Basics of Banking

The bfsi Landscape

The bfsi Landscape

Fed/BoE/FSA/RBI SEC/FSA/SEBI State Ins Depts/IRDA/FSA

Banks
Commercial/S&LA/. High Street/Building Societies/ Public Sector/Pvt. Sector/ Mortgage NBFCs DFIs/MFIs

Financial Services
Investment Banks Exchanges Stocks/Com/.. Depositories/DPs Brokerages Clearing/Settlement Houses Rating Agencies

Insurance
Life Property & Casualty Health Actuaries Assessors & Surveyors Insurance Brokerages

Depositors; Borrowers

Retail & Institutional Investors; Security Issuers

Insurance Buyers

You are a Corporate Banker if

Banking Overview

What is a Bank?
A bank is an institution that provides financial service, particularly taking deposits and extending credit Generally understood as an institution that holds a banking license Most importantly provide collection and clearing services

Evolution of Banking
U.S.A
Chartered Banking - 1781 1838 Free Banking 1837 to 1863 National Banking 1863 to 1913 Central Banking 1913 to 1932 Central Banking and the Safety Net >1933 IT and Innovation 1960s to till date

INDIA
Mid to late 1700s General Bank of India Early 1800s Establishment of the Presidency Banks Bank of Bengal, Bank of Madras and Bank of Bombay Mid to late 1800s entry of European Banks BNP and Credit Lyonnais 1921 Amalgamation of all Presidency Banks birth of Imperial Bank of India (later changed to State Bank of India) Establishment of Reserve Bank of India Apr 1, 1935 Nationalization of banks 1969 and 1980 1994-95 entry of new-age private sector banks 1995 to date: banking transformation

Banking and Economy

Strong correlation between state of economy and sophistication of banking system G-7 countries Sound banking infrastructure a pre-requisite for economic growth

The Intermediary Role

Economy Surplus
Households Businesses Insurance Companies Mutual Funds

B A N K I N G

Deficit
Households Businesses __________

Channelising Funds

The Transformational Role

Economy Surplus
Key Requirements Safety & Security Growth Liquidity

B A N K I N G

Deficit
Key Requirements Time/Schedule Risk

Transforming Needs & Profile

The Transactional Role

Banks move money They help complete transactions They act as agents They provide other services that enable transactions
BANKING
Move money and complete transactions

Importer / Buyer (USA-based) Quantity/Quality

Exporter / Seller (India-based) Payment/Timeliness

The Stabilizing Role

Provide stability to an economys financial system Stability achieved by identifying and managing risks

Other Roles
Guarantor Role Advisor Role Custodian Role Policy Role

Not all roles are played by all banks there are many different types of banks some perform all roles, while others focus on a few of these roles

Types of Banks in the U.S.A.

Commercial Banks
Serves corporates, commercial enterprises and individuals Basket of services Typically has multi-state operations

Savings Banks
Started in 1800s to provide workers a secure place to save their money Focus on depositors only Makes loans for home purchase, improvement and education

Savings & Loan Associations

Started in 1800s Aimed to help people buy homes Accepted deposits and used the money to make home loans S&LA industry faced crisis in the 1980s n 2005/8 Estimated loss of trillions of $ 1,000s of S&LA defaults

Credit Unions
In the nature of a cooperative Established to meet the needs of a group that shares a common bonding e.g., employees of a corporation

Online Banks
Exist only in the virtual world no physical branches Provide basic deposit and loan products Generally offer higher interests on deposits and charge lesser on loans

Types of Banks in India

Public Sector Banks

Predominantly Government of India owned Limited autonomy in operations Directed lending to a certain extent Vast branch network Laggards in technology adoption

Private Sector Banks

Two subgroups new age private sector and old age private sector Tech savvy, aggressive, innovative new age banks broad basket of products Relationship oriented, localized old age banks

Foreign Banks
Limited presence Growing interest Expanding operations Typically catered to the requirements of MNCs and bluechip Indian corporates A few in consumer lending

Regional Rural Banks

Focused on rural markets Focused on financial inclusion Promoted by any one of the Public Sector Banks Products and Services geared to meet rural requirements

Cooperative Banks
Established for meeting banking requirements of specific groups Prominent in Maharashtra and Gujarat Limited product offerings

You are a Corporate Banker if

Understanding Role of Central Banks

What is a Central Bank?

Manager of a countrys economy
Inflation Interest rates Exchange rates

Implementer of monetary policies Managing money supply in the economy Currency issuer Bank regulator Lender of last resort Banker to the Government Bankers Banker Provider of payment systems

Central Bank in India the RBI

Govt. of India Reserve Bank of India

Banking Regulation Act Negotiable Instruments Act

Powerful authorized to enact banking laws Central Banker or Bankers Banker

Monetary Policy

Banking Regulation

Payment Systems

Devpt. Role

Financial Ind. Health

Central Bank in the U.S.A the Fed

Federal Government

Federal Reserve
= RBI
Central/Bankers banker in the USA Commonly known as Fed Plays a very important role in managing economy and the banking system

OCC
= DBS of R B I
Office of the Comptroller of Currency Undertakes bank/ branch level inspection and certifies health of banks

FDIC
= DICGC
Federal Deposit Insurance Corp Protects depositors interests to an extent of USD 250,000 Formed in the aftermath of the great depression In India, the deposit ins. Is for an amount

Functions of the Fed

Federal Reserve

Monetary Policy

Banking Regulation

Financial System Management

Payment Systems

Monetary Policy
Monetary policy aims at managing the USA economy economic growth, employment generation, money circulation, inflation
Federal Open Markets Commission
Pre-emptive Reserves
Funds set aside in proportion to deposits to meet crisis situations

Open Market

Discount Rate

Buy & sell securities in the open market to control the flow of funds in the economy

Interest Rate levied by Fed On Banks/FI who borrow short term

Banking Regulation
Lays down only high-level policies and regulations Focuses on three core areas: Safety and Soundness Efficiency and Competitiveness Customer Protection Bank-level inspection and other controls are levied by OCC and the State banking authorities

Payment Systems
Success of an economy also hinges on the quality of the payment systems Efficient payment systems help move money faster, better and cheaper Worlds largest economy A dominant currency Money flow is in trillions of dollars and hence efficient payment system is a key requirement

Banking Products

Basket & Range of Services

Banking Services

Accepting Deposits

Making Loans

Retail Services

Wholesale Services

Payment Services

Trade Services

Forex Services

Inv. Bkg. Services

Individual checking accounts loan & investment products to staff

Payment, Clearing and Settlement Services: This service cuts across all product Working Capital and Term loans

Assisting in buying, selling and covering forex exposure Handling documentation & credits for domestic & international trade Raising long term funds: debt issues or equity issues

/1

Retail Deposit Products

Deposit Products Classification

Bank Deposits

Demand Deposits Non-Interest-bearing Transaction-accounts

Time Deposits Interest-bearing Non-transaction-accounts

RETAIL LOAN PRODUCTS

HOME LOANS HOME EQUITY LOANS HELOC - HOME EQUITY LINE OF CREDIT AUTO LOANS EDUCATION LOANS PERSONAL LOANS CREDIT CARDS

Comparison of Deposit & Loan Products Equivalent U.S. Bank Deposit Indian
Checking account Savings account Certificate of Deposit TD Open account Individual Retirement Accounts Current account Savings account ---------Fixed Deposit Recurring Deposit ~PPFs

U.S. Bank Loan

Mortgages HELOCs Credit Cards Educational Loans Auto Loans Personal Loans

Indian Equivalent
Home Loans Top-up Loans Credit Cards Educational Loans Vehicle Loans Personal Loans

Parameters Deposits: Generic

Customer Driven
Currency Amount Period Mark Lien Residence Status Free Price Threshold
Premature w/d permitted

Master Parameters
Minimum Period Interest Rate
Standard Free price

Special Features: If yes, then what parameters do you need and how will you set Can interest rate be floating? them? Other Regulatory Restrictions:

Penal Interest Nomination

Issuance

Comp Gen FDR

Tax threshold Tax rate

Parameters - Loans
Master Parameters
Revolving Secured General sec. Security held Sec Value Loan to Value MTM MTM periodicity Prepayment Permitted Prepayment after min period Max: Max: Prepayment penalty rate Installment Unsecured Specific Sec.

Approval Parameters
Loan Granted Tenor Granted LTV Interest Rate EMI Loan purpose

Margin call at LTV %

Loan Amt Tenor

Min: Min:

Parameters Home Loan

Master Parameters
Revolving Secured General sec. Security held Sec Value Loan to Value MTM house 1,200,000 90% Max Installment Unsecured Specific Sec.

Approval Parameters
Loan Granted Tenor Granted LTV Interest Rate EMI Loan purpose 960,000 25 80% 11.5% 1345 House purchase ?

MTM periodicity 95%

Annual

Prepayment Permitted Prepayment after min period Prepayment penalty rate 1st EMI Drawdown date plus 3y 2% 1m

Margin call at LTV %

Loan Amt Tenor

Min: 5 Min: 10

Max: 25 Max 30:

Parameters Personal Loan

Master Parameters
Revolving Secured General sec. Security held Sec Value Loan to Value MTM none nil Installment Unsecured Specific Sec.

Approval Parameters
Loan Granted Tenor Granted LTV Interest Rate EMI Loan purpose 200,000 3 yrs 22% 8,932 general

MTM periodicity -

nil

Prepayment Permitted Prepayment after min period 6m 2% 1m

Margin call at LTV %

Loan Amt Tenor

Min: 50000 Min: 1

Max: 3 Max 5

Prepayment penalty rate 1st EMI Drawdown date plus

Parameters Car Loan

Master Parameters
Revolving Secured General sec. Security held Sec Value Loan to Value MTM Car 380,000 95% Installment Unsecured Specific Sec.

Approval Parameters
Loan Granted Tenor Granted LTV Interest Rate EMI Loan purpose 361,000 3 95% 14% 11913 Car purchase

MTM periodicity -

Prepayment Permitted Prepayment after min period 6m 2% 1m

Margin call at LTV %

Loan Amt Tenor

Min: 50000 Min: 1

Max: 10 l Max: 5

Prepayment penalty rate 1st EMI Drawdown date plus

Funding Companies
CORPORATE LOANS

Long Term Short Term

Mostly

Short Term Funding Arrives as: Repay short term funding Receive realisations

Make payments to buy materials.

Sell Product: Directly to customers Through Dealers

Buy Materials on Credit terms.

Are all Sales and Creditors domestic?

Are all purchases domestic?

Are all debtors from within the country?

Documentary Credits

A business situation
Vignesh & Co, a manufacturer of chilli powder in Guntur gets an order for export from Banderas & Co from Curacao Vignesh does not know where Curacao is and does not know whether to trust Banderas & Co Vignesh & Co approach their banker Corporation Bank who contact their banker friends in Peru who know this company Through the other bank in Peru, Corp Bank is able to help Vignesh & Co trade with a party which they have never met or known

Documentary Letter of Credit

Importers Bank
Asks his banker to open a Releases documents; Letter of Credit favoring the either bythis LC Simply first taking Exporter. Ininforms that money is asked to or will imperfect documents Exporter(sight LC); furnish wait for listarrived. have of documents a specific importer to give evidencing(usance LC) money despatch If docs perfect, imperfect If documents aregoods are guarantee that if sends (no matter how minute the Per the code, releases them to Importer sent (documents should imperfection, documents are money against perfect show it to be so) payment Bankforwarded the claiming merely documentswithout will be made by the release of any funds. amount importers bank without fail Advises the LC: it is a

Exporters Bank
The exporter prepares and Intimates Exporter of LC Checks goods, and dispatches thedocs:of the opening, particularly if gives his banker aspecified list perfect releases of documents perfect set of documents as per which will provide evidence money. specification indepatch of perfect the LC

Importer
In case of imperfect Worries about goods documents the Importer from exporter: alone gets to decide 1. Quality whether he will accept 2. Quantity the goods (docs) or not.

Lack of Trust

Exporter
Worries about payment by importer: 1. Amount 2. Timeliness

Documentary Letter of Credit

Importers Bank Exporters Bank

The rules covering these transactions in international trade under Letters of Credit are governed by the Uniform Customs and Practices for Documentary Credits, known by the acronym UCP-DC. Current version is UCP DC 600. Governed by ICC, Paris

Importer

Exporter

Documentary Collections
Seller and buyer know each other Buyers willingness and ability to pay are beyond doubt Importing country is a stable one International payment system of importing country is not threatened by regulation or restriction

Documents on Collection
Importers Bank
Simply informs that Releases money and takes documents have documents arrived.

Merely passes on documents without Passes on money inspection or comment

Exporters Bank

Dispatches the documents Credits exporters account

Importer

Both know each other

Exporter

Importer and Exporter are using banking infrastructure for convenience.

HIERARCHY OF LIMITS
Funded Limits Non Funded Limits

Within Funded
Longer Term Shorter Term
(shortest: CMS)

Within Non-Funded

LC Limits Fx Limits

Within Funded
Unsecured Secured
(Incl. by debtors, inventory)

Installment Loans
Authorisation

Principal reduces with each EMI; and so does the authorisation reflected in the system
LOAN AMOUNT PERIOD FOR WHICH LOAN SANCTIONED Since authorisation in system declines with each EMI, borrower cannot redraw amounts he has repaid in the past months

End of period loan should be zero Authorisation

Revolving Credits
Authorisation At any time the borrower can draw down authorised amt <minus> used amount. 2. This means if he has repaid a sum of money in the previous months, he can draw that sum of money again 3. Periodically, the bank will charge interest on the loan which will increase the used amount. 4. At all times the loan taker must ensure that the authorisation should not be exceeded 5. Credit Cards (Retail) and Working Cap (W/s) are examples of End of revolving credits. period loan should be zero 1.

Availabl e for use LOAN AMOUNT

used

PERIOD FOR WHICH LOAN SANCTIONED

You are a Corporate Banker if

Understanding How Money Changes Hands

The Payment Systems Pyramid

Clearing House
Is the place where all banks have their accounts This enables funds to be transferred from one bank to another In the same fashion as when two people have their account in the same branch of the same bank

Lets dwell briefly on the concept and importance of Clearing Houses.

Take the case of two customers who bank with the same bank
3
Payers account debited for value of check

The movement of money is instantaneous.

Receives Check Verifies Check Determines account balance If everything in order, posts check

Payees Account Credited

2
Payee deposits check with his bank

John (Payer)

Payer issues check to Payee

Joe (Payee)

When two individuals the Clearing House. Of different That same place is have their accounts in course, So life would be a lot simpler if everyone had their banks, it helps if their bankersother functions too that the Clearing HouselifeWhy? like that. account in the Because both have performs have an same place. But their not is account in the account with the same bank. enable the movement of funds. same place.

Intra-Bank movement of Funds

Life would be so simple if all of us had our accounts with only one Bank But life is never simple
o o

There are thousands of banks spread across the globe, and The Yahoos, Microsofts, Tatas and the Fords of the world have their accounts with different banks, and Money constantly changes hands across this vast network

So how does this inter-bank movement of funds take place?

Inter-Bank movement of Funds

Accomplished with the help of a Clearing House The Clearing House is an integrating layer that
o

Has the accounts of all banks to facilitate movement of money between banks Provides the infrastructure backbone for processing millions of checks

Receives checks from multiple banks Sorts checks bank-wise Facilitates swapping of checks amongst banks Handles check returns

Calculates net positions of different banks

Key Players

Payer: say, the buyer of

goods and services

Payee: say, the seller of goods and/or

services

Payers Bank: FI where

the Payer has a Checking or a Savings Account
Clearing House: the agency that
facilitates inter-bank transfer of funds and holds the accounts of member banks

Payees Bank: FI where the Payee has a

Checking or a Savings Account

Central Bank: typically runs the

clearing house and also provides/runs other payment systems

Types of Paper-based Instruments

Paper Checks Preauthorized Drafts/Checks Traveler's Checks

Paper-based Payments Process Flow

Clearing house sends the check to the Payers bank for clearing 4 6 Credit passed to Clearing house Payers account debited for value of check Payees Bank sends the check to the clearing house for its collection 3 7 Clearing house passes credit to Payees Bank Payee deposits 2 check with his bank

Payees Account 8 Credited

Payer

Payer Issues check to Payee

Payee

How Clearing Houses Settle?

Settlement
The completion of a transaction, wherein the payer transfers the money or financial instruments to the payee.

Major Settlement Types

Net Settlement - the settlement of a number of obligations or transfers between or among counterparties on a net basis Gross Settlement - a transfer system in which the settlement of funds or securities transfer instructions occurs individually (on an instruction by instruction basis).

Gross and Net Settlements

Bank A
Gross

Bank B

Bank A

Bank B

Gross

Gross

Nettin g at Clg House

Bank C

Gross

Bank D

Bank C

Bank D

The movement of funds is the last step in what a Clearing House does.

Clearing precedes the step known as Settlement; here is what Clearing and Settlement achieve at the Clearing House

STEP 1

Clearing

Calculation of obligations given by clients to the

banks

Based on instructions

STEP 2

Settlement

Delivery of funds

Gives effect to the instruction

Who runs the Clearing House?

In India they are run by RBI or other banks nominated by RBI In USA, clearing houses are run by different agencies, usually as a business which pays for itself. Some are run for-profit; others are run by an association of banks on a shared-cost basis

Key technologies in Cheque Processing

Introduction of MICR

Introduction of Check Truncation ECP

MICR Overview
Magnetic Ink Character Recognition Describes the special numbers and symbols typically seen at the bottom of a check Characters either printed in special inks using offset printing presses or with MICR toners using a laser printer MICR font characters are magnetized and read electronically by special reader/sorter equipment E13-B MICR font is used in the USA Fonts must meet stringent specifications of ABA and ANSI in the U.S.

MICR Overview
Provides the receiving party with information needed for processing the check including:
o o o

check number, bank routing number, checking account number, and the amount of the check

Check Processing System Inefficiencies

In spite of MICR, the system has certain inefficiencies,
o o o

Increased processing times Higher handling and postage costs Security concerns

Improvements in Check Processing

The Check Clearing for the 21st Century Act Also referred to as Check Truncation or Check 21 Effective since October 2004 Check once received by the Payers bank is converted to an electronic image Image is now transmitted in place of paper check referred to as the Substitute Check The image contains both front and back portions

ECP: The Process Flow

Clearing house sends the check image to the Payers bank for clearing 4 6 Credit passed to Clearing house Payers account debited for value of check 3 7 Clearing house passes credit to Payees Bank

Payment Systems

Payees Bank sends the check image to the clearing house for its collection
Converts physical check into electronic image

Payees Account 8 Credited

Payee deposits 2 check with his bank

Payer

Payer Issues check to Payee

Payee

Substitute Check

Payment Systems

66

Check Processing
Not all processing of checks is successful Sometimes the payee receives the check back instead of receiving the payment In such a case, the check is said to have Bounced/Returned/Dishonored

EFT Systems in the U.S.A

1.Automated Clearing House 2.Fedwire Funds System 3.CHIPS 4.NSS

Automated Clearing House

Governed by NACHA operating rules Network of over 14,000 financial institutions

Payment Systems

Electronic Debit and Credit Funds Transfer System

Over 18 billion ACH transactions were put through in the USA in 2009

Bulk payments by large organizations

Transaction costs less expensive than checks or wires Funds settle only after one day Settlements between banks is on net basis

ACH Flows
Types of ACH flows ACH credit-funds are moved from the originator account to the receiver account Salary payment by a company Social security payments by the Government Dividend and Interest payments Corporate payments to vendors/contractors ACH debit-funds are moved to the originators account from the receivers account Insurance premiums Mortgage and loan payments Consumer bill payments Corporate cash concentration txns

ACH Process Flow Credit Funds

Receiver Receiver Authorizes Originator
1

Payment Systems
Originator

RDFI makes funds available and report on statement

ACH

RDFI

s te u rib I 4 is t F d D or to R t ra le e op H fi H C AC A

OD F fil I sor e to ts a AC nd H tra op n 3 er s m at its or

ODFI

All participants have to comply with NACHA operating guidelines

Originator forwards transaction data to ODFI

Another way to understand ACH Credit

Single-Debit: Mutliple-Credit

Dividend Payer

SHAREHOLDERS

Single-Debit to Dividend Payer: Mutliple-Credits to Shareholders

As stated earlier, also good for Payroll payments and Social Security Payments; And any other situation which fits the above graphic.

The ACH Credit Process Flow Jane Receiver

RDFI makes funds available and report on statement
Receiver asks to paid by Payer using ACH providing all information of her account and bank 1

John Originator
Originator forwards transaction data to his bank

Charges per txn fee from both

5
te bu ri ist DFI rd R to to ra 4 pe o C sA e fil

ACH
Da ys

OD FI so rts a

H AC

RDFI - JPMC

S be e n t fo at re le in as te t o nd n ed e o pa r tw ym o en td

nd t op ran er sm at its or f il 3 e

to

AC

at e

ODFI - BofA

All participants have to comply with NACHA operating guidelines

ODFI: Originating Depository Financial Institution: Payers Bank; RDFI: receiving DFI: Receivers Bank

Another way to understand ACH Debit

Single-Credit: Mutliple-Debits
Utility Compan y
(Receiver)

CONSUMERS
(payers)

Single-Credit to Utility: Mutliple-Debits to Consumers You may have noticed: the consumer gives prior authorisation. The debit is triggered by the Receiver. That implies the money is pulled from the Good for paying electricity bills, insurance premiums. Payers account; while we previously generalised to say that electronic Any situation which fits the above graphic payments are push payment systems.

ACH Process Flow Debit

John Consumer
Authorises service provider to raise electronic debit; and RDFI to accept such debit

AT&T Service Provider

Receiver
RELEASE FUNDS

Raises debit on client through his bank

Compare with consumers prior authorisation

RELEASE FUNDS

ACH

RELEASE FUNDS

RDFI - JPMC

ODFI - BofA

All participants have to comply with NACHA operating guidelines

Any other bank any where else in India

So long as bank branch has connectivity to log on

NEFT Hub

So long as bank branch has connectivity to log on

Any bank any where in India

In the old EFT system the hubs were in 26 Indian cities and the banks at those locations had to be enabled. Other locations could not offer/use EFT.

What is the Fedwire?

Is an electronic payment system designed with a structured message format Is a large-value dollar transfer network Is a real-time gross settlement system (RTGS) in which processing and settlement take place continuously on a transaction-by-transaction basis without netting Payments processed are final and irrevocable Is owned and operated by the Federal Reserve Banks and supported by the Federal Reserves FEDNET national communications network

Fedwire Process Flow

What is CHIPS?
Clearing House Interbank Payments System
o

Is the clearing system for Forex trades that typically have one leg in the US banking system Bank-owned payments system for clearing large value payments

Serves the largest banks from around the world, representing 19 countries world- wide Processes over 95% of the USD cross-border payments Has recently started putting through large-value domestic USD transactions All major international banks maintain accounts with the Fed/Clearing house for allowing debits/credits to their accounts

How CHIPS works?

Benefits of using CHIPS

Improves liquidity by offering Bilateral and Multilateral netting facility

No Netting

Bilateral Netting

Multilateral Netting

What is NSS?
NSS is a multilateral settlement service owned and operated by the Federal Reserve Banks Allows participants in private clearing arrangements to settle their net obligations with same-day finality Participants include
o o o o

Local check clearinghouse associations, ACH networks, credit card processors, and ATM networks

NSS offers payment finality similar to that of the Fedwire Funds Service

What is TARGET?
The Trans-European Automated Real-time Gross settlement Express Transfer system (TARGET) is the leading Euro payment system TARGET links together 16 national RTGS systems and the ECB payment mechanism (EPM) TARGET facilitates credit transfers in Euro between and within the Euro area countries, Denmark, Poland, Sweden and the UK TARGET processes both inter-bank (MT202) and customer payments (MT103/103+)

TARGET Interlinking

Transaction Processing
Cross Border Payments

One of the significant differences between other payments and Cross-border payments is shown below:

The US branch of theform Bank is not a member of Money in Currency US does not cross borders: that is any clearing system in UK. NOT how payments are effected.

Basically, a bank account is needed in the other country, from which to pay money. (Or into which money may be received.)
How to get funds across to the UK branch?
UK branch of US bank may be a member of UK Clearing Systems

In other words, this type of account is needed:

NOSTRO Account Nostro: a banks foreign currency account in that foreign currency center. Banks maintain one such account in each currency of importance in which that banks customers have dealings.

The Senders Bank simply needs to reach the money to this Nostro Account, which is present within its own country. It can use any of the payment systems previously discussed for this.

Senders Bank

Receivers Bank

Sender

Receiver

It is very important to notebe Senders account can that the only way the Sender and its can be can have Receivers account bank such information the homethe Receivers Banks Nostro isinif the Receiver debited only in about credited only the home currency currency correctly provides this. Most delays in international payments can be traced to sending of incomplete and improper information.

Correspondent Banking Sometimes it can happen that the Senders Bank does not have international accounts or networks to exploit. It can also be that a big bank finds it uneconomical to maintain a branch presence in certain countries. Customers of the bank do transact in that country but the volumes do not justify a direct presence. When a bank that has limited access to certain financial markets in another country or region, and therefore must use the services of another bank to conduct certain transactions, it enters into an agreement with another bank in order to receive necessary services like any other account holder. That other bank is referred as the Correspondent Bank (colloquially Corr Bank).

CLS: Continuous Linked Settlement

CLS is an interlinking of 17 banks so that banks of other countries (prone to insolvency/ default risk) do not have to be relied on)

Add Mexico and Israel

Central Banks

Instead of relying on private financial institutions which might fail, CLS relies on the Central Bankers of the world.

M
U U U U

M: Member Banks

Member Banks link through to Central Bankers. User Banks linke through to Member Banks. User Banks offer CLS settlement to their customers

U: User Banks

Customers C1

C2

C3

Messaging

SWIFT
Society for Worldwide Interbank Financial Telecommunication Industry owned cooperative that provides standardised and secure messaging services Membership of about 8,000 financial institutions Robust communications network Protocols: agreed methods and processes to be followed in communicating financial transactions Standard formats for communication type - literally hundreds of different message types (MT for short) Authenticated messages

SWIFT interconnects all players in the industry

Brokerdealers Insurance companies Investment Managers

Banks & Custodians

SWIFT
Stock Exchanges

Transfer Agents

Other Exchanges

User Groups Infrastructure ICSDs & CSDs

Central Securities Depositories International CSDs

SWIFT Messages
Typically a one-page document
o o o o

name and code of the originating bank, the date and time, the address and code of the receiving bank, the name and internal code of the officer initiating the transmission, the names and numbers of the accounts involved in the transfer, a description of the asset being transferred, the MT category of the transmission, and acceptable, standardized phrases

o o

Understanding Card Services

Routine Business Transactions/Scenarios

Raj bids for an old Sherlock Holmes masterpiece on www.eBay.com and makes an online payment to a seller based in South America Sachin walks into an electronic stores, swipes his credit card and buys a Sony Bravia HDTV Hrithik walks into a Citibank ATM in Mumbai and uses his ATM card to withdraw cash Tom walks into a Wal Mart store and purchases goods and makes payment by way of a Prepaid Card Munimji, working for Lalaji, Inc., no longer carries cash for meeting his petty cash requirements he now carries a Purchase card JetSetter, working for travelwaale.com, carries a T&E card he no longer takes advance from his employer for his tours Shirley, is scared of both credit and cash, she prefers to make all her purchases using a Debit card

Card-based Payments
Types of Card Products

Personal Cards
Credit cards Charge cards Debit cards Decoupled debit cards Deferred debit cards ATM cards Prepaid cards

Corporate Cards
Purchasing cards Corporate cards Commercial cards Business credit cards

98

The Next Step - Mobile Banking

Booking and Receiving the Mobile Ticket

How cards work

Interchange company validates transaction.

Interchange company
Issuer updates database with interchange The shoppers account is charged for the company of new issuances purchase.

Merchant swipes card on the machine. On submission of charge slip, account is credited.

Shopper repaying the issuer is a matter between them; that is why Assesses creditworthiness of shopper and issues assessed creditworthiness is her a card before issuance.

Issuing Bank

Acquiring bank
Customer signs chargeslip generated by machine.

Merchants account

Card Holder goes shopping and gives her card.

Card Holder

Merchant

You are a Corporate Banker if

Understanding Online Banking

Banking Services Delivery Channels

Branch Banking

ATM

Banking Delivery Channels

Online Banking

Phone

Banking

What is Online Banking?

a. Accessing banking services using the Internet as a medium b. A world of convenience for the customers c. An alternative sales and delivery channel for banks d. A source of cost savings for banks e. A potential prey for the hackers and phishers out there So, what is online banking? a. and b. or a. and e. or all of the above

Online Banking Drivers

Development of internet technologies Advent of security systems Network bandwidth availability Intense competition among banks Declining NIMs Above all, old fashioned, plain and simple economics
Cost of typical transactions at branch/store 100% 10% Cost of same transaction at ATMs Cost of same transaction in online mode
6%
(Source: The Virtual Banking Revolution by James Essinger)

Online Banking Snapshot

Online Banking Snapshot

Typical Online Banking Services

Single Sign-on for accessing different accounts/services
Deposit accounts Loan accounts Credit cards Investment accounts
Bank products Treasury 3rd Party Products Insurance

Brokerage/Securities trading
Equity trading IPO investments Mutual Funds Commodities Futures & Options

Typical Online Banking Services

Account Management
o o o o

Consolidated view of all accounts Query-based search of accounts Statement generation Service Requests
Stop payments Check book requests Check status inquiries Issue of Cashier Checks/Bankers Check

o o

Service issues Transaction archives

Typical Online Banking Services

Fund transfers
o o

Intra-bank Inter-bank Presentment Mode or Payment Mode

Utilities Insurance Credit Cards Others

Bill Payments
o

Typical Online Banking Services

Sales and Marketing of banks products and services
o o o o

Deposit products Investment products Online loan approvals rule-based engines Third party products mobile phone re-charges; insurance products of subsidiaries etc.

Challenges in Online Banking

Banks data exposed for the first time to the external world Smart fraudsters wanting to lay hands on banks/customers money and data Novel methods of perpetrating frauds Hacking, Phishing, Vishing, etc., Software glitches Need to ensure high system uptime (>99.5%)

ASSET LIABILITY MANAGEMENT

Interest Rate Risk

The risk to a banks income/ earnings From the possibility of a change in market rates Arising out of the particular combination of a banks advances and liabilities portfolio

114

HDFC gives fixed rate home loans to borrowers in September 2009. It charges say, 12% to these borrowers. HDFC faces interest rate risk because it is promising a fixed rate to its customers. Say HDFCs cost of money at 6% to make this loans: its margin is 6%. Subsequently, in March 2011, interest rates and so the cost of its money goes up to 9%. HDFC now finds that its margin has come down to 3%. This is due to the interest rate risk that it was running in the first place.

115

Liquidity Risk
The risk a bank does not have funds to meet its commitments Arising out of the particular combination of a banks advances and liabilities portfolio There could also be advances repaid and you may not find ways to disburse that money again.
To illustrate: A FD for 10 years has been invested as loan for 10 years to a borrower. However, after say 3 years, the depositor has withdrawn the funds by pre mature closer but HDFC cannot recall the loan from the borrower.

This is the example of LIQUIDITY RISK

Banks Treasury Department

Role of the Treasury

A Banks Treasury looks at the banks overall position:

In terms of liquidity and interest rate risk

Transfer Pricing

Bank Treasury Customer

Pays rate per formula Pays rate per formula

Supplier

Supplier Business Units that Accept Deposits

This difference is this BUs Profit
Gets actual Interest

Customer Business Units that Give Loans

This difference is this BUs Profit
Pays actual Interest

Client

Banks overall real profit

Client

Shared using a Transfer Pricing Formula

Bank Treasury Customer

Pays 8% Pays 9%

Reports 1% Margin

Supplier

Supplier Business Units that Accept Deposits

Customer Business Units that Give Loans

Reports 2% Margin
Gets 6%

Reports 2% margin
Pays 11%

Client

Client

Financial Overview of the Bank

Balance Sheet of a Bank Liabilities/Sources

Money put into the business by owners

Assets / Applications Banking assets Other assets 1250 80

Loans given
Like land, bldg, Furniture, infrastruc

Capital Bank deposits

100 1230

Deposits taken

Total Liabilities

1330

Total Assets

1330

Assets and liabilities will always be equal in a BS BS is a snapshot as on a particular date

123

Banking Liabilities on the Balance Sheet

Generic Category of Liabilities Type of Account Cost Impact

Current Accounts

Demand Liabilities:
Bank accounts from which money is immediately drawable by the customer

Checking Acct (US context)

No interest is paid/payable on these balances. They are, in essence, free money.

Some, very low interest is paid on these accounts based on a formula

Savings Account 15 day deposit Time Liabilities:

Deposits which customers have placed for a specific period of time. Till that maturity date the money is not expected to be called back by the customer; though they do have the right to ask back for the money earlier.

30 day deposit 6 month deposit 1 year deposit 3 year deposit etc

Interest is paid/ payable based on the rate card/ rate agreed by the bank for these deposits. This rate is as on the date the deposit was commenced.

Total Demand & Term Liabilities

1230 (illustrative number)

The cost impact is reflected on the expense side of the income statement
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Banking Assets on the Balance Sheet

Generic Category of Asset Reserves
Money held by the bank with the Central Bank/ in specified securities as preemptive reserves

Product

Earnings Impact
Interest is paid by the Central Bank/ government on these investments is reflected on the income side of the income statement. More explanation on
SLR/CRR is available in a later slide.

Reserve Accounts Spec. Securities Bonds etc. Equities Working Capital Credit Cards Term loans to cos
Home loans, car loans, personal loans

Investment Assets
Moneys invested by the bank in financial assets through the markets (as opposed to lending to customers)

Interest, dividends on these holdings. Profits from trading in these are reflected on income side of the inc stmt. Losses from trading/holding reflect on the expense side. Interest earned on these accounts are reflected on the income side of the income statement. Losses from bad loans made, which do not get repaid are reflected on the expense side Interest earned: reflected on income side of income statement. Losses from bad loans made are reflected on the expense side. Each time an EMI is paid, loan shown in BS reduces to that extent. Earnings reflect on Income Side. Losses from erosion in value of any 125 asset: on expense side

Revolving Credits (Loans

Loan which can used, repaid and then reused repeatedly. Usage and repayment as per customers wish, within the total limit

Straight (non-revolving) Loans

Loans given for a term which must be repaid as specified by the bank. In bullet or in instalments. Once repaid, cannot be redrawn. A new loan sanction is needed

Total Asset Portfolio

1250

Income Statement
What the bank spent
Some of these can be linked to liabilities Salaries, rents, utility costs are NOT linked to liabilities

Expenses 76 14

Income

What the bank earned

Intt paid on deposits Other Op Expenses

Intt earned on loans

80

Some of these can be linked to assets

Fee Income

20

Unconnec ted to loans

If income is greater than expense: that is a profit

Profits

10 100 Totals 100

Totals

126

Sources of Revenue for a Bank

A bank has several sources of revenues and expenses. These are broadly classified into four groups.

Core Banking Activity

A. Interest Income
Interest received on loans Interest on securities Federal funds sold and securities purchased

B. Non Interest Income

Service Charges Brokerage Fees Charges on Remittances Profits from Trading

Income from charges for services including third party product sales

Net Interest Income = (A) (C)

C. Interest Expense
Interest paid on deposits Interest paid on debt Interest paid on short term borrowing

D. Non-Interest Expense
Personnel Occupancy Equipment Amortization Operating Expenses

Income before Taxes = Net Interest Income + (B) (D)

Banking Regulation/Supervision

Banking Regulations -- Why regulate banks?

Banking are commonly treated as a matter of public interest This is because of the central role of banks in the financial system and the economy of a country If the financial system is to subserve the larger interests of the economy, efficient banking holds the key The regulatory system and banking laws have developed in response to financial crises and other historical and political events.

Aim of banking regulation

Protection of Depositors Monetary and financial stability Efficient and competitive financial system Consumer Protection

Risk and Basel Requirements

Banks need Capital

Need for Capital

To fund a banks need for infrastructure Capital position acceptable to depositors
shareholder willingness to put own funds at risk

Capital is needed to deal with losses

when revenue from asset shrinks capital provides cushion to continue servicing

The Basel II Accord Prescribes the Quantum of Capital a Bank shall keep Total Capital CAR

=
Credit Risk Total Assets At Risk + Market Risk +
Operational Risk

As per the Basel Accord this ratio should be atleast 8%.

Each countrys regulator can specify their own Capital Adequacy Ratio higher than 8% (but it cannot specify a ratio lower than 8%) For instance, RBI has specifed 9% as the Capital Adequacy Ratio for Indian Banks.

THIS SLIDE MAKES EXTENSIVE SIMPLIFICATIONS WHICH ARE VALID ONLY FOR THE LESSONS BEING DRIVEN IN THIS THIS SLIDE MAKES EXTENSIVE SIMPLIFICATIONS WHICH ARE VALID ONLY FOR THE LESSONS BEING DRIVEN IN THIS PARTICULAR SLIDE PARTICULAR SLIDE