Bank Management

PGDM IIMC Sept- Dec 2011 Praloy Majumder

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Course Coverage
Session 1 :
Position of Banks in Financial System; Bank versus other business units ; Sub prime crisis Indian Banking situation ; Financial Statement of Bank ;

Session 2 :
Sources of Fund :
Capital Fund Tier I, II and III ? Other sources of fund;

Factors to be considered for availing a particular sources ;

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Course Coverage
Session 3 :
Managing Assets of banks- Treasury Operation :
Investments : Nature of investments ; Valuation of Investments norms ; Different Investment instruments ; Issues affecting investment policy of banks ;

Session 4, 5 & 6 :
Managing Assets of banks- Corporate Banking :
Loans and Advances Major composition of bank assets; Nature of loans and advances ; Base Rate Assessment of Working Capital process; Case Discussion;
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Course Coverage
Session 7 : Off balance sheet items : Advantage of off balance sheet items ; Types of off balance sheet items; Strategies for off balance items ; Assessment of Off Balance Sheet Item facilities Session 8 : Trade Finance : Products for trade finance Selection of products for trade finance Product differentiation and increasing market share Session 9 : Retail Banking Products Factors changing retail banking Newer products liability side Strategic issues related to increase in retail banking business
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 Session 10 :

Course Coverage

Retail assets

Products associated with retail assets Characteristics of each product Assessment of each product Risk associated with each product Proper risk mitigant Session 9 & 10

Session 11 , 12 & 13 :

Infrastructure Finance Definition Types of financing Evaluation methods Discussion on Specific Sectors

Course Coverage
Session 14:
Prudential Norms of banking
Capital adequacy Provisioning Norms Non Performing Assets Restructuring of accounts RBI guidelines on raising funds

 Session 15 :

Course Coverage

Asset Liability Management of Bank : Regulatory frame work and ALM; ALM and Risk Management ; Interest Rate Risk Management ;
GAP and Earning Sensitivity Analysis DGAP and Economic Value of Equity Methods; Reduction of Interest Rate Risk Management

 Session 16 : Market Risk Management : VAR Model ; Monte Carlo Simulation ; Basle II and Market Risk ; Session 17 & 18 : Credit Risk Management : Modeling Credit Risk ; Basle II and Credit Risk Management ; Session 19 : Operation Risk Management : Modeling Operation Risk; Basle II and Operation Risk Management ; Session 20 : Basle II Issues ; World Banking Post Basle II and Post Sub prime crisis Issues related to Basle III
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Course Coverage

Evaluation Criteria
Project 1: Weightage 30%
Report 20%; Recommendation 10 % ;

Quiz Weightage 30% End term Weightage 40%

Session One

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Units in an economy ..
In an Economy there are three units :
Individual or Households : This is the unit which is providing labour and services to other two units against which it is receiving wages ; Government : This is the unit which is availing the service of the household and then producing goods and services as well as policy measures for overall improvement of a country ; Business : This is the unit which is generating goods and services by making investment and the same is being used for consumption of other two units.
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Flow of income,payments and production in the economic system

Flow of Expenditure For consumption and taxes Flow of production Of Goods and Services

Producing Units ( Mainly Business Govt)

Consuming Units (Mainly Households)

Flow of Productive Services Flow of Income

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Direct Finance
Flow of Fund

Borrowers (deficit budget unit)

Lenders (surplus budget unit)

Primary Security
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Semi Direct Finance

Primary Security

Primary Security

Borrowers (deficit budget unit)

Security brokers, dealers and investment bankers

Lenders (surplus budget unit)

Flow of Funds

Flow of Funds

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Indirect Finance
Primary Security Secondary Security

Borrowers (deficit budget unit)

Financial Intermediaries (Banks, Financial Institutions

Lenders (surplus budget unit)

Flow of Funds

Flow of Funds

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Financial Disintermediation
In the process of financial disintermediation , the role of financial intermediary has been eliminated and the borrowers can raise the fund directly from the lender with the help of either public issue or private placement of securities. This can be performed with the help of stock exchanges.
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Comparison of Tata Steel and ICICI Bank Liability Sl No Particulars Tata Steel ICICI Bank 1 Equity 1.27% 0.28%

2 3

Reserves and Surplus Outside Liabilities Current Liabilities and Provisions

Total

51.15% 33.28%

13.28% 82.50%

14.30%
100.00%

3.94% 100.00% 17

Comparison of Tata Steel and ICICI Bank Asset Sl No Particulars Tata Steel ICICI Bank
1 Net Fixed Assets Investment ( major portion for Investment in corus through sibsidiary) Current Assets Other assets Total 100.00% 100.00%
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20.96%

1.17%

2 3 4

52.00% 27.04%

33.16% 65.67%

Analysis Liability Side

In Bank : Equity and reserve component is much less than that of a manufacturing company . In Bank : TOL is higher; Financial leverage is significantly higher in case of a bank compared to that of a manufacturing company . If the financial leverage is higher , the risk of bank is also higher .
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Analysis Asset Side

Bank: Fixed asset part is significantly lower compared to that of the manufacturing company . Bank : Current asset in the form of loans and advances are significantly higher compared to that of the manufacturing company . Bank : Financial Investment is also higher compared to that of manufacturing company . Banks assets are financial where price call can be much faster.
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 Besides the on balance sheet items i.e. Assets and Liabilities , Banks do have large amount of Off Balance Sheet Items In the case of Off Balance Sheet items, some of them are traded and some of them are not traded. For Off Balance sheet items risks are quite high and this must be captured to contain the risk. Off Balance Sheet non traded items are associated with Credit Risk Off Balance Sheet traded items are associated with mainly Market Risk
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Off Balance Sheet Items

Complex Holding Structure

Banks are holding lot of investments in their books which is originated in the complex structures This complex structure makes it very difficult for the regulator to identify the risk and also to quantify the risks This complex structure should be also be addressed to contain the risk of the system The ring fencing strategy has to be adopted to contain the risk :
Study the recent draft guidelines of RBI
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How to reduce risk ??

From the composition , we find that a bank is a significantly high risk entity .
Higher TOL/TNW; Financial Asset on the asset side ;

Banks must operate within the risk ; The aim is to reduce the risk within this structural frame work of high leverage. How it is to be achieved ?

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Banking Business
Like any other business, Banks also do not have any fund on its own. It borrows money in the form of equity and loan. Then it invest in the form of fixed asset as little as possible and then it invest in the loan and investment . From this it earns income and then pay the expenses . Then the surplus is paid to the lender of loan and equity capital .
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Banking Business- How to reduce risk

Banks maintain minimum amount of capital to have repayment flexibility ; Banks are provided liquidity support from the central bank in time of necessity ; Banks should operate in such a way that many depositors should not come at a single point of time to withdraw the fund from the bank. Banks should maintain accounts so that major loss should not happen within a short period of time.
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Factors changing banking

Though the traditional banking means the borrowing of money from the depositors and lending the money to the borrower, over a period of time several factors have changed banking forever. Out of these several factors , five fundamental forces have changed the banking industry across the globe. One must know these five factors for acquiring a comprehensive knowledge of development of banking .
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Factors changing banking Deregulation

Over a period the degree of regulation has been relaxed . Regulations can take place in many forms like :
Maximum deposit rates; Maximum lending rates; Minimum Capital Asset ratio; Minimum legal reserve ration; Maximum exposure ration ; Restriction on products and services;

If we see that over a period , these restrictions have reduced and this resulted in the 27 uncertainty in profit.

 Previously banks were protected from competition by not allowing the others to offer activities which banks were offering . However, over a period many new players have been permitted to offer similar services and this has increased the competition. Over a period we have seen the development of following financial entities :
Non Banking Finance Companies; Captive Finance Companies; Money Market Mutual Funds ; Investment banking units ;

Factors changing banking Deregulation :Increased competition

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Recent phenomena in Banking ..

In the recent past , we have witnessed one of the worst banking crisis of the history
Sub Prime Crisis.

US Banking system has been severely hit by this crisis and due to world integration the global banking system has also been hit. World went into recession because of this

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Sub prime crisis

Economic cycle would result in recessionary phase from time to time. In 2001, US economy was under going recessionary phases . To overcome recession , money supply has to increase.
More money means more investment More investment means more growth More money means more inflation

In the initial years interest rate was put to very low by Fed . Banks started lending to sub prime borrowers as EMI was lower . 30

Sub prime crisis

Innovation made in the product :
No EMI up front Credit Enhancement by getting rating Credit Enhancement by CDS; Securitised loan for generating more loan;

Due to this innovations , more and more good money went to bad loan When inflation goes up , Fed had to increase the rate . With increased interest rate , EMI became non payable . People started defaulting ; 31 Crisis escalated

Sub prime crisis- Causes

Selection of borrower was wrong;
In adequate data

Repayment properly :

capacity

was

not

examined

Repayment based on adhoc income calculated

Financial innovation was used to justify fundamental mistake :

Securtisation CDS Rating with complicated models

Psychological aspect of lending was not taken in to consideration .

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Sub prime crisis

Macro economic parameter
Growth rate Liquidity Interest Rate Inflation

At the time of origination of Sub prime crisis

Low High Low Low/ Rising

Today

Lowest Highest Lowest Low/ Rising

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Recent phenomena in Banking ..

Path breaking policy changes in the near future. Addressing the agency issue in the banking system. Regulator may ask bank to eschew complexity . More capital requirement at the time of difficulties. More regulation by regulators. In India, banking industry has not attained the critical mass as per the global standard. Mergers among banks are expected. RBI may withhold the foreign bank entry policy in India.

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Indian Banking System

Indian Banking System Regional Rural Bank & LAB

Commercial Bank

Cooperative Bank

PSU Banks

Private Bank

Foreign Bank

SBI & Associates

New

Nationalised Bank

Old 35

Indian Banking Situation

Commercial Banking in India is divided into two types namely :
Scheduled Banks and Non Scheduled Banks .

Scheduled Bank -Bank registered under the Second Schedule of the RBI Act.
Participation in clearing Offering of non fund based product

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Indian Banking Situation

Ownership wise , Indian banking can be segregated into the following :
PSU Banks Private Banks Foreign Banks

Under PSU Banks we have SBI Group and Nationalized Banks .

SBI groups consist of SBI and Associate Banks . Nationalized Banks are those banks where the majority shareholding is in the hand of government .

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Indian Banking Situation

Under the Private Sector banks we have two types of Private Sector Banks.
Old Private Sector banks New Private Sector banks

Under the foreign banks, parent banks are the foreign entity and they are treated as foreign banks by the regulator . Banks at the localized level:
Co Operative Banks , Local Area Bank and Regional Rural Bank.

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Bank Asset
Serial No 1 2 Particulars Fixed Asset Investment Characteristics Limited Marketable ; Non Marketable ; Comes under treasury operation

Loans and Advances

Non Marketable ; Comes under Corporate Banking ;

Vault Cash Branch Banking ; Bank Balance Treasury Operation
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Cash and Bank Balance

Bank Assets
Loans :
Major assets in most banks portfolios; Generates the greatest amount of income Exhibits highest default risk Relatively illiquid.

Investment securities :
For interest earning For trading profits For statutory requirements Relatively liquid than loan

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Bank Assets
Non interest cash and dues from banks:
vault cash, deposits held at central bank, deposits held in other banks and cash items in the process of collections.

These assets are held :

To meet customers withdrawal needs and To comply with legal reserve requirement, To assist in check clearing and wire transfers .

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Bank Assets- Loans

Loan to Government Commercial Loan Individual Loan Real Estate Loan : Agricultural Loan Other loan to domestic offices Other loan to foreign offices

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Bank Liability
Bank Liability

Owned Fund

Outside Liability

Capital Tier I

Sub ordinate Debt Tier II

Borrowing from Public

Borrowing From Bank

Borrowing From Central Bank

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Borrowing from Public

Borrowing from Public

Demand deposit

Time Deposit

Certificate Of Deposit
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Borrowing from Bank

Inter Bank Borrowing

Unsecured

Secured

Call

Notice

Term

CD

IBPC

Refinance

CBLO

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Borrowing from Central Bank

Borrowing from Central Bank

Secured

Unsecured

LAF

Fixed Rate Repo

Refinance
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 Banks source of revenue : Interest Income ( II) Non Interest Income ( OI) Securities Gain ( SG) Banks expenses include : Interest Expenses ( IE) Non Interest Expenses ( OE) Provision for Loan Losses ( PLL) Security Losses ( -SG) Taxes ( T)

Income statement ..

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Income statement ..
Net Interest Income ( NII) = II-IE
NII= yiAi- cjLj

Burden = OE-OI Efficiency Ratio = (OE)/[II+OI] NI = NII- Burden PLL+SG-T

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Important ratios
Burden ratio = (Non Interest expenses- Non interest income)/ATA Efficiency Ratio = Non Interest Income/ ( NII+Non Interest Income ) Credit Deposit Ratio = Loans and Advances / Total Deposit ; CASA % = Current Account and Savings Account Amount / Total Deposit ; Net Interest Margin = Net Interest Income / ATA
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