
confidence in the banking system.
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Capital adequacy ratio is the ratio which determines
the capacity of a bank in terms of meeting the time
liabilities and other risk such as credit risk, market
risk, operational risk, and others. It is a measure of
how much capital is used to support the banks' risk
assets.
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The ratio is calculated by dividing Tier1 + Tier2capital by the risk weighted assets.
Capital
Capital Adequacy Ratio = ------------
Risk
Tier1 + Tier2 capital
= -----------------------------Risk Weighted Assets
* 8%
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Tier 1 Capital: This is the bank's core capital
comprising of share capital, disclosed reserves and
minority interests. Some institutions expand this
definition to include restricted forms of "equity-like"
capital instruments.
Tier 2 Capital: This includes supplementary Capital
consisting of general loan loss reserves andrevaluation reserves on investments and properties
held for investment purposes.
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Risk-Weighted Assets: This includes the total assets owned.
The value of each asset is assigned a risk weight (for
example 100% for corporate loans and 50% for mortgageloans) and the credit equivalent amount of all off-balance sheet
activities. Each credit equivalent amount is also assigned a risk
weight.
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Takes risk into account.
Since different types of assets have different risk profiles,
CAR primarily adjusts for assets that are less risky by
allowing banks to "discount" lower-risk assets.
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RISKS
FINANCIAL RISK NON FINANCIAL RISK
CREDIT RISK MARKET RISK
TRANSACTION RISK
PORTFOLIO RISK
INTEREST RATE RISK
LIQUIDITY RISK
FOREX RISK
OPERATING RISK
SYSTEMATIC RISK
POLITICAL RISK
HUMAN RISK
TECHNOLOGY RISK
Classification of Risk
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Risks Faced by Banks
Credit Risk
Market RiskLiquidity Risk
Interest Rate Risk
Foreign Exchange RiskOperational Risk
Solvency Risk
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Credit default riskoccurs when a borrower cannot
repay the loan. Eventually, usually after a period of90 days of nonpayment, the loan is written off. Banks
are required by law to maintain an account for loan
loss reserves to cover these losses.
Banks reduce credit risk by screening loan applicants,requiring collateral for a loan, credit risk analysis,
and by diversification.
A bank can also reduce credit risk by diversifying
making loans to businesses in different industries or
to borrowers in different locations.
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Transaction Risk
Risk relating to specific trade transactions, sectors or
groups.
Portfolio RiskRisk arising from lending to sectors non related to
the core competencies of the Bank / concentrated
credits to a particular sector / lending to a few big
borrowers.
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Market risk is the risk to a banks financial condition thatcould result from adverse movements in market price. The
risk that an un-expected happening ,which is extreme
sudden or dramatic will cause an all-round fall in market
prices. It signifies the adverse movement in the market
value of trading portfolio during period required to
liquidate the transaction
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TYPES OF MARKET RISK
Interest Rate Risk
Risk felt, when changes in the interest rate structure putpressure on the net interest margin of the Bank. This riskis the possibility that assets or liabilities have to berepriced on account of changes in the market rates andits impact on the income of the bank.
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For instance, if a bank has a loan for $100 for whichit receives $7 annually in interest, and a deposit of
$100 for which it pays $3 per year in interest, that is a
net interest margin of $4. But if current market
interest rates for deposits rises to 4%, then the bank
will have to start paying $4 for the $100 deposit
while still receiving 7% on the long-term loan,
decreasing its profit in this scenario by $1.
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Liquidity Risk: Risk arising due to the potential forliabilities to drain from the Bank at a faster rate thanassets. Liquidity risk is when the bank is unable to meet a
financial commitment arising out of a variety ofsituations. However, there are times when an FI can facea liquidity crisis. When all or many FIs are facingsimilar abnormally large cash demands, the cost of
additional funds rises as their supply becomes restrictedor unavailable. Such serious liquidity problems mayeventually result in a run in which all liabilityclaimholders seek to withdraw their funds simultaneously
from the FI. This turns theFIs
liquidity problem into asolvency problem and could cause it to fail.
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Forex Risk:
To the extent that the returns on domestic and foreigninvestments are imperfectly correlated, there are
potential gains for an FI that expands its asset holdingsand liability funding beyond the domestic frontier.
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NON-FINANCIAL RISKSOperational Risk :arises as a result of failure of operating
system in the bank due to certain reasons like fraudulent
activities, natural disaster, human error, omission etc.Systemic Risk: is seen when the failure of one financial
institution spreads as chain reaction to threaten thefinancial stability of the financial system as a whole.
Political Risk arises due to introduction of Service tax or
increase in income tax, freezing the assets of the bankby the legal authority etc.
Human Risk: Labour unrest, lack of motivation, inadequateskills, etc
Technology Risk: Obsolescence, mismatches, breakdowns,adoption of latest technology by competitors, etc, comeunder technology risk
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THANK YOU