Summary_Banking Business.pdf

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Financial Framework

The Financial system consists of:

Markets (Stock Markets, Bond Markets,)

Market Players (Banks, NBFIs)

Instruments (Stocks, Bonds etc)

Regulators (RBI, SEBI etc)

Banks

The term ‘bank ’ is used generically to refer to any financial institution that is licensed to accept deposits that arerepayable on demand, and lend money.Services offered by a bank to a corporate are:

Loans: Banks provide short and long-term funds to businesses.

Cash Deposits: Corporates deposit surplus funds in a bank.

Foreign exchange transactions: Banks act as authorized dealers to facilitate foreign exchange

transactions.

Advisory Services: Banks provide financial advisory services such as valuations, issue management,

mergers & acquisitions, etc. to corporates.

Trade and commerce: Banks play the role of the trusted intermediary between parties involved in trade

and facilitate trade and commerce.

NBFCs

‘NBFC’ stands for ‘Non Banking Financial Company’. An NBFC broadly carries out lending and investment functions.Only few permitted NBFCs can accept deposits.

The three key differences between a bank and NBFC are:1.

An NBFC cannot accept deposits which are repayable on demand. Some can accept fixed-term deposits.2. Any deposits accepted by NBFCs (these will be of fixed maturity as explained above) are not insured3. Only banks can participate in the payment system; hence NBFCs cannot issue cheque books to their

customers.

Categories of Banks in India

Scheduled banks: Banks which have deposits > INR 200 crore are ‘Scheduled Banks’.

Non-scheduled banks: Banks which have deposits <= INR 200 crore are ‘Non-scheduled Banks’.



Banking Structure in India:

Public sector Banks: PSBs are those where the government holds a majority (>50%) ownership.

Private Banks: Private banks, are banks owned by private (i.e. non-government) Indian entities such as corporates

and individuals.

Foreign Banks: Foreign Banks are those owned by multi national/non-Indian entities.

Regional Rural Banks: RRBs are also banks with a Government ownership. The idea was to create banks which

will focus on the rural areas and serve the under banked sector. A scheduled commercial bank acts as a sponsor of

an RRB.

Urban Co-operative Banks: Co-operative banks are formed by a group of members. Traditionally the thrust of

UCBs has been, to mobilize savings from the middle and low income urban groups and ensure credit to their

members - many of which belong to the weaker section.

State Co-operative Banks: SCBs are set up with state government partnership to help agricultural and rural

development.

The Central Bank

The ‘Central Bank’ (CB) of any country is the banker’s bank. It acts as a regulator for other banks, while providing

various facilities to facilitate their functioning. It also acts as the government’s bank. The Federal Reserve is the

Central Bank of the United States, while the Reserve Bank of India (RBI) is the Central Bank in India.

National Housing Bank: National Housing Bank, a wholly owned subsidiary of RBI, governs the functioning of all

housing finance companies.

Capital adequacy ratio-Basel accord/norms

The Basel Accord is a global regulation controlling the amount of risk that banks face. The norms defined the amount

of capital (owners’ funds – i.e. money invested by owners, plus profits) a bank or NBFC must maintain, based on the

risks it takes. This is called the Capital Adequacy Ratio (CAR). The higher the risk a bank takes, the higher capital it

must maintain.

Risks covered by Basel norms are:

Credit risk: Risk of loss a bank faces while lending.

Operational risk: Risk of loss a bank faces during regular operations.

Market Risk: Risk of loss a bank faces while trading in various financial markets etc.



Reserve Requirements

Reserve requirements are a certain percentage of deposits taken which are to be maintained with the RBI. Reserve

requirements in India are of two types:

1)

Cash Reserve Ratio: A certain percentage of all deposits must be placed with the RBI in the form of cash.

CRR defines this percentage.

2)

Statutory Liquid Ratio: A certain percentage of all deposits must be used to purchase Government

securities. SLR defines this percentage.

Key Concepts for Banks & NBFCs

1) Net Owned Funds: Essentially NOF is Owners’ Equity – i.e., money belonging to the owners.

Net Owned Funds = Owners‟ Equity – Losses

2) Capital to Risk Weighted Assets Ratio (CRAR): CRAR gives the ratio of owners’ money as a

percentage of risk weighted assets (loans).

3) Ways of charging interest:

a)

Flat rate method: Charging interest on constant principal. That is, if a loan of Rs. 1 lakh is given,

interest is always calculated on Rs. 1 lakh, even if Rs. 5000 is repaid each month.

b) Reducing balance rate method: Charging interest on outstanding principal – i.e. any repaid principal

is deducted from the outstanding amount and interest is only charged on unpaid principal.

4)

Methods of securing a loan with collateral:

a)

Pledge: When a borrower ‘pledges’ an asset and borrows against it, she loses the right to use it. This

means usually that, the asset will lie with the lender.

b) Hypothecation: ‘Hypothecating’ an asset gives the owner the right to use it, and the lender the right to

seize and sell it in case of default.

c) Mortgage: Mortgage is used whenever the asset used as collateral, is immovable property.

d)

Lien: A lien means, the claim of the lender on any asset used to secure the loan.

5) NPA and Provisioning: An NPA is a ‘Non Performing Asset’. Lenders must ‘provision’ for NPAs, which

means they must keep aside a certain portion of their income to provide for the losses against these NPAs.

For a bank , a loan becomes an NPA after 90 days overdue; for an NBFC, after 180 days.

6) Priority Sector Lending: For all domestic commercial banks, 40% of their lending must be to the prioritysector defined by the RBI.The priority sector includes:

• Agriculture

• Small enterprises

• Self Help Groups

• Micro Credit

• Educational Loans

• Housing Loans



Banking Business

The primary function of a bank is to collect funds (deposits) at a lower interest rate and lend them out at a higher

interest rate. A bank makes money via ‘Net Interest Income’.

Net Interest Income (NII) = Interest Earned on Loans – Interest Paid on Deposits

However, a sizeable portion of income comes from fee charged on various services such as

Demand drafts

Advisory services to corporate,

Trading income,

Commission via selling other (non-bank) financial products like insurance and mutual funds.

Cost of Funds for a Bank

It is critical for a bank to keep close track of the cost of the money it is borrowing. It has thousands of deposits, each

of different tenors (tenures/maturity) and with different interest rates. It can work out its lending rate, only if it

knows the cost of the money it has borrowed.

Weighted Average Cost of Capital (WACC)

We can find the cost of funds using the concept of Weighted Average Cost of Capital. It can be calculated as shown

below.

Rate Weight Weighted cost

Savings A/cs 3 % 0.45 1.35

Fixed deposits 7% 0.25 1.75

Current A/cs 0% 0.3 0

WACC = 3.1 %

Spread

The difference between the average deposit rate and the average lending rate is called the ‘spread’.

Spread = Average Lending Rate – Average Deposit Rate

In India, banks typically work on spreads of 3-5%. So, if SBI says its spread is 3%, it means that the differencebetween its average deposit rates and lending rates is 3%.

Difference between Spread and NII

NII is the income earned (difference of the actual interest earned and paid) by the bank in absolute terms. Spread is

the difference between the interest rates.



Business Offerings of a Bank

Banks are structured based on what specific businesses they focus on. For example, if its two-wheeler loans business

is large, it may have a separate business unit (department) just for this product. If not, there maybe a unit catering

jointly to two wheeler loans, loans against securities, etc.

Described below is a generic overview of what a large bank would look like.

Broadly, a bank’s divisions can be categorized for easier understanding, into:

1. Line Functions - Business units which are a key part of banking operations, are called ‘Line Functions’ – and are customer facing or part of the ‘Front Office’. This means they are interacting with the customer.These include the sales functions, the channels and each specific group of offerings like retail banking,corporate banking, etc. as shown.

2. Back Office & Support Functions - The second category also comprises key line functions, but these are

‘back office’ or operations. They support the front office. These include all operations such as account

opening, loan documentation processing; also risk management, payments, new product development and

Asset & Liability Management or ALM.

3. Staff Functions - The third set is the ‘staff’ functions – they are not key banking or line functions, and

would be there in any large organization. These are functions like Human Resources, IT, Legal, Finance &

Control, etc.

Let us know about each section in brief.

Channels: Systems/Infrastructure which enables a customer to access the bank’s services.

Sales & Marketing: Division managing sales of all the products of the bank.



Retail Banking: Division which handles banking requirements of domestic individuals and small businesses –

proprietorships and partnerships.

NRI Banking: Specific to India – handles banking requirements of NRIs. This can be clubbed in the Retail Banking

Division.

Rural/Agricultural Banking: Division seen mainly in Public Sector Banks (PSBs) in India, as they must, by

mandate, cater to the needs of this sector.

SME Banking: Small and Medium Enterprises division. Sometimes also included under Corporate Banking – depends

on the bank.

Corporate/Wholesale Banking: Division which handles the banking needs of corporates only.

Pvt. Banking & WM: Managing the investment needs of wealthy individuals, called High Networth Individuals

(HNIs).

Investment Banking: A specialized division that caters to the niche requirements of corporates. For example,

Mergers and Acquisitions advisory (M&A).

Financial Markets & Treasury: Trading division of the bank. This could be proprietary (for their own books) or on

the behalf of clients. Product Development: Designs new product offerings based on market requirements.

Product Development: Designs new product offerings based on market requirements.

Operations: Entire set of processes to enable banking services. Can be divided into Operations for each division or

merged for economies of scale.

Risk Management: Handles credit, market, operational, liquidity risks for the bank – can be segregated for each

division.

Payments/Remittances: Handles all the payments processing. Large operational area, hence separate division.

ALM: Manages a bank's balance sheet to minimize interest rate and liquidity risk.

HR: Manages Human Resources function such as recruitment, training etc.

Legal & Compliance: Ensures compliance to regulatory requirements.

IT: Managing the technology required for the various processes.

Audit: Internal function, ensuring processes are within guidelines.

Finance & Control: Preparing the financial statements, budgeting, forecasting & internal reporting of the bank.

Let’s look at the channels in detail.

Channels

Banking channels refer to the means by which customers access a bank’s products and services. Typical channels offered by banks include:

1.

Branch Banking

Branch banking refers to a physical location where a bank offers a wide array of services to its customers. It

involves large investment in infrastructure and employees.

Branch banking is the most popular channel and also the most expensive channel for a bank.

Functions of a branch - The functions of a branch are illustrated below. They can be divided into:



a)

Front-office or customer interfacing functions - The front office or customers facing functions are

those of the teller, customer service and sales staff. Often, as shown, one person can have dual

responsibilities: A teller can also answer customer queries or a customer service staff can use his interaction

time to sell a bank product.

b) Back office or operations - The typical back office operations are payments, check book processing, loan

processing etc. These operations are usually centralized in a region. Hence for large banks, operations

within each branch are minimal.

2.

ATMs

An Automated Teller Machine (ATM) is a computerized device that provides the customers of a bank easy access

to transactions, without the need for a branch.

ATMs can be just cash dispensers or evolved facilities offering facilities such as:

Balance Enquiry

Statement of Accounts

Cash Withdrawal

Cash deposit

Check deposit

Check cashing

Funds transfer

Bill Payment

Currency Exchange

Loan Application

Investment Advice

MF, Insurance sales

Electronic Purse loading

Ticketing

3.

Internet Banking

Internet Banking refers to the ability to access banking services/products via the internet. It is one of the

cheapest channels for a bank.

Typical Internet Banking offerings include:

Static information about the bank’s offerings, application forms

Specific account information: Statements, Alerts,

Ability to change/edit account information

Stop payments, cheque book requests/other instructions

Payment transactions to other accounts within and external to the bank

Bill Payments

4. Phone Banking

Call centers enable customers to access services as described below:

Enquiries about Loans and Deposits - Check your account balance, enquire the last five transaction details,

make general foreign exchange rates enquiry etc.

Transactions - Request for a cheque book or account statement, transfer funds between accounts (samecurrency), make bill payments etc.



5.

Mobile Banking

Banking using a mobile phone network can use either SMS or WAP technology. Interactions can be classified as

either transactions or enquiries; as also if they are bank initiated (‘Push’) or Customer initiated (‘Pull’), as shown

in the table below.



Retail Banking

Retail banking is a division that handles banking requirements of individuals and small businesses. The retail bank

acts as a key channel to collect deposit funds, which are in turn used to generate profits for the bank.

The retail bank broadly offers two categories of products:

Liability (Deposit) Products

Asset (Loan) Products

Liability Products

A deposit is a contract between the bank and the customer. The bank must repay the deposit per the terms of thecontract. Hence deposits are liabilities for the bank. Bank deposits are insured. Some deposit accounts pay interest.

In India, RBI mandates four basic types of domestic deposit accounts:

a) Savings Accounts: These accounts are meant for individuals. The key features of a savings account are:

Users Meant only for individuals.

Withdrawal

frequency

There is some restriction on the number of times a customer may withdraw or deposit

funds.

Interest rate

It pays interest. Currently (Oct 2011), RBI has deregulated the savings rate. The

interest is calculated on the daily balance in the account. The interest is credited to the

accounts on a quarterly or longer rests.

b)

Current Accounts: The key features of a current account are:

Users

They are held mainly by businesses. Legally speaking, they can also be opened by

individuals, but unless they have a large (say, more than a hundred per month) number

of transactions, they’d be better off with a savings account which pays them interest.

Withdrawal frequencyThese are accounts primarily meant for transacting, and hence have no restrictions on

the number of transactions.

Interest rateBanks do not pay any interest on current accounts, though RBI allows Urban Co-

operative Banks to pay some interest if they wish.

c) Term/Time/Fixed Deposits: These are deposits with a fixed maturity, hence also called Fixed Deposits

(FDs).The key features of a fixed deposit are:



Users Either an individual or a business.

Withdrawal frequency The customer cannotadd to, or withdraw from, this deposit till maturity – i.e.,

transactions are not allowedon an FD.

Interest rate FDs earn higher interest than savings deposits, and banks are free to fix the interest

rates.

As there are no transactions, FD accounts do not come with means of withdrawal, such as cheque books or ATM

cards.

Recurring Deposits - These are a fixed deposit variant. The only difference being that, the customer has the

flexibility to deposit the amount in installments.

Users Meant only for individuals.

Withdrawal frequency No withdrawals are allowed. One can, however avail a loan against the deposit.

Interest rate Depends on the maturity period. It earns a compounded rate of interest.

d)

Public Provident Fund Accounts: These are accounts meant for retirement savings. In India, they are fully

tax exempt – you pay no tax on the principal or interest earned.

They currently earn a tax free interest rate of 8.7% p.a., compounded annually.

Combination Accounts

Apart from the above, banks also offer some combination structures. They are:

1. Book the FD in small „pieces‟ : Here the F.D is booked as multiple FDs of small equal amounts. Hence a

customer can withdraw or break these small amounts without disturbing the other parts of the FD.

2. Loan against the F.D: This is actually a loan – an OverDraft (OD) - against the security/collateral of your

FD.

Banks charge a higher interest rate on loans against F.D. If the customer doesn’t repay the loan, the FD (on

which there is a ‘lien’) is seized to repay both principal and interest.

3. Savings/Transaction Account with F.D: The customer is offered the option of having surplus money in

a savings account /Current account moved automatically into an FD, thereby earning higher interest. In

case an amount more than what’s there in the savings account is needed, the linked FD is broken and

money ‘swept’ back into the savings account. These are typically called ‘Sweep-in/Sweep-out’ accounts or

an ‘Auto Sweep’ facility.



NRI Banking

There is a separate category of accounts for NRIs. If a bank has a large NRI deposit base, they may have a separate

business division for NRI deposits.

An NRI can hold only any one of the following three types of NR (Non Resident) accounts.

Non ResidentOrdinary (NRO)

Account

Non Resident External(NRE) Account

Foreign Currency NonResident (FCNR)

Account

Deposit Currency Foreign Currency/INR Foreign Currency Foreign Currency

Withdrawal Currency INR INRForeign Currency – but nointerim withdrawals

Currency Risk forCustomer

No Yes No

Repatriable

No limit on interest

amount. Principal cappedat USD 1 Mn.

Principal and interest Principal and interest

Liability Processes

The liability process is as follows:

a)

Account Opening: An account can be opened only after various checks like identity, source of funds etc.

are done.

b)

Relationship Management: Relationship management involves ongoing interaction with the customer in

order to service any requests.

c) Operations/Servicing: The operations around the lifecycle of a deposit are reasonably complex and

large. They involve interest accrual, statements, any modifications to the customer details (such as

address, phone number etc), managing transactions and closure.

d)

Monitoring: With countries coming together to fight terrorism via tracking and blocking terrorist and illegal

funds, banks have the additional responsibility of monitoring the transactions of deposit accounts.

Liability Account Status

The status of any account can be classified as follows:

a)

Active Account - An active account is a normally functioning one.

b) Dormant Account - If an account sees no depositor activity for a certain period it is called a dormant

account. Some banks define this period as a year, or 1.5 years of inactivity. A dormant account needs special

monitoring.

c)

Frozen Account - A frozen account is one where transactions are blocked.



Asset Products

Asset products can be categorized based on certain parameters. They are:

1)

Basis Security – There are two types of products under this category

a)

Secured Loans: Loans in which an item of value is collateral for its repayment.

b) Unsecured Loans: Unsecured loans do not involve the pledge of collateral. Assurance of repayment is

the borrower’s promise to repay the loan.

2)

Basis Repayment – The following products are offered based on repayment

a)

Single Payment Loan - The borrower repays the loan in one lump sum with the single-payment plan.

b) Installment Payment Loan - Borrowers repay loans over a period of time at periodic intervals (for

example, monthly, quarterly, or semiannually).

3) Basis Disbursal

a)

Open Ended Loan - Also called a revolving loan or an overdraft (OD), borrowers are assigned a limit

or ‘line of credit’ upto which they can borrow. They can repay and borrow again upto the limit, hence

the term ‘revolving’ .

b)

Close Ended Loan - A lender extends a specific amount of funds to a borrower, after which no

additional advances can be made, even if the borrower makes payments on the loan.

4) Basis Interest Rate - Interest rates on the loan can be fixed-i.e., the rate remains the same for the period

of the loan, or floating (adjustable) – i.e., the rate floats, tied to a benchmark interest rate.

Typical Loan Products

The typical loan products offered by a retail bank are:

Home Loans

Loans against Property

Vehicle Loans

Loans Against Fixed Deposits

Credit Cards

Personal Loans

Education Loans

Asset Processes/Roles

Irrespective of the type of loan, the retail lending process typically follows the following stages:

a.

Origination: Informing the prospective applicant about the features of the loan, collecting the completed

application and required additional documentation and verifying the collected information, are all parts of

this stage of the loan process.

b. Underwriting/credit appraisal: The bank evaluates the prospective borrower and decides how risky s/he

is.

c. Documentation: The documents required for closing the loan – such as title papers of any collateral – are

collected and verified.

d. Loan Closing: All parties to the loan sign the contract.

e. Disbursal: The loan is then disbursed, either at one go or in stages, depending on the terms of the loan.



f. Servicing: The loan does not end with disbursal. The principal and interest repayments need to be

collected in a timely manner. Also the servicing function has to ensure that the title and value of the

collateral remains secure.

g. Collections and recovery: In case the borrower delays payment, the process of collections starts. If there

is no payment on a loan for more than 90 days, it is classified as a ‘Non Performing Asset’ or NPA. If a loan

shows no signs of repayment after that, then the process of recovery – seizing any collateral and recovering

the loan amount – starts.



Corporate Banking

Corporate banking is the name given to the different banking services which companies need for their day to day

operations. It is also called wholesale banking.

Structure of Corporate Banking Division

A typical Corporate Banking structure looks like this:

The relationship chain manages the customer relationship. This can be called the front office. They interact

with the customers and understand their requirements.

The credit chain, on the other hand, rarely meets the customer. Their role is to evaluate the credit

requirements of the company, as presented by the relationship chain, and evaluate them.

Product management is responsible for customizing the banking products and services to suit customer

needs.

Transaction banking is often separated from the relationship chain & the credit chain and can be an

individual business unit called TBG (Transaction Banking Group). TBG is responsible for ensuring product

and service delivery to the customers.

Products and Services

The types of credit products and services offered can be classified as follows:

1. Fund Based Facilities – Line of credit

These are products in which a bank is ‘out of funds’ by lending money to its customers – hence, they are loan

products. The earning of the bank for such facilities is mainly interest income.

2. Non – Fund Based Facilities:

Here, the bank primarily stands guarantee for its customer. Examples of non-fund based facilities are ‘letters of

credit’ and ‘guarantees’. They are called non-fund facilities as they do not involve actual lending of funds.



Both fund-based and non fund-based facilities can be classified on the basis of:

1. Purpose

2. Maturity

3. Revolving or one-off

4. Security

To understand the various facilities, we will use the funded and non funded classification.

Funded facilities:

Working Capital Loans

• Overdraft Facility

• Cash Credit Facility

• Working Capital Demand Loans (WCDL)

Long-term Loans

Trade Finance

• Pre-shipment Loans

• Post-shipment Loans

Non Funded facilities:

Trade Products

• Intermediaries

• Letter of Credit (LC)

• Bank Guarantee

Cash Management Services (CMS)

Working Capital Loans: Banks provide various forms of loans to meet the daily requirements of businesses. These

are generally for a short term (up to 1 year).

Overdraft Facility: An overdraft facility or OD is a revolving credit facility that allows a borrower to

overdraw funds beyond the available balance, up to an agreed limit, from her account.

Cash Credit Facility: As in an OD, the business can withdraw up to the sanctioned limit when needed,

paying interest only on the amount withdrawn and for the period withdrawn. This is a facility against

collateral of receivables and inventory of the business. The limit is typically 60-70% of the value of the

collateral. The buffer (30-40%) which the bank keeps on the value of the asset is called the ‘margin’.

Working Capital Demand Loans (WCDL): Working Capital Demand Loan (WCDL) is, in essence, a short

term revolving loan facility given for the working capital requirement of the company.

Long Term Loans: Banks provide secured or unsecured long term loans to corporations – these could be to finance

expansions, buy real estate or machinery etc.

Trade Finance: Corporate banking provides services to facilitate international trade. These include loans to the

seller, to bridge his funding requirements till he/she gets payment from the buyer. These can be both pre-shipment

and post-shipment loans.

Bill Discounting: It serves to provide liquidity to an exporter. This is done by advancing him/her a portion of the

face value of a trade bill drawn by the exporter. The bill must have been accepted by the buyer, and then endorsed

to the bank.



Trade Products

Intermediaries: Banks also act as intermediaries for documents and funds flow in an international trade

transaction. This is because transfer through banking channels is far more secure, than if the buyer were to send

money directly to the seller, or the seller trying to send documents directly to the buyer.

Letter of Credit: The Letter of Credit (LC) allows the buyer and seller to contract a trusted intermediary (a bank),

that will guarantee full payment to the seller provided he has shipped the goods and complied with the terms of the

agreement.

Bank Guarantee (BG): A Bank Guarantee (BG) is an instrument by which the issuing bank guarantees the

satisfactory performance of a contract, or of the non-happening of an event (such as an event of default), to the

beneficiary. It can be a financial or performance guarantee.

Cash Management Services (CMS): CMS involves no credit risk for the bank. The bank provides a pure

administrative service for the corporate by managing the company’s receipts and payments across the country.

Hence, credit evaluation (that is, evaluating whether or not to grant a credit limit for the company) is not relevant

here.

Credit Evaluation: Before granting a facility/loan, the bank must follow a stringent credit evaluation process, to

determine whether or not to give the loan to the company.

This function analyses the ‘credibility’ of an organization.

The credit process involves a qualitative and quantitative appraisal of the client.

Qualitative analysis includes analysis of:

Promoter’s reputation

Industry outlook

Past track record

Extent of competition etc.

Quantitative analysis includes comparing the financials over a period of time to evaluate performance.

SME Banking

An SME – Small and Medium Enterprise – is also a corporate. So the facilities offered are similar. The most popular

products a bank provides to an SME are working capital products. They are:

Cash Credit: As described earlier, this is an overdraft facility which is secured by a business’ inventory and

receivables.

A bank will offer 60-70% of the value of the collateral as a cash credit facility. While the receivables &

inventory should be revalued periodically, usually a bank will do this once a year.

Overdraft (OD) Facility: This is an unsecured line of credit. The bank will allow the SME to overdraw their

current account upto a certain limit. Interest is charged only on the overdrawn amount for the period it is

overdrawn.



Specialized Divisions and Support Functions

Specialized Divisions

Let’s look at the specialized divisions of a bank.

1. Investment Banking

The traditional function of a bank was to accept deposits and lend money. But, as the needs of corporates

became more complex, a separate division got carved out of the corporate bank to cater to these niche

requirements of customers. This was called the investment banking division.

Its functions can be broadly classified as follows:

a)

Advisory Services - Mergers and acquisitions advisory – Investment Banks assist in negotiating and

structuring a merger between two companies. If, for example, a company wants to buy another firm, then

an investment bank will help finalize the purchase price, structure the deal, and generally ensure a smooth

transaction.

b)

Loan Syndication - In case, a company wishes to raise a large sum of money, the investment bank can

help arrange funds from a group of banks. ‘Syndicate’ means group and this process of funding is called

loan syndication.

c)

Issue Management - This is also called Merchant Banking. In case a company wishes to raise money

directly from the public by issuing shares or bonds, the investment bank will advise and facilitate the entire

process. This involves determining the price, the regulatory formalities to be complied with, and to ensure

the investor gets the shares, and the company the money.

d) Other services - Some other services that fall within the gamut of investment banking are Private Equity

and Venture Capital. This involves investing in the equity of operating companies that are not publicly

traded on stock exchange. Private equity or Venture Capitalists take an equity stake and assist the

management in the overall direction of the business.

The investment bank also provides underwriting services. An underwriter guarantees that the capital

issue will be subscribed to the extent of his underwritten amount.

2.

Financial Markets/Treasury

The Treasury division provides order and trade execution functions to corporates and individuals in financial

markets. Investors can place orders for various markets through an interface provided by banks.

Companies can buy or sell foreign currency through the bank for their import or export requirements.

Banks route orders to markets and maintain the information regarding positions and prices for such trades. They

also facilitate the process of settlement.

3. Private Banking/Wealth Management

Private banking involves personalized services such as money management, financial advice, and investment

services for ‘High Net worth Individuals (HNIs)’.

The services to HNIs can be classified into traditional banking services and special advisory services.



Traditional Banking Services –

Personalised check books

Separate counters

Banking at your doorstep

Instant wire transfers

Advisory Services – These are divided into

a) Investment Management & Advice: A client relationship manager understands the client’s liquidity,

capital and investment needs. Advisory services can relate to investments, tax planning, real estate

management and art advisory.

The investment advice can be of two types:

Self-Directed or Non-discretionary - This is investment advisory in which the bank offers

investment recommendations based on the Client’s approval. The client may choose to ignore this.

Discretionary - In this case, the bank’s portfolio managers make investment decisions on behalf of

the customer.

b)

Liquidity Management: This involves management of a Client’s liquidity (cash etc) needs through short-

term credit facilities, flexible cash management services etc. An exclusive cash management service with

"sweep" facility is a Private Banking feature.

Private banking clients typically demand higher returns on their investment, and as a result banks offering

these services are heavily dependent on efficient systems and processes to achieve this.

Private Banking – Workflow

The high-level process flow for private banking is shown below.

The front office manages the client interaction and trade execution part. He gets inputs from the middle office in

terms of investment research reports. The back office handles the processing and settlement of the transactions.

This includes sending regular statements, payment messages, to the client etc.

Certain activities are outsourced to the service providers such as safe custody of securities, tax processing etc.

4.

Rural & Agricultural Banking

A bank’s involvement in rural banking can be to take deposits and lend money. However, the branch network

required to access rural areas vs. the typical deposit amounts gathered, make it an unviable proposition for

private sector banks.



An important vehicle for funding in rural areas tends to be microfinance which can be retail (to SHGs) or

wholesale (to Micro Finance Institutions who then lend the money to SHGs).

Broadly, credit or funding can be focused on three parts of the agricultural chain described below:

The risks a bank faces specific to agricultural lending are the risk of crop failure and drop in crop prices, as both

will impact repayment.

Support Functions

Below are some of functions that encompass the whole bank, and are not restricted to a specific division.

a) Sales & Marketing: The sales function is largest for the Retail Bank (offerings for individuals). The sales staff

can be divided by product. Banks and NBFCs achieve their sales for Retail Banking through:

External/outsourced agencies: These are called Direct Sales Agencies (DSAs) or Direct Marketing

Agencies (DMAs). They are paid a commission on every sale. Other outsourcing agencies are tele-

marketing and direct mailing agencies.

Internal sales staff: Every interaction with the bank is seen as an opportunity to sell its services. Hence

branch staff and relationship managers often cross sell various products and services of the bank.

b)

Asset Liability Management (ALM): For a business, timings of the returns from the asset, must match the

due date of the liability. A basic aspect of financial planning encompasses such matching activities of cash flows

and is given the generic label: Asset and Liability Management or, in short, ALM.

Asset Liability Management consists of managing this interest rate risk to within acceptable limits. ALM also

manages liquidity risk for the organization; that is, the bank must always have sufficient funds to service their

depositors.

FARMERS &

FARMER COLLECTIVES

INPUT: SUPPLIERS

Suppliers of: Seeds, Fertilisers,

farming equipment

PURCHASERS

Agriprocessors, Wholesalers,

Agri Businesses

Working Capital

Financing

Dealer financing

Guarantees

Working capital

funding

Short term and long

term loans

Warehouse financing

• Individual loans against

crops

• For Land development

• Mechanisation

• Poultry, piggery, dairy

farming support

• Warehousing financing

• Funding of fertiliser

and seed distribution



c)

Human Resource Management: As the name suggests, this deals with managing the employees of the bank.

This includes recruitment, training, evaluation, compensation and any issues of conflict amongst the employees.

d) Legal and Compliance: This deals with any regulatory requirements of the bank. Any lawsuits will be handled

by the legal department. Any new client contracts or legal agreements will also be drawn up and vetted by this

division.

e)

Finance and Control: This manages the internal and external reporting requirements for the bank. This is

where the financial statements of the organization are prepared and reported. This department is closely

associated with the senior management of the organization.

f) Audit: This manages the internal audit requirements for the bank. It is an independent division that evaluates

the control systems within the organisation.

g) Technology: This is responsible for managing the existing technology platform of the bank. They also design

any new systems and processes that are required to provide the bank with a competitive edge. A lot of this

activity could be outsourced to IT companies as well, in which case managing the technology vendors would

also be a role of the technology division.



NBFCs

Introduction

Non Banking Finance Companies (NBFCs) are financial institutions that provide services, similar to banks, but they donot hold a banking license. The main difference is that NBFCs cannot accept deposits repayable on demand.

Classification of NBFCs

NBFCs have been classified into three types:

1. Asset Finance Company (AFC): An AFC is an NBFC, whose principal business is the financing of physicalassets.

This includes financing of automobiles, tractors, lathe machines, generator sets, earth moving and material handlingequipments and general purpose industrial machines.

An AFC may be either1. Giving loans to businesses for purchasing the physical assets – tractors, machinery etc.2. Leasing these assets to businesses.Examples of AFCs are Infrastructure Finance Limited, Diganta Finance etc.

2. Investment Company (IC): This is an NBFC whose primary business is purchase and sale of securities(financial instruments, such as stocks and bonds).

A mutual fund would come under this category. Examples of an Investment Company (IC) areMotilal Oswal, UTI Mutual Fund etc.

3. Loan Company (LC): Loan Company (LC) means any NBFC whose principal business is that of providing finance,by giving loans or advances. It does not include leasing or hire purchase. Example of a Loan Company (LC) is TataCapital Limited.

NBFCs can be further classified into those taking deposits or those not taking deposits. Only those NBFCs can takedeposits, thata) Hold a valid certificate of registration with authorization to accept public deposits.

b) Have minimum stipulated Net Owned Funds (NOF – i.e. owners’ funds)c) Comply with RBI directions such as investing part of the funds in liquid assets, maintain reserves, rating etc.issued by the bank.

How do NBFCs Access Funds?

NBFCs cannot access CASA funds, they can only access fixed deposits which are the most expensive among alldeposits. Also, not all NBFCs can access deposits – there are regulations governing which can, and which cannot.

Their cost of funds, and hence lending rate, is typically higher than a bank’s. People borrow from NBFCs becausetheir lending norms are not as strict as a bank’s. However, their default rates are therefore also generally higher.

NBFC Business Offerings

NBFCs focus primarily on the areas which banks do not service, or service sparingly. Deposits (for some), lending,leasing and hire purchase are key activities. Business offerings of an NBFC are:

1. Deposits: Customers deposit with NBFCs because they pay rates higher than those of banks. They can acceptpublic deposits which are of fixed maturity. The minimum maturity period is 12 months and the maximum 60months.



2. Leasing & Hire Purchase: An asset finance company, mainly derives revenues from financing assets such asequipment, vehicles, etc.

In a Lease transaction two parties are involved:a) Lessor: The person who pays rent for land or property from a lessor.b) Lessee: The person who rents land or property to a lessee.

The ownership of the asset rests with the asset finance company. The AFC earns lease rentals, which comprisefinance or hiring charge and recovery of the ‘used up’ value of the leased asset. In hire purchase the ownership of the asset is transferred to the hirer at the end of the HP period.

3. Lending: NBFCs tend to take on higher risk than a bank. They are not constrained by the priority sector lendingrequirement which banks have.

4. Investment Services:

NBFCs offer a wide range of investment services such as:

Merchant Banking and Underwriting - Investment Banking functions where a business that wishes to raisecapital is provided various services.

Stock Broking - Trading on behalf of customers.

Asset Management - Managing clients’ funds. Mutual Funds, Pension Funds, Private Equity Funds all offerthese services.

Venture Capital & Private Equity - Equity capital to start-up companies; and private (not public) equitycapital for other businesses.

Custodial services - Settlement of securities transactions.

Most NBFCs tend to focus on a combination of lending, leasing & hire purchase or investment services.



Payment Systems: An Introduction

Any non-cash payment system consists of four parties:

1. The payer, who’s making the payment

2.

The payee, who’s receiving the payment

3.

The payer’s bank

4. The payee’s bank

Only banks can participate in the payment system. Hence the payment system concerns itself with the payer’s and

payee’s banks. They in turn interact with the payer and payee respectively.

The two banks can exchange the funds either directly or through an intermediary called a Clearing House (CH) or

Clearing Agency (explained later).

Let’s now understand what a non-cash payment looks like. It consists of two components:

1.

The Payment Instruction: The payment instruction, where a message is transmitted between the two

banks.

2.

Transfer of Funds: Transfer of funds between the two bankscan happen either along with, or later than,

the payment instruction.

Concepts and Terms:

Let us look at some concepts and terms used in the world of payments.

Clearing: This is the process of defining payment obligations between banks within a payment system – that is,

which bank owes what to whom.

Clearing House (CH): The banks could either exchange messages and funds with each other, or through a central

intermediary.

One central agency keeping track of the payment instructions and fund exchanges between banks means that, each

bank only needs to interact with one entity – the Clearing House (CH).

Functions of a clearing house:

Record

Reconcile

Calculate

Send information

Settlement: Once the payment obligation has been defined, then the bank has to exchange funds, or settle the

obligation.

Settlement Bank: Settlement happens via debit/credit of accounts which banks hold with a settlement bank.

Each of these banks can hold a settlement account with a third bank, designated for this purpose as the ‘settlement

bank’.

Correspondent Bank/Correspondent: A correspondent bank is one which acts as a representative of another

bank. Banks have correspondent relationships with each other across the world and locally.



Nostro Account: It is a bank’s foreign currency account with any other bank. This means, „our account with

them‟.

Vostro Account: This is how a correspondent bank refers to another bank’s foreign currency account with it. It

means ‘their account with us’ .

On-Us: This term is used within a bank, when the payment transaction it receives, is drawn on it. That is, payer and

payee belong to the same bank.

Off-Us: In case the payer and payee belong to different banks, the transaction is called ‘Off -Us’ or a ‘transit

item/clearing item’.

Float: Advantage to the payer/payer’s bank because of delay in the payment system, as he enjoys the usage of the

money (over which he has no claim) till it is paid out.





Payment Systems – Process and Methods

Layers within the payment system

Various layers within the payment system are:

Central Bank of the country: The Settlement Bank - most often, the RBI – ensures that payments get

settled between various banks.

Clearing house: The Clearing house in turn, sends data to the settlement bank.

Service branches: Each bank in turn, will have one service branch which interacts with the clearing house.

Member banks: Exchange of funds between the individuals and businesses takes place via their banks,

who are members of the payment system.

Households/Firms: The largest users of the system – households/individuals and businesses.

Steps in a payment system

There are 2 steps in payment systems:

1. Clearing: It is the process of classifying which bank owes what to whom.

2.

Settlement: It involves settling obligations via exchange of funds.

Settlement can be of two types.Deferred Net Settlement systems: Refers to settlement between banks by netting off what they oweeach other. Since netting can only happen once some transactions have occurred, there is always a lagbetween clearing and settlement.Hence netsettlement systems are also called Deferred Net Settlement or DNSsystems/methods.

Real Time Gross Settlement (RTGS) systems: RTGS systems enable settlement of each transaction, atthe same time as the payment instruction. These are typically used for large value payments, and are notfeasible for small value retail payments.DNS is feasible for large volume, lower value payments and RTGS is great for high value, time criticalpayments.

Categorization of Payment Methods

Payments can be classified into various categories, depending on how the payment instruction is given by the payer:



Paper based payments

Cheques: A cheque is a payment instrument in a specified format, using which, the payer instructs (or ‘draws on’ ) his bank to allow a debit from his account.

Demand drafts: Similar to acheque except that a cheque, is payable finally by the payer (‘drawer’, incheque terminology) who holds an account with the paying bank, while a draft is payable by the payingbank itself.

Card based payments

Debit cards: Plastic card which one can swipe to give electronic instruction to bank to debit his accountand transfer funds to recipient.

Credit cards: Plastic card which one can swipe to give electronic instruction to bank to transfer funds to

recipient but without debiting his account for a specified period.

Electronic payments

Electronic Clearing Service (ECS): The Electronic Clearing Service clears and settles mainly bulk,repeated electronic payments. In this one time authorization, your account may be debited periodically.

National Electronic Funds Transfer (NEFT): NEFT is useful for one time electronic payments.

Real Time Gross Settlement (RTGS): RTGS is usedif one wants to make a one time transactioninvolving amount more than INR two lakhs and funds will transfer immediately.



Risk Management in Banks and NBFCs

Risk is the probability of financial loss. It’s not a certainty. This is important, in order to measure and manage risk.Risks can arise both from causes internal to a business (such as employee fraud) or externally from theenvironment - causes not directly related to operations (e.g. exchange rate risk for IT companies).The key then, is to be aware and take steps to manage risks.

Risk Management Process

Risk management is a three stage process and is shown below:1. Identify the risk2. Measure the risk3. Implement risk management measures

Risk Management in Financial Institutions

Risk Management for financial institutions like banks and NBFCs gathers large significance, as there are a lot ofparties/processes dependent on them.If a bank fails, hundreds of thousands of depositors money is at stake; the entire chunk of payments which is due tobe paid to other banks via the deferred net settlement process, is at stake – hence other banks are affected; thisbank will have borrowed from other FIs – they in turn will have problems paying back their obligations.

Typical Causes of Financial Crises

The root causes of financial crises have been classified as follows:

Asset (Loan) Quality: The subprime crisis in 2008-09, caused by poor credit risk management by banksand financial institutions, is a case in point.

Asset-Liability Mismatch: Banks and financial institutions have assets and liabilities of differentmaturities. This exposes them to Interest Rate Risk and Liquidity Risk.

Fraud: Poor risk management processes have also resulted in frauds in large institutions.

Let’s discuss the risk management process in detail.

Identifying Risk

The first step in the risk management process is to identify the sources of risk.Credit Risk, Market Risk andOperational Risk encompass over 90% of the risk faced by financial institutions today.

Market Risk - Risk of loss due to price movements in any market the institution is trading in, such as

currency, stocks, bonds, commodities etc.

Credit Risk - Risk of loan default

Operational Risk - Risk of incurring losses due to manual errors, fraud or system failure.

Liquidity Risk - Risk of not having liquid funds when needed. Liquidity risk exists typically in emerging

markets.

Let us now map each of these risks more specifically to each division of a bank/financial institution to make it more

relevant.



Current Account and Savings Account (CASA) - Liquidity Risk: The institution should have enough

funds to give loans and repay depositors.

Loans – Credit Risk: The institution should ensure that loans given are recoverable from the parties and

there are minimum defaults.

Cheque Clearing – Operational Risk: The institution should ensure that the clearing process takes place

smoothly without any manual errors. Else they would be exposed to operational losses.

Letter of Credit – Credit Risk: As the institution is providing a guarantee, they are exposed to default risk,

similar to loans.

Cash Management Service (CMS) – Operational Risk: Here again, as this activity is operation intensive,

the institution is exposed loss due to system failure, manual errors etc.

Trading – Market Risk & Operational Risk: As this involves the front office activity of trading in market

variables such as stocks and bonds and the back office activity.

Underwriting – Market Risk: As the institution agrees to buy unsubscribed amount in case of public issues

and issuance of other financial instruments.

Asset Liability Management – Market Risk & Liquidity Risk: Both loans and deposits are subjected to

market risk and liquidity risk.

Measuring Risk

The next stage in risk management process is to measure the risk. We all know that risk can be defined asprobability of occurrence and deviation from expectation.There are a number of other risk parameters such as ‘Duration’ – used for bonds, ‘Beta’ - used for equities,

‘Factor sensitivity’ - used for currencies etc.

Let us discuss briefly about a comprehensive measure of risk called ‘Value at Risk (VaR)’. Value at Risk (VaR)

VaR is an attempt to provide a single number summarizing the total risk in a portfolio of financial assets. It hasbecome widely used by corporate treasurers and fund managers as well as by financial institutions.

Some of the impetus for the use of VaR has also come from the regulators. Regulators now require all banks tocalculate VaR. They use VaR in determining the capital a bank is required to keep, to reflect the risks it isbearing.

Remember, risk measures are statistical estimates which can never be made with 100% confidence.The full statement of VaR therefore reads as follows “We are X% confident that we will not lose morethan V rupees over the next N days.”

There are various methodologies for computing VaR.

Variance -Covariance Methodology

o

J.P Morgan's Risk Metricso FEDAI methodology for currencies in India

Simulation Methodologyo Historical Simulation (using past data)o

Monte Carlo (using random sampling)

Basel Norms for Capital Adequacy

The Bank for International Settlements (BIS) is an international organization that fosters international monetaryand financial cooperation, and serves as a bank for central banks of various countries.The Basel Committee on Banking Supervision was formed in order to secure standardization across the globalbanking industry, to limit risks faced by the banking system.



Basel – I NormsBasel I norms defined the minimum capital required to be maintained by internationally active banks. This capital

required, was linked directly to the risk faced by them in their operations.

The norms established a standard of risk weights applied to different classes. So, riskier lending (such as

unsecured loans to borrowers of doubtful credit history) attracted higher risk weights, and hence, higher capital

requirements.

The risk weights suggested to banks were as follows:

Lending to your own branch – 0%

Lending to another bank – 20% Lending to a corporate of certain credibility – 50% Lending to other entities – 100%

Basel – II Framework

The Basel II framework is based on three pillars -Pillar I – Minimum Capital: This part of Basel II coversthe Capital Adequacy norms. It defines different ways of measuring credit, market and operational risk, andhow much capital banks must have in order to protect against each risk.

Pillar II – Supervisory Review: This part of the Basel II process provides for Supervisors to the firstpillar. This means, that every bank should have an internal audit division that checks that the method of riskmeasurement chosen is most appropriate; that the tracking and measurement is being done correctly.

Pillar III – Market Discipline: The third pillar of the Basel II norms recommend that banks need tobecome more transparent by disclosing information.What information? Well, the methods they are using to calculate risk, what is the quantum of risk beingfaced using these methods and hence what is the capital being maintained.

Basel III – The Latest

The financial crisis of 2008 made the Basel committee review and come up with more stringent norms. One of

the main outcomes of Basel III is a significant rise in the banking industry’s capital requirements.

It increased the minimum capital requirement for RWA to 10.5% from 8%.

It also increased the weightage of core capital (Tier I) against RWA.

It introduced measures for better management of liquidity risk within banks.



Banking Laws and Regulatory Compliances:

Banking Laws

Some of the main laws in banking are:

1.

Negotiable Instruments (N.I) Act: The N.I Act covers the rules around transactions of negotiableinstruments. Negotiable instruments are payment instruments which are transferrable from one party toanother.Example: promissory note, bill of exchange

A Promissory Note is a note written by a borrower, promising to pay back the sum borrowed.

Bill of exchange is an instrument used in business transactions. A seller will prepare a bill saying ‘Pay (seller or whoever is to be paid) the payment amount’, and send it to the buyer.

2. UCPDC: It stands for Uniform Customs and Practices for Documentary Credits. A Letter of Credit (LC) isalso called a documentary credit. As trade finance is across countries, there have to be uniform practicesfollowed globally. Hence, the International Chamber of Commerce (ICC) has issued this set of regulationsgoverning international trade. It’s commonly called ‘UCP’ and as the current version is called 600, the ‘UCP600’.

3. SARFAESI Act: SARFAESI stands for Securitization and Reconstruction of Financial Assets and Enforcementof Security Interest Act. This Act covers the rights a lender has over the collateral, when a secured loandefaults.

‘Reconstruction’ of an asset, is banker-speak for reworking the terms of a loan to ensure that the money isrepaid.The SARFAESI Act in case of default, covers features such as:

a) Securitization: Issuing securities – financial instruments – against the recovered assets. It can bedone only by specific registered entities called an asset reconstruction company or securitizationcompany.

b) Guidelines for Asset Reconstruction: It covers how a defaulting business should be managedor controlled to ensure repayment. Payments can be rescheduled, and secured collateralrepossessed.

c)

No court intervention needed: One of the main features of this Act is, the lender can take overthe collateral without court intervention, which was not possible earlier.

Regulatory Compliance

Regulatory compliance means, ensuring that the bank is functioning within the regulatory requirements laid down bythe regulator-the Central Bank. The compliance requirements for a bank are:

1. Reserve Requirements: These requirements define how much of every deposit must be deposited withthe RBI.Currently, 4% of every deposit must be deposited with the RBI under the Cash Reserve Ratio (CRR). And23% of every deposit must be invested in defined Government securities, under the Statutory Liquidity Ratio(SLR).NBFCs have only SLR requirements, no CRR. This protects the bank/finance company (FC) against liquidityrisk and the customer against default risk.

2.

Know Your Customer (KYC) & Anti Money Laundering (AML): These compliance requirements comefrom the Prevention of Money Laundering Act (PMLA). KYC and AML norms have been implemented theworld over post 9/11.

KYC procedures enable banks to know/understand their customers and their financial dealings better, whichin turn help them manage their risks prudently. Here the entire focus is on gathering sufficient information



on a customer’s profile, and monitoring his transactions on an ongoing basis for ‘suspicious’ (unusual)activity.

A bank has hundreds of thousands of customers. The effort involved in actually monitoring every transaction is huge.The steps involved in monitoring transactions are:

1. Customer Identification Procedure: to gather adequate information about a customer and his/herfinancial behavior. The key elements are, to collect and verify proof of identity and address (forindividuals), categorise the customer into different risk profiles and review risk categorization regularly.

2. Monitoring Of Transactions: To make monitoring of transactions easy the customers are classifiedinto low, medium and high risk customers. Once customers are categorized, their account profiles aredeveloped.

3. Reporting: As per RBI regulations, all cash transactions greater than INR 1 million must be reported viawhat’s called a Cash Transaction Report (CTR). Further, any suspicious transactions also need to bereported.



Technology in Banking

As we realize by now, technology is a key requirement for customer convenience and for banks to manage their

operations. RBI has made it mandatory for all banks – including RRBs – to move from manual to technology driven

processes.

Core Banking Solution (CBS)

What banks mainly look at is, a technology platform which covers all the main functions, and enables data to reside

centrally. Such a technology solution is called a Core Banking Solution.

A bank may also have other technology applications for its ‘non-banking’ activities such as Sales & Marketing, or HR

management/payroll management, or external financial market feeds.

Typically these separate technology applications will integrate with the Core Banking (CB) system to collect data

from/send data to it. Thus, customer data from the CB system will move into an application used for telecalling sales,

for example.

Universal Applications of a Core Banking Solution (CBS)

Let us look at the universal applications of a Core Banking solution first –meaning, those which service the entire

bank. We will then look at the technology applications for each function/division of a bank.

1. Centralized Data Repository: A single, unique customer ID is created for every customer. All deposit and

loan accounts held by the customer can then be linked to this ID.

2.

A Flexible General Ledger: Accounting is a huge function as every transaction has to be entered into the GL,

and then reconciled across branches. What the CBS does is, maintain a centralized GL. Therefore updated

account and transaction data is available almost instantly. This also helps a bank manage liquidity risk and risk of

fraud.

3. Management Information System (MIS): A Management Information System (MIS) is used for obtaining

analytical reports and is vital for taking management decisions. So if the senior management wants to know, for

example, the amount of interest received today or the amount of interest paid on deposits across the bank: it’s

done easily!

4.

A Risk Management System: A Risk Management system tracks every transaction, measures each type of

risk, across multiple cities, across branches, and gives this information through a variety of reports. This system

will track various risk limits, and alerts can be raised if these get exceeded.

5. A Clearing Application: Another key feature of a CBS is the Clearing application, which will track all payment

instruments received (inward clearing) and sent (outward clearing); the settlement paid/received for each, and

any ‘suspense’ or problem items.

6. Calculation & Tracking: The CBS also has a system that enables calculation and tracking of interest, charges,

commission, fees, brokerage and taxes.



7.

Security Management system: This feature of CBS ensures that only authorized users access what they are

supposed to (you wouldn’t want a bank officer to be able to transfer funds from your account to his!), and also

that data remains secure.

Each of the above applications is relevant to the entire bank. Hence it has to be connected with every part of the

bank, i.e. it has to be available to every division.

Modules for Individual Divisions

Now, let us look at the ‘modules’ or applications which automate different divisions or functions.

Sales & Marketing Module:

A sales & marketing application is typically a separate application which integrates into the Core Banking system. It

enables:

Input of external databases (which can be purchased). These are used for sales campaigns via mailers,telecalling etc.

Importing of customer data from the Core Banking application. This is also used for sales campaignswhich are more targeted.

Tracking of the results of each sales campaign. Targets and incentives management for sales staff

Channels Modules:

Each channel has its unique work flow, and some standard work flows. Channel specific IT applications will ensure

specific functionality. Let’s see how ATMs are connected and how they function.

1. ATMs – These are connected to each other via a ‘switch‟ or network . That’s the reason why you can

withdraw from an ATM hosted by Axis Bank, even if your account is with HDFC Bank. The Axis Bank ATM and

the HDFC Bank ATM are connected to the same network via a switch and messages can flow from an ATM to

another bank.

2. Branch Banking - A branch banking application will mainly enable teller and customer service functions.

Some of these are:

Account Opening

Regular Account Transactions

Payments/Fund Transfer

Sale or Purchase

Fixed Deposit Transactions

Loan Account Transactions

3. Internet Banking - The internet banking application is separately built, as it needs a lot of specific

functionality. It will need extensive security to ensure that secure customer data is not accessible by

unauthorized people on the net.

Retail Banking Modules:

Following are the modules under retail banking division.



1.

The Current Account and Savings Account (CASA) Module - The CASA module, helps in supporting acomplete range of savings, current and overdraft accounts (that is loans against the current or savingsaccounts).

2.

The Term Deposits Module - This module helps in handling the full range of retail term deposits, includingrecurring and sweep-in deposits.

3.

The Standing Instruction Module - This is for automating the periodic processing of customer instructions.Thus, if you instruct your bank to transfer INR 10,000 to another account on the first of each month, the S.Imodule will send a debit instruction to the GL module.

4.

The Signature Verification System - This system is used for image capture and retrieval. So when you openan account, your signature is scanned and stored. This is retrieved whenever necessary. If the debit issuccessful, a confirmation is sent from the S.I module via email or sms to you. No human interventionwhatsoever is needed.

5. The Loans Module - A loans module, offers transaction processing services for all events in the lifecycle of aloan.

A loans system would broadly cover:

a) Loan origination which covers the workflow up to the time the loan is disbursed, and

b) Loan maintenance and administration: statements, payment collection, etc.

Corporate Banking Modules

Typical corporate banking modules are:

1.

Cash and Liquidity Management Module – This module enables a bank to offer sophisticated cash andliquidity management services to corporate treasuries for managing their cash positions.

2. Corporate Deposits Module – This module supports all kinds of term deposit products for corporates. Itautomates processes like interest payment calculations on deposits.

3. The Letters of Credit, Bank Guarantees and Bills Modules – These modules offer comprehensive supportfor a bank’s trade financing activities. For example, banks can automatically credit the Cash Credit (CC) accountof a customer upon receiving its bills.

Investment Banking Modules:

Typical investment banking modules are:

1. The Loan Syndication Module - Addresses the processing requirements of consortium or group loans.

For example, a lead banker can input the share of each bank in the consortium; track the repayments made bythe borrower and how much and when these have been routed to the various banks, how much is outstandingfor each bank, fees/income earned etc.



2.

The Mergers & Acquisitions Modules - This will enable a bank to use different valuation models for pricing

M&As. This module has inbuilt valuation models which will give the valuations of companies – by varying input

data such as revenues, cash flows, growth rate etc.

Financial Markets & Treasury Modules:

1.

The Foreign Exchange & Money Markets Modules - These modules support all currency and money market

transactions. These are supplemented by an integrated dealing room decision support system – which allow a

dealer to analyse the result of various possible scenarios and take trading decisions.

2. The Securities Module - Offers support for handling a bank’s primary and secondary market deals, whether

for itself or on behalf of its customers.

For example, this module takes data from various sources and feeds the user interface with latest market prices

of various securities. This will help the users (traders in the bank) take the trading decisions

Mutual Fund Management Modules:

These are ‘optional’ modules, i.e. useful only if the bank also owns a mutual fund.

1. The Asset Management Module - This module helps a bank to create funds and manage all transaction

processing activities over the life cycle of a fund.

2.

The Mutual Fund Investors Services Module - This module is for servicing the investor interface for mutual

funds – that means, an investor can directly place orders or view her account details using this interface.

Domestic and International Payment Modules:

1. The Loan Payments and Collections Module - The ‘local payments and collections module’, for processingall local payments and collections, including ECS (Electronic Clearing Service – i.e., electronic) instructions.

2. The Cross Border Funds Transfer Module - The ‘cross-border funds transfer module’, for processing alltypes of international inward and outward funds transfers.

3. The Nostro Reconciliation Module - This module is used for automatic reconciliation of balances andtransactions in nostro accounts. Nostro accounts, as you know, are foreign currency accounts of a bank,maintained with a correspondent bank.

4.

The Electronic Messaging system - This system is for smooth message transfer over SWIFT, with featuresfor supporting ‘straight through processing’ . SWIFT is a common messaging format used across the world,and enables the sending and receiving banks to process the message without human intervention, calledstraight through processing.

Document Management Module



A document management module enables a bank to secure, track and manage information that is generated in the

form of documents. This enables the bank to save a lot of cost, time and of course, gives them peace of mind.

General Administration Modules

The following modules cater to the general administration division of bank:

1. The Expense Processing Module - Enables the automation of all processes relating to vendor payments –

vendor contract details, monitoring of credit limits if any to vendors, contract settlements and making final

payments to vendors.

2. The Fixed Asset Management Module - Enabling a bank to reduce the cost of maintaining its fixed assets

and supporting the processing of all events in the life of fixed assets –acquisition, depreciation, revaluation,

sale/transfer of assets and disposal of assets.

3.

Cost Allocation System - For allocating expenses and incomes across products, branches or divisions

For staff functions like HR, legal & compliance and audit, usually there will be a separate module which

may or may not integrate with the CB solution

Cheque Truncation

There are a large number (over 100 crore!) of cheques which are processed in India every year. Each cheque, to be

processed, must travel from the bank where it is deposited, to the paying bank.

The costs and time delays are huge in manual processing of cheques – imagine 100 crore cheques travelling all over

the country!

Hence the introduction of the ‘Cheque Truncation System’ or CTS in India, which is a technology initiative

introduced by the RBI to simplify the cheque clearing process.

That means, a bank scans the cheque – both front and back – and sends it electronically to the Clearing House (CH),

which also forwards it electronically to the paying bank.

This of course, reduces the time for clearing as well as the cost of transmitting paper.

Date post:	04-Jun-2018
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