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Indian Institute of Banking & Finance


Indias abundant, high quality and cost effective services and its vast resource of
skilled software human resources have made it one of the global software
powerhouses. There has been a healthy growth in the number of Indias IT
professionals over the last decade. Many of the leading IT companies have taken
initiatives to train their technically skilled knowledge-workers with the right mix of
business and functional skills to gain competitive advantage in the international
It is against this backdrop that IIBF has decided to offer a Certificate Course in
Banking to facilitate IT professionals to acquire a sound understanding of
relevant theoretical and practical concepts of banking and to enable them to
apply these principles in real life situations.
The Courseware for the subject is designed and developed with the help of
experts drawn from banking industry and practicing banking professionals and
the Institute acknowledges with gratitude the valuable services rendered by
We are sure students of information technology would welcome this book. This
book may be useful to regular students of the subject as well, who are yet to
enter banking field.

We welcome suggestions for improvement of the book.

With best wishes.

Mumbai [R.Bhaskaran]
Chief Executive Officer

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GLOSSARY 146 - 152



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Financial system can be defined as the structure which manages the flow of
funds within national and/or supranational levels. It consists of institutions like
Banks, Financial Institutions, Non-Banking Financial Companies (NBFCs),
Insurance Companies, Mutual Funds, Stock Brokers, etc. World financial system
and national financial systems are complementary to each other. For
understanding what a financial system stands for, a typical national financial
system is diagrammatically illustrated hereunder (Figure 1).

It may be added here that the primary and a major component of financial system
is payments and settlements.

National Economy

Flow of goods and Payment and External sector

services national settlement system Flow of goods,
sector services, capital


Fig.1 payment and settlement of all transactions in national economy forms a subset of financial system

Payments and settlements are basic functions of banking in national and

supranational economies. These transactions happen through the banking
system and give rise to what are called current deposits with the banking system.
These deposits are basically transitory in nature and can be withdrawn without
notice. With the disintermediation on the rise, in times to come, the payment and
settlements would be the core business of banks. It should be added here that,
even as of now this is the source of a big chunk of income and forms the main
income stream of major banks in advanced countries. With the rest of the
countries catching up, it is evident that this will be the future market.

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Government sector, private sector, and house hold sector hold surplus in their
hand and this comprises the national savings. National savings are held in
physical and financial assets. National savings comprises of Government sector
savings, household savings and private sector savings and is the most important
component of the financial system.

Government Household savings Private sector

sector savings savings

National Savings

Physical savings
Land, housing, Financial
Ornaments, savings
Carpets and
valuable physical

Fig.2 Financial savings are the largest component of financial system. For the purpose of Financial System, physical
savings are excluded.

The financial system constituents sub-serve the financial savings and payment
and settlement system in the national economy.

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Financial system comprises money markets (money market is by nature a short-
term market) and capital markets. While Money markets deal with financial
instruments with maturity of less than a year, Capital markets deal with
instruments where the maturity exceeds a year. The constituents of the financial
system broadly sub-serve these two segments. Under-noted diagram explains
these inter-linkages.


MARKETS equity - both primary and
call money secondary
treasury bills debentures and convertible
commercial paper bonds,
bill discounting securitization of medium and
forex cash and forwards long term loans,
currency swaps pension and provident funds,
loans, overdrafts cash-credits, insurance - both general and life
bill rediscounting market assurance,
inter-bank deposits medium and long term
securities /Repo refinancing of loans,
bankers acceptances derivatives for equity, debt and

Fig 3. Short term money markets are domain of banks. Capital markets are domain
of investment banking. Central Banking Authority controls banking while Capital
Market Regulator controls Investment Bankers. Insurance Markets are in the
domain of Insurance Regulatory Authority. In U.K., FSA (Financial Services
Authority) covers all three domains.

Central Banking Authority of a country controls and supervises banks, Financial

Instituitons and Non- Banking Financial Companies (NBFCs). Its domain extends
over financial institutions providing long term funds for industry and agriculture. It
also supervises co-operative banks with diluted powers, part of supervision being
with state governments.

Capital Markets Regulator (Securities Exchange Board of India (SEBI)) in India

and (Securities Exchange Commission (SEC)) in the U.S.A., supervise all stock
exchanges, broking houses, Investment banks, depositories, foreign institutional
investors and mutual funds.

Insurance Regulatory Authority supervises all insurance companies - both in

general and life assurance business.

Pension Regulatory Authority supervises all private sector pension funds which
are allowed to sell pension plans to individuals.

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To simplify, the overall financial system can be presented diagrammatically as
shown in figure:
Financial System - a Schematic Presentation

Central Banking Capital Markets Insurance &

Authority Regulatory Authority Pension

1. Monetary control 5. Equity market and 1. Regulatory

2. Supervision over debt market framework,
banks, including supervision & control including rules
RRBs 6. Supervision over and regulations
NBFCs Stock Exchanges, for running
primary dealers brokers, insurance
financial equity and debt business
institutions raisers 2. Supervising all
co-operative investment bankers Insurance
banks (merchant bankers) companies both
clearing and foreign institutional in general and
settlement system investors life insurance
1. Management of custodians business
government debt depositories 3. Regulating
2. Banker to mutual funds
government listed companies
and cost
3. Lender of last resort service providers to structure of
to banks capital markets like
4. Regulating money insurance
registrars companies
markets through
monetary instruments 4. Regulating
(CRR, SLR, Bank insurance
Rate, Repo Rate,etc.) brokers such as,
individuals, and

1. Framing rules for
pension funds
2. Regulating all
pension funds

Figure 4. This schematic diagram illustrates the various constituents in

financial system and the broad categories in which they can be
categorized on the basis of activities that they perform.

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Roles and Functions in Brief

1.1.1 Central Banking Authority

The Central Banking Authority has two distinct roles;

monetary control including controlling inflation, and

bank supervision

Among the major Central Banks, Bank of England looks after only
monetary planning and control. The Bank Supervisory function has been
entrusted to Financial Services Authority (FSA) the super-regulator for
financial system. This came into force after the failure of Barings Bank(*).

All the other major central banks look after both functions and have the
responsibility of ensuring that the over all financial health of banks is not
impaired. This is ensured through off-site and on-site surveillance of
banks. Central Banks now classify banks in three broad categories, i.e.,

1) internationally active banks,

2) nationally active banks and
3) other banks

The rigour of regulation and supervisory surveillance is applied on a

calibrated scale on the three categories. The health of individual banks is
judged through CAMELS model which quantifies Capital adequacy,
Advances, Management, Earnings, Liquidity, and Systems for the banks
licensed by the Central Monetary authority.

Monetary control is exercised through Bank Rate, Repo Rate, Cash

Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR) mechanism.
Bank Rate and Repo Rates are the main instruments available to Central
Banks to control interest-rates in the market. Central Banks have
statutory powers to order opening and closure of banks, powers to fine
banks and their executives and in extreme cases, initiate penal action
against executives of defaulting banks.

Central Banks do act as lenders of last resort to banking system, and are
responsible for ensuring an efficient payment and settlement system (refer
1.1.7., 1.1.8, 1.1.9 & 1.1.10 for other functions of Central Bank)

(*) The collapse of Britains Barings Bank in February 1995 is a classic tale of
financial risk management gone wrong. An individual trader, over the course of a
few days, brought a bank to bankruptcy, by virtue of having control over both
trading as well as risk management functions.

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1.1.2. Non-Banking Financial Companies (NBFCs)

All companies allowed to raise monies as deposits from public and lend
monies through various instruments including leasing, hire-purchase and
bill discounting etc., whose Articles of Association do not specifically
mention their core business in manufacturing, trading or service industry
come under this category of NBFCs. NBFCs cannot accept
current/savings deposits nor allow funds to be withdrawn by cheques.
Thus, they are Financial Institutions who are specifically restricted from
carrying on banking functions. NBFCs are licensed and supervised by
the Central Banking Authority and are subject to both off-site and on-site
inspections. Central Bank prescribes CRR and SLR for them and fixes
lower and upper limits for interest rates payable and chargeable by them.
No NBFC can operate without having a valid license from Central Banking

1.1.3. Primary Dealers (PDs)

PDs are dealers in government securities and deal both in primary and
secondary markets. Their basic responsibility is to provide two-way quotes
and act as market makers for government securities and strengthen the
government securities market.

1.1.4. Financial Institutions (FIs)

FIs are development financial institutions which provide long term funds
for industry and agriculture. these institutions come under off-site and on-
site surveillance of Central Banking Authority. FIs raise their resources
through long-term bonds from financial system and borrowings from
international financial institutions like International Finance Corporation
(IFC), Asian Development Bank (ADB) and International Development
Association (IDA), International Bank for Reconstruction and Development
(IBRD), etc.

1.1.5 Co-operative Banks

These are regional/provincial banks formed under co-operative principles.

These are allowed to raise deposits from public, and lend to public and are
subject to CRR and SLR requirements.

In India, there is a duality of control over these banks and this has resulted
in lax control over the working of these banks. Co-operative banks are
classified as short-term (agriculture) Co-operative Banks and Urban Co-
operative Banks. Urban Co-operative Banks are controlled by State
Governments and RBI, while short-term Co-operative Banks are controlled
by NABARD (National Bank for Agriculture and Rural Development) and

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State Governments. Previously, these banks had certain concessions/
exemptions in paying higher interest on deposits. But now a days, the
interest rates are deregulated. The regulatory framework for Urban Co-
operative Banks is almost similar to that of commercial banks. The short-
term co-operative structure enjoys certain concessions in capital
adequacy norms.

1.1.6 Payment and Settlement System

An efficient and effective Payment and Settlement System is a necessary

condition for a well running Financial System. Maintenance of Clearing
houses at various centres, creation of currency chests in different
geographical areas, maintenance of Fedwire for electronic transfer of
funds and RTGS for gross on-line settlement of funds in real time basis
are some of the ancillary but vital activities undertaken by Central Banks.

1.1.7 Management of Government Debt

Most of the Central Banks manage issue and servicing of government

debt. This involves price discovery, volume to be raised, tenure of debt,
and matching it with over-all cash management of the debt. In doing so, it
has to ensure that government borrowings do not affect the money
markets and credit is not denied to productive sectors of economy.

1.1.8 Bankers to Government

Most of the Central Banks maintain Governments deposit account and

carry out their cash management through issue of bonds and treasury
bills. This helps the monetary management by sterilization of large inflows
of revenue and purchase of Treasury/Bills and Government securities on
own account in times of large payments by government, without creating
high volatility in security prices and destablising interest rates. Commercial
banks have found that this business is quite attractive. There is
competition from commercial banks for business from the Governments.

1.1.9 Lender of Last Resort to Banks

The Central Bank provides liquidity support on temporary basis through

repurchase of bills and securities to banks to meet short term liquidity
requirements. Bank rate is the rate at which Central Banks would normally
discount bills bearing sovereign risk. Some of the Central Banks rely more
on REPO Rate (Repurchase obligations), rather than Bank Rate to even
out interest rate and liquidity fluctuations in money markets

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1.1.10 C.R.R. / S.L.R.

Cash Reserve Ratio (C.R.R.) is the mandatory deposit, as prescribed

percentage of their Demand and Time Liability, to be held by banks with
monetary authority. This controls credit multiplier and increase or
decrease therein can be used by the Central Bank to pump in, and soak
liquidity out of the banking system.

Statutory Liquidity Ratio (S.L.R.) is the prescribed percentage of Demand

and Time Liabilities of a bank, to be held in prescribed securities, mostly
government securities. The increase or decrease enhances and fetters
credit creation, thereby increasing or decreasing money creating capability
of the banking system.

1.1.11 Equity and Debt Market

Marketability of corporate equity adds to share holders value and enables

corporates to raise equity from markets at good premium. Marketability of
corporate securities, i.e., bonds, debentures and convertible debentures,
enables corporates to raise debt at a very fine price, while debenture
holders enjoy very high liquidity. Securities to be quoted on stock
exchanges and freely bought and sold on exchange can be issued only
after obtaining approval of Capital Market Regulator. Such approvals are
subject to appropriate applications being made through investment
bankers and submission of proposed prospectus to the Regulators (SEBI
in India and SEC in U.S.). The process involves due disclosures and
transparency towards investors. Equity and debt issued with due approval
of Regulators can be listed on stock exchange after payment of the
prescribed fee. Once the security is listed, investors can buy and sell
securities, subject to stock exchange rules.

1.1.12 Stock Exchanges

A Stock exchange is duly approved by the Regulators to provide sale and

purchase of securities by cry or on-line on behalf of investors. The
stock exchanges provide clearing house facilities for netting of payments
and securities delivery. Clearing houses guarantee all payments and
deliveries. Securities include equities, debt, and derivatives. In India, only
dematerialized securities are allowed to be traded on the stock exchange.
Settlement in securities account is made by depositories through
participants accounts.

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1.1.13 Brokers

Only brokers approved by Capital Market Regulator can operate on stock

exchange. Brokers perform the job of intermediating between buyers and
seller of securities. They help build up order book, price discovery, and are
responsible for a brokers contract being honoured. The services are
subject to brokerage. Despite wide spread belief in India that brokers will
disappear once on-line trading comes, the brokers have proved their
worth in intermediating in stock market.

1.1.14 Equity and Debt raisers

Companies wishing to raise equity or debt through stock exchanges have

to approach Capital Market Regulator with prescribed applications and a
proforma prospectus for permission to raise equity and debt and get them
listed on a stock exchange. Once the approvals are granted and
concerned stock exchange agree to list the securities, the company can
go in for a public issue through its investment bank (merchant banker).
Applications and monies are received by bankers to the issue,
applications are processed by Registrars and allotment of securities is
made in consultation with stock exchanges where security is to be listed.
Once securities are allotted and issued, the banker to the issue releases
the money collected to the company. Securities are issued mostly in
demat form.

1.1.15 Investment Bankers (Merchant Bankers)

These agencies/organisations are regulated and licensed by the Capital

Markets Regulator. They arrange raising of funds through equity and debt
route and assist companies in completing filing of the prescribed
document and related formalities with the Regulator, book building, pricing
of issue, arranging registrars, bankers to the issue and other support
services. They also buy and sell on their account. As per regulatory
stipulations, such own account business should be separately booked and
confined to scrips where inside information is not available to the
investment/merchant banker. Investment/Merchant banking can be an
exclusive business. A bank can also undertake these activities.

1.1.16 Foreign Institutional Investors (FII)

FIIs are foreign based funds authorized by Capital Market Regulator to

invest in countries equity and debt market through stock exchanges. They
are allowed to repatriate sale proceeds of their holdings, provided sales
have been made through an authorized stock exchange and taxes have
been paid. FIIs enjoy de-facto capital account convertibility. FII operations
provide depth to equity and debt markets and increased turnover. In India,

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these activities have brought in technological advancements and foreign
funds in equity and debt market.

1.1.17 Custodians

Custodians are allowed to hold securities on behalf of customers and

carry out operations on their behalf. They handle both funds and securities
of qualified institutional borrowers (QIBs) including FIIs. Custodians are
supervised by the Capital Market Regulators. In view of their position and
as they handle the payment and settlements, banks are able to play the
role of custodians effectively. Thus most banks perform the role of

1.1.18 Depositories

Depositories hold securities in demat form, maintain accounts of

depository participants who, in turn, maintain sub accounts of their
customers. On instructions of stock exchange clearing house, supported
by documentation, a depository transfers securities from buyers to sellers
accounts in electronic form.

1.1.19 Mutual Funds

Mutual funds are intermediaries, who sell units to their fund subscribers.
The money received from the investors in the fund is deployed in buying
and selling securities listed in the prospectus to the scheme. Mutual funds
are formed as Asset Management Companies (AMCs). Each AMC can
launch one or more Mutual funds. Each Mutual fund will decide its rules of
operation (which securities will the mutual fund buy, what is the minimum
investment required by a potential investor in the fund, what will be the
transaction charges for investors who invest in the fund, etc.) and will seek
Regulators approval before approaching the public for subscriptions. The
mutual fund schemes are quoted on stock exchanges. One can buy and
sell through stock exchange. In many schemes, the fund itself buys and
sells its units every day on the quoted price. This provides much needed
liquidity to unit holders. Mutual funds have started the process of
disintermediation and they have competed reasonably well with banks in
weaning away deposits towards units of mutual funds.

1.1.20 Listed Companies

Companies listed on the stock exchange have advantage of their equity

and debt being traded on the exchange. A listed company has to make
regular disclosures to the stock exchange about its business and agree to
comply with the code of conduct for listed companies.

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1.1.21 Registrars

Maintain register of share and debenture holders and process share, and
debenture allocation, when issues are subscribed. Registrars need
Regulators approval to do business.

1.1.22 Insurance Regulatory and Development Authority (IRDA)

IRDA (in India) is the Regulator for insurance business, both general and
life assurance. IRDA regulates all aspects of insurance business, including
licensing insurance companies, making regulations about conduct of
business supervising all insurance business in the country, etc.

1.1.21 Pension Regulatory Authority

Regulatory authority for private sector pension funds. It has licensing and
regulatory powers.

Meaning and Objectives of Banking

A bank can accept deposits from the public (customers or members of the
society). Such deposits of the customers can be withdrawn by cheque or
otherwise (withdrawal slip, letter and voucher) on demand, or repayable on
maturity to the customers.

The bank lends or invests the funds collected from its customers, subject
to its obligation to repay the deposits to the customers on demand or
otherwise as per the terms of the deposits. Acceptance of deposits and
lending the same are thus core functions of a bank. The above process is
known as intermediation.


The principle of intermediation is closely related to the core banking

functions, taking of deposit and extending of credit. Banks are called
financial intermediaries and they represent an important segment of
intermediaries (banking and non-banking financial companies) in a
countrys financial system. The word intermediary means some one who
carries messages between people who are unwilling or unable to meet
personally (Cambridge International Dictionary of English, page 743).
Banks are financial intermediaries because they invest or lend the funds
of depositors who themselves are unable to lend their funds to others due
to risk and other factors involved in direct lending. Banks assume the
credit and other risks involved in direct lending to those who need funds
(borrowers) because of their expertise and administrative abilities to

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manage such risks. Thus banks mediate between the depositors (savers
of money) and borrowers (users of money) and earn interest spread as a
reward for risk taking and also for meeting administrative expenses and
making provision for some portions of loans that turn bad or difficult to
recover (termed as non-performing assets or NPAs). The term dis-
intermediation means the reversal of the intermediation process involved
in banking. An investment by a person in certain stocks of a company is a
direct exposure or risk taking by the investor in the particular company. In
this example of dis-intermediation, the investor may or may not get back
the capital invested in the company when he wants, as he has assumed
the risk involved in direct investment. However, in the case of deposits
with a bank, the depositor is assured of repayment of the amount of
deposit (capital with or without interest) on demand or maturity date, as
the depositor has not assumed any risk, whereas the bank, as
intermediary, has assumed the risk of lending the depositors money.

Types of Banking Institutions

Banking Institutions

The banking institutions may be categorised as:

(a) traditional banking institutions and

(b) modern banking institutions.

The traditional banking functions are the core functions which have been
performed by almost every bank in various countries for several decades.
These include deposit-taking, lending and remittance of funds. Modern
banking functions comprise, core banking functions, cross-border banking
and merchant banking, etc., which constitute a near-full range of banking
services in a broader sense. These specialized services have come up
during the last couple of decades to meet emerging needs of the
businesses in developed countries and later in developing countries.
These full range of banking services are offered by large banking groups
through their commercial banking branches and specialized outfits or
subsidiaries for international banking, leasing, factoring etc.


A bank accepts money from its customers (members of the public) who
may keep funds in non-interest bearing accounts (current accounts) or
interest-bearing accounts (savings, fixed deposits, recurring deposits) as
per their choice exercised at the time of opening the accounts. Deposits
constitute the largest portion of a banks funds (liabilities), along with its
own capital. Deposits may be repayable on demand (like current and

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savings accounts) or on specified maturity dates (fixed and recurring
deposits). Primarily, deposits are made for earning interest. Over and
above these, several advantages accrue to the customers by maintaining
deposit accounts with banks, e.g., safety, liquidity, transactions record and
statement of account, cheque book facility.


Lending money to businesses by way of loans and advances of various

kinds is a traditional function of a bank. Funds mobilised from deposits are
deployed by a bank in making loans and advances to earn profits by way
of interest spreads, i.e. the differential between the average interest rates
on loans and on deposits. The interest income from loans and advances
forms a large portion of a banks operating profit. While lending funds,
banks have to follow not only internal guidelines issued by their banks
Board of Directors or top management, but also regulations issued by
Central Banking Authority e.g. statutory liquidity ratio, capital adequacy
ratio. Some portion of loans may turn into non-performing assets (NPAs)
which cause loss of income and also of capital to the bank. Loaning
therefore requires adequate care, caution and supervision by the banks
management, to prevent loans turning into NPAs and the consequent
erosion of their profits and capital. The Bank of Credit and Commerce
(BCCI), an international bank, and Barings Bank of UK also failed and
became bankrupt during 1990s due to indiscreet loaning, speculating in
derivatives market and supervisory weaknesses. Recent example of
Global Trust Bank (GTB) in India, shows how the banks net worth got
substantially eroded due to bad loans, eventually leading to a temporary
moratorium (on withdrawals by the banks depositors) declared by the
Reserve Bank of India and subsequently to its merger with another bank.

Funds Remittance

Banks have branch network spread in various cities/ regions/ states in the
country of their incorporation/ operations. Some banks have branches and
correspondent banks overseas as well. Banks remit funds of their
customers from one place to another in the same country or overseas
through their branches and correspondent banks by mail/
telegraphic/electronic funds transfer or by issuing bank drafts. Banks
charge commission or fee to the remitting person. Banks remittance of
funds is fast, safe, secure and cheap as compared to other modes like
post office money order, physical transfer of money, etc.

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Miscellaneous Services

In addition to the above mentioned core functions, banks also render other
services which are useful to businesses and members of the society. They
charge commission or fee on such services, which provides them with
non-interest income and augments their profits. These miscellaneous
services include safe deposit lockers, safe custody of valuables; issuance
of travellers cheques, letters of credit and guarantees; collection of out-
station cheques/ bills/ hundies; furnishing opinion reports on their
customers; Agency services for government business, correspondents;
trusteeship and executors business.

Modern Banking Institutions - Functions / Services

Modern banking services have evolved especially during the last, say,
three decades in USA / UK/ other developed economies and during the
last one decade in India, by the continuous up-gradation, expansion and
diversification of core banking functions, coupled with innovations of new
products/ processes for meeting emerging and new financial needs of
people and businesses. The modern banking services comprise the
traditional banking services plus new services that make an expanded
range of banking services. Furthermore, in present times, banking forms
an important segment of services sector in a countrys economy and it
would be preferable to refer banking functions as banking services in
tune with the focus on service quality. Modern banking is characterized by
certain features which may be briefly mentioned as follows:

Banking has become increasingly customer-oriented as banks vie with

each other to satisfy/ delight their customers by constantly improving
range of their products and also quality of their services.
Banking is getting increasingly competitive not only among banks inter-
se, but also vis--vis the non-banking financial companies (NBFCs).
The phenomena of globalization and dis-intermediation in India and
other countries are also contributing to the increasing competition and
customer focus amongst banks.
Advancement in information and communication technologies have
revolutionized banking processes, procedures and products.
Electronic Banking or e-Banking has opened new delivery channels
(Automated Teller Machines, Tele-banking, Internet banking) which
provide any where and any time banking at customers convenience.

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Universal Banking

Universal banking refers to provision of wide range of financial services

e.g. commercial banking, merchant banking (or investment banking),
insurance all by one bank. Universal banking thus involves blurring of
the demarcated functional boundaries that once existed between these
financial services providers viz., commercial banks (short/medium-term
credit providers), development banks or financial institutions (long-term
credit providers), merchant banks (dealing in securities) and insurance
companies. Universal banking usually takes one of the three forms
inhouse, through separately capitalized subsidiaries, or through a holding
company. Citibank and HSBC are examples of universal banks in USA
and UK respectively and both these banks have global operations in a
wide range of modern banking services. In India, examples of universal
banks are State Bank of India (through its several non-banking
subsidiaries/ affiliates dealing in long-term project finances, investment
banking, leasing, factoring, securities, credit cards, life insurance, mutual
funds etc., apart from commercial banking) and ICICI Bank. In 2002, the
erstwhile ICICI (financial institution) had a reverse merger with its former
subsidiary ICICI Bank, which has since become a universal bank providing
commercial banking, long-term project finance, merchant banking, credit
card, insurance, etc. IDBI and IDBI Bank have also merged recently and
became a universal bank.

Principles of Banking


Some important principles that emanate from the core functions of banks
are explained below.

Liquidity Principle

The simultaneous operations of acceptance of deposits repayable on

demand or otherwise (to depositors) and lending the same funds to others
(borrowers) in such a manner that the bank would be able to meet funds
demanded by its depositors at any point of time is called liquidity
management. In terms of liquidity principle, the bank must keep certain
portion of its deposit liabilities in liquid form so as to be able to repay it on
demand or on maturity dates to the depositors. The remainder of the funds
collected from its customers may be invested by the bank by way of loans/
advances or other kinds of lending business.

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Profitability principle

The profitability principle underlines the fact that, the banking business,
like any other business, has to be profitable in order to sustain the
required growth of its business. It must also maintain sufficient liquidity
and sound financial health (solvency) to inspire public confidence as
banking business is essentially based on trust of the customers and
public. A banks profit mainly arises from the interest income which
represents the interest differential, i.e., interest spread between its
loans/investments and deposit rates. The interest earned by a bank on its
lending operations is higher than interest paid by it on its deposit
operations. Interest spread and volume of its deposits and loans
determine its total net interest income. Interest income, along with non-
interest or fee-based income (e.g. commission on letters of credit, funds
remittance; exchange on bank drafts, foreign exchange business) mainly
contributes to a banks profits.

Solvency principle

The Principle of Solvency ensures that after paying all creditors, some
balance does remain for shareholders. (This principle is closely interlinked
with pillar of capital adequacy recommended by Basel Committee for all
banks). A properly capitalized bank would always remain solvent. It
ensures that all depositors, i.e., creditors of the bank would be paid off
without any difficulty and in full, in case a bank goes into liquidation.

Meaning and Definition of Banking, U.S., British, and Indian Law

United States of America

In United States of America (USA), the term banking was defined in one
of the earliest Acts of the Congress as follows (vide Tannans Banking
Law and Practice, 20th Edition (2002), Ch. VII, page 210):

By banking we mean the business of dealing in credits and by a bank

we include every person, firm or company having a place of business
where credits are opened by the deposit or collection of money or
currency, subject to be paid or remitted by draft, cheque or order; or
money is advanced or loaned on stocks, bonds, bullion, bills of exchange;
or promissory notes are received for discount or sale.

Banks collect deposits from public by way of demand deposits and term
deposits and use these funds and their own for making loans and
advances for business and trade. Banks pay interest only on term
deposits and follow the directions issued by the regulatory authorities

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Comptroller of the Currency, Federal Reserve, and State Banking

United Kingdom

In United Kingdom, there is no statutory definition of banker and the term

has been defined by the jurists and subject experts, on the basis of the
decisions of the Courts of England, as follows:

A banker is one who in the ordinary course of his business, honours

cheques drawn upon him by persons from and for whom he receives
money on current accounts (Dr. Herbert L. Hart)

A banker is an individual, partnership or corporation, whose sole pre-

dominant business is banking, that is the receipt of money on current or
deposit account; and the payment of cheques drawn by and the collection
of cheques paid in by a customer. (Halsbury)

According to Sir John Paget, another great authority on British banking

law, a banker must perform at least four essential functions in order to do
banking business. No person or body corporate can be a banker who
does not:

take deposit accounts,

take current accounts,
issue and pay cheques, and
collect cheques crossed and uncrossed- for his customers.

Thus, a money lender who lends his own capital to others and charges
interest in course of the lending business would not qualify to be a banker
as per the British banking law, as he is not taking deposits from the public
and as also not issuing/ paying/ collecting cheques of his customers in the
course of his business.


In India banking has been defined by a statute, viz., the Banking

Regulation Act (BRA), 1949 (vide section 5 b, c) as follows:

Accepting for the purpose of lending or investment, of deposits of money

from the public, repayable on demand or otherwise, and withdrawal by
cheque, draft, and order or otherwise (section 5 b)

A banking company is a company which transacts the business of

banking in India (section 5 c)

Page 20 of 157
As per the above definition of banking, following are its essential or core

Acceptance of deposits from the public (customers or members of

the society).
The deposits of the customers should be withdrawable by cheque
or otherwise (withdrawal slip, letter, voucher) on demand, or
repayable on maturity to the customers.
The bank lends or invests the funds collected from its customers,
subject to its obligation to repay the deposits to the customers on
demand or otherwise as per the terms of the deposits.

Cheque is a negotiable instrument defined in the Negotiable Instruments

Act, 1881 as a bill of exchange drawn on a specified banker and not
expressed to be payable otherwise than on demand. Bill of exchange has
been defined in the same Act as an instrument in writing containing an
unconditional order, signed by the maker, directing a certain person to pay
a certain sum of money only to, or to the order of, a certain person or to
the bearer of the instrument. Thus a cheque is issued by a person who
maintains a current/ savings account (drawer), drawn on a specified
branch of a bank (drawee), directing it to pay the specified sum to the
specified person (payee) or his order or bearer, on demand.

Structure of Banking


Banking in its initial years evolved as family owned business but presently
all banks are either joint stock companies or statutory corporations created
by sovereign authority. Except a few statutorily created banks, joint stock
banks shares are listed on stock exchanges and are widely traded, and
ownership of banks is subject to anti trust laws in various countries. Today
banks, internationally are widely held entities and are required to maintain
high standards of corporate governance by Capital Market Regulators,
National Banking Regulators and the Basel Committee. The balance sheet
of largest banking group in the world, viz., Citi group is a trillion dollar
balance sheet, while that of small unit banks governed by state regulations
in the same country run only in hundred million dollars.

Basel Committee classification

According to BASEL Committee, banks can be categorized in three main

Internationally active banks,
Nationally active banks, and
Other banks.

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This classification sub-serves Regulators purpose of differentiated
supervisory control on banks to ensure systemic integrity of banking

Comparative Structure of banks In U.K. & U.S.

U.K. has unitary Bank supervisor, the Financial Services Authority(FSA).

Banking system is branch banking based. There are six large national
banks having large number of branches, supported by ATMs, electronic
and Internet banking. London is the largest forex trading centre in the
world; it does 39% of volumes in the world. Banks are highly sophisticated
and do all types of banking under one roof. As building societies are
allowed to open deposit accounts and give check drawing facility to their
members, competition is stiff in what is called as savings bank market,

U.S.A. has three Banking Regulators, the Federal Reserve Bank, the
State Banking Authority, and the Federal Deposit Insurance Corporation
(FDIC) in case the bank is insured. There are no banks having thousands
of branches like U.K. or India. Banks have to get state banking licence
both for setting up a bank and for opening branches. Most of the banks in
U.S.A., (reportedly more than 13,600) are unitary banks catering to niche
markets and do not have national or international ambition. Federal
Reserve Board has reportedly identified only 5-6 internationally active
banks, Citi, JP Morgan Chase, Bank of America being prominent amongst
them. There have been a slew of mergers amongst top banks thereby
creating a structure having very large international banks, a few state wise
active banks and very large number of unit banks.

Page 22 of 157
International Banking

Banks operating offices outside the domain of home regulator (i.e.,

American banks controlled by Federal Reserve System operating in
Japan, Europe, and North and South America) and conducting banking
business having cross border ramifications, subject to host Regulators
control, and earning major portion of their revenues from cross-border
banking business are categorized as international banks. Mere buying and
selling foreign currencies or financing foreign trade, is not a sufficient
condition for a bank to be categorized as a bank doing international
banking. The major concomitants of an International bank are:
Operating in a number of countries with different host regulators,
Settling and financing cross-border transactions, like import/export
trade, guarantees, bid bonds, arbitraging, offering complex cross
border derivative products,
Raising cross-border resources both from retail and wholesale
markets, and building up multi currency assets to optimize income
Splitting the entire operations in front, middle, and back offices,
Maintain front office in host countries but maintain back and middle
office in cost effective bases (preferably in low cost economies) by
using Information and communication technology to full extent, thereby
generating large but cost effective transaction processing and storage
capability. This increases margins through cost control, and make
them offer services at very competitive prices,
Major income streams in the overall income statement come from
transnational operations and home country business income streams
are not major income generators,
Organizationally, while the top managerial positions, business, and
manpower policies are highly centralized and controlled by the home
office, substantial degree of decentralized decision making for
operational matters exist in these banks,
Personnel recruitment is well diversified, is predicated to meritocracy,
and key personnel are highly mobile,
Compliance systems are well developed, as these cater to diverse
regulatory authorities. The internal controls are well defined, and tightly
administered with no lee-way to operating managers to violate the
same. International banks are systems oriented organizations,
Anti-money laundering, suspicious transactions reporting, and Know
Your Customers (KYC) reporting is highly sophisticated and
computerized to ensure that none of these transactions pass through
the bank, as any default can have serious financial, regulatory, and
reputation risk.

Page 23 of 157
Running a multicurrency payment and settlement system for its
customers in diverse time zones and currency areas. Operations, risks,
and activities of an International bank are illustrated in figure 5 below.

Risks Corresspondent1 Branch 1

Interest E.C.B.s
Currency Foreign Bonds sold
Settle- Correspondent 2 ADR/GDR proceeds
Acceptance bills Branch n
ment Subsidiary 1
Subsidiary 2
party Correspondent 3
Gap Subsidiary n
Credit Correspondent n


Forward rate agreements,
Interest rate swaps ,
Currency Swaps

Page 24 of 157
Retail Banking

Retail banking organizations deal with very large number of customers

both on liability and asset side of the balance-sheet. Their business
organization comprises large distribution channels including brick and
mortar branches, cash dispensers, on site and off-site ATMs, internet
banking, and telephone banking. They endeavour to divert large number
of their customers to offsite service channels to reduce costs per
transaction, get some of the data entry work being done by customers,
and reduce costs by setting up back office at low cost centres to cut costs
and create centralized service factories for cheque-book, statement of
accounts, bankers cheque, draft issue, and centralized cheque clearing
operations etc. They outsource customer acquisition and servicing to third
parties and depend on outsourced BPO call centres to provide customer
service. Their portfolio is very finely grained and due to very large number
of small value accounts the volatility in their portfolio is very small. They
are high cost and high margin business originators. Their business has
very high volume of low value transactions. Reduction in per transaction
cost is achieved by computerization, creating alternate channels of
service, centralized back office, and factories for common services to retail
customers. Concomitants for retail banking organizations are :

Serving very large number of customers both for raising deposits and
giving loans. A typical retail bank has a large number of savings and
term deposit accounts and concentrates on building up large portfolio
of automobile, residential mortgages, personal loans, consumer
finance, and credit card portfolio.
They have large to very large distribution channels, comprising brick
and mortar branches, ATMS, cash dispensers, internet banking,
telephone including mobile banking, and call centres.
Large volumes with individual transactions of low value imply high cost
per transaction. This is corrected by large scale use of IT to create
processing capability for very large volumes of transactions thereby
pushing down cost per transaction.
Back office is invariably set up at low cost centres to reduce cost, and
centralize all operations to enable customers to operate on their
accounts from anywhere and unfetter them from dealing with a specific
Centralized factories are set up to do cheque processing and clearing,
cheque book issue, statements issue, bank draft and bankers cheque
issue, forex sale and purchase to retail customers, documentation and
maintenance of records.
Customer acquisition and servicing is outsourced, both for deposits
and advances. While some regulators require that deposit activity is

Page 25 of 157
not outsourced, in most of countries regulators do permit outsourcing
of both activities.
Basic strategy is to minimise customers interface with banks regular
staff, and provide a technological interface including call office
interaction to do majority of customer transactions. Large retail banks
even automate activities like KYC (Know Your Customer), where staff
interaction with customer is desirable, through expert systems to avoid
human interaction to reduce cost.
Credit decisions are done through technology, by introducing credit
scoring models, thereby enabling large volumes of small credit
proposals being processed by IT systems in minimal time and at highly
reduced cost.
Account opening decisions for deposits including anti money
laundering checks and suspicious transactions reporting is handled
through middle and back offices on a centralized basis. The branches
as such are converted into pure marketing front offices.
High usage of technology diversified large number of customers each
one of them being fine-grained, reduces volatility of earnings, and
provides large margins. Retail banking provides stable resources and
low volatility on assets side.

Page 26 of 157
Activities of a typical retail banking institution are shown hereunder:

Resource- Resource
Mobilization Large volume deployment (domestic
(domestic currency) currency)
low size Personal loans
business automobile
and financing
savings residential
accounts mortgage
Term finance
moneys credit card both
own and
others, charge
savings slip purchases
schemes SME financing
Current Micro credit
deposits through NGOs
facilities Bill discounting
receivables of
-s and

Retail banking
high volume
low size
Back office
ATM switch
Internet site
Bank database
Wide Area Distribution
WAN channels
Telephone line Brick and
Satellite based mortar
Mobile telph- branches
Ony based ATMs and cash
Linking all dispensers
Distribution Point of sales
Channels to (POS)
Central Internet
computer system. All transactions being Banking
captured on line. Phone banking
Customer becomes customer of entire and mobile Call centre attached to
bank and is not fettered to a branch. He or banking
She can do any transaction at any POS
back office and attending
ATM or branch and can settle all marketing loans all customers 24hrs/7 days
transactions through Internet banking. and deposits

Figure 6. Retail bank illustrative activities, depending upon IT capabilities variations can
be there

Page 27 of 157


Wholesale banking is more common to North American and European

Union countries. It is possible to raise large resources through institutions
without going through the intricate process of setting up large distribution
channels to market the deposits of retail savers. Naturally, the price for
resources raised by wholesale banks is more than that for retail banks.
The advantage is savings on cost due to absence of cost centres and
huge transaction processing cost incurred by retail networks. Major
sources of funds are:

Term money market offering 15 days to five years funds wherein

market players are international banks and the price is linked to the
rating of the accepting bank and its relationship with lending bank.
Brokers funds are normally available in London and New York markets
from non-banking financial companies like Merrill Lynch and others,
and the rates are linked with LIBOR and the duration of funds.
Certificate of Deposits (CDs.) can be raised from the wholesale
markets. In U.S. minimum size of a CD is a million dollar; the issue can
run into a few hundred million dollars. The interest is paid as a discount
in purchase price and is interlinked to duration of CD and credit rating
of issuer. CDs are transferable by endorsement and can have a
secondary market.
Unit banks in US have little out let for good assets and cannot go in for
big ticket financing, they place their funds through bigger whole-sale
banks which take up their funds as term liabilities on their balance
Co-operative Land banks in Germany and oil rich middle-east banks
are perennial lenders in term money markets and lend large funds to
wholesale banks.

On asset side, whole-sale banks discount short term, large value buyers
and sellers credit bills in oil market. They arrange for large project finance
in conjunction with international financial institutions, arrange for large
value cross border leasing and loans for civilian aircraft. They also go in
for large ticket loans to large corporations over the medium term, the
amounts run anywhere from US $ 100 mio to $ 500 mio, over say, five
years. These banks do large value but small volume business, though the
margins are small, large volumes provide very large gross incomes. The
whole-sale banks are very selective in clientele selection. They refuse to
deal with even nationally recognized banks in case the deal size is small
or they find that the other bank cannot sustain commitments made over
the years.

Page 28 of 157
Hybrid model

Most of the international banks run a hybrid of wholesale and retail

banking, with the exception of Citi which has developed into an
outstanding retail bank in almost 94 countries. Banks like Bank of Tokyo
Mitsubishi (BOTM), Mizuho, Deutshe Bank, and Bank Paribas are typical
example of wholesale banks outside home regulators domain but retail
bank in home country. Most of the first world banks, ie., banks in
developed countries, with the exception of Hongkong & Shanghai Banking
Corporation (HSBC), Standard Chartered Bank (SCB), and Citibank do
wholesale banking once outside the home domain. It would be difficult to
identify a single commercial bank as a pure wholesale bank but parts of
most of the international banks do wholesale banking. Even in the case of
Indian banks with offices in U.S. and U.K. and some places in Middle East
their local branches do act as wholesale banks.


Typical activities of a whole-sale banks are depicted in figure 7 (below).

Page 29 of 157

TERM MONEY Buyers sellers credit bills oil

Buyers market

BROKERS FUNDS Project finance with intl.inst.

C.D. Cross border lease & funding for


Large ticket E.C.B., bonds


LANDS CO-OP BANKS Derivatives contracts

IT based
Wholesale derivatives,
Banking ALCO,sett-



A global bank operates under diverse banking regulatory authorities in

different countries where its offices are situated. It is subject to regulatory
control by home office regulator and host country banking regulators of the
countries it operates in. A host regulator examines and supervises
banking activities in its jurisdiction. Inter-country operations are somewhat
loosely supervised. It is the responsibility of home office supervisor to
examine the bank in its entirety, by taking a global view. The other
regulators (hosts) depend to a large extent on the home regulator to
ensure that all rules have been complied within inter-country transactions.
A typical global Bank is organized on geographical basis as depicted in
Figure 9 below. Most global banks centralize Strategic Planning,
Personnel, Treasury, Risk Management, and Credit function at home
office, directly under the control of Chief Executive Officer at Corporate
Centre and the Board.

Page 30 of 157
east &

Country President
manager Canadian
U.S. subsidiary
operations Home
office &
r London

President President
Japan, Far- European
East, & subsidiary
Oceania Frankfurt

Figure 9. Organization chart of a typical global bank

Some regulatory regimes like in U.S., Japan, Singapore, and European

Union allow opening of branch offices of bank. Some regulatory regimes
like in Canada, Russia and States like California in US are more open to
issuing licences for fully or partly owned subsidiaries which are local
banks under the control of the bank.

A subsidiary is a local bank under the control of local regulator and

home office regulator has no authority to look into that subsidiary
without host regulators permission.
On the contrary, while foreign branches are under the control of foreign
regulator, the home regulator has authority to look into its affairs being
regulator and licencing authority of the entire bank.
Subsidiaries have independent boards, and the main bank exercises
control through directors nominated by it on the Board,
The main bank cannot exercise managerial and operational control.
Directors nominated by it can advise and guide the managers of the
subsidiary through the Board.
Branches, say, in U.S., Japan, Middle East are directly under the
control of CEO of the bank and only for these branches the bank can
centralize treasury, ALM, product development, marketing, sales, risk,
credit, inspection and audit, HRD & Corporate communications.

Page 31 of 157
The compliance being a host regulators concern cannot as such be
IT function has to sub-serve local regulators concern.
In number of regulatory regimes especially in North America and
European community, I.T. systems have to be approved by regulators.
For this reason, centralization is not possible.


A typical global bank exercises control on its subsidiaries just like a

majority share holder exercises control over a company through the
Board. It cannot interfere in day-to-day business nor force executives of
the subsidiary to take directives from its executives except through
directors nominated by it on the board, the intervention of directors being
well within the principles of good corporate governance prescribed by
regulator and signed by the nominated directors.


For its foreign branches, the bank can centralize various functions at
CEOs level, subject to host regulators requirements being met. The bank
can centralize treasury, ALM, product development, marketing, sales, risk,
credit, inspection and audit, HRD & Corporate communications.

In USA, special statutes like PATRIOT Act (2001), Bank Secrecy Act,
Sarbenes-Oxley Act (2002), Foreign Assets Control Act, stipulate that
suspicious activity reporting have to be complied with and banks are
statutorily required to ensure that all reporting is done through
seamless IT systems without any manual intervention. It functions
especially for US operations have to be under the direct control, of
country manager US. This is an essential regulatory requirement and
cannot be centralized in home office.
Risk management systems have to be calibrated to local regulatory
concerns. In North America the product development itself is subject to
risk calibration unlike regulatory regimes elsewhere. Introduction of any
new product has to be weighed with reference to risk being taken and
precise work stages are prescribed by regulator for new product
introduction. Home office products cannot be suo-moto introduced in
US offices.
Property laws especially in regard to leasing of properties vary widely
among various countries. Hiring of property as such can not be
centralized and has to be done at foreign office level.
As Internal revenue, and social security regulations vary from country
to country pay roll can not be centralized.

Page 32 of 157
The prime item for centralization is the general ledger, day to day
balance-sheet and profit and/or loss. It is a good international practice
to centralize these basic requirements.


1.12.1 Two major trends are discernible over last decade. U.S. regulators gave a
go- bye to Glass-Steagal Act by default permitting U.S. banks, and largest
international banks are U.S. owned, to do commercial banking and
investment banking simultaneously. This gave acceleration to proprietary
trading and brought in sharp focus treasury operations. The second trend
has been disintermediation in international markets from commercial
banks to capital markets. Savers have started investing directly in capital
markets through mutual funds. Increase in strength of mutual funds and
capital markets has seriously threatened income streams of banks and
have brought in its wake, need to innovate, cut costs, and find new
businesses to generate new income streams.

1.12.2 Pressure on income streams have resulted in large number of bank

mergers and acquisitions in JENA (Japan, Europe, and North America.)
markets. The largest mergers have occurred in Japan, under Government
pressure, resulting in creation of new behemoths like Mizuho, UFJ and
BOTM. A completely new development has been SHINSEI a boutique
bank which has revolutionized banking and reportedly has become
preferred bank of young Japanese customers. Dresdner and Commerz
have disappeared in Germany and have merged into larger banks.
Banque the Paris has merged in Paribas and a host of mergers have
taken place in Italy and Spain. In U.S. Travelers got merged in Citi and
Chase Manhattan got merged in J.P.Morgan. In 2004 Banc One got
merged with J.P.Morgan Chase. There is consolidation through mergers
and acquisitions.

1.12.3 International Organisation of Securities Commission (IOSC - a body of

security regulators worldwide) is closely working with Basel Committee for
Bank Supervision (BCBS) to ensure that banks do follow strictest control
on their securities trading more so on proprietary trading. Proprietary
trading in forex markets has risen to all time high and as per BIS statistics
published in May 2004 less than 10% of forex turnover relate to actual
transactions. Great profits and great risks have emerged in securities,
forex, and derivatives markets. Risk mitigation is the key function of the
boards of the international banks. All regulators expect that major
international banks and major national banks have in place proper risk
identification, risk measurement, and risk mitigation systems. Boards of
Directors are now statutorily required to look into this aspect and are
directly accountable both to regulators and to shareholders.

Page 33 of 157
1.12.4 Basel Committee has requested all regulators to ensure that all
international banks and major national banks must ensure compliance
with the requirements laid down by Accord known as BASEL-II latest by
March 2006. This requires attention to credit risk, market risk, operational
risk, supervisory control and market discipline by way of transparency in
annual accounts and periodical publication of reviewed accounts.

Page 34 of 157


Deposit-taking means accepting money (notes/coins) or money

equivalents (like cheques, bankers drafts) in deposit accounts. It is the
most important function of a commercial bank. When entrepreneurs seek
a banking licence, their purpose is to establish a business to attract
savings and transaction money in the economy and make income by
lending monies to companies for project or working capital finance. No
banking licence would be fulfilling the objective for opening a bank if it
were to be denied raising of deposits. A recent widely known example is
the repeated attempts by Citibank and J.P. Morgan Chase to persuade
Chinese Government to permit acceptance of renminbi deposits by foreign
banks. It was obvious that denial of permission to raise deposits in
domestic currency made the foreign banks unviable. Left to themselves all
companies, financial and non-financial, would like to access to deposits.
Deposits constitute the bulk of a banks total liabilities and the remainder
portion is represented by its Owned Funds (capital and reserves),
borrowings and provisions. Thus, deposits represent the main source of
funds for a banks operations and determine the size of its balance sheet
as well as its strength and market share in the banking industry.

The quantum of deposits of a bank and its market share in deposit

business depend on the mix of factors as follows:

Financial soundness of the bank that inspires public confidence to

place deposits with a feeling of safety of the deposits;
Number of its branches and its delivery channels that offer deposit
Range of its deposit and other products;
Efficiency in the delivery of its products
Quality of its customer service and
Rates of interest offered on deposits, as compared to its competitors /
other banks.

Acceptance of deposits and allowing its withdrawal by cheque or

otherwise are the essential and unique features of a bank. A non-banking
finance company is not allowed to issue cheque book to depositors for
withdrawing funds and can only repay the deposits (term deposits) on their
maturity to the customers. Similarly, money lenders who lend their own
funds are not termed as bankers, as they do not perform deposit-taking
function, which is an essential attribute of a banker

Page 35 of 157

Depositors keep their savings and salary/business funds with one or more
commercial banks because of a mix of advantages, as compared to other
avenues for deposits, e.g., non-banking finance companies, co-operative
banks, post offices, investment in shares/ debentures. Main advantages to
the customers by keeping deposits with commercial banks are as follows:

Liquidity or easy withdrawals by cheques/ATMs for meeting day-to-

day requirements. Liquidity refers to the quality of an asset in terms of
its convertibility into cash without risk of loss to the holder. Bank
deposit accounts (current and savings) are liquid financial assets and
even term deposits can be repaid before their maturity at the discretion
of the bank or a loan can be obtained against their security.
Quick and convenient transferability of funds to third parties and to the
depositors other accounts by cheques/ debit card/ clearing/ collection
Safety of funds.
Earning of interest on savings and term deposits
Record keeping via statements of accounts and pass books.
Availability of other facilities to depositors, e.g., safe deposit locker,
credit/debit/ATM cards.

Depositors interests are protected by common law of the country in

general and Contract Law in particular. Apart from the legal protection
enforceable in courts, the Regulators ensure that banks function in a
manner, so as not to jeopardize depositors stake, to be specific not risk
the deposits placed at their disposal. The primiary relationship between a
banker and depositor is that of a banker and customer. Under different
national regimes banker depositor relationship has been defined. More
important is the definition of a deposit. The major economic entities, i.e.,
India, EU and US, define deposits diversely; some of these are mentioned


Depositor and banker have creditor-debtor relationship. This relationship

flows from Indian Contract Act, which is, largely based on U.K.s Law of

European Union and U.S. have more comprehensive definition of

deposits. While E.U. law specifically defines deposits U.S. definition is the
definition used by Federal Deposits Insurance Corporation (FDIC).

Page 36 of 157

Any credit balance which results from funds left in an account or from
temporary situations deriving from normal banking transactions and which
a credit institution must repay under the legal and contractual conditions
applicable, and any debt evidenced by a certificate issued by a credit
institution. Shares in United Kingdom and Irish building societies, apart
from those of a capital nature, shall be treated as deposits. It is obvious
that EU definition of deposits extends much beyond debtor creditor
relationship, and covers even funds left with a bank during temporary
situations deriving from normal banking transactions.


The Federal Deposits Insurance Corporation (FDIC) insures deposit

accounts, such as, checking, Negotiated Order of Withdrawal (NOW) and
savings accounts, money market deposit accounts, and certificate of
deposits (CDs). The basic insurance limit is $100,000 per depositor per
insured bank
Single accounts
Self-directed retirement accounts
Joint accounts
Revocable trust accounts

Single Accounts

These are deposit accounts owned by one person and titled in that
persons name only. This account category does not include deposits held
in individual retirement accounts because they are protected in a separate

A customers all single accounts at the same insured bank are added
together and the total is insured up to $100,000. If a customer have a
checking account and a CD at the same insured bank and both accounts
are in clients name only, the two accounts are added together and the
total is insured up to $100,000.

Self-directed retirement accounts

These are deposits clients have in retirement accounts at an insured bank,

for which clients have the right to choose how the money is deposited or
invested. Types of self-directed retirement accounts include traditional and
Roth Individual Retirement Accounts (IRAs) and Simplified Employee
Benefit Plans (SEPs).

Page 37 of 157
All of clients self-directed retirement accounts at the same insured bank
are added together and the total is insured up to $100,000. Naming
beneficiaries on a self-directed retirement account does not increase
insurance coverage.

Joint Accounts

These are deposit accounts owned by two or more people who have equal
rights to withdraw money from the account. Each persons share of each
joint account, with the same or different co-owners at the same insured
bank, is added together and the total is insured up to $100,000. If
customers have joint checking and savings accounts at the same insured
bank, customers portions of the two accounts are added together and
insured up to $100,000.


John and Mary have $220,000 in a CD at an insured bank. Under FDIC

rules, each persons share of each joint account is considered equal
unless otherwise stated in the banks records. This means that John and
Mary each own $110,000 in the joint account category, putting a total of
$20,000 ($10,000 for each) over the insurance limit.

Account Ownership Amount Amount

Holders Share Insured Uninsured
John $ 110,000 $ 100,000 $ 10,000
Mary $ 110,000 $ 100,000 $ 10,000
Total $ 220,000 $ 200,000 $ 20,000

Revocable Trust Accounts

These are deposits held in either a payable-on-death account or a living

trust account.

Payable-on-death (POD) accounts also known as testamentary or

Totten Trust accounts are the most common form of revocable trust
deposits. These informal revocable trusts are created when the account
owner signs an agreement usually part of the banks signature card
stating that funds will be payable to a beneficiary upon the owners death.

Living trusts also known as family trusts are formal revocable trusts
created for estate planning purposes. The owner controls the funds in the
trust during his or her lifetime. Upon the owners death, the trust generally
becomes irrevocable.

Page 38 of 157
If certain conditions are met, revocable trust accounts are insured up to
$100,000 per owner for each qualifying beneficiary.

Qualifying beneficiaries are the owners spouse, child, grandchild, parent,

or sibling. Adopted and step children, grandchildren, parents, and siblings
also qualify. Others including in-laws, cousins, nieces and nephews,
friends and organizations (including charities) do not qualify.

Note that living trust coverage is based on the interests of qualifying

beneficiaries who would become entitled to receive trust assets when the
trust owner dies (or if the trust is jointly owned, when the last owner dies).
This means that, when determining coverage, the FDIC will ignore any
trust beneficiary who would have an interest in the trust assets only after
another living beneficiary dies.

The account title for a revocable trust account must include a term, such
as, payable on death, in trust for, living trust, family trust, or similar
language or an acronym (such as POD or ITF) to indicate the existence
of a trust relationship. In addition, for POD accounts, the beneficiaries
must be identified by name in the banks account records.

The undernoted table summarises the broad definitions of the term


Indian definition E.U. definition F.D.I.C. description as

applicable to all insured
banks in U.S.
Funds kept with a credit Funds left with a credit Under-noted products
institution and forming a institution in are treated as deposits
debtor creditor relation i. an account, i. checking
ship as per Indian ii. temporary situation in accounts of all
Contract Act normal banking types,
transactions, ii. NOW (negotiable
iii. repayment should be order of
made under legal and withdrawal)
contractual conditions, iii. Savings
and / or Accounts,
iv. Debt must be iv. M.M.D. ( Money
evidenced by a market
certificate issued by a Deposits),and
credit institution. v. C.D. (certificate of

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These may be held in
under-noted ways
Single account
Self directed
retirement plans,
Joint accounts,
Revocable trust


Commercial banks mobilize a large portion of the savings of the

community and deploy them in loans and advances to the industry, trade,
agriculture, infrastructure, services sector and other bankable economic
activities and thereby help development of the economy. This function is
called financial intermediation by banks, which has already been
explained in Chapter 1. Let us elaborate it further. Banks act as
intermediary between the depositors (savers of money) and businesses
(users of money) by lending to the latter the depositors money at their
(banks) own risk. Banks thus play an important role in economic growth of
the country by channeling the communitys savings for productive

Commercial banks are the creators of the Money Supply through demand
deposits, time deposits, and credit creation capability through credit
multiplier. Each time a credit is given it gives rise to countervailing deposit,
which in turn is used to create credit; in sum deposits and credit grow like
a spiral and one of the major jobs of the Central Banking authority is to
ensure that this deposit and credit creating ability of banks does not go out
of control to hurt the national economy.


United States of America

In U.S. the main products on the deposit side are as under:

Checking Account (Non-Interest bearing)

In an ordinary course, these accounts are non-interest bearing.

"NOW" accounts (Negotiated Order of Withdrawal)

These are interest bearing checking accounts.

Banks have different minimum average deposits maintenance stipulation

and, there is cost for having such accounts in most of the banks.

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There are different variants in respect of maximum number of checks that
may be written per month.

Most banks recover check printing charges from their customers.

Savings Account: (interest bearing)

They do not have check writing facility. Minimum deposit stipulation is

much lower as compared to Checking Account. These are interest bearing

Money Market Deposit Accounts (MMDA)

These accounts are a combination of limited liquidity with better returns, at

times close to fixed deposit accounts. In these accounts, one may write
not more than three checks favouring third parties in one month. Three
transfers like fedwires etc can be sent each month. On ones own account,
one may write as many checks as one wants to. Minimum deposit
stipulations for these accounts are higher than in case of all other category
of accounts mentioned above.

Certificate of Deposits:

These are fixed deposit accounts. These are issued for a fixed face value
and zero coupon rates. As such, the initial investment is a discounted
future value at agreed percentage of return. These are, unlike other
deposits, transferable and negotiable.

Almost all banks have different minimum average deposit stipulations for
business accounts. Also, depending on the business size(s) and
requirements, most banks have different business checking account
products. No interest is paid on a business checking account.


Deposits of banks in India are broadly classified into three categories:

(i) Demand deposits that are repayable on demand. These comprise
Current account deposits
Savings bank deposits
Call deposits

(ii) Term deposits that are repayable on maturity dates as agreed

between a customer and the banker. These comprise:
Fixed deposits
Recurring deposits

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(iii) Hybrid deposits or flexi deposits combine features of demand and
term deposits. These deposits are introduced in recent times by
some banks to meet customers financial needs and convenience
and are known by different names in different banks.

Current accounts

Current accounts form a large portion of demand deposits of a bank.

Current accounts can be opened by individuals, business entities (firms,
company), institutions, government bodies/ departments, societies,
liquidators, receivers, trusts, etc. Main features of current accounts are:
There are no restrictions on number and amount of withdrawals /
deposits. Hence this account is maintained by all businesses with one
or more banks.
Cheque book facility is provided to each current account holder and
bank undertakes to honour all cheques drawn correctly so long as
there is sufficient balance to the credit of the account. Withdrawals are
permitted by cheques in favour of self and also in favour of other
parties. The payees of cheques can endorse the cheques in favour of
third parties who can receive payment in cash at the drawee bank
branch or through their bank account via clearing or collection.
All current accounts are non-interest bearing and banks are not
allowed to pay any interest or brokerage in any form in these accounts.
Overdrafts ad hoc for very short period or on a regular basis up to
specified limits - are allowed in current accounts. Regular Overdraft
facility is granted as per prior arrangement made by the account holder
with the bank. In such cases the bank would honour cheques drawn in
excess of the credit balance but not exceeding the overdraft limit. The
bank would charge agreed interest on the overdraft portion of
Cheques/ bills collection and purchase facilities may also be granted to
the current account holders as per arrangements and charges agreed.
These and the overdraft facilities are required by businesses for their
operations and liquidity requirements.
The account holder gets periodically from the bank branch statements
of accounts for reconciliation and record. The statement of account
would show date-wise all the debit and credit transactions and
balances, as recorded in the banks ledger account of the customer.

Savings Bank Accounts:

As the name indicates, Savings bank accounts are intended for keeping
savings of individuals and small businesses for meeting their future money
needs. Interest is given by banks on these accounts with a view to

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encourage saving habit in the community. Savings accounts can be
opened by individuals, guardians (on behalf of their minor children/
wards), Karta of Hindu Undivided Family (HUF), clubs, associations,
trusts, small businesses, etc.

The Savings bank accounts are of two types:

(a) Cheque book facility accounts in which withdrawals are permitted by

cheques drawn in favour of self or other parties. The payees of
cheques can receive payment in cash at the drawee bank branch or
through their bank account via clearing or collection. The account
holder may also withdraw cash by filling up withdrawal form
(b) Non-cheque book facility accounts where withdrawals are permitted to
the account holders only at the drawee bank branch by filling up a
withdrawal form or letter accompanied with the account pass book. In
such accounts third parties cannot receive payments.

Main features of savings bank accounts are as follows:

Withdrawals are permitted on demand of the account holder by

presentment of cheques or withdrawal form/letter. However, cash
withdrawals in excess of the specified amount per transaction/ day (the
amount varies from bank to bank) require prior notice to the bank
Banks put certain restrictions on the number of withdrawals per month/
quarter, amount of withdrawal per day, minimum balance to be
maintained in the account on all days, etc. and levy fee/ penalty for
violations of these rules. These rules are different for different banks,
as decided by their Board/ Top Management. The rationale of these
restrictions is that savings bank account should not be used like a
current account as it is primarily intended for keeping and
accumulating savings.
Banks pay interest on the minimum balance maintained in the account
during the specified period of every month, say from 10th to the last day
of the month. Let us illustrate this with an example. Suppose in a
savings bank account the credit balances in the month of July were Rs.
20,000/- on the 1st, Rs.12, 000/- on the 2nd, Rs.8, 000/- on the 20th and
Rs. 5,500/- on the 30th July. The bank would pay interest only on Rs.5,
500/- for the month of July, as this was the minimum balance
maintained during July 10-31.
Interest on savings bank account continues to be regulated by the
Reserve Bank of India. It is 3.50% per annum from July 2004 and all
commercial banks have to pay this rate on savings bank accounts.
No overdraft in excess of the credit balance in savings bank account is
permitted, as there cannot be normally any debit balance in savings

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Most banks provide to every savings bank account holder a pass book
wherein date-wise debit/credit transactions and credit balances are
shown as per the customers ledger account maintained by the bank.

Term Deposits

Fixed deposits are repayable on the fixed maturity date along with the
principal and agreed interest rate for the period and no operations are
allowed to the customer against the deposit, as is permitted in demand
deposits. The depositor foregoes liquidity on the deposit and the bank can
freely deploy such funds for loans/ advances and earn interest. In view of
this, banks pay higher interest rates on fixed deposits as compared to
savings bank deposits where withdrawals are permitted on demand by the
depositors, requiring banks to keep some portion of deposits always at the
disposal of the depositors. Another reason for banks paying higher rates
of interest on fixed deposits is that administrative cost in the maintenance
of these accounts is small, compared to savings bank accounts where
several transactions take place in cash, transfer or clearing and
administrative cost is higher.

Main features of fixed deposits are as follows:

Fixed deposits are accepted for specified periods at specified interest

rates as mutually agreed between the depositor and the banker at the
time of opening the account. Since the interest rate on the deposit
becomes contractual, it cannot be altered even though the interest rate
changes upward or downward during the period of the deposit.
Interest rates on fixed deposits, which were earlier regulated by the
RBI, have been deregulated and banks offer varying interest rates for
different maturities as decided by their Boards. Maturity-wise interest
rates in a bank will, however, be uniform for all customers subject to
two exceptions high value deposits above certain cut-off value and
deposits of senior citizens (above the specified age normally 60 years)
may be offered higher interest rate by specified Basis Points. However,
clear directions are issued by the Banks Board in regard to the
differential rate and the authority vested to allow such differential rate
of interest, to prevent discrimination and misuse at branch level.
Minimum period of fixed deposit is 7 days, as per the extant directive of
RBI. The maximum term and band of term maturities are determined
by each bank along with the respective interest rates for each band.
A deposit receipt is issued by the bank branch accepting fixed deposit -
mentioning the depositors name, principal amount, maturity period and
interest rate, dates of the deposit and its maturity etc. The deposit
receipt is not a negotiable instrument, nor is it transferable, like a
cheque. However, a term deposit receipt evidences contract for the
deposit on specified terms.

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On maturity of a deposit, the principal and interest can be renewed for
another term at the prevailing new interest rate and a fresh deposit
receipt is issued to the customer evidencing a fresh contract.
Alternatively, the deposit can be paid up by obtaining the discharge of
the depositor on the reverse of the receipt.
Many banks prepay fixed deposits, at their discretion, to accommodate
customers request for meeting emergent expenses. In such cases,
interest is paid for the period actually elapsed and at rate generally1%
lower than the rate applicable to the period elapsed. Banks also may
grant overdraft/ loan against the security of their fixed deposits to meet
emergent liquidity requirements of the customers. Interest on such
facility will be 1% to 2% higher than the interest rate on the fixed

Recurring Deposits

In the case of recurring deposit accounts, regular savings are required to

be compulsorily deposited at specified intervals for a specified period.
These are intended to inculcate regular and compulsory savings habit
among the low/ middle income group people for meeting their specific
future needs, e.g. higher education or marriage of children, purchase of
vehicle or costly equipment.

Main features of these deposits are:

Customer deposits into the account a fixed sum at pre-fixed frequency

(generally monthly/ quarterly) for a specified period (12 months to 120
Interest rate payable on recurring deposits is pre-fixed and it is
generally a little lower than the fixed deposit rate for the same period.
Total amount deposited along with the interest is repaid on the maturity
date. However, depositor may be allowed to take advance against the
deposits or to have the deposit pre-paid before the maturity, for
meeting emergent expenses. In the latter case, the interest rate
payable by the bank would be lower than the contracted rate and some
penalty would also be charged.


These deposits are a combination of demand and fixed deposits for

meeting customers financial needs in a flexible manner. Hence, these are
hybrid deposits or flexi-deposits. The new private sector and foreign banks
had introduced this new deposit product some years ago to attract bulk
deposits of high net worth individuals to their books. The increasing
competition and computerization of branch banking has facilitated the
introduction and spread of this product in several other banks in the recent

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past. Banks have given their own brand names to such deposits e.g.
Quantum Deposit Scheme of ICICI Bank, Multi-Option Deposit Scheme
(MODS) of SBI.

The flexi-deposits show a fusion of demand and fixed deposits as

reflected from the following features of the product:

Only one savings/ current account is opened and the term deposits
issued under the scheme are only on the banks books as no term
deposit receipts are issued to the customer. However, the term
deposits issuance and payment particulars would be reflected in the
statement of the savings/ current account for customers information/
Once deposits in savings/current account cross a pre-agreed level,
such surplus amount is automatically transferred to term deposit
account of a pre-determined maturity (usually one year) in the
customers name for higher interest earning.
In the event of a shortfall in the current/savings account, the cheques
drawn on the account are honoured by automatically transferring back
the required amount to the savings/ current account from the fixed
deposit account (reverse sweep).In such a case, the term deposit is
broken and the amount of the reverse sweep earns lower interest rate
due to the pre-mature payment of that portion of the term deposit and
the balance amount of the term deposit continues to earn the original
interest rate.

Thus, main advantages of the flexi-deposits to a customer are:

Advantage of convenience: The customer opens only one account

(savings or current) under the scheme and need not come to the bank
branch each time for opening term deposit accounts or for pre-paying/
breaking term deposit for meeting the shortfall in the savings/current
Advantage of higher interest earning: The customer earns higher
interest on his surplus funds than is possible when he opens two
separate accounts- savings and term deposits.

Comparing the Indian and U.S. banking practice it is obvious that majority
of services in U.S. are non-interest bearing, and cost to the customer. The
table below illustrates this:

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S.No. Type of Indian deposit products US deposit products
1. Non interest Current accounts in all All checking accounts and
bearing types of banks business checking accounts
in particular. Customers
have to pay for all services
including for transactions
and checkbooks.
2. Interest Savings bank interest is All interest rates are fixed by
bearing administered by regulator; banks independently of
accounts all other interest rates are regulator. Charges have to
fixed by banks. Almost no be paid by customers for
charges are levied for services received.
services rendered.
3. Money No such schemes exist in It is a common product
market India offered by almost all banks.
4. Nomination Facility exists in India for Payable on death, account
all accounts and is optional opened if it is a trust and is

Call deposits

Call deposits or deposit at call accounts are maintained by one bank with
another bank. These accounts may or may not fetch interest as per the
rules framed by RBI or Indian Banks Association (IBA), from time to time.


Basic requirements

With the establishment of Financial Action Task Force (FATF -

International Anti-money-laundering organization), enactment of PATRIOT
Act (Providing Appropriate Tools Required to Incercept and Obstruct
Terrorism Act) by the U.S. Congress, and agreements among all major
economies to take anti money laundering measures and penalize
countries and financial institutions regarded as safe havens for money
laundering, banks before accepting any deposit, have to comply with three
basic requirements for each depositing customer. These are:

Legal status of the depositor,

Sources of funds, and continued scrutiny to ensure that funds flowing
through the accounts are commensurate with the activity of the
account holder, and

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Ensuring that KYC (Know Your Customer) norms are complied with to
the banks satisfaction, before a client-bank relationship is allowed to

The above-mentioned three requirements are followed by all banks

situated in complying countries, and if they wish to operate in Organisation
for Economic Co-operation and Development (OECD) countries either
directly or through correspondents. It is almost impossible for any bank to
open a correspondent account with a U.S. Bank unless it satisfies among
others these basic conditions, and ensures that it does not handle any
monies emanating from or going to entities mentioned in the OFAC (Office
for Foreign Assets Control) filters.

KYC (Know Your Customer)

These guidelines are mandatory in OECD countries, and are being

followed by all national Regulators, with different variations.

In United States, KYC is based on FDIC instructions. For opening

any bank account four identifications are prescribed. These are social
security card, passport, driving licence, and employers identity card.
To complete identification part of the KYC at least two of these which
do not correlate to each other must be verified and recorded, the more
important part is source of funds and verification by bank that these are
legal. Bank has to ensure that funds initially deposited are in
synchronization with the activity in which customer is involved, and all
future flows are in line with the sources of business/earnings of the
customer. In case of any suspicion bank has to report online a
suspicious activity report to Financial Centre (FinCen) at Detroit.

In United Kingdom, the deposit accounts are risk rated. They are
categorized as low risk, medium risk, and high risk. For small amount
deposit accounts, which carry very low risk, the KYC is less severe and
verification of documents to establish identity and sources of incomes
are less rigorous. For large deposit accounts, procedure is as rigorous
as in U.S.

In India KYC prescribes the same rigour for all accounts; it does not
risk rate all accounts and retains obtaining a proper introduction for all

Office of Foreign Assets Control (US Treasury) (OFAC) FILTERS

For all foreign currency accounts opened where corpus is held in a

NOSTRO account with an U.S. based bank, it is necessary to check that
depositors name does not exist on OFAC filters. If it happens The

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Department of treasury can seize balances in the NOSTRO account
without reference to legal process. These filters also apply to all in ward
and outward remittances to and fro to an American correspondent. Failure
to comply can result in seizure of balances, launching of criminal federal
cases and stoppage of all business in U.S. for the concerned bank.

KYC Process as understood internationally is depicted in the undernoted

flow chart.

Ask for specific identity


Not in order
Social security card

Driving licence Atleast two

Found in order
identifiers obtained

Check for sources of

Identity issued by
Proceed with a/c opening


We shall briefly discuss in this section some general observations for

opening deposit accounts that would be common to most of the accounts.
These would include topics who can open deposit accounts, need for
obtaining introduction (only in India). In other countries KYC takes care
of it. Identification / residence proof, specimen signature, joint accounts,
nomination, etc., shall be dealt with in the subsequent section dealing with
operations of deposit accounts.

Who can open deposit accounts?

Any person who has legal capacity to enter into a contract can open a
deposit account with a bank. The person should have attained majority
age (18 years in India) and be of sound mind. On behalf of minor child, the
guardian can open a bank account. Some banks also allow deposit
accounts with limited facilities for school students who are less than 18

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years of age, with the idea of catching them young or for inculcating
saving/-banking habit among them.

Following types of legal entities can open deposit accounts with banks:

Individuals singly or jointly

Firm Sole proprietorship or partnership.
Joint stock company Private or Public Limited.
Government Company.
Government Department
Local authority
Club or Association
Liquidator and Receiver

Benefits of Know Your Customer (KYC)

It establishes the identity with residence address of the customer for

future correspondence by the bank.
It prevents benamior fictitious depositors opening bank accounts, as
such accounts are prohibited by RBI/ taxation authorities.
It prevents misuse of cheque facility (by issuing cheques in favour of
third parties far in excess of the balance in the account) or other
fraudulent practices by the customer, which may cause pecuniary loss
to the members of the public, apart from the embarrassment to the
banker of such a customer.
It protects the bank under Negotiable Instruments Act, 1881. By taking
introduction of a customer, while opening an account, the bank is
deemed to have acted in good faith and without negligence. Without
obtaining such introduction, the bank incurs the risk of being held liable
for negligence by a court of law in a legal suit brought by third parties
who have suffered loss as a result of fraudulent act of such a

Identity verification

In 2002, RBI advised banks to follow KYC procedure to establish identity

of the customers by obtaining certain documents (like, passport, ration
card, election card, driving license, etc.) while opening new accounts and
also in respect of existing accounts. Accounts belonging to trusts,
intermediaries, or operated by power of attorney holders should be
subjected to KYC procedure with diligence. The banks board has to lay
down the KYC procedure. The objective of KYC is to combat money
laundering and financing terrorism by obtaining proper documentary
identification of the account holders. RBI has also stressed that by

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adopting this procedure, access to banking services should not be denied
to general public.

Specimen signatures

Specimen signatures of the account holder(s) are also obtained while

opening a new deposit account. The signatures are normally obtained in
the presence of a bank officer who also attests the signature of the
account holder by signing at the appropriate place in the account opening
form. It is only through the signature of the account holder that
withdrawals are permitted in the account.

In banking operations, a customer is recognized by his/ her signature, as

the signature binds the customer for the withdrawals or other
authorizations. If the drawers signature on a cheque is forged, the bank
cannot seek protection for acting in good faith and without negligence
under the Negotiable Instrument Act, 1881, and can be held liable for the
loss caused to the customer. Therefore, a banker before paying a cheque
ensures that the signature of the drawer is genuine by tallying it with that
on its record. If there is doubt about the genuineness of the drawers
signature, the instrument should be referred or returned to the drawer
without payment.

Caution in Joint Accounts:

A joint account is one which is opened in the names of more than one
individual and all the account holders have signed on the account opening
form. In joint accounts, mode of operation has to be authorized by all the
account holders on the account opening form itself or subsequently
revised by a letter signed by all of them. Mode of operation in joint account
of, say, two individuals, can be any of the following:
Jointly by both the account holders
Either or Survivor
Former or Survivor.
Latter or Survivor.

In joint account of A and B when both are alive, the account can be
by both A and B jointly in (a)
by A or B in (b)
by A in (c)
by B in (d)

In case of death of either A or B, the account can be operated:

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By the legal representative of the deceased and the survivor (it would
be better to close the account after permitting withdrawal of the
balance by the legal representative and the survivor and open fresh
account in their names).
By the survivor without obtaining legal representation for the estate of
the deceased account holder, in case of (b), (c) and (d) above. This is
the great advantage of the joint accounts with the operation by the
survivor as this obviates the problem involved in obtaining legal
representation for the deceased and the account can be operated by
the survivor without any interruption.

Instructions of the account holders

The banker has to meticulously follow mandate of the account holders as

per their instructions. In case of laxity or omission in this regard, the
banker can be held accountable for wrong payment of a cheque as it was
not drawn as per the mandate of all the joint account holders.


The deposit account opening form contains provision for nomination which
can be made in single or even in joint accounts by the account holder(s)
by signing the declaration in the form as per the provisions of section 45-
ZA of the Banking Regulation Act, 1949 (amendment of 1983). The effect
of a valid nomination is that in the event of death of the sole depositor or
all depositors, the amount lying in the account will be returned to the
nominee without any further legal formality. The banks action in giving
money to the nominee cannot be questioned by any heirs to the
deceased, as the banks action is in pursuance of the law mentioned
above. It is note worthy that nomination per se does not bestow legal heir
ship to the nominee. It only authorizes the nominee to collect the amount
from the bank. The nominee can be questioned by the heirs as regards
the distribution of the money collected. However, the bank has nothing to
do with any such dispute as it stands discharged from its liability by giving
money to the nominee.

As a banker, one should always advise the sole account holder to make
nomination by explaining the advantage and the above provisions of law.


1) Termination by customer

A customer is entitled to terminate the relationship with a bank by applying

for closing the deposit account if he/ she is not satisfied with the services
of the bank or for any other reason, e.g., transfer to another place. In that

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event, the bank would close the account by obtaining the unused cheques
from the customer and returning the balance in the account against the
customers acknowledgement.

2) Termination by bank

A banker may close account or stop operation on a customers deposit

account in any of the following cases, by giving reasonable notice to the
customer, wherever necessary:

Death of customer: Death of a customer terminates the authority given

by him/her to the banker to pay cheques drawn on his/ her account. On
the death of a sole customer, the balance in the account is paid to the
nominee or legal representative and the account closed by the bank. A
joint account may also be closed on the death of only one of the
account holders and fresh account opened in the names of the
surviving account holders, to avoid legal problems.
Insanity or insolvency of the customer: The bank may stop operations
on receiving such notice and thereafter close the account by notifying
the customer.
Garnishee Order or Order of Courts: If a banker is served with a
prohibitory order in execution of a decree by a court, garnishee order
by a Court or an Attachment Order by Income Tax Authority, the
banker should immediately put a caution note in the account and stop
payment of cheques or debits to the account, until the order is lifted in
writing by the Issuing Authority. The customer should be
simultaneously advised of such order and the consequent freeze on
the withdrawals from the account. The account operations are
stopped for temporary period of the court order and it is not closed.
Assignment of an account: On receiving notice of assignment made by
the customer of the credit balance in a deposit account, the banker
should pay the money to the assignee and stop withdrawals from the
account by the customer.


Deposit-taking is the foremost function of a commercial bank. Deposit

collection and the cheque book facility for permitting withdrawals of the
depositors funds distinguish banks from non-banking financial
companies and other financial services providers. Deposit-taking
function plays a significant role in the economic growth of a country as
it helps mobilize savings of the public for use of industry, trade and
other kinds of businesses. Deposits represent the largest source of
funds for a commercial bank and enable it to perform the role of a
financial intermediary in the economy. Demand and time liabilities of

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banks mainly comprise M3 or broad money that represents a major
chunk of money supply in the Indian economy.

Deposits are broadly categorized as demand deposits and term

deposits that represent the demand and time liabilities of a bank.
Demand deposits mainly comprise current and savings accounts, while
the term deposits comprise fixed deposit and recurring deposit
accounts. Current accounts do not yield interest and also do not
impose any restrictions on the number and amount of withdrawals.
Savings accounts afford interest, but contain some restrictions on
withdrawals. Term deposits are repayable only on maturity dates and
provide higher interest rate on deposit accounts of banks. Flexi-
deposits are a combination of demand and term deposits and have
been introduced in recent years to provide convenience and advantage
to the customers by way of higher interest than is possible under the
conventional savings account.

While opening a deposit account, a banker sees the eligibility of the

person to open the desired account and obtains his/her photograph,
identity/ residence proof, introduction, specimen signature on the
account opening form. The banker also advises the customers about
the nomination facility and its advantage. While permitting withdrawals,
the customers mandate must be followed by the banker as regards the
operation mode and the genuineness of the signature ensured.
Deposit accounts may be closed at the customers request and also by
the banker under certain situations like insolvency, insanity or death of
the customer. Under certain conditions, the bank can stop the
operations in the account, after giving reasonable notice to the



Lending is an important core function of a bank. The Funds mobilized from

deposits are deployed by banks in making loans and advances to various
businesses, trade and commerce and also for consumption needs. The
main purpose of loans and advances by banks is to earn profit by way of
interest spread, i.e. the differential between the average interest rates
receivable on loans and payable on deposits. Banks are financial
intermediaries and lend funds of depositors who themselves do not want
to take the risk of lending directly to the businesses. Banks undertake this
risk of direct lending of a major portion of their deposits by way of loans/

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advances. The banks earn interest spread as a reward for risk-taking.
Lending function is thus an important element of intermediary role of
banks in a financial system.

Lending function of banks is important not only for banks but also for
economic development of a country. Banks lending activities also play an
important role in determining the velocity of circulation of money in the
monetary system of a country. The importance of bank lending can be
explained as under:

i) For the bank: Loans/advances constitute a major chunk of a banks

assets in its balance sheet. They also yield returns by way of
interest income that contributes the largest percentage of a banks
profits in its Profit and Loss account. Bank charges interest on the
funds lent to the borrowers at periodic intervals (generally monthly)
and the total interest collected from its various borrowers during a
financial year represents its gross interest income in its Profit and
Loss account. After deducting the total interest payable by the bank
on its deposits, the net interest income generally represents the
highest percentage of its operating profits.

ii) For development of the economy: By lending the money of the

savers (depositors) to the users (borrowers), banks help the latter
in setting up and expanding businesses and trade in the country
and thereby help its economic development. Without loaning by
banks, the industry, trade and commerce of the country will
languish and tend to stagnate or grow very slowly, as the own
savings or retained earnings of businesses are inadequate for
achieving required growth. Banks lending to the various sectors
(industrial/ agricultural/infrastructure/ trade, etc.) increases the pace
of economic development in a country.

iii) For the monetary system: In the process of lending (or credit
creation), banks create fresh deposits on account of the fractional
reserve system under which they are required to keep only a
specified small portion of their deposits in cash in terms of Cash
Reserve Ratio (CRR) and the remainder is lent out. The funds lent
out accrue as fresh deposits in the banking system and these
deposits are again lent out, leaving another small portion as cash or
liquidity reserves with banks. The money supply in the economy
thus increases due to the acceleration in the velocity of its
circulation (called credit creation by banks). The actual extent of
credit creation by banks would depend on the demand of credit in
the economy and also how widely the people are inclined to use
bank deposits, banking services and negotiable instruments like
cheques, bank drafts, bills of exchange, promissory notes, etc. (as

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opposed to cash transactions) as a means of settling transactions.
The extent of monetization of the economy would also determine
the velocity of circulation and credit creation by banks as the non-
monetised segment (e.g. hoarding of money, commodities/bullion,
etc.) contributes to seepages by preventing some portion of money
supply not coming back to the banking system at all or after a
prolonged period.

iv) For the society: Banks lending function indirectly helps the society
or community at large by employment and income generation which
takes place along with the growth of the economy. Further, banks
as responsive corporate citizens, invest back a portion of their
profits (which mainly comes from lending) in community welfare
projects/ activities, like beautification of parks/ gardens/ other public
places, public sanitation, environmental upgradation, support to
charitable organizations engaged in uplifting the less privileged
sections of the society. Banks also undertake loaning for poverty
alleviation programmes of the government at very low/concessional
interest rates.

Cash Reserve Ratio (CRR) is the term used by Reserve Bank of India.
The Bank of England requires all deposit taking institutions to maintain
a Cash Ratio Deposit (CRD) with it. The Federal Reserve System
requires all deposit raising banks to keep prescribed Reserve
Requirement as either cash in their vault or as balance with the
concerned Federal Reserve Bank. While RBI uses CRR to reduce or
expand availability of lending resources, the Bank of England and FRB
depend more upon Repo and OMO (open market operations) to
reduce or expand resources of member Banks.

The comparative position is summarized here-under:

Particulars Reserve Bank Bank of Federal Reserve System

of India England
Reserve named as CRR (Cash CRD (Cash Reserve Requirement
Reserve Ratio) Ratio Deposit)
Base to which it NDTL (Net Deposits of Net transaction accounts
relates Demand& deposit taking of commercial banks and
Time institutions deposit taking institutions
Applies to All commercial Deposit taking Commercial banks and
banks institutions deposit taking institutions
Major Monetary CRR Repo and Bank Discount Rate, and
Instrument with Rate Federal Fund Rate
Central Bank

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Banks follow basic principle of prudence in lending, as the money they are
lending belongs to their depositors and has to be repaid on demand or on
maturity as per the terms of deposits. A bank looks into three Cs of the
entrepreneur running the company. These are:

Character, i.e. the corporate governance in its present version,

Capability, i.e. the managerial and technical competence to run the
company, and
Capacity, i.e. the financial strength to support the debt being raised.

In the older paradigm, the loan to be raised was predicated to the value of
collateral. The present paradigm places emphasis on cash flows and the
loan to be raised is predicated to cash-flows and income generating
capacity of the borrowing company.

Banks are also guided by under-noted principles of lending. The principles

help the banks to balance their commitment to ensure safety and security
to the depositors interest and earning profit through their lending activities
by taking calibrated risk. There is no possibility of earnings without risk
taking. A bank has to balance the need to take risk to earn and need to
provide security and safety to depositors interest.

Safety and Security Principle

Safety principle means timely return of the funds lent by a bank. While
making a loan, a bank carefully examines the economic, commercial and
financial viability of the applicants business, the quality of its management
(integrity, honesty, willingness to repay loan, reputation in market,
business acumen, etc.) and past track record. The applicants financials
(balance sheet, profit and loss account, and funds flow statement) of the
previous years and present trend and future projections are scrutinised
critically to establish the business viability. These form the essential
processes for sanction of a loan proposal and their objective is to ensure
safety of funds lent and their timely repayment by the borrower, so that the
bank, in turn, may be able to repay money to the depositors in time.

Assets acquired out of bank loan are charged to the bank as security in
the form of mortgage over immovable property and pledge/hypothecation
of goods/ receivables of the borrower. Wherever necessary, additional
collateral securities over tangible assets and/ or third party guarantees are
also obtained by the bank. In case of default in repayment of the loan by
the borrowers, the bank can take recourse to the securities for the loan
and recover its dues of principal and interest. If the realized value of the

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securities is less than the dues and the balance amount remains unpaid
by the borrower/ guarantor, it is eventually written off by the bank out of
the provisions made for bad/ doubtful debts, thereby reducing its reserves.

Risk diversification Principle:

Lending involves risk taking and the banks try to minimize such risk. Main
risk in lending is credit risk arising from business failure of the borrower or
default in repayment of the principal/interest by him or due to other
reasons. The credit risk is sought to be diversified by banks by avoiding
concentration of loans to a few borrowers/industries/sectors, as per
prudential norms set internally and stipulated by the regulatory authorities.
This is in keeping with the old saying : Do not put all your eggs in one

Profitability Principle:

Profit earning is necessary for any business for its sustenance and growth.
Further, the logical corollary of risk taking is profit making. Banks seek to
earn profit by charging interest higher than the interest payable by them
on their deposits. The difference between the average interest earned on
loans (yield) and paid on deposits (cost of funds) is the gross interest
spread. After deducting administrative and statutory reserves costs (by
way of provisioning for bad and doubtful loans, Statutory Liquidity
Ratio, Cash Reserve Ratio, etc.), balance portion is net spread, which
represents profit of the bank. After paying taxes, the remainder net profit
is used for paying dividend to its shareholders and the balance profit is
retained in business in the form of various reserves.

Liquidity Principle

A bank has to manage its assets and liabilities (Asset Liability

Management or ALM) in such a manner that it can meet all its deposit
liabilities in time out of loans repayment. It has to match the maturities of
its assets (loans) in tune with the maturities of its liabilities. No bank can
afford a delay or default in meeting its deposits or other liabilities as this
would result in loss of trust and faith of the depositors/ customers, on
which rest the edifice of banking business. For maintaining liquidity, the
Statutory Liquidity Ratio (SLR)(@), Cash Reserve Ratio (CRR) are
maintained by all banks as prescribed by the regulatory authority (RBI).
Capital Adequacy Ratio (CAR) is also prescribed to prevent banks from
lending more than the prescribed percentage of its capital and to maintain
financial soundness.

Loan Purpose Principle

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Banks grant loans and advances for lawful purposes as per public policy
and its own objectives. Unlawful activities include money laundering (for
terrorist activities, illegal trafficking in drugs) or for activities banned or
restricted by RBI and other regulatory and statutory authorities. Banks
must avoid loaning for unlawful or restrictive purposes. A bank may have
special knowledge and expertise of certain industries and therefore lend
mainly to the units in these segments. Every banks loan portfolio is
therefore different as per its objectives and credit policy.


Credit facilities of banks are categorized under two broad heads as


(@) Statutory Liquidity Ratio SLR) is very specific to Indian commercial

banks, there is no such requirement either in U.K. or U.S.A. Reserve Bank
of India requires all scheduled commercial banks to maintain 25% of their
Net Demand & Time Liabilities (NDTL) in securities approved as SLR
securities by RBI. These are mostly securities of Central and State
Governments and securities of public sector entities guaranteed by
Central Government.

a) Fund based credit facilities: These involve outlay of funds by a bank

Working capital requirements by way of cash credit, overdraft,
demand loan, bill discount/ purchase; and
Capital expenditure or Project requirements by way of term loan,
project finance, Deferred Payment Guarantee (DPG).

b) Non-fund based credit facilities: These do not involve outlay of funds

by the bank and are fee-based. These include:
Letters of Credit (LC)
Bank Guarantees

The working capital requirements relate to processing, production and

sale of goods/services and are granted for bridging the financial
gaps/shortages in the production cycle of a borrower unit. The funds lent
to the borrower unit get paid on realization of sales proceeds towards the

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end of the production cycle. Thus working capital facilities are intended to
finance the current assets (that are often hypothecated/charged to the
lending bank) and the outstanding thereagainst are reflected as current
liabilities in the units balance sheet. These credit facilities are granted for
short term period (generally up to one year) and are thereafter renewed or
rolled over from year to year, based on fresh assessment of working
capital requirements of the unit.

The main kinds of fund based facilities (that yield largest chunk of income
to a bank by way of interest earnings) are discussed in this section,
followed by non-fund facilities (that earn fee income to the bank) in the
next section.

Cash Credit

It is a running account for drawings with a specified credit limit sanctioned

by the bank against the security of stocks (raw materials, stock-in-process,
finished goods, stores) and book debts, which are pledged/ hypothecated
by the borrower. Following are the typical features of cash credit facility:
The borrower submits statements of charged assets at periodic
intervals (mostly monthly) and the bank permits the borrower to draw
cash/cheques within the drawing power (value of the charged assets
less the stipulated margin) available in cash credit account.
The bank officials periodically verify the stocks shown in the stock
statements by visit to the borrowers godowns/ factory with references
to the books of accounts and actual inventory stored in the factory.
They also monitor the account to ensure that business transactions are
adequately represented by transactions in the account.
The borrower uses the cash credit account for meeting his working
capital requirements and also deposits his sale proceeds in the
account. Interest is charged at agreed rate on the daily debit balances,
which will vary from day to day as per withdrawals and deposits of
funds in the cash credit account.


Overdraft means drawings in a current account over and above the credit
balance therein. A limit for overdraft is sanctioned for specific purpose and
period. Overdraft facility may be secured (against government securities,
company shares/bonds, banks own fixed deposits, etc.) or clean
(unsecured). Drawings can be made up to the sanctioned limit and interest
is charged at agreed rate on the daily debit balances in the account.

Demand Loan

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A fixed amount is advanced to the borrower initially for specified purpose
and short period (generally up to one year). No subsequent drawals are
allowed to the borrower as the loan is one-time facility subject to periodic
or lump sum repayment along with interest applied to the account monthly
or quarterly. Once a loan is closed, another loan may be granted by
opening a fresh demand loan account and obtaining of fresh

Bills Purchase/ Discount

Bills of exchange are drawn by a seller upon the purchaser as per the credit
terms agreed. Bills can be of two types:
(a) Demand bills: These are payable on demand without any credit period
except the transit time involved in the movement of the bill of exchange and
transportation receipts (lorry or railway receipt, or airway bill or bill of lading)
from the seller to the purchaser through the banking channel. A typical
transaction would be a firm in Kanpur sending one wagon load of mustard oil
to a firm in Kolkata. It sends the railway receipt and invoice under the cover
of a demand bill through its bank to consignees bank in Kolkata. Bill covering
this transaction would be as under.
Rs. 1,623,454 Kanpur, 21/09/05

On demand Pay to Punjab National Bank a sum of Rs. One million Six
Hundred Twenty Three Thousand Four Hundred Fifty Four Only
for Value Received against our invoice number 00/0000 dated 20th
September 2005.

Hari Ram and Sons, For Mangat Rai and Sons
Usance bill: These are payable on the expiry Partner
of the credit period normally up
to 3 months, as per different trade practices.

Following are the typical features of bills purchase/ discounting facility:

The seller submits the bills along with transportation receipts (railway /
lorry/air/ bill of lading) to his bank.
The bank sends the documents to the drawees through the banking
channel for presentment for payment (demand bill) or presentment for
acceptance (usance bill).
The sellers bank purchases demand bills and discounts usance bills by
crediting to the sellers account with the amount of the bills less the
interest discount and handling charges.
The advances against bills are adjusted on receipt of the proceeds of the
relative bills. In case of non-payment of the bills on the due dates,

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additional interest is charged to the seller and amount of the bill is also
recovered if it remains unpaid.
The bank ensures that bills purchased or discounted are genuine and
represent actual movement of goods from the seller to the purchasers.
Accommodation bills are the bills that are drawn without any movement of
goods from the drawer to the drawee, with a view to obtain bank finance
for non-trading purposes. Banks do not finance such bills and also take
extreme care in financing clean bills which are not accompanied by
document of title to goods and transport receipts evidencing movement of

A typical usance bill is drawn as under

Non-judicial Stamp Paper of appropriate amount

Rs.1,623,454 Kanpur 21/09/05

Thirty days after acceptance please pay to Punjab National Bank a sum of
Rs. One million Six Hundred Twenty Three Thousand Four Hundred and
Fifty Four ONLY
for Value Received against our invoice no. 00/0000 dated 20th
September 2005.

Hari Ram and Sons, For Mangat Rai and Sons
Kolkata Partner

Term Loans/ Project Finance:

Term loans are granted for acquisition of fixed assets (land, building,
machinery and equipments) for setting up a new industrial unit, or for
financing modernization, expansion or diversification of an existing unit.
Typical features of term loans are as follows:

The project is appraised on the basis of a detailed analysis of the

borrowers projected balance sheets, profit & loss and funds flow
statements (for the period of the loan) to determine the financial
viability of the project and its debt servicing capacity. The technical,
commercial and managerial viability of the project is also critically
examined by the banker before sanctioning a term loan.
Term loan is secured by mortgage over the specific fixed assets
financed or the entire block of fixed assets of the borrower unit.

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Term loan is granted for medium term (generally 3 to 5 years) or long
term (over 5 years) and is repaid by the borrower from its cash
accruals (net profits after depreciation, etc.) in installments spread over
the period of the loan.
Equated monthly or quarterly installments (principal and interest) are
fixed depending on the projected cash accruals over the loan tenure.
Apart from the mortgage over the fixed assets of the unit and
guarantee of the promoters, covenants or conditions are also
stipulated by the bank for ensuring the desired financial discipline by
the borrowing unit.
In case of large sized projects (e.g. infrastructure projects) requiring a
large amount of loan for longer tenure (10 to 20 years), term loans are
granted by a group (consortium) of banks/financial Institutions. This
helps in diversification of the credit risk of lenders.


Non-fund credit facilities involve only issuing of banks commitment to

honour certain promises as per the letter of credit or guarantee or similar
documents favouring a third party, without requiring any outlay of funds by
the bank at the time of making the commitment. However, funds outlay
may take place in the event of the devolvement of the commitment on the
issuing bank. The issuing bank charges certain fee for issuing such
commitments. They also appraise the risk of its devolvement and take
adequate security to meet that eventuality. These commitments do not
appear in the banks main balance sheet except by way of contingent
liabilities in the Notes attached to it. Hence they are known as Off-balance
sheet liabilities of the bank.

Letters of Credit

A Letter of Credit (LC) is an arrangement whereby a bank (Issuing Bank),

at the request of a customer, (buyer or opener of LC), undertakes to pay
to a named beneficiary (seller) by a specified date, against presentment of
the specified documents, the value of the goods /services. A LC therefore
enables seller to supply goods as per the agreed terms of the LC to the
buyer and tender documents of the consignment to the issuing bank
against its undertaking in the LC. The issuing bank makes payment of the
bills to the seller through the banking channel (if the LC terms are strictly
complied with) and recovers the payment from its customer (buyer). In
view of the issuing banks commitment to honour the bills drawn under the
LC, the bank opens LCs only after appraising the creditworthiness of the
openers. Normally, openers of LC already enjoy fund-based credit

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facilities with the issuing bank which has a satisfactory record of dealings
with such customers.

LC has atleast three parties issuing bank, opener (buyer) and

beneficiary (seller), as mentioned above. It may be issued on DP
(deliverable on payment) or DA (deliverable against acceptance) basis as
regards the delivery of the documents of title to goods to the buyer to
enable him to take delivery of the goods from the carrier. LC may be
Inland (for domestic trade) or Foreign/cross-border (for import from
overseas). The issuing bank charges commission on issuance of LC or for
effecting amendments thereto or for extension in its validity period. It also
charges interest and other charges for negotiating documents under the


In commercial transactions, bank guarantees are required as a security for

due performance of a contract by the obligors in favour of the beneficiary.
The obligors financial standing and credentials may be unknown to the
beneficiary of a commercial contract and a banks guarantee on behalf of
the obligor would satisfy him. The bank issues the required guarantee on
behalf of the obligor after making a proper assessment of his financial
standing and ability to fulfill his part of the contract. The bank may also
take some tangible security or cash deposit to fall back upon in the event
of enforcement of the guarantee by the beneficiary. Every guarantee has
definite limits as regards the banks liability in terms of the amount and
time frame for its enforcement by the beneficiary. The issuing bank
charges commission on the basis of the amount and validity period of the
guarantee. Guarantees may be of different kinds financial guarantee,
performance guarantee and deferred payment guarantee depending on
the nature of the contract between the applicant and the beneficiary.



Each credit decision implies a risk, and can result in a loss to the Bank
depending on the probability of default. The return paid by a borrower on a
loan must weigh in

cost of funds,
operating cost for sanctioning,
following up of the loan,
risk taken depending upon the probability of default, and
adequate profit margin on the loan.

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Prime Rate

Each Bank calculates a prime lending rate for its prime customers. Risk
being lowest, prime rate is the finest price a bank would offer its best
customers. A borrowing customer can expect a price related to this bench
mark pricing as interest rate payable by it on amounts borrowed by it.
Probability of default being different for various customers, component of
risk will vary, and will relate interest charged to the risk carried by the

Floating Interest Rates

Prime rate is subject to change at any point of time, and is determined by

changes in cost of funds or
conscious movements in Central Bank REPO rates.
these invariably are guided by consideration to reign in inflation.
inflation in turn being a creature of macro economic variables like -
a. money supply,
b. international oil prices,
c. taxation, and
d. above all by productivity of labour force.

All quotes for interest rates linked to prime rate are floating interest
rates. As the prime rate is changed by the bank, the effective interest rate
for borrower changes as under:

In an inflationary scenario it works against borrowers interest.

In a deflationary scenario it helps borrowers to reduce interest burden.
For a bank having floating rate liabilities, floating rates provide hedge
against interest rate risk.
Banks having large fixed rate liabilities and floating rate loan portfolio
cover interest rate mismatch by buying I.R.S. (Interest Rate Swaps) to
convert their interest pay out liability from fixed to floating.

Fixed Interest Rates

Mortgages for residential property and automobile finance are typical

credit products carrying fixed interest rates. The reasons being that :

the borrowers to quantify their liability, over the life of loan, seek fixed
interest loans.
once the interest rate is contracted, irrespective of the changes in
interest rate structure the contracted rate is payable through out the life
of loan, and

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in case of long term deflationary economies like Japan, borrowers
stand to lose to the advantage of lending banks. In other countries,
with a history of inflation the borrowers do gain.
Most banks offer both floating and fixed interest rate(s) to their
Fixed interest rates are always higher than floating interest rates in the
short run. This is done to provide a premia for IRS to convert fixed into
a floating income streams as a risk mitigation technique by banks.

A comparative chart of fixed versus floating interest rates is given below:

Particulars Floating interest rates Fixed interest rates

Facilities Working capital mostly short Medium and long-term loans, with
covered term loans contracting borrowers going in for
an I.R.S. depending on whether
their income streams are fixed or
floating, and lenders going in for IRS
if there is a mismatch in their
liabilities and assets pay out and
pay in income streams. A number of
lenders do put in a reset clause
which de-facto implies a floating rate
after fixed period.
Volatility Incomes can be highly Income streams are predictable, but
volatile and create instability in a rising interest rate scenario, the
for P&L management lenders can suffer from mismatch
between interest pay out on liability
and fixed income on assets.
Lenders do cover risk by bringing
pay-outs for liabilities of same
maturity as assets under an IRS
Maturity Unpredictability in short term As the duration and maturity of
loans is low, but it is loans rises unpredictability for
anachronistic that when the interest rates is higher. In U.S and
predictability is high floating U.K. markets most of long and
interest rates predominate. In medium term lendings are linked to
U.S. and U.K markets short LIBOR for the period. This implies a
term rates are largely fixed floating rate regime. This is sharply
rates. at variance with Indian situation
where fixed interest rates
predominate over medium and long
term. Most large corporates always
hedge interest rate risk by buying an
Legal Each time the rate changes No changes in agreement or
implication agreement has to be recast supplemental letter(s) are needed

Page 66 of 157
by obtaining a
supplementary letter,



Most of the banks lend against income streams expected to be generated

by the business (es). The repayment of principal and interest is predicated
to continued good management, operational efficiency, and stable
economic, legal, and political environment. Borrowers businesses face
under-noted diverse risks
failure of markets,
obsolescence of product lines,
increased cost of inputs,
loss of managers holding critical positions,
induction of imported products quoting competitive price,
over-saturation of markets,
failure of large customers especially in a monopsony (i.e., a market
condition in which demand comes from one source),
failure to bring new products in time,
poor financial planning,
failure to upgrade technology,
failure to upgrade human resources,
economic down-turn, and
international economic factors, i.e., oil price rise, excessive soya-bean
production in Brazil, slump in demand for soya-bean in South-East
Asia, etc.

Lending banks cover their risks by ensuring that their loans are properly
secured so that in case of borrowers failure to generate projected cash-
flows they can have recourse to security and recover both principal and

Guiding principle

The principle, that guides banks to decide when to secure the loan and
when to allow loans to remain unsecured, is simple and practical. The
borrowing entitys capability to repay also relates to size of its cash-flows
and the exposure the bank has taken.

Unsecured Loans

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Short term loans including bill discounting are generally allowed to remain
unsecured. The basic security in these cases is the signature of the
company. Bankers trust that for the amounts lent borrowers signature
binding it to a legal contract is good enough and there is no reason to
believe that borrower will go back on its promise to pay. It is not out of
place to mention that these loans are basically predicated to strength of
the balance sheet. Indian Oil Corporation (IOC) has been able to buy oil
from ARAMCO of Saudi Arabia without a L/C or bank guarantee for very
many years. In U.S., a number of loans given under Community
Reinvestment Act are unsecured. This is due to regulation and the
availability of Small Business Agencys guarantee for repayment. In
number of cases, in India, as per regulatory guidelines no security is taken
for small loans, loans to tiny industries and agriculture. These are small
size loans and at times carry guarantee of Guarantee Organizations.

Secured loans

Most of the loans are secured by:

Mortgages of Title to goods,

Pledge or hypothecation of goods,
Lien on securities,
Acknowledgement of beneficial interest in financial segment,
Acceptances of banks,
Mortgage of property acquired from the loan,
Countervailing deposits,
Registration of charge on receivables, and
Endorsement on bills of lading, railway receipts, airway bills and noting
of lien on goods ready for shipping.

Banks normally insist that securitys market-value must be at least 133%

(this is floor value) of the exposure so that even after a fair haircut the loan
could be recovered. The underlying securities are called primary securities
and in case of failure to repay the loan the banker has right to take
possession after complying with process prescribed by law sell the
security and appropriate the amount towards full or partial satisfaction of
its claim.

Collateral security

Dictionary meaning of collateral is accompanying as secondary or

subordinate. Collateral security is obtained to secure the exposure taken
by the lending bank in addition to the primary security already available.
Separate legal documents are obtained to extend the coverage to these
securities. To illustrate, some of the collaterals are mentioned here-under:

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Equitable mortgage of all properties of owners to cover all exposures,
Directors guarantee to cover all loans to the company,
Holding companys guarantee to cover all exposures to the company,
Guarantee by Export Credit Guarantee and Small Business Guarantee
Organizations for specific contracts, business, etc.
Mortgage of third party property to cover loans given to a company,
Guarantee by government for payment of principal and interest, and
Guarantees by IFC for private sector enterprises in various countries.

As a legal requirement, banks insist that owners of property must join as

guarantors. This ensures that their liability becomes co-extensive with that
of principal borrower and recourse to collateral securities becomes
simultaneous and not after execution of sale of primary securities.

Wholesale lending (Large value loans to corporations)

The flow chart depicts the generic loan delivery value chain for wholesale

Identify customers Check with Bank

credit need for negative list for
its management

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Check exposure limit for Is it within Not complied, drop
country and industry rules? proposal
customer belongs to

Assess credit rating based on

financials, market, quality of
Norms within limits
management, technology proceed with
used assessment

Assess credit need and Appraise credit needs Recommend credit under
products three signatures and six eyes

Approved send to Committee Put up to Credit

relationship manager Committee

Hand over
Convey sanction and terms to No go
and conditions to borrower accounts Stop
Obtain documentation for day to
securities, open loan day
account routine

Monitor utilization of credit

through periodic cash flows Ensure recovery of interest
do on site inspections, on due dates and ensure
monitor profitability clean up of loan as
periodicity not less than contracted
one month

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Value of wholesale loan
Wholesale loans have different values in different countries. In North
America one cannot even join as junior syndication member if contribution
is less than US $ 5 million, The Loan size starts from $ 50 million. In India,
any thing above say Rs.100 million, i.e., $ 2.5 million is treated as
wholesale. One should understand the specific market to define what is
treated as wholesale loaning in that regime.

Structure of credit sanction process

As per best practice, the sales, assessment, appraisal, recommendation,

and approval of loans must go to different persons. In European Union,
this is a mandatory requirement. In U.S., this is the preferred practice. In
India, it is not mandatory but is in vogue with top rated banks.

Credit rating

Most of the banks, rate borrowing entities on the basis of their financial
statements, quality of management, industry in which they operate,
competitive environment, projected cash flows including future profitability,
and legal and economic factors affecting the company. Under Basel II,
internal credit rating has been prescribed for all international banks. Such
credit rating is used to decide about taking up the proposal and fixing price
if proposal is found to be in order. Currently in India, most of the banks,
use credit rating models which are based on past experience but not as
sophisticated as Internal Rating Based (IRB) recommended by Basel
Committee. Once this happens the capital adequacy requirement for the
loan would also be calibrated on the basis of credit rating.

Credit appraisal

Different credit appraisal techniques are used for short term and medium
and long-term loans. These are:

Short term loans are basically given to tide over short term liquidity
mismatches. The credit appraisal is either based on cash-flow
approach or projected balance sheet approach. The bank does not
finance any core capital but only gap or liquidity requirements. Major
factors to be seen are quick and current ratios, trend of profitability,
and debt equity to ensure that credit being picked up is not a potential
problem account. All these factors are examined over a time series
including projections to ensure that there is no risk to moneys being

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Medium and Long term Loans are invariably more thoroughly
examined and basic tool is projected cash flows over the life of loan,
sensitivity analysis to cash flows and whether the cash generations
would be able to service the loan. Banks insist that cash flows
generated must be at least twice as large as the servicing

Relationship managers

The sale, assessment, appraisal, and recommendation of credit are

handled by relationship managers, who are also responsible for
monitoring and recovery of periodic instalments. The routine accounting,
maintenance of accounts and operations are invariably handled on
centralized basis by Accounts wing. While terms and conditions of credit
are approved by credit committee the Relationship Manager is the focal
point for conveying sanctions to customers.

Security, documentation, stamping

All securities are to be charged to the bank before any monies are
disbursed. Documentation, stamp duty payment, and execution of
documents are taken care of by legal advisor and relationship manager
jointly. The stamp duty is paid according to local laws and must be
correctly paid to ensure enforceability of contract.


Banks obtain, from the borrowing units, monthly statements about cash
flows and funds generated each month and monitor cash generation and
profitability trends. Cash generation ensures that there is no liquidity
problem. The continued profitability ensures that bank will be assured to
have satisfaction of owners stake in business and it is not being run on
borrowed monies alone. The consecutive financial and other statements
are examined to ensure that borrowing entity remains on virtuous path of
growth. In case there are any slip back bank asks for corrective action
from management including enhanced security and in extreme case, can
recall loan well in time.



Retail loans are high volume low value loans. As the numbers are very
large and individual loan value is small, special sales, marketing,
processing, appraisal, accounting and credit monitoring processes are in

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vogue to keep down transaction costs, and earn/allow fair margin from this
business. As the retail loan portfolio has very large number of accounts
each of small value the portfolio is finely grained. The business as such
is less risky than wholesale loan portfolio. Keeping in with the nature of
business which is spread over:
automobile finance,
mortgages for residential properties,
personal loans and loans for purchase of consumer articles which can
come under various schemes targeting specific customers, and
SME lending including agriculture.

Customer acquisition, appraisal, servicing, monitoring and repayment

processes are different than one for whole sale banking.

Customer acquisition

Most of the banks use direct sales agents to acquire customers, while they
accept direct business it is the D.S.A. who forms effective sales force. As
a risk mitigator DSA have no say in appraisal and processing of loans.

Credit scoring

Based on numerical credit rating models, which take into account trait
based factors and are based on historical data of past loans, individual
retail banks have their credit scoring templates. These are totally
computerized and the proposed customers data is fed into the template
and approval or rejection decision is taken. These credit scoring templates
are widely used for;
Automobile finance,
Mortgage loan,
Credit cards,
Personal loans.
Small value agriculture loans.

Know Your Customer (KYC)

KYC norms are applied as prescribed. Further, the banks verify

customers identity by visit to customers residence. Such visits can be by
an agent or own staff.

Sanction, documentation, recovery, monitoring

Sanctions including terms and conditions are conveyed from a centralized

processing centre. This ensures loan sanction process is of same quality.

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The specific work stages are as under:
Documentation is obtained and maintained at a centralized place. The
concept of maintenance of all documents at a document factory is
well established in all major retail banks.
Presigned and predated cheques are obtained for ensuring
repayments well in time. These cheques are stored, processed and
encashed through cheque processing centralized factories in most of
retail banks. In internet enabled banks customers can pay through
internet through a call centre under the control of the bank.
In case of bad debt, the banks use out side recovery agents for
recovery. The agents are paid a commission based on recoveries
In view of very large number of loans, the banks do not verify security
regularly but in case of default, repossess security through agents.
This is very common in case of automobile finance. In case of
mortgages it is necessary to resort to legal process to enforce and sell
the mortgaged house or flat.

Retail Banking requires central processing capabilities of high order,

centralized control on appraisal, documentation, handling of recovery
(instalment) cheques, and correspondence with customers. Retail banking, as
such, is necessarily to be backed up by complete re-engineering of
work processes and total computerization of operations.

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Major services

The banks offer a number of services to customers opening non-interest

and interest bearing deposit accounts with them. These are invariably
charged for, except for sending periodical statement of accounts to
customers. Major services offered to customers are:

Statement of accounts and updating pass books,

Executing standing instructions for payments to other account
holders, club, associations, insurance policies etc.,
Collecting cheques, including other financial instruments on behalf of
Transferring/remitting monies through bank drafts, and electronic fund
Offering sale and purchase of foreign exchange, including prepaid
foreign exchange cards for foreign travel,
Offering inter-bank electronic debit and credit clearing for periodic
receipt and payments,
Safe deposit services for keeping sealed boxes, wills, and other
important documents,
Execution and trustee business for individual customers,
Letters of credit to other branches for encashing cheques, since largely
redundant due to introduction of core banking and ATM networks,
Safe deposit lockers for keeping valuables.


As in the case of deposit accounts, in the case of loans and advances

also, banks have to comply with KYC guidelines and satisfy them-selves
about identity, legal position of client to open an account, and sources and
size of funds and their legal status before opening an account. The details
about KYC are furnished in chapter 2 on deposits.


Closure of a bank deposit or loan account is legally rescinding a

contract. Laws of contract, with various variants, are applicable in all
major countries, more importantly the OECD countries. An account can
be closed on the specific request of a customer. The bank has right to
recover all its dues and charges before closing the account.

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The banks traditionally were branch based institutions with large manpower,
and paper based ledgers and records. Because of size and storage of
cash and records, the banks were traditionally housed in solid looking
brick and mortar structures. This has given rise to the term Brick and
Mortar Banking. Introduction of computers in banking reduced paper
storage, and man power requirement. Subsequent technological changes
have converted banks into a virtual institutions. Some of these
developments are discussed in detail here.

Electronic banking

Electronic banking means banking done through electronic systems for

customers transactions (front office computerisation) and/or internal
accounting and book keeping (back office computerization), as against
traditional/manual system of banking. It may also include decision support
system for various levels of management and marketing/ cross-selling
through electronic medium.

Electronic banking is the result of several useful advancements in

Information Technology and Communication Technology made in the last
two decades. Let us mention briefly about communication systems.

Communication channel can be of three types bit serial, byte serial and
parallel. For faster communication, data compressions techniques are
used. For secure transmission, data encryption techniques are used. E-
mail is used for transmission of data from one place to another with speed,
accuracy and security. Email can be used over dial-up line or a dedicated
line. The dedicated leased line connectivity can be via satellite link or
terrestrial link. VSAT networks are used across banking industry for many
on-line applications.

Impact of Information Technology

Iimpact of Information Technology on Indian banking is far-reaching and it

can be identified mainly in following areas:

i) Customer Service: This has improved considerably in the following

increasing new delivery channels: ATMs, internet banking, and
increasing customer convenience: Anywhere and anytime
banking and 24 x 7 day banking, home banking.
routine banking transactions are speedier, safe and secure.
integrated banking service with Inter-connectivity of branches.

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banker-customer communications are fast and neat and
information service is available on 24 x 7 days basis via call
banks can also handle non-banking services for their
customers, e.g. payment of electricity/ telephone/ gas bills,
insurance premia and receipt of pension/ interest/ dividends,
ii) integrated internal accounting system: Banks book-keeping is
automated, fast and accurate. It saves time of staff for marketing
and other work after banking hours.
iii) management information system has improved, due to better data
classification and retrieval, integrated accounting system,
communication and conferencing system and inter- connectivity of
iv) cross-selling of various financial products, due to data mining and
electronic marketing channels.

Automated Teller Machines (ATM)

ATM is a computer driven system which is user friendly and operates 24

hours a day and 7 days a week. It is totally menu-driven, which displays
step-by- step instructions for the customer in withdrawing money form
his/her account. ATM can be accessed by a customer by using his ATM
card to gain entry into the ATM room and the Personal Identification
Number (PIN) for desired transactions. ATMs are installed at banking
premises (on-site ATMs) for which no licence is required from RBI. For
non-branch ATMs at public places (off-site ATMs), banks have to obtain
licence post-facto. Many banks have opened off-site ATMs at airports,
railway stations, petrol pumps, market centres, universities etc.

A full-fledged ATM can perform following functions, although only some of

these are being provided in the ATMs of most banks in India:

cash dispensing
generating statement of account
account balance enquiry
accepting request for cheque book.
deposit of cash/ cheques etc.
issue of gift cheques/ travellers cheques
utility payments like telephone bills, electricity bills.

Main advantages of ATMs are:

Round the clock banking for 365 days in a year. Only exceptions
are when they are out of order/short of cash.

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Customer can choose his own time of banking at any time or any
day of the week.
Quick and efficient service.
Response time/process is uniform and fixed for all customers as
per programme set. There is no scope for discourteous or
subjective behaviour as could happen with human interaction at
a banks counters.

However, there are some limitations of ATMs as follows:

cash withdrawals are restricted to certain amounts fixed by the

bank and notified to ATM card holders.
cash dispensation is restricted to certain denomination of currency
notes- usually Rs. 50/100/ 500.
ATM can perform only limited functions. For other services/
functions, the customer has to visit branch or make enquiries
from the call centre concerned.

Big banks have installed their own ATMs on-site and off-site. Banks
which do not have their own ATMs or which have only few ATMs and want
to have wider use of ATMs for their customers, enter into arrangements
with other banks for such usage on a mutually agreed sharing
arrangement and fee basis. Shared Payment Network System (SPNS) is
used by the participating banks, which are connected to the network by a
host computer. SPNS was in vogue in 1990s in Mumbai among
commercial banks, when the number of ATMs was limited due to high
capital cost of installing ATMs. SPNS enables one bank/ branch customer
to access another bank/ branch ATM, nearer to his residence/ office, for
putting through the permitted transactions. It also helps better utilization of
resources to a larger section of customers.

Mobile Banking

Mobile banking, as the name indicates, is in contrast to the traditional

brick and mortar banking which is done from a fixed branch premises
where the customers have to go for transacting desired banking
transactions. Mobile banking tries to reach the customer to enable him/
her to transact banking. Mobile banking is used in two different senses as
i) Banking through a mobile van (called mobile bank), with or without
computerized banking system, which moves from one place to
other on designated routes at designated hours and the customers
can transact their routine banking, like cash deposit and
withdrawals, draft issue, cheque collection, cheque book issue,
pass book update. Main advantages of this type of mobile bank

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lower capital investment, compared to a brick and mortar bank,
larger area coverage,
banker visiting customers for banking, rather than customer visiting
the bank as in the case of a conventional bank,
it also serves as a tool for marketing on special events, like
exhibitions, melas, festivals

Issues connected with mobile bank are:

Safety and security of cash, equipments and records,

On-line communication with base office,
Wireless technology for data communication and on-line back-up
for transactions.

ii) ATM on ship or airliner: This can be even lighter than an on-road
ATM and should be able to perform certain specific travel needs,
e.g. main currency exchanges relating to the destination,
acceptance of certain kinds of credit cards (global cards), debit
cards for payments/ purchases. This requires communication with
the central data base which is compatible with the navigational
system of the aircraft/ ship.


Tele-banking requires authorized customers to use a special telephone

number of the bank from anywhere and at any time. Thus chief advantage
of tele-banking is that there are no geographic or time restrictions for the
customer for banking transactions. Tele-banking is of two kinds:
i) Public enquiry: General information about the banking services/
facilities can be obtained by customers and non-customers alike, by
dialing a special enquiry number of the bank (call centre) and
desired information can be obtained after reaching the relevant
extension number/ desk.
ii) Private enquiry: This relates to account specific information and can
be accessed only by the account holder by disclosing his/ her
secret Personal Identification Number (PIN) and customer ID.
Following banking facilities are available via tele-banking:
balance enquiry,
request for cheque book/ statement of account: which are sent by
courier to the customer,
request for draft or cash withdrawal: These facilities are made by
few banks and to selective clients by using a special telephone
number. The customer gives his PIN and customer ID and tells
amount of withdrawal, draft and other particulars. The cash or
draft is sent by the bank to the customer at the recorded

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address and delivered to him/ her, against the cheque for the
amount plus service charges.

Internet banking
Internet banking is on-line banking from home or anywhere and it provides
anywhere and any time banking access to ones accounts and public
information put on its web site by the bank. It has been introduced by
most of the commercial banks in India which have fully computerized their
operations involving back-office and internal accounting system. Just as
the bank staff accesses the account of a customer on-line, the customer
can also access his/ her account on-line via internet.
A customer requires the following for Internet banking:
i) a personal computer
ii) a telephone link
iii) a modem
iv) an arrangement with one of the Internet Service Providers (ISPs),
e.g., VSNL, MTNL, TataIndicom, Sify Online, Reliance Infocomm,

Internet banking is different from tele-banking in the following ways:

i) In internet banking the customer himself accesses the desired

information about his account through internet connected to the
bank data base and the position of the accounts is displayed on his
PC screen, which can be browsed by him. In tele-banking this
information is furnished to the customer from the call centre over
telephone line.
ii) The customer cannot order cash withdrawal through internet
banking, but he can transfer amount from one of his accounts to
another, and also to third partys account within authorized limits.

Security Issues in Internet banking:

i) confidentiality of transactions has to be ensured as the internet can

be a target of hackers. Strict log-in procedures are followed by
banks in this regard.
ii) integrity of transactions: This is done by following encryption
iii) non-repudiation of transaction by the customers: This is done by
building a suitable certificate authority.
iv) privacy when the account is accessed by a customer from some
public place, like cyber caf. Once a customer logs out of his
account, there are some traces of transaction in the form of history
files. These need to be removed by certain programmes, e.g.,
cookies or other devices, in order to ensure privacy of the
customers transactions.

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Int. TV

ho bran
me ch

phone network

work Call centre

place P.C.



The above diagram depicts a technology driven modern bank.


Automated Clearing House (ACH)

ACH is run in United States to clear both debits and credit between more
than 13000 participating institutions.

The Automated Clearing House (ACH) Network is a highly reliable and

efficient nationwide batch-oriented electronic funds transfer system, which
provide for interbank clearing of electronic payments for participating
depository financial institutions. The Federal Reserve and Electronic
Payments Network Act as ACH Operators, central clearing facilities
through which financial institutions transmit or receive ACH entries.

ACH payments include:

direct deposit of payroll, social security and other government benefits,

and tax refunds;
direct payment of consumer bills such as mortgages, loans, utility bills
and insurance premiums;
business-to-business payments;

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e-commerce payments;
Federal, State and local tax payments.

Number of ACH payments originated by financial institutions increased to

8.05 billion in 2002, up 13.6 percent from 2001. These payments were
valued at $21.7 trillion. Including payments originated by the Federal
government, there were a total of 8.94 billion ACH payments in 2002
worth more than $24.4 trillion.


Any individual, corporation or other entity that initiates entries into the
Automated Clearing House Network

Originating Depository Financial Institution (ODFI)

A participating financial institution, that originates ACH entries at the

request of and by (ODFI) agreement with its customers. ODFIs must
abide by the provisions of National Automated Clearing House Assocation
(NACHA) Operating Rules and Guidelines.

Receiving Depository Financial Institution

Any financial institution qualified to receive ACH entries that agrees to

abide by National Automated Clearing House Association (NACHA)
Operating Rules and Guidelines.


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An individual, corporation or other entity which has authorized an
Originator to initiate a credit or debit entry to a transaction account held at
an Receiving Depository Financial Institution (RDFI).

Electronic Funds Transfer (EFT)

Traditionally, the funds are transferred by banks from one place to another
by mail transfer and telegraphic transfer and the latter is faster than the
former. In both kinds of transfer, banks use the postal and telegraph
department services and use certain codes to keep confidentiality and
safety in transmission of the messages. In electronic system of
communication, the transmission is much faster and safer. Several banks
have started following systems for funds transfer:

i) State Bank of India has electronic payment system called STEPS

whereby funds can be effectively remitted electronically from one
customers account at one centre to another customers account at
another centre on the same day.
ii) Under Core Banking Solutions (CBS) where the technology
platform connects several branches at distant places, transfer of
funds from one account to another account at different places can
be easily done between inter-connected branches.
iii) SWIFT: The Society of World-wide Inter-bank Financial
Telecommunication is an international Society for electronic funds
transfer internationally between member banks world-wide. State
Bank of India and several other banks in India are members of the
Society. The member banks are connected through a high speed
closed user group communication system. Structured and codified
messages are sent by remitting bank to receiving bank for credit of
the beneficiarys account with it. Inter-bank settlement of account is
done via the correspondent banks. The funds transfer system is
fast, secure and efficient.


Clearing House System

Inter-bank cheques drawn on branches of a city/ town are cleared/ paid

through a system of clearinghouse. (Outstation cheques are sent for
collection through a different system). Clearing house is a common
service provided by RBI in metros and by scheduled banks in other cities.
Clearing house functions in all cities/ towns where there are 5 or more
banks. In big cities and metros, service branch of each bank does the
clearing house operations and also the centralised draft payment function.

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Conduct of clearing house operations require huge expenditure by way of
premises/ equipment/ staff costs.

Number of cheques in clearing house transactions is very large and the

volume of transactions is huge. For speedier processing, manual systems
have been replaced by Automated Clearing System (ACS). Main elements
of Automated Clearing System are as follows:

a) MICR cheques : Magnetic Ink Character Recognition (MICR) cheques

are used for clearing system in India. As the cheques are processed
on high speed machines, the cheques are printed on specific type of
paper to meet other specifications including two white bands on top
and bottom, which should be free from any marking or impressions.. In
these bands the details are encoded with special magnetic ink. The
details encoded on the lower band are as follows:

i) First 6 digits - Cheque no. in 6 digit code is pre-printed

ii) Centre Code in 9 digits: first 3 digits represent City Code, next
3 digits represent Bank Code and the last 3 digits are for the
Branch Code.
iii) Transaction Code of 2 digit indicating the type of the account
(e.g., savings/ current/ Demand Draft/ Pay Order/ Refund Order/
Dividend Warrant, etc.)

c) Encoder: This machine is used to write with magnetic ink details of the
cheque in the lower band. In power encoder, the data on cheques are
keyed elsewhere at branches and sent to the service branch along with
a floppy/CD containing the information. When the cheques are passed
through the power encoder, the data from the floppy are encoded on
the cheque.

d) Cheque Reader-cumsorter: Cheques in the clearing house are run

through this machine, which records the drawee bank wise/ branch
wise presentation of cheques from the magnetic ink impression on the
lower white band. The sorter portion of the machine automatically sorts
the cheques drawee bank wise/ branch wise and also lists out the
cheques in the same order. Cheques are made into packets to the
service branch of each bank for further processing.

The payee branches process the payments on the next day and all returns
are submitted to the clearinghouse in the next day clearing. The customer
therefore gets the credit on the third day.

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Debit Clearing System

Under this system, the utility service provider (like telephone, electricity,
gas, insurance company) obtains an authorization from the customer to
debit his specified bank account with the amount of the bills at regular
intervals. The letter of authority is submitted by the service provider to his
banker which raises a debit for the amount listed on the other bank
maintaining the clients account. Advantages of the Debit Clearing System

customer is not required to keep a track of his bills for ensuring payment
before due date and need not write and cheques in payment thereof.
service provider print out bill and send it to the customer for information,
before debiting the payment in customers account.
system helps banker in saving expenses as cheques are not used for
payment of the bills.

Credit Clearing System

This is just opposite of the Debit Clearing system. It is used by a company

for making payments to its shareholders/ depositors dividends/ interest at
periodic intervals. Instead of sending out cheques to the investors, the
company directly credits through the clearing system its bank amounts to
their bank accounts, in terms of letter of authority (or mandate) obtained
from the customers. The letter of authority contains all relevant particulars,
e.g., bank, branch, account number. Advantages of Credit Clearing
System to various parties are:

company need not print dividend/ interest warrants. The work regarding
reconciliation of paid and outstanding amount is avoided.
investors need not deposit cheques to their bankers every time and wait
for the clearing credit. Under the Credit Clearing System, credits to the
customers account are on the fixed date.
bank saves time in processing large number of cheques/warrants
deposited by the customers in the manual system.

RTGS (Real Time Gross Settlement System)

Basically, this is a system for large-value interbank funds transfers. This

system lessens settlement risk because interbank settlement happens
throughout the day, rather than at the end of the day.

RTGS is a product of re-engineering and restructuring processes. It

provides an on-line Payment System in which processing and settlement
takes place continuously in real time (i.e., without deferral) and gross (i.e.,

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transaction-by-transaction). The system handles large value, time-critical

Settlement of credit transfer instructions is done when there is sufficient

balance in the settlement account of the participants with the Central Bank
and is guaranteed for its finality and irrevocability. Thus, it helps to reduce
systemic risk, as central objective of the RTGS system is to reduce
systemic risk, by preventing failure of a payment or of a participant having
knock-on effects on other participants and thereby endangering stability of
the financial system.

In addition, the system significantly reduces risk associated with current

net settlement systems in operations and also accelerates the payment
process while guaranteeing finality and irrevocability of transfers and

The operators of the Real Time Gross Settlement System(RTGS) are the
Central Bank, and commercial banks, for net settlement position of banks.
Each participant of the RTGS has obligations (responsibilities) towards the
smooth operation of the RTGS. Operational procedures of the RTGS
system are clearly well defined, including roles and responsibilities of and
for the Central Bank and the other participants. Central Bank will act as
the Operator of the RTGS system that will enable participants to achieve
prompt settlement of payments by debiting and crediting their accounts
with Central Bank.

Participants in the RTGS must maintain accounts with the Central Bank
and may use the system to transfer funds to each other directly and /or
perform third party transfers for and on-behalf of their customers/account
holders. Deferred Net Settlement (DNS) obligation from clearing system
(e.g., cheques, Point-Of-Sale (POS), ATM and other cards transactions)
would also be settled over the RTGS System.

Real Time Gross Settlement System (RTGS) Operations

RTGS system will have a time schedule for operations within which
participants are expected to effect all transfer instructions in RTGS. These
instructions would be settled if and when participants accounts are

Some of the features of the RTGS System include :

instruction processing
settlement processing
liquidity risk management
queue management

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settlement account monitoring
connectivity to other systems, etc

Liquidity Risk Management

To prevent liquidity risk during the operation hours, i.e., if participants

experience shortfall of their settlement account, Central Bank employs two
liquidity mechanism facilities, namely:

If there is insufficient fund in a participants account, Central Bank

would not settle the transfer instruction but place that instruction in a
queue for it to be settled on a FIRST IN FIRST OUT basis for smooth
operation of the RTGS system.

For net settlement requests for low value net settlement systems, a
participant not having sufficient funds to settle net position, could prove
a risk to the whole system. In such cases, Central Bank would provide
collateralized intraday credit facility, which would be accessed to
enable participants to make payments. The collateral must be high
quality and the amount would be determined by CBN. Any participant
that enjoys this facility must make funds available in its account to
cover the credit, not later than the close of the days business.

Components of the Real Time Gross Settlement System (RTGS)

The RTGS system is made up of 3 components:

Terminal Access Device [TAD]

This is the module that would be made available by CBN to be

installed at participants Head Office. This module would be used for
data entry payment instructions, monitoring of participants own
instructions, queue management, etc.

Operation Control Terminal [OCT]

This module would be installed at CBN for monitoring and used as the
management tool for the RTGS.

Real Time Gross Settlement System(RTGS) Server Application

This module processes high value payment instructions and is installed

at Central Bank Head Office.

Network Communication Requirement

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Participants are expected to hook up to communication network to be able
to participate in the payment system. All accesses to network and
application would be authenticated and validated.

Real Time Gross Settlement System (RTGS) Rules and Regulations

There must exist clearly defined rules and regulations and operational
guidelines for operating the RTGS to prevent systemic risks as well
collapse of the financial sector.

Society for Worldwide Inter-bank Financial Telecommunication (SWIFT)

Society for Worldwide Inter-bank Financial Telecommunication (SWIFT) is the

financial industry-owned co-operative supplying secure, standardised messaging
services and interface software to 7,800 financial institutions in more than 200
countries. SWIFT's worldwide community includes banks, broker/dealers and
investment managers, as well as their market infrastructures in payments,
securities, treasury and trade. It is the largest transmission system for inter-bank
transactions in the world and used universally by all banks. SWIFT handles
under-noted areas for banks:

customer transfers and cheques,

financial Institutions transfers,
financial trading,
collection and cash letters,
documentary credits and guarantees,
precious metals and syndications,
traveller Cheques,
cash management and customer status, and
supporting system messages.

Free format messages are also allowed.

SWIFT consistently delivers quantifiable business value and proven technical

excellence to its members, through its comprehensive messaging standards,
security, reliability and five nines availability of its messaging platform and its
role in advancing Straight Through Processing (STP). The guiding principles of
SWIFT are clear: to offer the financial services industry a common platform of
advanced technology and access to shared solutions through which each
member can build its competitive edge. Over the past ten years SWIFT message
prices have been reduced.

Main features of SWIFT are:

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operational throughout the year 24 hours a day,
transmission of messages to any part of the word is almost
about 400standardised formats are used by SWIFT for message
transmission for inter-bank transactions,
all messages are acknowledged,
Information is confidential and is protected from disclosure and
SWIFT assumes financial liability for the accuracy and timely delivery
of all validated messages from the point these enter the network to the
point the same leave the network,
method of transmission is cost effective.

SWIFT has emerged as a need of the financial world for a fast, safe, and
universal means of transferring funds immediately. It has helped in standardizing
and automating the international payments messaging, to the great benefit of
banking community. Of late, institutions other than banks are joining SWIFT. An
illustrative list is:

investment management institutions,

security brokers and dealers,
central depository and clearing organizations,
recognised exchanges,
trust or fiduciary service providers,
subsidiary providers of custody and nominee services,
registrar and transfer agents,
money brokers,
issuers of traveler cheques,
domestic clearing participants.

Some of the major usages are:

Interchange facility for foreign exchange, money market, and derivative

Processing of confirmation messages as a result of forex, and money
market deals,
Confirmation reports of execution of standing settlement instructions.


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Trade finance implies financing of the movement of goods and services
internationally and within ones country. In all banks trade finance normally
relates to financing of foreign trade, both exports and imports. Over all domain of
trade finance covers under-noted areas:

pre-shipment credit, including packing credit, advances against

cheques and drafts, advances against subsidies if any receivable, and
foreign currency loans.
post-shipment credit including post shipment finance in domestic
currency, post shipment finance in foreign currency, regulations
relating to exports, scrutiny of various forms, and documentation for
post shipment credit.
Export Guarantee Organisations,
Import finance, suppliers credit, letters of credit and Uniform Customs
and Practices for Documentary Credits (UCPDC).

Risk in Trade Finance, especially in International Trade

Operators in international markets are exposed to various kinds of risks,

which fall under two broad categories:

Business risks - arising from economic conditions outside the control of

the operator, or from the internal factors connected with the operating
conditions, and

Financial risks - arising from factors affecting cash flow and/or profits of
the operations

Various types of risks can be diagrammatically represented in the

following manner:


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! !
Business Risks Financial RIsks
! !
Economic Risk Credit Risk
Systemic Risk Liquidity Risk
Country Risk Market Risk
Political Risk Price Risk
Operational Risk Interest-rate Risk
Settlement Risk Mismatch Risk
Regal & Regulatory Risk Basis Risk
Yield Curve Risk

There are three types of financial risks. These are:

credit risk arising out of non performance by a buyer abroad,

market risk arising out of the variations in the general level of prices,
interest rates and currency values,
liquidity risk which lead to funding crisis.

Foreign exchange risk arises due to changes in the values of currencies

relative to the domestic currency. A net long or short position in a given currency
will expose bank to a foreign exchange rate risk. If the dollar assets of a bank
exceed dollar liabilities, the bank would gain if dollar appreciates but would lose if
dollar depreciates. Exporters and importers are always exposed to forex risk as
their payments and receipts are denominated in forex but balance sheet is in
domestic currency. Same holds true of a local bank.


A bank guarantee is normally required by a customer when his counter-party

is not sure of his credit and seeks credit mitigation by obtaining a guarantee from
the bank. Once the guarantee is issued by a bank, it is bound to pay, once the
guarantee is invoked by the beneficiary. To protect banks interest, bank does
obtain counter guarantees from the customer, in some cases, cash deposit and
other securities are also obtained. As the facility is a contingent liability, it is
shown as a note to the balance sheet of the bank.

Bank guarantees can be classified in four classes:

Financial Guarantees : These guarantee the credit of the customer and

not his technical or manufacturing ability. To illustrate, Government

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gives advance payment to a customer and bank gives guarantee for
the amount knowing by its assessment that customer is good for the
amount. A bank in India is allowed by Regulator to give such
Performance Guarantee : It is for technical and managerial
competence. To illustrate, customer is asked by the government to
give guarantee that the construction of a dam given to it would be
completed in two years from the date of work order. This is a
Performance guarantee. Banks are asked to desist from entering this
type of business by the regulator.
Deferred Payment Guarantee : It is given for guaranteeing periodical
payments for goods supplied. This is akin to granting a term loan and
is permissible business for banks.
Statutory Guarantee : It is a guarantee to statutory authorities or a
court that the customer will honour his commitments when due, as per

Though a guarantee is a contingent liability, it becomes a funded once it is

invoked. Banks, as such, examine issuance of guarantee with same rigour as for
approving fund based credit to customers.


A letter of credit is an arrangement by which the bank acting at the request of

its customer undertakes to:

pay to or to the order of the third party (the beneficiary),

pay, accept, or negotiate bills of exchange (drafts drawn by
beneficiary), or
authorise such payments to be made or such drafts to be paid,
accepted or negotiated by another bank against stipulated documents
provided the terms and conditions of the L/C are complied with.

A contract between an importer and an exporter may call for payment under a
letter of credit (L/C). The L/C sets a time limit for completion and specifies which
documents are required to confirm the transactions completion.

Normally, under noted documents are prescribed for presentation to the

negotiating bank:

commercial invoice,
certificate of origin,
insurance document, and
bill of lading or combined transport document.

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A letter of credit is an additional contract dealing with credit between applicant
(importer) and the issuing bank and is separate from the original contract
between buyer and seller. The bankers deal only in documents and not in goods.
If documents are in order the issuing bank will pay whether or not the goods are
of expected quality.

Types of L/C

In terms of article 6 of Uniform Customs and Practices for Documentary

Credits (UCPDC) a letter of credit can be either revocable or irrevocable.
In case there is no clear indication the L/C is deemed to be irrevocable.
Letters of credit can be of under-noted type:

revocable letters of credit,

unconfirmed irrevocable letter of credit, and
confirmed irrevocable letter of credit,

Proper letters of credit have following basic components:

Applicant - The party applying for the letter of credit, usually the Importer
in a transaction.

The Issuing Bank - The bank that issues the letter of credit and assumes
the obligation to make payment to the beneficiary, usually the exporter.

Beneficiary - The party in whose favour the letter of credit is issued,

usually the exporter in the transaction.

Amount - The sum of money, usually expressed as a maximum amount,

of the credit defined in a specific currency.

Terms - The requirement, including document that must be met for the
collection of the credit.

Expiry - The final date for the beneficiary to present the documents as per
the terms and conditions of the letter of credit.

These are the necessary components of any letter of credit for the credit
to become a valid, operable instrument. In addition, letters of credit come
in various forms that define their level of risk. A revocable letter of credit
allows the issuing bank (at the applicants request) to amend or cancel the
credit at any time without the approval of the exporter (beneficiary) and is
the most risky form. In contrast, an irrevocable letter of credit has terms
and conditions that cannot be amended or changed without the expressed
consent of all parties, the issuing bank, the exporter (beneficiary) and the
importer (applicant). Finally, the addition of a commitment by a bank other

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than the issuing bank to irrevocably honor the payment of the credit,
provided the exporter meets the terms and conditions of the credit, results
in a confirmed irrevocable letter of credit.

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The over all flow of documents in a L/C transaction can be depicted by
under-noted flow chart.

Contract signed for purchase of

Indian importer goods Indian importer and Taiwanese exporter wants
approaches Indian payment by a Taiwanese Exp
bank for a L/C Taiwanese exporter bank at Kaohsiang once orter
goods are put on board for start

Submits contract Gets margin, issues

agreement, data, and Bank examines irrevocable L/C laying
counter guarantee to
the request ask down conditions. Sends
honor documents by SWIFT to Bank in
for margin and
when presented in decides to issue Kaohsiang Taiwan

Exporter ships
Bank one copy of goods, gives,
L/C to Indian Bank stores copy of B/L,cert.Origin,inv
Importer for record documents, copy of oice,L/C to his
and verification L/C for future bank

Find in order Check

receives documents pay exporter s
checks find in order, send paper
debits partys account document to
remits money to its Indian bank
NOSTRO account- draw
for future
delivers documents to reimbursemen
importer in India. t on


Companies with multiple channels of distribution maintain bank accounts at

various centres, receive payments at those centres, and send monies to a nodal
centre for payments to their employees, suppliers, statutory payments, etc. They
have number of centres which maintain companys cash. At some centres they
may have to borrow, while at other places they may have idle cash. It is a typical
inventory management problem. Idle cash has a lost opportunity cost just as idle
inventory has a cost for the company. To maximize profits it is essential to
reduce idle cash. It should be used to reduce loans or invested in short term
securities to earn money. This thus becomes the responsibility of the Treasury
Division in the company. How fast to bring all receipts to a centralized point, and
plan out payments to the last moment so as to get interest free credit from

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Banks offer cash management services to large companies with
offices/branches at various places. In short the system works as under:

Bank connects its branches in different cities through communication

network, at times V-SAT linking various offices to central branch. The
system can at a predetermined time each day transfer all balances at
the linked branches to central branch electronically. The system
sweeps the branch database and what ever clean balances exist in the
companys accounts gets credited to its main account at the main
branch. A computerized output both online/hard copy/magnetic media
is given to the client company giving details of credit received from
various branches on that day.
Company concentrates on recovering receipts of sales at various
centres and whatever amounts are deposited are swept into the main
More sophisticated computer systems can give intimation of each and
every credit at each branch from where the amounts were swept on
the day.
Company is able to follow up its receivables, keep a tab on its sales
force, reduce cash inventory to minimum and, if necessary, invest
excess cash elsewhere.

Just like receipts are swept in, payments go electronically to various centres.
It implies maintaining a Just-in-time Cash inventory in the company.

For banks having core banking solution, where all branches are interlinked
and the main database is at central computer, the process becomes much

Some banks run rather unsophisticated CMS based on phone/fax/ and

electronic connectivity. Some run highly sophisticated CMS software giving detail
of each and every credit at all branches.

There is competition on the pricing and at times the CMS can be sold by
banks as a loss leader, in order to get more profitable foreign exchange and
export import business.


Functions of Treasury

treasury maintains and controls centralized pool of cash in a bank.

all the cash that comes in and goes out is tracked by treasury.
so it borrows from branch offices when it receives cash from them and
lends monies to them for creating assets.

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treasury makes its own investment from the surplus remaining with it
meeting the reserve requirements for which it bears primary
it invests surplus in money markets,
fixed income securities, equities, and
foreign assets, subject to regulatory guidelines for taking position in
foreign currencies.

Investment in fixed assets securities brings in its wake problems of -

interest rate risk,
asset liability management,
gap analysis a variant of ALM, and
liquidity risk

Keeping a position in foreign exchange, brings in its wake problems of -

foreign exchange rate risk,

interest rate risk,
cross currency rate risk, and
settlement risk, and
country risk

Risk Return

Investments in money markets are less risky but so are the returns which
remain low. The treasury has to take calibrated risk to optimize income by
switching between money markets, fixed income assets, and foreign
currency assets to optimize returns. Money market investments have to be
tempered with exposure limits on every major borrowing institution,
depending upon the balance sheet and managerial capability of that
institution. The treasurys, major objective function is to optimize returns
and balance the risks without breaching exposure limits on various
borrowers and asset classes.

In keeping with international good practice, the treasury organization has to

have three wings, i.e.,

Front office : where all dealers operate in money markets, fixed

income securities , equity and foreign exchange, and deals are entered
with the dealers of other organizations,
Back office : where all deal confirmations are prepared, counterparty
confirmations are obtained and exposure limits are monitored.
Payment and settlement is completely controlled by back office, and

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Mid office : which is responsible for risk control and MIS for entire
treasury. Among other things, mid office monitors exposures, out of
market deals, and transactions where management has to be warned
about excessive risk being taken. Mid office is not internal audit, but
more risk identifie. Also, more of risk measurement and risk control

As interplay between domestic assets and foreign assets is allowed as a

good practice, it is necessary to integrate the treasury. An integrated treasury
searches all opportunities to optimize returns and this is achieved by integrating
foreign, money market, fixed income securities and equity and derivatives desk
under the over-sight of one functionary.

Integrated Treasury

An integrated treasury would imply switching investible liquid funds, after

meeting SLR and CRR requirements, either in Indian rupee money market
or forex markets subject to open limits prescribed by RBI. Currently, this
has been possible, as banks are permitted to hold open positions in
foreign exchange/foreign assets as a percentage of their tier-I capital,
subject to the bank having its Board having approved risk containment,
reporting and control system. By and large, majority of banks have been
switching from domestic assets to forex assets, at basic level through
currency swaps.

Currency swap is the most basic and relatively safe instrument and helps
a bank to make more income than a call placement/deposit in inter-bank
market or reverse repo placement with an approved bank or Primary
Dealer. For a bank with surplus cash, a currency swap is a good source of
dollar income, which can be used for financing imports, loans to
customers, or investments abroad. But this business can be done only
when Rs. Dealer and forex dealer work in tandem.

Such transactions require both physical and mental proximity of Rupees

and Forex dealers, an integrated view of the money markets embracing
rupees and forex markets and, expertise to shift liquid assets from Rupees
money markets to forex money markets depending upon opportunity
returns being higher in either of the two markets. The integration of
treasury would be a paradigm shift, and requires changes in
organizational structure, and more importantly, unification of forex dealing
with Indian Rupees dealing room.

Nature of Integration

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Generally, an integrated treasury implies vertical as well as horizontal
integration. Under the vertical integration, the forex dealing room, which is
located at International Banking Division is merged with domestic treasury.
That means both domestic and forex dealing operations, along with back
office activities are carried at the same place. Under the horizontal
integration, front office and back office are located at different places, but
combined operations are carried out with the same policies, accounting
system and technology platform.

Integration of Structure

To develop an integrated treasury, to begin with, bank has to opt for

vertical integration of treasury operations. That means forex dealings will
be merged with domestic treasury (Investment Department), and
integrated treasury department must be set up at the banks Head Office.
Once the bank decides to have merger of international banking division
and investment department, it has to evolve an appropriate organizational
structure for integrated treasury. Such a structure can be designed as per
the chart given below.

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Structure of Integrated Treasury

Country Head

Vice Head (Treasury)

Front Office Head Risk Back Office

- Chief Dealer (in charge) Chief Dealer

Reporting Directly
To R M D

Manager Manager Manager Manager

(Dealers) (Dealers) (In-charge in-charge of
Domestic Tr. Forex Tr.

G-Securities Merchant
Non-SLR (on behalf of Settlement Merchant
Call/notice/Repo customers) Custodian Reconciliation
Maintenance of trading Accounting SWIFT
CRR forward &other other documents FCNR
MM Derivatives fx related SLR Maintenance
(interest rate) derivatives

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Technology Support

Integrated treasury requires adequate technology support both in the form

of hardware and software. The software must be such that it provides
solution that integrates the operations across money markets, securities
markets, forex markets and derivatives markets, cash flow, accounting
work, collection of current data and its analysis, monitoring of limits and
control function. Thus, the software must meet requirements of treasury in
items of forex and domestic markets and derivative products. Software
should provide trading platform and support to mid and back office
operations. Further, it should have interface with Negotiated Dealing
Ssystem (NDS), Clearing Corporation of India Ltd. (CCIL), SWIFT, RTGS
and Reuters, etc., to facilitate execution as well as settlement of deals in
various segments of financial markets.

While selecting appropriate software package for integrated treasury, the

following factors may be taken into account:

software vendor has a proven track record.

package (i.e., solution) should be tried, tested and must be functional
in some other bank /financial institution.
software product should be robust and must have open architecture to
support various operating system platforms.
it should facilitate to have interfaces with NDS, CCIL, RTGS, SWIFT
and Reuters Screen, etc.
it must have compatibility of capturing deals from other platforms, such
as, NDS, Reuters, etc., and must provide online transmission to CCIL
and other settlement systems.
the software not only should have domestic and forex treasury
functional systems, but should have derivatives module so as to meet
banks future requirements.
it should have inbuilt support system for accounting, keeping in view
Indian accounting standards and Generally Accepted Accounting
Principles (GAAP).
it should be user friendly and must have adequate security so as to
avoid problem of misuse of the system and access by unwanted
terms and conditions for ongoing support systems and subsequent
upgradation should be clearly spelt out.
it must support the MIS system and must be able to generate reports
to meet banks requirements.

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Revision in the existing policy documents.

Adoption of integrated treasury calls for definite changes in investment

and trading strategies. Therefore, to move from a traditional to an
integrated treasury a bank will have to revise and improve the following

investment policy document.

derivatives policy document.
credit policy document (whenever, there is a need)
Asset Liability Management (ALM) policy document

Instead of having separate documents for investment function and derivatives

trading, the banks adopt a comprehensive document on treasury management,
covering all aspects of operations in the money, securities, foreign exchange and
derivatives markets. Further, the bank shall require bringing necessary changes
in the existing risk management system so as to make it more appropriate for
integrated treasury. Further, the bank will have to prepare a manual on
integrated treasury giving details on following aspects.

functions of front, back and mid office, including processes.

organizational structures with clearly defined authority position in the
role and responsibilities of various functionaries at all levels, including
process for RTGS and SWIFT
brief idea about products in money markets, securities markets, forex
and derivatives markets and their working.
brief idea about negotiated dealing system, auction system and
liquidity adjustment facility of the RBI.

Typical activities for forex treasury group in integrated treasury


1) bank must give forex quotes both ways, i.e., for buying and selling.
These must appear online say on Bloomberg and Reuters.
2) base rate for buy and sell can be interbank rate, or to be more
competitive, interbank cross-rate offered for Rs-US$ in Singapore
market in morning and Bahrain or London in evening.
3) to do so, bank must be ready to do proprietary trading and hold
positions in its account. Policy clearance would have to be taken from
the Board.
4) based on point 2 mentioned above, bank must quote special rates for
forex transactions say, above a critical amount, to be fixed by the bank.

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5) overnight limit for the bank has to be fixed. The bank must have an
overnight limit at least upto 15% of tier-1 capital.
6) dealers should be given a cut loss limit. It would be applicable to chief
dealer or head of treasury at whose level forex position is compiled.
All losses must be reported to CFO for approval and corrective action.
7) bank should consider having interbank forex dealings desk at Major
forex centres.
8) bank must work out a forex liquidity policy and place it for Boards
approval. Subsequently, it needs to be made as part of overall asset
liability management policy.
9) daily position of overall forex operations, including monthly report on
P&L, must be put up to General Manager of Integrated Treasury
10)reference point No. 6 in due course a VaR model needs to be
introduced to calculate prudential cut loss for dealers.
11)bank must set up an MIS to find date-wise reimbursement of foreign
LCs issued by branches so that no cash out-flow occurs in Nostro
accounts nor are they over-funded. This must be treated as top


Correspondent banks

For a bank doing international transactions and keeping multiple currency

accounts, it is prudent and advisable to have correspondent relationship
with foreign banks. This enables getting market information about
business in those countries, opportunity to enter into business with
correspondent bank and to maintain accounts with them on favourable
terms. Purely on business considerations it is found that keeping a good
correspondent bank in a foreign country, can be more cost effective than
opening a branch office.


These are foreign currency accounts maintained by a domestic bank with

a foreign bank. To illustrate if Bank A maintains a U.S. $ account with
Citibank New York, Bank A will classify that account as its NOSTRO
account in American $.


If WACHOVIA BANK New York opens a Rupee Account with Bank A in

India, Bank A will call it as VOSTRO account of Wachovia bank.

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Advisory services.

Banks give advisory services for debt structuring, debt raising, and
syndication for both domestic and foreign currency loans. Banks share the
risk with other banks by sharing loans and this stands them in good stead
for syndicating for debt raising especially on external commercial

Initial Public Offer (IPO)

First IPO requires preparation of detailed financial plans for incorporation

in prospectus for approval of Capital Market Regulator (SEBI). Apart from
requiring a merchant banker who is authorized to do this business, the
commercial bank advises about financial position and prospects of the
company and can share its view of the strength of the management and
the company. Market and investors depend more on views of the bank,
rather than prospectus. This happens because investors believe that a
bank has more private information about a company than other sources in
the market.

Capital Restructuring

A company needs capital restructuring both for raising capital and debt,

when it diversifies or
when it goes sick or
when it thinks of an acquisition.

A commercial bank can play advisory as well as proprietary investment role

in a company either directly or through its venture capital activities.


Credit Card System

Let us see how a credit card is issued and used. Generally, a bank enters
into an agreement with its customer and issues the customer a credit card.
A credit card is small plastic card around 8.5 cm by 5.5 cm. It has the
name and the account number of the holder embossed on it. In addition,
the date up to which the card is valid will also be embossed and a
specimen signature panel on the reverse. The card issuer should normally
get the card holder to sign on the specimen signature panel in his
presence before parting with the credit card. A card holder is also

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generally given list of shops and establishments in each city where the
card will be accepted in lieu of cash. The limit up to which the card holder
can make purchases in a month is also informed to the card holder; this
limit is called the card-limit. When a card holder purchases or uses the
service of a Merchant Establishment/s (ME), he/she gives the card to the
shopkeeper at the time of payment. The Merchant Establishment/s verifies
the card for validity date and then checks a booklet called "Hot list
Bulletin". This "Hot list Bulletin" lists all cards which have, been lost,
stolen, surrendered by customer or invalidated by the issuer. If the card is
not hot listed, the Merchant Establishment/s will proceed to make a bill for
purchases effected.

Each Merchant Establishment has a limit below which he can accept

payment without seeking "Authorisation". Such a limit is called Merchant
Establishment's floor limit. The floor limit varies from Merchant
Establishment to Merchant Establishment depending on the nature and
location of the business. However the card holder need not know the floor
limit, nor does the Merchant Establishments have to know the card
holder's limit. If the transaction exceeds the floor limit, the Merchant
Establishment/s calls up the card issuer who may authorise the
transaction or may not.

If the card issuer refuses to authorise the transaction, the Merchant

Establishment may advise the card holder of the refusal of the issuer and
may accept only cash instead of the card. The reasons for authorisation
refusal may be because of having intimation of the card having been
stolen or lost, or the total value of transaction exceeding the card limit,
arrears or default in payment by card holder.

Once authorisation is received, along with the authorisation code, the

charge slip is prepared. It is got signed by card holder. The charge slip is
presented to issuing bank which pays the amount to Merchant

Types of Credit Card

Charge Card
All transactions are accumulated over a period of time and total amount
charged is debited to card holders account. Cardholder is given about 10
to 15 days time to credit his account if sufficient funds do not exist in the

Credit Card
Is same as charge card except that card holder may pay only 10% of
amount and gets credit to the extent of 90%.

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Smart Card
These can be charged to carry credit and each time goods are purchased,
the amount is deducted. It is more of a re-chargeable pre-paid card.

Member Card
This is used exclusively by members of a club or a chain of hotels. Cards
can be used only for the member of a group or establishment and can be
used only in specific establishments.

Debit Card
Bank account of the card holder is straight away debited from Point-of-
Sale Terminal (POST).

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Basic laws and Compliance

Banks all over the world are regulated entities, and are subject to regulation
by Central Banking Authority. They have to comply with laws of the home and
host countries where they do business. In the previous chapters in defining bank,
its products and processes the applicable laws and regulatory guidelines have
been taken into account. Primarily it should be said that Contract Act, Negotiable
Instrument Act, Banking Regulation Act, Transfer of Property Act, Securities and
Contracts Act, etc., apply to the functions of Bank, in India. An illustrative list of
important regulations and laws that banks have to comply with on day-to-day
basis are:

reserve requirements,
exposure limits on individual and group of clients,
submission of offsite inspection data periodically to central bank,
ensuring not to take exposure on negative list circulated by Regulator,
ensure participation in specialized lending like Community
Reinvestment Act, or similar regulation or law,
implement in letter and spirit, regulations issued by Central Bank
regarding covenants binding Board of Directors for good corporate
implementation of risk management systems as directed by Regulator,
maintain capital adequacy on day to day basis,
enforce effective K.Y.C. (Know Your Customer) regime,
report all suspicious activity transactions to designated authority,
maintain an effective anti-money laundering system to ensure that
related laws are followed in letter and spirit,
if a listed company, comply with stock exchanges and periodical
reporting requirements, including reporting any market sensitive
banks listed at any U.S exchange have to comply with Sarbanes Oxley
provisions of labour law, Income Tax laws, and state laws having
bearing on banks business have to be complied with,
in respect of any business done through correspondent banks, banks
outside US, have to comply with Bank Secrecy Act, PATRIOT Act, and
rules of Office of Foreign Assets Control (OFAC)
filing of annual reports and periodical profit and loss statements with
regulator, stock exchange and Company Law Board as laid down by
regulation and laws, well within prescribed time limits.
provisions of Right for Information Act as applicable.

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The above list is illustrative. The failure to comply with the requirements can
result in:

financial penalty,
cease and desist order,
suspension of business,
cancellation of banking licence, and
criminal prosecution of Principal Officers including Directors.

As, non-compliance can be a serious offence and result in business

closure and severe financial losses, banks are required to have a
Compliance Wing to ensure that no violations take place.

Compliance function in a bank is an independent function that identifies,

assesses, advises on, monitors and reports on the banks compliance risk, i.e,
the risk of legal or regulatory sanctions, financial loss, or loss to reputation a
bank may suffer as a result of its failure to comply with all applicable laws,
regulations, codes of conduct and standards of good practice (together laws,
rules and standards).

Compliance function ensures banks commitment to Excellence in

performance and highest ethical standards, as well as adherence to applicable
legal and regulatory requirements and professional standards.

Responsibilities for Compliance

Compliance responsibilities are shared among all staff members as well

as across various units of the Bank, the most notable of which are the

Management and line managers have primary responsibility for

compliance in the bank.
The Compliance Unit identifies and assesses compliance risks, guides
and educates staff on compliance issues, performs a monitoring and
reporting role and in cooperation with the legal service also an advisory
The Legal Service has a primary responsibility for identifying relevant
laws, rules and standards with which the bank should comply and for
providing interpretation in case of doubt.
Risk Control monitors banks financial risks (credit risk, market risk and
liquidity risk) and ensures compliance with the respective policies and
Internal Audit reviews adequacy of controls established to ensure
compliance with policies, plans, procedures and business objectives, in
accordance with the internal audit charter.

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Compliance Committee

A Compliance Committee has to be established to ensure that important

compliance issues are coordinated and communicated throughout the
bank. The Compliance Committees responsibilities are:

to determine priorities for the Compliance Unit and

approve a compliance programme on the basis of proposal from the
Head of Compliance.
ensuring co-ordination of the Compliance Units activities with the legal
service, risk control, internal audit and other sections involved in
compliance at the Bank.
Also serves as vehicle for informing and advising the Executive
Committee on material compliance matters.

The Committee is normally chaired by the CEO. Its other members are the
Head of Compliance, the respective Heads of the Legal Service, Risk Control
and Internal Audit, and one senior staff member from each of the Monetary and
Economic Department and the Banking Department. The Committee may invite
at any time other members of Management or staff to discuss special topics
when necessary. The Head of Compliance acts as Secretary to the Committee.

The Committee meets minimum four times a year. Any member of the
Committee may call for an extraordinary meeting, with the prior approval of the
Head of Compliance Committee.

The Compliance Unit

The role of the Compliance Unit is to assist Management to ensure on a

reasonable basis that bank-wide activities are conducted in conformity
with applicable laws and regulations, in accordance with the Central
Banks Statutes, the Banks Code of Conduct and all relevant rules and
policies, and generally with sound practices pertinent to those activities.

Specific responsibilities of the Compliance Unit

The Compliance Unit shall have following specific responsibilities:

On a pro-active basis, identify, document and assess compliance risks

associated with the Banks activities;
assess the appropriateness of the banks compliance procedures and
guidelines, promptly follow up any identified deficiencies and, where
necessary, formulate proposals for amendments;

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In cooperation with the Legal Service and relevant business units,
provide guidance and advice to staff on the appropriate implementation
of relevant laws, rules and standards through internal policies and
assist Management and line managers in educating staff on
compliance issues, and to act as a contact point within the Bank for
compliance queries from staff members;
monitor compliance by performing sufficient and representative
compliance risk assessment and testing - this includes performing spot
checks to test compliance with policies and procedures, making
enquiries into deficiencies and/or breaches and carrying out

The Head of Compliance shall report on regular basis to his/her line manager
on compliance matters - the reports should refer to the compliance risk
assessment and testing that has taken place during the reporting period, indicate
the details of material deficiencies and/or breaches and recommend measures
to address them, and give a report on the corrective measures already taken.

In addition to this regular reporting, the Head of Compliance should report

any deficiency or breach of which he/she becomes aware to the
appropriate level of management in accordance with materiality criteria to
be approved by the Compliance Committee.

Independence and Accountability

The Compliance Unit must be independent from the business activities of

the Bank and is managed by the Head of Compliance. The Head of
Compliance should report directly to the CEO. The Head of Compliance
and Compliance Unit staff shall not be placed in a position where there is
a possible conflict of interest between their compliance responsibilities and
any other responsibilities they may have.

In addition to the above, the Head of Compliance shall submit an annual

report to the Compliance Committee, the CEO, and the Audit Committee of the
Board of Directors on the activities of the Compliance Unit. The Head of
Compliance shall meet with the Audit Committee at least once a year and shall
also have right of direct access to the Audit Committee.


To carry out its mission effectively, the Compliance Unit in the course of its
activities shall be authorised to:

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Enter all areas of the Bank and have access to any documents and
records considered necessary for the performance of its
responsibilities; and
Require all members of Management and staff to supply such
information and
Explanations as may be needed within a reasonable period of time.


The Compliance Unit shall keep abreast of sound practices in its field and
in particular take into account the recommendations of the Basel
Committee on Banking Supervision on compliance-related issues.

Relationship among Bank units

In addition to the specific collaboration through the Compliance

Committee, on an ongoing basis, efforts shall be made to;
Ensure good coordination and close and continued cooperation
between the Compliance Unit and other units, in particular the Legal
Service, Risk Control and Internal Audit.
The Compliance Unit shall seek legal and interpretative advice from
the Legal Service, in particular, through regular bilateral meetings.
Where ever necessary, the Legal Service may arrange for consultation
with external experts.
The Legal Service retains primary responsibility for relations with public
authorities and is involved in responding to external compliance-related
Similar to other business units of the Bank, the Compliance Unit
should be subject to Internal Audit.

Best Practices

Compliance starts at the top. It will be most effective in a corporate culture

that emphasizes standards of honesty and integrity and in which the Board of
Directors and senior management lead by example.

The banks Board of Directors is responsible for overseeing the management

of the banks compliance risk. The Board should approve the banks compliance
policy, including a formal document establishing a permanent and effective
compliance function. At least once a year, the board or a committee of the board
should assess the extent to which the bank is managing its compliance risk

The banks senior management is responsible for establishing and

communicating a compliance policy, for ensuring that it is observed, and for

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reporting to the Board of Directors on the management of the banks compliance
risk. Thus, they are responsible for the effective management of the compliance
function and compliance risk.

The banks compliance function should be independent and have resources

to carry out its responsibilities effectively.

The responsibilities of the banks compliance function should be to assist

Senior Management in managing effectively the compliance risks faced by the

The scope and breadth of the activities of the compliance function should be
subject to periodic review by the internal audit function.

Banks should comply with applicable laws and regulations in all jurisdictions
in which they conduct business, and the organisation and structure of the
compliance function and its responsibilities should be consistent with local legal
and regulatory requirements. Banks operating say in, U.S., U.K., and India have
to comply with three regulators.

Compliance should be regarded as a core risk management activity within the

bank. Specific tasks of the compliance function may be outsourced, but they
must remain subject to appropriate supervision by the head of compliance.

The head of compliance is responsible for the day-to-day management of the

activities of the compliance function in accordance with the principles set out in
this paper.

Staff exercising compliance responsibilities should have the necessary

qualifications, experience and professional and personal qualities to enable them
to carry out their duties effectively

The Board should establish the Supervision Committee that will assist it in
accomplishing its supervisory functions in the following critical areas:

Risk management
Asset and liability management
Internal audit (or compliance)

Good governance practices currently require that the members of the audit
committee have the additional quality of independence.

The Bank, in organizing its functions, should strive to apply the basic
operational risk management principle of segregating responsibilities that may
present potential conflicts of interest.

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KYC as a part of deposits and lending was studied, briefly in previous

chapters. KYC as a compliance and risk management system is equally
important. Sound KYC procedures have particular relevance to the safety and
soundness of banks, in that:
they help to protect banks reputation and the integrity of banking
systems by reducing the likelihood of banks becoming a victim of
financial crimes and suffering consequential reputation damage;
They constitute an essential part of sound risk management (e.g. by
providing basis for identifying, limiting and controlling risk exposures in
assets and liabilities, including assets under management).

International best practice, coupled with anti-money laundering laws in force

in OECD countries and India require that Financial Institutions should not keep
anonymous accounts or accounts in obviously fictitious names: they should be
required (by law, by regulations, by agreements between supervisory authorities
and financial institutions or by self-regulatory agreements among financial
institutions) to identify, on the basis of an official or other identifying document,
and record the identity of their clients, when establishing business relations or
conducting transactions (in particular opening of accounts or passbooks,
entering into fiduciary transactions, renting of safe deposit boxes, performing
large cash transactions). In order to fulfill identification requirements concerning
legal entities, financial Institutions should, when necessary, take measures:

To verify their legal existence and structure of the customer by

obtaining either from a public register or from the customer or both,
proof of incorporation, including information concerning the customer's
name, legal form, address, directors and provisions regulating the
power to bind the entity.
to verify that any person purporting to act on behalf of the customer is
so authorized and identify that person.

Financial institutions should take reasonable steps to obtain information about

the true identity of the persons on whose behalf an account is opened or a
transaction conducted. If there are any doubts as to whether these clients or
customers are acting on their own behalf, for example, in the case of domiciliary
companies (i.e., institutions, corporations, foundations, trusts, etc. that do not
conduct any commercial or manufacturing business or any other form of
commercial operation in the country where their registered office is located).

Financial institutions should maintain, for at least five years, all necessary
records on transactions, both domestic or international, to enable them to comply
swiftly with information requests from the authorities.

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Such records must be sufficient to permit reconstruction of individual
transactions (including amounts and types of currency involved if any) so as to
provide, if necessary, evidence for prosecution.

Financial institutions should keep records on customer identification (e.g.

copies or records of official identification documents like passports, identity
cards, driving licenses or similar documents), account files and business
correspondence for at least five years after the account are closed.

These documents should be available to domestic authorities in the context of

relevant criminal prosecutions and investigations.

Financial institutions should pay special attention to all complex, unusual

large transactions, and all unusual patterns of transactions, which have no
apparent economic or visible lawful purpose. The background and purpose of
such transactions should, as far as possible, be examined, the findings
established in writing, and be available to help supervisors, auditors and law
enforcement agencies.

If financial institutions suspect that funds stem from a criminal activity, the
same should be promptly reported to the appropriate authorities.

Financial institutions, their directors, officers and employees should be

protected by legal provisions from criminal or civil liability for breach of any
restriction on disclosure of information imposed by contract or by any legislative,
regulatory or administrative provision, if they report their suspicions in good faith
to the appropriate authorities, even if they did not know precisely what the
underlying criminal activity was, and regardless of whether illegal activity actually

Financial institutions, their directors, officers and employees, should not, or,
where appropriate, should not be allowed to, warn their customers when
information relating to them is being reported to the competent authorities.

Financial institutions, while reporting their suspicions should comply with

instructions from the appropriate authorities.

Financial institutions should develop:

internal policies, procedures and controls, including the designation of
compliance officers at management level, and adequate screening
procedures to ensure high standards when hiring employees;
An ongoing employee training programme;
An audit function to test the system.

A KYC is thus not only customer identification but extends to find out the
sources of funds and its legal status. In practical situation, a standard KYC is run
as under:

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For opening any bank account four identifications are prescribed.
These are social security card, passport, driving licence, and
employers identity card.
To complete identification, part of the KYC at least two of these which
do not correlate to each other must be verified and recorded,
The more important part is source of funds and verification by bank
that these are legal. The bank has to ensure that funds initially
deposited are in synchronization with the activity in which customer is
All future flows are in line with the sources of business/earnings of the
Deposit accounts are risk rated.
They are categorized as low risk, medium risk, and high risk.
For small amount deposit accounts, which carry very low risk, the KYC
is less severe and verification of documents to establish identity and
sources of incomes are less rigorous

The inadequacy or absence of KYC standards can subject banks to serious

customer and counterparty risks, especially;
legal and concentration risks.

It is worth noting that all these risks are interrelated. However, any one of
them can result in significant financial cost to banks (e.g. through the
withdrawal of funds by depositors, the termination of inter-bank facilities,
claims against the bank, investigation costs, asset seizures and freezes,
and loan losses), as well as need to divert considerable management time
and energy to resolving problems that arise.

Reputational risk poses a major threat to banks, since the nature of their
business requires maintaining the confidence of depositors, creditors and the
general marketplace. Bank should ensure that audit functions are staffed
adequately with individuals who are well-versed in KYC policies and procedures.
In addition, internal auditors should be proactive in following-up their findings and
Training of staff at all levels on KYC and Anti Money laundering is important.
Towards this,

All banks must have an ongoing employee-training programme so that

bank staff are adequately trained in KYC procedures.
The content of training for various levels/sections of staff will have to
be decided on the basis of its needs.
Training requirements should have a different focus for new staff, front-
line staff, compliance staff or staff dealing with new customers.

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New staff should be educated in the importance of KYC policies and
the basic requirements at the bank.
Front-line staff members who deal directly with the public should be
trained to verify the identity of new customers, to exercise due
diligence in handling accounts of existing customers on an ongoing
basis and to detect patterns of suspicious activity.
Regular refresher training should be provided to ensure that staff are
reminded of their responsibilities and are kept informed of new
It is crucial that all relevant staff fully understand the need for and
implement KYC policies consistently.

A culture within banks that promotes such understanding is the key to

successful implementation.

In many countries, external auditors also have an important role to play in

monitoring banks internal controls and procedures, and in confirming that they
are in compliance with supervisory practice.

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In the preceding paragraphs on KYC the focus was on compliance, legal

and reputation risk. There are other risks in banking business. Among
them three major risks are:
Credit risk,
Market risk (trading risk) and
Operational risk

Calculation of



Credit risk is the possibility and the likely extent of default, i.e., failure to
comply with their obligation to service debt. In the case of investmens this could
be in the form of delay or default of repayments on due dates or after. Default
triggers a total or partial loss of amount lent to the counterparty

Market Risk: Market risk is the risk of possible variability in income due to
changes in the rates in the immediate period and of adverse deviations of the
mark to market value of trading portfolio during the period required to liquidate
the transactions. Market risk exists for a period of time. The holding period of
instrument is not appropriate to value market risk, since at any moment it can be
decided to liquidate the instrument or to hedge their future changes of value. The
risk is that market value may move adversely during the minimum period
required to liquidate the market transactions. This is why market risk is limited to
the liquidation period.

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Operational Risk: Operational risks could arise due to human failures,
systems defects, system failures, malfunctioning of the information/reporting
systems and laxity in internal rules and monitoring. Operational risks appear at
two different levels:

The technical level, when the human/information system, or risk

measures, are deficient
The organizational level.
Basel-II has defined operational risks to be other than credit and market
risks but exclude risk due to wrong strategy followed by management.

Some other risks which are variants of the three risks are:

Liquidity risk which implies that short term asset values are not
sufficient to match short term liabilities.
Interest Rate risk is the risk of decline of earnings due to the
movement of interest rates, more particular in respect of
asset/liabilities maturing in the short term
Foreign exchange risk is the possibility of losses due to change in
exchange rate/s. Variation in earnings is caused by the indexation of
revenues and charges to exchange rates, or of the values of assets
and liabilities denominated in foreign currencies.
Solvency risk is the risk of being unable to cover losses, generated by
all types of risks, with the available capital. Solvency risk is therefore
the risk of default of the bank.

A bank should be capable of managing risks in the five areas:

assets & liabilities management
foreign exchange
money laundering, and
internal control and compliance

A Banks Board should establish the supervision committees that will assist it
in accomplishing its supervisory functions in the following critical areas:

Risk management
Asset and liability management
Internal audit (or compliance)

Risk Management Committee

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The Risk Management Committee (RMC) should be headed by the
MD/CEO and the Chief Risk Officer (CRO) and be responsible for the
formulation and oversight of the Banks corporate risk policy. The
Committee comprises senior management officers involved in other
business units reporting to the MD/CEO (or in his absence the CRO) who
will chair RMC meetings. Independence is critical to the RMCs role of
ensuring risks are properly monitored and managed - and adds another
check and balance to the risk process.

General Composition of risk management committee is as follows:

Chairperson: MD/CEO
Vice-Chairperson: Chief Risk Officer (CRO)

Chief Finance Officer (CFO)
Chief Credit Officer (CCO)
Treasurer (TR)
Head of Branch Operations (HBO)
Head of Audit (or Compliance Officer)

The committee can call other senior officers as resource persons in the
committees discussions, from IT/MIS, personnel/ training and
development, as the case may be.)

Credit Committee :

Credit Committee is involved in the policy formulation and review of overall

credit performance. It is well known that credit is a core banking function
and substantial funds of a bank is involved in credit. As such credit
function is critical to the financial health of a bank and therefore the
function Credit Committee is critical. The Credit Committee (CreCom)
may typically have the same core members as the RMC, with the Chief
Legal Counsel as an advisor.


Chairperson: MD/CEO
Vice-Chairperson: Chief Credit Officer (CCO)


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Chief Finance Officer
Chief Risk Officer
Head of Branch Operations

Assets & Liabilities Management (ALM) Committee

The business-mix and balance sheet of a bank is made up of short to

long-term assets and liabilities. The interest rates on these are not
common but vary. The remaining maturities of assets and liabilities vary.
Such variations in maturities and interest rates lead to risk and possible
income variability. Therefore, if assets and liabilities and their composition
and structure are managed efficiently, the bank stands to gain. It should
be noticed that a perfectly matched balance sheet in terms of remaining
maturities of assets and liabilities and interest rates there against will not
leave any scope for earning a spread. Banks make profit by playing on the
spread on risk or period of assets and liabilities. It is therefore essential
that there is an element of mismatch in the assets and liabilities and such
mismatch is within allowed tolerances. This will enable the bank to use the
opportunity rendered by risk at the time avoid too much of risk.

ALM is a crucial/specialist area of bank management. While mismatches

in assets and liabilities cannot be avoided, a totally matched position will
lead to opportunities to earn a spread. In these circumstances, ALM
attains great importance in a bank. ALM Committee looks into the issue of
ALM. ALCO will lay down the tolerances as also exposures within which
the credit and treasury operations will take place. It will also broadly
decide on the business mix.

As a senior management committee, the Asset and Liability Committee

(ALCO) may have the same core members as the Risk Management


Chairperson: MD/CEO
Vice-Chairperson: Chief Finance Officer

Chief Credit Officer
Chief Risk Officer
Head of Corporate Banking
Head of Retail Banking
Head of International Division

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Internal Audit (or Compliance) Committee

The Internal Audit Department is an essential part of the risk management

system that takes lead in the ongoing monitoring of the internal control
processes and providing an independent assessment of system integrity.

As a good practice, in accordance with the mandate of the Central Bank of

a country, the Board of Directors should form a board level Audit
Committee, which is responsible for overseeing the activities of, and
serves as a direct link and primary contract between, the Banks internal
audit department and the external auditors whom it shall engage. An
Audit Committee however will not take away the duties away of the full
Board, which alone is legally empowered to take decisions.

Composition of the Committee :

Chairperson: Chairman of the Board

Members: 2 other members of the Board (preferably with auditing or

accounting background) except the MD/CEO, who may be invited as a
resource person during the committee deliberations.

Every bank, in organizing its functions, should strive to apply the basic
operational risk management principle of segregating responsibilities that
may present potential conflicts of interest. HR, Treasury, Branch
Management and Internal Control functions should also be organized on
these lines. This is essential to avoid operational risk and better efficiency.

The core principle involves the creation of front, middle and back offices.

The following figure depicts the process.

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A bank should establish a set of policies that clearly outline business

development priorities and the conditions under which the grant of credit is to be
undertaken. These guidelines must be updated annually to reflect changes in
economic outlook and the evolution of the loan portfolio.

Good lending practices, additionally, call for the following:

Establishment of an appropriate credit risk environment, under which

the Board is responsible for approving and periodically reviewing the
credit risk strategy and significant policies. The strategy should reflect
the Banks tolerance for risk and the level of profitability that it should
expect to achieve vis-a-vis the various risks incurred.

Responsibility of management for implementing the board-approved

strategy as well as developing policies and procedures for identifying,
measuring, monitoring and controlling credit risk at the individual credit
and portfolio levels.

Institution of a culture for identifying and managing the risks of loan

products / Good Practices / activities, as well as subjecting these to
adequate procedures and controls.

Operating under sound credit granting process that takes into account
lending criteria, know-your-customer (KYC) appraisal processes,
lending limits, portfolio diversification, and transacting at arms-length

Maintaining an appropriate credit administration, risk measurement

and monitoring process.

Instituting work-out procedures for non-performing loans; and

Ensuring that independent, on-going credit review is undertaken and

reports are submitted in time to appropriate levels of management.
Such reviews would determine whether the credit-granting function is
properly managed and that credit exposures are within approved limits
and prudential standards.

A bank may develop credit scoring models that are applicable to its target
customers and product types (e.g., mortgage financing, vehicle financing, micro
credit, small and medium enterprises, agri-business, etc.). Credit scoring will
introduce an ability to conduct more meaningful and discrete assessments of

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loan applications, and provide the bases for acceptance-rejection and risk-based

Policy on Valuation of Securites/Collaterals

The Bank should adopt a policy to ensure that the valuation of assets
which are offered to secure loans is conducted by professionally-certified /
trained appraisers, regardless of whether they are in-house/Bank-
employed officers or third parties.

Accounting of all loans and non-funded credit exposures (L/Cs, guarantees,

etc.) must be centralized to make it possible to conveniently review the over all
position of an account.

It is a good business practice for the bank to institutionalize an independent

credit review process whose objectives should be to:

determine health of the loan portfolio through an internal risk grading

system; and
determine adequacy of monitoring and recovery actions taken in
respect of all accounts, particularly for non-performing loans

All new loans, deposit and treasury products should undergo rigorous
analysis (for interest/market, default/settlement and other operational risks).
Product manuals should be developed and approved by the Management prior to
launching these new products


Good Practices

Under Basel-II, the importance of operational risks is underscored by need

to begin provisioning for potential losses brought about by internal
weaknesses (i.e., inadequate or failed internal processes, people and
systems). Indian banking system is taking steps to comply with the
guidelines in the New Accord. Individual banks have also started
improving/strengthening the internal control environment, as well as the
capability of the staff who are to monitor compliance.

In order to achieve desired results, banks may consider:

Adoption of a suitable internal control and compliance risk policy.

Recruiting of appropriately trained or experienced internal control and
audit staff and
Creation of a manual of all regulations, internal policies and

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Central bank of every country undertakes on site and off site inspection
of banks. Its report is sent to the management of banks. Strict
monitoring of the set of deficiencies and findings contained in such
reports, and ensuring that these are rectified within reasonable time
frames by officers and staff who are specifically assigned for the
reviewing/updating the current sanctions policy for non-compliance
with regulations/policies, and strictly enforcing these and
prosecuting all known perpetrators of insider abuse and fraudulent

Internal Audit & Compliance Risks

The bank relies on an internal control and compliance (ICC) unit to

define, identify and report on operational risks. Problematic staff
should not be posted for this work.
There should be a central repository for all compliance-related circulars
and documents.
Under noted steps are normally taken to reduce risk:

o the Bank must have up-to-date Accounting manuals ;

o the Bank must have a General Ledger account;
o the accounting function must be manned by qualified staff;
o The reconciliation of inter-branch and other general ledger
accounts, must be kept up-to-date.

Market risk

To mitigate market risk, banks adopt the following.

Stress testing/scenario analysis. In the case of illiquid products, a

cross comparison of pricing of similar products in other financial
institutions or the pricing from the primary issuance market may be
used for stress testing purposes.
Expected Return and Treasury performance
Limit management performance (stop-loss, currency, position, product,
transaction, etc.)
Evaluate and quantify the performance of the Treasury unit within the
designated risk profile and risk appetite approved by ALCO.
Historical comparatives and performance benchmarks on the risk
measures, including commentary and analysis by Head of risk
management and Head of treasury as applicable.
Market benchmarks such as key interest rates, LIBOR and other prime
rates should be clearly published in the internal reports and the various
rates of the Bank in relation to these rates disclosed for comparative

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The information requirements should be presented in a format that is
consistent with the purpose of the report. For ALCO or senior
management purpose.


Basel Committee on BANK SUPERVISION has laid down the agreed

framework for measuring capital adequacy and the minimum standard to be
achieved. It indicates how risk should be measured, and how weightages should
be applied to calculate weighted risk. Its basic emphasis is that banks should
have/bring in prescribed levels of capital for covering both unknown and known

Basel-II would be implemented as of year-end 2007. The national supervisor,

RBI in Indias case, will consider, carefully the benefits of the Basel-II in the
context of Indian domestic banking system, and develop a time-table and
approach to its implementation.

Basel-I had introduced risk weighted capital of 8% across the banking

system. Within this, RBI had stipulated that commercial banks will achieve 9%
capital adequacy. Basel-I norms were uniform across the system.

Since the introduction of Basel-I market changes have been rapid and more
risk management tools have appeared in the market.

Basel-II is an improvement over Basel-I. It also recognizes that banks could

be internationally active or confine their operations within the home country. It
has indicated that the capital requirement of internationally active banks should
be developed on the basis of three of (i) minimum capital requirement, (ii)
supervisory review, and (iii) market discipline.

The under-noted diagram shows the three basic pillars of BASEL-II accord.

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Capital requirement
to be arrived at on the
basis of
Scope of Application

Part 1:The First Pillar Part 2 Part3

Minimum Capital The Second Pillar The Third Pillar
requirement -Supervisory review -Market Discipline

Calculation process.

II.Credit risk-the standardized approach
Operational risk.. Initially on a prescribed
III.Credit risk the internal Ratings based
basis. Later on more information will be approach.
available. IV. Credit risk Securitisation Frame work.

VI. Trading Book issues(including market risk)

The committee has retained the key element of 1988 capital adequacy
accord including basic requirements for banks to hold capital
equivalent to 8% of their risk weighted assets.
Major innovation is the greater use of assessments of risk provided by
banks internal systems as inputs to capital calculations.
A detailed set of minimum requirements has been prescribed to ensure
the integrity of internal risk assessments.
National supervisor is expected to ensure compliance and overall
integrity of a banks ability to provide prudential inputs to capital
A range of options are available to supervisors (RBI) and banks to
determine the capital requirement for credit risk and operational risk.

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National supervisor (RBI) is allowed a limited degree of discretion in
which each of these options may be applied to adapt to local market
conditions, but should ensure sufficient consistency in application.
For Banks having branches in foreign countries, general principles
have been prescribed for recognition of Operational Risk Capital
charges under advanced measurement approach for host and home
Revised framework is designed to establish minimum level of capital
for internationally active banks.
Under second pillar the national supervisors must expect host banks to
operate above minimum regulatory capital levels.
Both for broad-brush standardised approach and more sophisticated
Internal ratings based approach, the major loss events may be higher
than allowed for and banks should be asked to hold capital over and
above Basel-II minimum capital.
Inappropriate disparities between regulatory and accounting standards
must be reduced to absolute minimum.
The third pillar relates to market discipline. This requires proper
disclosures in balance-sheet and Profit &Loss account. The guidelines
have been jointly worked out by International Organisaiton of
Securities Commission (IOSCO) and BASEL Committee (BCBS).

Regulatory Capital

Total minimum capital requirement must cover Credit, Market, and

Operational Risks
Total capital ratio must not be less than 8% of risk weighted assets
Tier-II capital is limited to 100% of Tier-I capital
In the Basel-I general loan loss provision as percentage of standard
assets was taken as part of Tier-II capital subject to 1.25% of risk
weighted assets, In Basel-II once a bank switches to Internal Rating
Based (IRB) approach and discards the standardised approach for risk
based assets general loan loss reserves can not be part of Tier-II
o If IRB is used for securitisation exposures or the PD (probability
of default), LGD (Loss given default) approach for equity
exposures {Care - Credit is not included here} EL (expected
loss) must be deducted from Tier-I and Tier-II (both sharing
50% of EL)
o For other security classes (Credit, securities) if IRB is used the
treatment would be as under.
o Compare total eligible provisions made with expected losses as
per IRB approach. If EL exceeds provisions deduct the
difference from capital. Ratio would be 50% each from Tier-I
and Tier-II.

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o If Total EL is less than provisions made the difference may be
added to Tier II capital subject to a maximum of 0.6% of credit-
risk weighted assets. RBI can make it less than 0.6%.


Total risk weighted assets are determined by multiplying the capital

requirement for market risk and operational risk by 12.5 (i.e., the
reciprocal of minimum capital ratio of 8%) and adding the resulting figures
to the sum of risk weighted assets for credit risk. There is distinct
possibility that regulators may permit a scaling factor in order to broadly
maintain the aggregate level of minimum capital requirements, while also
providing incentives to adopt the more advanced risk-sensitive IRB
approach for credit risk.

Flow chart, depicting the way total risk weighted assets of a bank are to be
calculated, is given here-under


Total risk

The Basel Committee itself mentions in its recommendations that they expect
national regulators to start the processes by year 2006 and ensure that
internationally active banks follow them by 2007. National regulators are
expected to extend the coverage to nationally significant banks immediately


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The accounting concepts and standards, double entry book-keeping

system, account books and financial statements are applicable to all types
of business. Banks have to maintain their accounts and watch their
financial strength. For this they need an efficient accounting system. Also
banks, as lenders, assess the financial position and strength of the
borrowing entities by analyzing their financial accounts. Thus accounting
Concepts and Standards have great relevance to day to day banking. The
basic framework of:

the accounting concepts and standards,

the systems and methods of accounting,
the rule of double entry book-keeping and
the main kinds of books of accounts,

The meaning and composition of balance sheet and profit and loss
statement is explained below.


Meaning of Accounting:

Book-keeping and accounting are similar but distinguishable concepts.

Book keeping refers to the recording of business transactions in the books
of original entry (Journal) and ledger. Accountancy is a broader concept. It
refers to the compilation of accounts in a manner that enables one to
know and assess affairs of the business. The American Institute of
Certified Public Accountants has defined Accounting as an art of
regulating, classifying and summarizing in a significant manner and in
terms of money, transaction and events which are, in part at least, of a
financial character and interpreting the results thereof.

Flowing from the above definition main features of Accounting are:

It records, classifies and summarizes business transactions in an

orderly and systematic manner.
It records transactions in terms of money to make them meaningful
and comparable on the basis of their monetary values.
It records events and transactions that are monetary in nature.
It helps in interpreting the financial data for decision making.

Accounting Concepts:

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Accounting is guided by specific concepts and principles. The brief
implications of ground-level basic accounting concepts are explained

Business entity concept: Business entity (firm, company, and

corporation) is different from the persons who own or run the business.
The accounts of the business and owners are kept separately from
each other and are not inter-mingled, so that the true financial position
of business can be known at any point of time.

Dual Aspect concept : Each transaction has dual aspects i.e., debit
and credit. Every debit has a corresponding credit and vice versa.

Going Concern concept : Accounting presumes the business to be

going continuously till it is wound up. It is based on the principle that a
corporate is a perpetual entity. Accordingly assets and liabilities are
shown at book value as not intended for sale. If, however, the
accountant has good reason to believe that the company is going to be
liquidated, the assets will be reported at their liquidation value.

Accounting period concept : Accounting measures the result of

business activity at specified periods, usually a year. Revenues and
costs pertaining to a particular yearly period are prepared. The yearly
period is called accounting year of the business and it may be a
calendar year (from 1st January to 31st December), or financial year
(from 1st April to 31st March), or any other yearly period.

Money measurement concept : As mentioned above, accounting

records transaction that is expressed in monetary terms. Non-
monetary transactions that can not be expressed in monetary values
on objective basis are not recorded in accounting.

Matching cost against revenues: All transactions pertaining to the

same period are recorded simultaneously to derive the income or loss
for a particular period. It thus matches income with cost incurred to
earn that income, so that the resultant profit or loss is correctly arrived

Historic Cost concept : Transactions are recorded at the amount

involved and assets are recorded at cost incurred. This is called the
historic cost concept.

Accrual concept: Income and expenses are generally recorded as and

when they become due for receipt and payment, and not when they
are actually received or paid in cash.

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Accounting is done on the basis of certain accepted customary principles,

which are known as accounting conventions. Accounting Standards are
written policy documents issued by government or regulatory body
covering various aspects of revenue recognition/ measurement,
presentation and disclosure of accounting transactions in financial
statements. The main objectives of accounting standards are:

To standardize diverse accounting policies and practices to eliminate

non-comparability of the financial statements,
To produce reliable financial statements that give a true and fair view
of the financial position disclosed thereby.
To facilitate corporate accountability.
To fix responsibility on auditors to report deviations from the standards:
Auditors satisfy that the accounting standards are properly
implemented by the businesses whose accounts are audited by them.
In cases of deviations from the accounting standards, the auditors
have a duty to make proper disclosures in their report about such
deviations and qualify their report.

Accounting Conventions:

Following are the main accounting conventions or principles:

Principle of Consistency : The accounting principles followed by a firm

in one accounting year should also be followed in the subsequent
years, to make the financial data of the firm for various accounting
years comparable. Any change in the accounting principle introduced
in a year for certain reasons, should be specifically mentioned in the
financial statements and the effect of the change should also be

Principle of Disclosure : The significant accounting practices and other

material information followed in preparation of financial statements
should be disclosed accurately, to enable the analysts to draw proper
conclusions from the statements.

Principle of Conservatism: This is based on the rule that anticipate no

profit, but provide for all possible losses. Between the optimistic and
conservative scenarios, the former is taken into account by the
accountants. Thus, all foreseeable losses are accounted for and
uncertain gains/ profits are not recognized as income.

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Principle of Materiality : An event is considered material if it affects
significantly a decision or transaction or value. Accordingly, all material
events and policies are disclosed in the financial statements.

Accounting Standards:

The European Union and majority of countries have adopted International

Accounting Standards. The U.S. companies and companies listed on
stock exchanges in America have to prepare Accounts according to U.S.
Generally Accepted Accounting Principles (GAAP). In India the regulators,
the Income-Tax act, and the Company Law Board requires all accounts to
be maintained according to Indian Accounting Standards. Pending setting
up of an Accounting Standards Board of India, the Company Law Board
has authorized, the Institute of Chartered Accountants of India (ICAI) to
prescribe Accounting Standards in India. ICAI constituted the Accounting
Standards Board in 1977, recognizing the need to harmonize the diverse
accounting policies and practices in India and keeping in view the
international developments and internationalization of business in the
country. The Accounting Standards are mandatory for the accounting
profession but are secondary to specific instructions of RBI and SEBI and
specific laws framed by the parliament. In case any company does not
follow the standards, the auditors will have to qualify his report on the
companys accounts.

The Board has issued 15 Standards applicable for financial institutions.

These are as under

Disclosure of accounting practices.

Valuation of inventories
Change in financial position
Contingencies and events happening after balance sheet
Prior period and extra-ordinary items and changes in accounting
Depreciation accounting
Accounting for construction contracts
Accounting for research and development
Revenue recognition
Accounting for fixed assets
Accounting for changes in foreign exchange rate
Accounting for government grants
Accounting for investments
Accounting for amalgamations
Accounting for retirement benefits.

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The International Accounting Standards Board, the international body has
issued under noted standards:

IAS1 Presentation of financial statements

IAS2 Inventories
IAS7 Cash Flow Statements
IAS8 Accounting Policies, Changes in Accounting Estimates and Errors
IAS10 Events After the Balance Sheet Date
IAS11 Construction Contracts
IAS12 Income Taxes
IAS14 Segment Reporting
IAS16 Property, Plant and Equipment
IAS17 Leases
IAS18 Revenue
IAS19 Employee Benefits
IAS20 Accounting for Government Grants and Disclosure of Government
IAS21 The Effects of Changes in Foreign Exchange Rates
IAS23 Borrowing Costs
IAS24 Related Party Disclosures
IAS26 Accounting and Reporting by Retirement Benefit Plans
IAS27 Consolidated and Separate Financial Statements
IAS28 Investments in Associates
IAS29 Financial Reporting in Hyperinflationary Economies
IAS30 Disclosures in the Financial Statements of Banks and Similar
Financial Institutions
IAS31 Interests in Joint Ventures
IAS32 Financial Instruments: Disclosure and Presentation
IAS33 Earnings per share
IAS34 Interim Financial Reporting
IAS36 Impairment of Assets
IAS37 Provisions, Contingent Liabilities and Contingent Assets
IAS38 Intangible Assets
IAS39 Financial Instruments: Recognition and Measurement
IAS40 Investment Property
IAS41 Agriculture


Single and Double Entry Systems are the two major systems of recording
transactions in books of accounts. A single entry system follows a receipt and
payments mode and only a Cash or Bank Book is maintained. It does not, for
example, distinguish receipts against credit sales and cash sales. It does not
recognize parties either. As such it is, at any given point of time, difficult to
comment on the financial strength of the business. On the contrary, in Double

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entry system, every transaction is recorded in two of accounts one representing
the debit side of the transaction and the other representing the credit side.

Other methods of accounts are Cash and Mercantile Methods. In Cash

method of accounting, entries for transactions are made only when cash is
received or paid. No entry is made when a payment or receipt becomes due. In
Mercantile method of accounting, income and expenditure are recorded at the
time of their occurrence during the year, irrespective of actual receipt or payment
in that year.


Double entry system is the universally adopted accounting system for

business. The main principles of Double entry book-keeping are:

Every business transaction has two aspects one receives benefit and
the other gives benefit. This gives rise to double entry system which
implies that every debit has a corresponding credit.
Both the aspects of transaction debit and credit sides- are recorded in
books of account.
The two-fold effect of a business transaction is recorded by debiting
one account and crediting other account at the same time.

There are distinct advantages of double entry system as mentioned below;

because of which banks and all business organizations follow double entry
system of book-keeping:

Since both the aspects are recorded simultaneously, and they are
equal in amount, the system ensures arithmetical accuracy of the
All business transactions are recorded systematically and the chances
of error are reduced.
It enables one to know at any time the amounts receivable/ payable
from/ to customers, expenses and income under each head of account
and the amount spent under various heads.
The system enables the accountant to prepare the annual accounts
profit and loss account and balance sheet.
The system can be implemented by any type / size of organization.

Rules of Double Entry:

Business activity revolves mainly on three categories of accounts:

Real account: they relate to assets or properties. A separate account is

maintained for each asset, e.g. cash, stock, building, machinery.

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Personal account: These are accounts of various entities, e.g.,
individual, firm, company, local authority, association, society.
Nominal account: These are accounts of expenses (losses) and
income (Profit/Gain).

The rules of double entry system of book keeping in respect of the three
kinds of accounts are given below:

Rule for Personal accounts: Debit the receiver and credit the giver.

Rule for Real accounts: Debit what comes in and credit what goes out.

Rule for Nominal accounts: Debit the expenses or losses and credit the
income or gains.


Journal: Journal means a daily record of transactions. It is a book of original

entry and all business transactions are recorded in journal in the order in which
they take place. The process of recording transactions in journal is called
journalizing. After recording in the journal, they are posted in the ledger in the
respective accounts, mentioning the folio number (L.F or ledger folio) of the
ledger where the respective account is opened. In the journal, both debit and
credit sides of each transaction are recorded with the amount and brief
particulars of transaction are given by way of narration.

Ledger: A Ledger is a summary of statement of all transactions relating to a

person, assets, expenses/ incomes, which took place during a particular period
of time, and their net effect. A ledger has pages numbered serially. An alphabetic
index is also provided in the ledger to facilitate reference.

We may now distinguish between journal and ledger as follows:

Journal Ledger
A book of original entry. A book of final entry.
Transactions are recorded daily Posting is made simultaneously from
Information about accounts is datewise Information is account-wise and
Journal shows both aspects of double It shows that aspect of journal which is
entry. ( each aspect may deal with two related to the head of a/c.
heads of accounts such as real a/c,
personal a/c or nominal a/c)
Vouchers, receipts, debit/credit notes Journal constitute basic record
form basic record
The basic documents for entry.

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Cash Book : It keeps record of all cash transactions receipts and payments.
Its ruling is like a ledger account and it is divided into two sides debit and credit.
All receipts are recorded on the debit side, and all payments on the credit side. It
is a book of original entry as all cash transactions are first recorded in cash book
and thereafter to various ledger accounts from the cash book. It is also called a
ledger or book of final entry, as all cash receipts are entered on the debit side
and all payments on the credit side. Thus a cash book is both a subsidiary book
and a ledger account.

Petty Cash Book : A petty cash book is a subsidiary book where all petty
(small value below a defined level) cash expenses are recorded, e.g.,
conveyance, cartage etc. If these petty expenses are recorded in cash book, it
will become too bulky and unwieldy. The firms therefore appoint a petty cashier
to make all petty cash payments and record them in petty cash book.

Journal : When cash transactions are entered in cash book/ petty cash book,
all non- cash transactions are routed through Journal e.g., all opening, closing
and rectification entries are first made in journal and then posted in ledger.

Trial Balance : It is not a book of account. It is a statement showing debit and

credit balances taken from ledger, including cash and bank balances as on a
particular date. Its features are:
It is a list of debit and credit balances taken from ledger.
It includes cash and bank balances.
Its main purpose is to establish arithmetical accuracy of transactions
recorded in the books of account.
It is usually prepared at the end of a month/ quarter/ half year/ year.
It facilitates preparation of final accounts.


As per the Companies Act, 1956, Financial Statements include the

balance sheet, Profit and Loss account, Accounting Policies and Notes to
the account. Accounting Standard AS.3 framed by ICAI deals with
financial statements of corporates. Accounting policies and Notes to the
accounts are disclosures made by the company in the financial statement
as per accounting norms for a realistic understanding of the accounts
presented. The meaning and structure of balance sheet and Profit & Loss
statement is explained below.

Balance Sheet: Balance sheet is a financial statement showing the assets

and liabilities of a business entity as on a particular date. The total assets must
tally with total liabilities, as every balance sheet is based on double entry book-
keeping system. The name balance sheet also signifies that its two sides must
balance. If the two sides do not balance, it is a sure sign of some arithmetical

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error or mistake in the accounts. A classified structure of balance sheet of ABC
Bank Ltd., is illustrated below. It should be remembered that in a Balance sheet -

ABC Bank Ltd. - Consolidated Balance-sheets

as at December 31 2004 (in millions dollars)

2004 2003
Cash resources:

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Cash and deposits with Bank of Canada 328 256
Deposits with regulated financial institutions 4,094 3,373
4,422 3,629
Investment 1,967 2,234
Trading 1,055 642
3,022 2,876

Businesses and governments 13,450 11,664
Residential mortgages 11,966 10,880
Consumer 3,252 2,702
Allowance for credit losses (349) (313)
28,319 24,933
Customers liability under acceptances 3,754 3,247

Land, buildings and equipment 101 111

Other assets 1,381 1,141
5,236 4,499
GRAND TOTAL : 43,263 37,509
Liabilities and Shareholders Equity
Regulated financial institutions 635 641
Individuals 14,818 13,924
Businesses and governments 18,395 14,774
33,848 29,339
Acceptances 3,754 3,247
Securities sold under repurchase agreements 23 30
Other liabilities 2,785 2,340
Non-controlling interest in trust and subsidiary 230 230
Subordinated debentures 6,792 5,847
Shareholders equity: 426 504
Capital stock
Preferred 125 125
Common 1125 950
Contributed surplus 177 169
Retained earnings 770 575
2,197 1,819
GRAND TOTAL : 43,263 37,509

Profit & Loss Statement:

Profit & Loss Statement (abbreviated as P&L Statement) shows the

revenue (income) and expenses (costs) of a business and the resultant
surplus (profit) or deficit (loss) of an entity during an accounting period.

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ABC Bank Ltd.s consolidated statement of income showing net profit
made is reproduced here-under:

ABC Bank Ltd.

Consolidated Statements of Income

For the years ended December 31 (in millions of dollars except per share amounts)

2004 2005
Interest income:
Loans 1,396 1,375

Securities 82 103
Deposits with regulated financial institutions 69 54
1,547 1,532
Interest expense:
Deposits 617 632
Debentures 34 35
651 667
Net interest income 896 865

Provision for credit losses 66 61

Net interest income after provision for credit 830 804
Non-interest revenue:
Deposit and payment service fees 81 79

Credit fees 81 69
Capital market fees 110 93
Investment administration fees 60 53
Foreign exchange 68 61
Trade finance 28 26
Trading revenue 12 9
Securitization income 25 26
Other 61 27
526 443
Net interest income and non-interest revenue 1,356 1247
Non-interest expenses:
Salaries and employee benefits 423 379

Premises and equipment, including amortization 101 107

Other 272 259
796 745

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Income before the under noted 560 502
Effect of accounting change 14 -
Income before provision for income taxes and non- 574 502
controlling interest in income of trust
Provision for income taxes 210 188
Non-controlling interest in income of trust 16 16
Income from continuing operations 348 298
Income from discontinued operations 5 2
Net income 353 300
Preferred share dividends 8 8
Net income attributable to common shares 345 292
Average number of common shares outstanding (000s) 4,81,066 471,168
Basic earnings per common share 0.72 0.62

IMPORTANT MONITORING TOOLS (Net Interest Income, Cost to Income)

Under-noted factors are monitored by the managements, analysts and

market to keep track of income generating capability of the Bank. These
Net Interest Income : This is the net contribution of fund based
operations of the bank, and shows operational and financial
effectiveness of the management. For ABC Bank Ltd., this increased
from Can $ 865 million to Can $ 896 million in one year. This shows
that Bank is able to generate more contribution from its core
Non Interest Income : This income increased from Can $ 443 million to
Can $ 526 million. This income is not affected by fluctuations in interest
rates and forms bed-rock of stability in a bank. The employee cost in
these two years was $379 million and 423 million. It is noted that other
income more than amply covered the staff cost. Internationally good
banks cover their staff cost through other income. None of the Indian
banks have this feature.
Cost to Income ratio. It compares net income (net interest income+ net
other income) with employee cost and other costs. In the case of ABC
Bank Ltd., it improved to 170% in 2004 from 167% in 2003. It shows
that for each Can $ 100 earned ABC Bank Ltd., gets operating income
of $41.17. This by any standards is a very high ratio, and shows
satisfactory financial health of ABC Bank Ltd.

Accounting in Core banking environment

Most of the banks being dependent on branches, maintain branchwise

general ledger. This suffers from few basic draw-backs as under:

There is no general ledger for the bank,

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Income and expense for the entire bank is not maintained in one book
at one place,
There is no way to find out on day to day basis as to whether banks
operations are making net contribution to its worth or it lost money on a
day or during a specified period,
Distributed accounting databases in branch banking suffer from
serious MIS problems.

With the introduction of Core Banking, Bank captures all transactions in

the bank at one place and generates general ledger on day to day basis.
While Core Banking does in no way change the accounting system or
accounting principles. it provides ready MIS, income, expense and
business figures on day to day basis. Internally it increases the
effectiveness of MIS and adds to managerial effectiveness.



It has been previously stated that the bank accounting double entry
concept follows accrual principle wherein the income and expenditure for
the year whether or not actually received / spent is accounted on an
accurual basis. For example, if a bank has to receive Rs.1,000 as interest
income for the period April to March the entire Rs.1000 is accounted as
income, though only Rs.900 might have been received. Actually, Rs.1,000
is shown as income. Rs.900 received and Rs.100 receivable. This concept
does not take into account possible defaults. As such defaults and bad
accounts are recorded as and when they occur.

Such approach will result in volatility of income and in respect of banks

possibily affect market price of shares, which are quoted in the market.
Since the income may not be realized, should the account become bad,
the profit and loss account may not be true and fair. It was, therefore,
necessary that banks should conservatively estimate their income and
unrealizable income may not be taken into account. Accordingly banks
may not recognize income in respect of debts which are not regular,
wherein either interest payment or installment due is in arrears. These
accounts, known as overdue accounts have been broadly classified as
Non-Performance Assets (NPAs). Basel-I had stipulated that in the case
of NPAs prudential accounting norms, i.e., Income Recognition & Asset
Classification (IRAC) norms are applied.

6.9.1 Asset Classification

Banks advances are classified as performing and non-performing assets.

An advance giving income on continuous basis is called performing asset.

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A non-performing asset, on the other hand , is one which remains overdue
for 90 days.

The term loan is treated as NPA, if interest installment remain overdue for
more than 180 days while cash credit/overdraft account is treated as NPA,
if outstanding amounts remain over and above sanctioned limits/ drawing
power for more than 90 days.

The bill purchased/ discounted is treated as NPA, if bill remains overdue

and unpaid for 90 days.

6.9.2. Income Recognition:

The income from performing assets is recognised on accrual basis and

interest income from non-performing assets is recognised on cash basis.

6.9.3 Asset Classification for Provisioning Requirement:

The rules regarding classification and provisioning requirements are listed


Category Standard Asset Sub-Standard Doubtful Asset Loss Asset


Definitional A performing asset Which has Which has

Requirement with just normal remained NPA for remained NPA for
risk attached a period not a period
exceeding 18 exceeding 18
months. months.

Provisioning 0.25% 10% of total Unsecured portion- 100% of total

Requirement outstanding 100% outstanding

Secured portion:

-Debt doubtful 20%

upto one year

1 to 3 years- 30%

More than 3 years



Assets - Value of possessions owned by the business.

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Amortization - The process of fully paying off indebtedness by installments of
principal and earned interest over a definite time.

Account Introduction - For opening a bank account, introduction from

someone known to the bank (like an existing account holder) or a satisfactory
reference (such as, Passport, Identity Card, Ration Card, etc.) is required so as
to establish the identity and genuineness of the person/party in whose name the
account is being opened.

Account Payee - These are the words added to the crossing on a cheque,
which means that the cheque be collected through a banker and proceeds
deposited, only in the payees account. These words, however, do not affect the
negotiability of a cheque.

Bond Bonds are medium or long term debt instruments issued by Government
of India or State Government or Public Sector Undertakings

Bank Rate - Interest rate at which the Central bank lends to the commercial

Bill discounting Buying of Bills at a predetermined rate at a discount to face


Bill re-discounting - Discounting a bill (generally by the Central Bank) that has
already been discounted by a commercial bank.

Bill of exchange - A means of trade payment that a company uses to raise

finance from a bank

Balance-sheet - It shows the financial position of a concern as on a particular

date .It is a statement of assets [property owned] and liabilities [amount owed] of
the business as on that date.

Bank Charges - This term is used for the charges levied by a bank for the
various services it renders to its customers.

Bank Draft - A bank draft is a cheque drawn by a bank on one of its own
branches or correspondents requesting the latter to pay the specified sum of
money to the person named in the draft.

Banker's Acceptance - Banker's acceptances are negotiable time drafts, or bills

of exchange, that have been accepted by a bank which, by accepting, assumes
the obligation to pay the holder of the draft the face amount of the instrument on

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the maturity date specified. They are used primarily to finance the export, import,
shipment or storage of goods.

Bill of Lading It is a shipping document issued to an exporting firm or its bank

by a shipping company for carrying of goods.

Basel-II -The revised Basel Capital Accord that seeks to make the capital
adequacy requirements for banks more risk-sensitive than the original 1988

Bank for International Settlements (BIS) - International organization

established in 1930 and based in Basle, Switzerland, that serves as a forum for
central banks collecting information, developing analyses and co-operating on a
wide range of policy-related matters.

Clearinghouse Inter-bank Payments System (CHIPS) - An automated clearing

system used primarily for international payments. This system is owned and
operated by the New York Clearinghouse banks and engages FedWire for

Collateral Securities - Property that is offered to secure a loan.

Correspondent Bank - Bank that accepts deposits of, and performs services for,
another bank (called a respondent bank); in most cases, the two banks are in
different cities.

Credit Scoring System - A statistical system used to determine whether to

grant credit by assigning numerical scores to various characteristics related to

Commercial Invoice - It is issued by the exporter. It contains a precise

description of the merchandise, such as, price, quantity, etc

Cheque -The term cheque is defined under Section 6 of the Negotiable

Instruments Act, 'as a bill of exchange drawn on a specified banker and not
expressed to be payable otherwise than on demand.

Current Account - This is a type of account which can be opened in a bank by

any individual, business enterprise, company, government/semi-government
organisation, etc. whose transactions happen to be numerous on every working

Current Assets - Assets which are reasonably expected to convert into cash
during the operating cycle of business, e.g., stock, debtors, cash ,etc.

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Current Liabilities - Liabilities which are repayable within a period of one year,
e.g., Trade Creditors.

Capital - Money invested in a business by the partners.

Current Assets - Assets expected to be converted into cash within a year.

CAMELS Model - An international bank-rating system with which bank

supervisory authorities rate institutions according to six factors. The six areas
represent Capital Adequacy, Advances, Management, Earnings, Liquidity &
Systems (CAMELS).

Commercial paper - An unsecured short-term loan issued by a corporation,

typically for financing accounts receivables and inventories. It is usually issued at
a discount reflecting prevailing market rates.

Convertible bonds - A bond that can be converted into a predetermined amount

of the company's equity at certain times during its life, usually at the discretion of
the bondholder.

Capital Reserves - A reserve created out of capital profits like share premium,
profit on revaluation of assets etc.

Cash Credit - It is a running account for drawing within a specified credit limit
sanctioned by the bank against the security of stocks (raw materials, stock-in-
process, finished goods, stores) and book debts, which are pledged/
hypothecated by the borrower

Currency swap - It is a derivative instrument.It is an agreement between two

parties to exchange cash flow in one currency with that of another currency at a
pre-determined rate.

Debentures - An acknowledgement of indebtedness usually given by an

incorporated company under its common seal.

Disintermediation - The borrowing and lending of funds without the use of the
middleperson e.g., banks, brokers, etc.

Derivatives - A financial product having a value deriving from an underlying

variable asset.

Deferred Payment Guarantee - is a form of guarantee /undertaking given by a

bank on behalf of its customer while purchasing machinery items on deferred
payment basis.

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Deposits - It is a sum of money lodged in a bank for the purpose of earning
interest. A deposit is repayable according to terms of acceptance.

Demand Deposits - These include balances in current account and term

deposits which have become due for payment but are yet to be paid.

Debit Card - A card that resembles a credit card but which debits a transaction
account (checking account) with the transfers occurring concurrently with the
customer's purchases.

Electronic Funds Transfer (EFT) - Transfer of funds electronically rather than

by check or cash.

Euro-dollars - Deposits denominated in U.S. dollars at banks and other financial

institutions outside the United States. Although this name originated because of
the large amounts of such deposits held at banks in Western Europe, similar
deposits in other parts of the world are also called Eurodollars.

Equity - Money invested in a company by the owners via issued share capital
and reserves.

Fixed Deposit Account - Fixed Deposits are for a fixed or specified period
chosen by the depositor and are repayable on expiry of that period.

Factoring - The process of buying a manufacturers invoices at a discount and

taking the responsibility of collecting the payments due to them.

Financial System - A mechanism in an economy mobilizing the resources from

various surplus sectors and allocating to various needy sectors.

Finished Goods Completed goods held by a business and ready for sale.

Fixed Assets - Assets that are normally purchased for long term use, e.g., car,
machinery, etc.

General Reserve - A reserve created out of profits to meet any unforeseen


Goodwill - Value of reputation associated to a business and expressed in

monetary terms.

Hire purchase Agreement - An agreement under which the goods are let on
hire and the hirer has an option to purchase them in accordance with the terms of
the agreement.

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Intangible assets - Fictitious Assets which have no tangible existence, e.g.,

Lease - Lease may be defined as a contractual arrangement whereby the

owner (lessor) of an equipment transfers the right to use the equipment to the
user (lessee) for an agreed period of time in return for rental.

Lien - Where the debt is due by one person to another, the creditor has the right
to hold and retain the debtors property until the debt has been settled.

Liabilities - Value of items owed by a company.

Letter of Credit - It is a document issued by a bank at the request of an


Merchant Banking - Activities relating to corporate finance, public issue, project

finance, mergers and acquisitions, etc., undertaken by a merchant bank.

Mutual Funds - Mobilisation of Funds by rganisations in public sectorand

private sector for purposes of investment in stock market securities so as to give
adequate return to shareholders who cannot invest directly.

Net Profit - Actual profit made by a company after taking away the variable and
fixed costs.

Nomination - Banks ask their account holders to make nominations which mean
that they should nominate persons to whom the money lying in their accounts
should go in the event of their death. Nomination can be made in account
opening form itself or on a separate form indicating the name and address of the
nominee. The account holders can change the nomination any time.

Net worth - The amount by which an individual/firms assets exceed the liabilities

Non-performing assets - Any asset that is not effectively earning any income.

Order Cheque - This is a cheque which is payable to a person named in the

cheque or as per his order. A paying banker is granted protection if he makes
payment of an order cheque having forged endorsement on behalf of payee.

Primary Dealers - Dealers who first buy securities that are issued in the market,
especially government securities.

Pension Funds- Investment firms whose main source of funds are the pensions
of salaried employees.

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Overdraft - Overdraft means drawing from a current account, over and above
the credit balance therein. A limit for overdraft is sanctioned for a specific
purpose and period. Overdraft facility may be secured (against government
securities, company shares/ bonds, banks own fixed deposits etc.) or unsecured

Over-the-counter (OTC) - Figurative term for the means of trading securities

that are not listed on an organized stock exchange such as the New York Stock
Exchange, as in OTC margin bonds. Over-the-counter trading is done by broker-
dealers who communicate by telephone and computer networks.

Payments System - Collective term for mechanisms (both paper-backed and

electronic) for moving funds, payments and money among financial institutions
throughout the nation.

Profit & Loss Statement - it shows the performance concern during the relevant
period [normally, one year] showing the sources and the amount of revenue and
the expenses incurred and profit or loss made by the business.

Repo {repurchase agreements} - An agreement by which, for example, the

Federal Reserve purchases a security for immediate delivery and receives
interest at a specific rate from a government securities dealer, with an agreement
to sell the security back at the same price by a specific date.

SLR - Statutory Liquidity Ratio (SLR) are reserves to be maintained by

commercial banks in the form of unencumbered securities to ensure liquidity of
the banking system

Stock - Accumulated value of raw materials, work in progress and finished goods
held by a company at a specific time.

Trade Creditors - Suppliers the company owes money to, usually for services or
goods supplied.

Trade Debtors - Clients who owe the company money for services and goods
bought on credit.

Securitization-The process of creating a financial instrument by combining other

financial assets and marketing them to investors.

Savings Deposit Account - Such deposit accounts are generally meant for a
class of people who want to save a small part of their income to be used in the
near future and also intend to have some income on such savings.

Standing Instructions - Such term, when used in the context of a banker and
customer relationship is meant to be an instruction given by a customer to his

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banker to pay a person or an organization a certain sum of money at regular
intervals by debit to his/her account.

Stop Payment - A customer has a legal right to give instruction to bank for
stopping payment of a cheque issued by him but before it has been presented for

Tier 1 capital- A term used to describe the capital adequacy of a bank. Tier-I
capital is core capital, which includes equity capital and disclosed reserves.

Treasury Bills- A government security with a maturity period of less than a year

Term Deposits It is a Time Deposit accepted for a fixed period carrying a fixed
rate of interest.



ACH- Automated Clearing House

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ACS- Automated Clearing System
ADR- American Depository Receipts
ALCO- Asset Liability Committee
ALM- Asset Liability Management
AMC-Asset Management Company
ATM- Automatic Teller Machine
ATS- Automatic Transfer Service
BCBS- Basel Committee for Bank Supervision
BCCI- Bank of Credit and Commerce International
BIS- Bank for International Settlements
BOTM- Bank of Tokyo Mitsubishi
BPO- Business Processes Outsourcing
BRA- Banking Regulation Act
CAMELS - Capital Adequacy, Advances, Management, Earnings,
Liquidity & Systems
CAR- Capital Adequacy Ratio
CBN- Core Banking Network
CCIL-Clearing Corporation of India Limited
CCO- Chief Credit Officer
CD- Certificate of Deposit
CEO- Chief Executive Officer
CFO- Chief Finance Officer
CHIPS- Clearinghouse Interbank Payments System
CIF- Cost, Insurance, Freight
CMS-Cash Management Services
CRD- Cash Ratio Deposit
CRO- Chief Risk Officer
CRR- Cash Reserve Ratio
DA- Deliverable against Acceptance
DFID-Department for International Development
DP- Deliverable on Payment
DPG- Deferred Payment Guarantee
DSA- Direct Selling Agent
DSCR- Debt Service Coverage Ratio
ECB- External Commercial Borrowing
EFT- Electronic Funds Transfer
EFT- Electronic Funds Transfer
EMI- Equated Monthly Installments
EU- European Union
FATF- Financial Action Task Force
FDIC- Federal Deposit Insurance Corporation
FII-Foreign Institutional Investor
FINCEN- Financial Crimes Enforcement Network
FIs- Financial Institutions
FOB- Free-on-Board
FRB- Federal Reserve Bank

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FSA- Financial Services Authority
GAAP- Generally Accepted Accounting Principles
GDR- Global Depository Receipts
GTB- Global Trust Bank
HBO- Head of Branch Operations
HRD- Human Resources Development
HSBC- The Hongkong and Shanghai Banking Corporation Ltd.
HUF- Hindu Undivided Family
IA- Internal Audit
IBA- Indian Banks Association
ICAI- Institute of Chartered Accountants of India
IDBI- Industrial Development Bank of India
IFC- International Finance Corporation
IOSCO Interantional Organisation of Securities Commission
IPO- Initial Public Offer
IRA- Individual Retirement Accounts
IRB- Internal Rating Based
IRDA- Insurance Regulatory and Development Authority
IRS- Interest Rate Swaps
JENA- Japan Europe North America
JIBC-Japan Bank for International Co-operation
KYC- Know Your Customer
L/C- Letter of Credit
LIBOR- London Interbank Offered Rate
ME- Merchant Establishments
MICR- Magnetic Ink Character Recognition
MIS- Management Information System
MMD- Money Market Deposits
MMDA- Money Market Deposit Accounts
MODS- Multi-Option Deposit Scheme
NABARD- National Bank for Agriculture and Rural Development
NACHA National Automated Clearing House Association
NBFCs- Non-Banking Financial Companies
NDS- Negotiated Dealing System
NDTL- Net Demand and Time Liabilities
NGO- Non-Governmental Organisation
NIA-Negotiable Instruments Act
NOW- Negotiable Order of Withdrawal
NPAs- Non-Performing Assets
OCT- Operation Control Terminal
OECD- Organisation for Economic Co-operation and Development
OFAC- Office for Foreign Assets Control
OMO-Open Market Operations
OTC- Over-the-Counter
PD- Primary Dealer
PIN- Personal Identification Number

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POS- Point-of-Sales
QIBs-Qualified Institutional Borrowers
RBI- Reserve Bank of India
RCC- Risk Control and Compliance
REPO- Repurchase Agreement
RMC- Risk Management Committee
RMG- Risk Management Group
RRB- Regional Rural Bank
RTGS- Real Time Gross Settlement
SEBI- Securities and Exchange Board of India
SEBPs- Simplified Employee Benefit Plans
SLR- Statutory Liquidity Ratio
SME- Small and Medium Enterprises
SPNS-Shared Payment Network Systems
STP- Straight Through Processing
SWIFT- The Society of Worldwide Inter-bank Financial Telecommunication
TAD- Terminal Access Device
T-Bills- Treasury Bills
TR- Treasurer
VaR- Value at Risk


Sample Questions
[Question Paper pattern]

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Q 1] Which one of the following statement is not true in respect of financial
system and payment and settlements:

a] The first major component of financial system is payment and settlements.

b] Payment system enables two-way flow of payments in exchange of goods and
services in the economy.
c] Payments and settlements are the basic function of banking in national and
supranational economies
d] Financial savings is one of the smallest components of financial system.

Q 2] The Central Banking Authority of a country controls and supervises the

following sectors :
1] All Commercial Banks
2] All Stock Exchanges, Investment Banks and Mutual Funds
3] All Life and General Insurance Companies
4] Non Banking Financial Companies
a] 1and 2 are true
b] 1and 3 is true
c] 1 and 4 are true
d] 2 and 3 are true

Q 3] The term Primary Dealers in the context of Government securities and

money market refers to
a] Dealers who provide long term for industry and Agriculture
b] Dealers in Government securities both in primary and secondary
c] Dealers who are allowed raise deposits and give advances and are subject to
d] Dealers who are allowed to lend money for leasing, hire purchase, bill
discounting etc.

Q 4.The following statement/s is/are true in respect of mutual funds :

1] Mutual Funds are financial intermediaries who sell units to their
2] Mutual Funds are formed as Asset management Companies
3] Mutual Funds can accept deposits from the public
4] Mutual Funds pay interest on the units sold by them
The following statements are true
a] 1and 2 are true
b] 1 and 3 are true
c] 3 and 4 are true
d] 1 and 4 are true

Q 5] The following may be considered as important principles that emanate from

the core functions of Banking
1] Liquidity Principle

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2] Solvency Principle
3] Profitability Principle
4] Leverage Principle
5] Operational Principle
Which of the above statements are important?
a] Statement 1, 2 and 3 are important
b] Statement 1,3and 4 are Important
c] Statement 1, 4 and 5 are Important
d] statement 1, 2 and 4 are Important

Q 6] Banking is defined as accepting for the purpose of lending or investment of

deposits of money from the public, repayable on demand or otherwise and
withdrawable by cheque, draft, order or otherwise
The above definition on banking is attributed to
a] Definition in Banking Regulation Act, 1949
b] Definition given by Haisbury
c] Definition given by John Paget
d] Definition given by Dr.Herbert L Hart

Q 7. High volume and low size accounts with multiple distribution channels are
considered as some of the characteristic features of the following type of banking
a] Retail Banking
b] Wholesale Banking
c] International Banking
d] Universal Banking

Q 8. Basel Committee on banking supervision categorizes banks into three main

categories. Which of the following category of banks does not belong to the
above three?

a] Internationally active banks

b] Nationally active banks
c] Regionally active banks
d] Other banks

Q 9.. Merchant Banking involves:

a] Only fee-based services

b] Only fund-based services.
c] Banking services which generates interest income for the merchant banker .
d] Foreign Exchange business .

Q 10 Money market is an important component of the financial market of a

country. The following is not one of the a instruments traded/dealt in money

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a] Certificate of Deposit
b] Commercial Paper
c] Treasury Bills
d] Debentures

Q 11. One essential requirement for a bank is that the deposits should be
collected by it from:

a] General Public
b] High Net Worth individuals.
c] Government Institutions.
d] Target clients and private corporations.

Q 12. The ability of a bank to meet the demand of its depositors and other
creditors in time is called:

a] Assets and Liability management.

b] Liquidity management
c] Profitability management
d] Time management.

Q 13. The financial soundness of a bank is indicative of its:

a] Solvency
b] IT architecture and its soundness
c] Efficiency of its staff.
d] High profits in last three years.

Q 14. Cross-border banking involves:

a] Banking transactions between individuals of two nations.

b] Banking transactions between companies of two nations.
c] Banking transactions between institutions of two nations.
d] All the above

Q 15. SLR in banking parlance refers to:

a] Standard Liquidity Ratio
b] Statutory Loan Ratio
c] Statutory Liquidity Ratio
d] Standard Loan Ratio

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