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Unformatted text preview: INDIAN INSTITUTE OF INDIAN INSTITUTE OF BANKING & FINANCE RISK MANAGEMENT MODULE C & D By M.Ravindran Syllabus Syllabus Module C: Treasury Management: Treasury management; concepts and functions; instruments in the Treasury concepts functions treasury market; development of new financial products; control and supervision of Treasury management; linkage of domestic operations with foreign operations. Asset-liability management; Interest rate risk; interest rate futures; Interest stock options; debt instruments; bond portfolio strategy; risk control and hedging instruments. Investments – Treasury bills – Money markets instruments such Treasury as CDs, CPs, IBPs; Securitisation and Forfaiting; Refinance and as CDs, rediscounting facilities. rediscounting Syllabus Syllabus Module D Capital Management and Profit Planning Prudential Norms­ Capital Adequacy­Basel II­ Asset Classification­provisioning Profit and Profitability­Historical Perspective of the Approach of Banks to profitability­Effects of NPA on profitability­A profitability Model­Share holders value Maximization & EVA­Profit Planning­Measures to improve profitability Integrated Treasury Integrated Treasury refers to integration of money market, securities market and foreign exchange operations. Functions: ­Meeting reserve requirements ­Efficient merchant services ­Global cash management ­Optimizing profit by exploiting market opportunities in forex market, money market and securities market ­Risk management ­Assisting bank management in ALM FRONT OFFICE Dealing MID OFFICE BACK OFFICE settlement MIS Treasury Treasury Money Market Money Market Certificate of Deposit (CD) Commercial Paper (C.P) Inter Bank term Money Treasury Bills Call Money Inter Bank Participation Certificates Certificate of Deposit Certificate of Deposit CDs are short­term borrowings in the form of Usance Promissory Notes having a maturity of not less than 7 days up to a maximum of one year. CD is subject to payment of Stamp Duty under Indian Stamp Act, 1899 (Central Act) They are like bank term deposits accounts. Unlike traditional time deposits these are freely negotiable instruments and are often referred to as Negotiable Certificate of Deposits Features of CD Features of CD Issued by all scheduled commercial banks except RRBs Minimum period 7 days Maximum period 1 year Minimum Amount Rs 1 lac and in multiples of Rs. 1 lac CDs are transferable by endorsement CRR & SLR are to be maintained CDs are to be stamped Commercial Paper Commercial Paper Commercial Paper (CP) is an unsecured money market instrument issued in the form of a promissory note. Who can issue Commercial Paper (CP) Highly rated corporate borrowers, primary dealers (PDs) and all­India financial institutions (FIs) Eligibility for issue of CP Eligibility for issue of CP a) b) c) c) the tangible net worth of the company, as per the the latest audited balance sheet, is not less than Rs. 4 crore; crore; the working capital (fund-based) limit of the the company has been sanctioned by banks borrowal account of the company is classified as a borrowal Standard Asset by the financing bank/s. Rating Requirement Rating Requirement All eligible participants should obtain the credit rating for issuance of Commercial Paper Credit Rating Information Services of India Ltd. (CRISIL) Investment Information and Credit Rating Agency of India Ltd. (ICRA) Credit Analysis and Research Ltd. (CARE) Fitch Ratings Duff & Phelps Credit Rating India Pvt. Ltd. (DCR India) The minimum credit rating shall be P­2 of CRISIL or such equivalent rating by other agencies Features Features CP can be issued for maturities between a minimum of 7 days and a maximum upto one year from the date of issue. Minimum issue price Rs. 5 lakhs and in multiples of Rs. 5 lakhs Issued in demat form only To whom issued To whom issued CP is issued to individuals, banking companies, other corporate bodies registered or incorporated in India and unincorporated bodies, Non­Resident Indians (NRIs) Foreign Institutional Investors (FIIs). CP­Yield calculation CP­Yield calculation Yield = (Face value­Price)*365*100 ­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­ Price *No of days to maturity Face value 5 lakhs price 4,92,711 for 90 days Find out yield 500000­492711*365*100 ­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­­= 6% 492711*90 Calculation of price­CP Calculation of price­CP PRICE= Face Value ­­­­­­­­­­­­­ ( 1+Yield *No of days ­­­­­­­­­­­­­­­­­­­­­­­ 365*100) Face Value Rs.500000 for 90 days at 6% 500000 ­­­­­­­­­­­­ 1(6*90/365*100) = Rs 492711 Meaning of Repo Meaning of Repo It is a transaction in which two parties agree to sell and repurchase the same securitya t a mutually decided future date and a price The Repo/Reverse Repo transaction can only be done at Mumbai between parties approved by RBI and in securities as approved by RBI (Treasury Bills, Central/State Govt securities). Repo Repo Uses of Repo It helps banks to invest surplus cash It helps banks to raise funds at better rates An SLR surplus and CRR deficit bank can use the Repo deals as a convenient way of adjusting SLR/CRR positions simultaneously. RBI uses Repo and Reverse repo as instruments for liquidity adjustment in the system Coupon rate and Yield Coupon rate and Yield The difference between coupon rate and yield arises because the market price of a security might be different from the face value of the security. Since coupon payments are calculated on the face value, the coupon rate is different from the yield. Example Example 10% Aug 2015 10 year Govt Bond Face Value RS.1000 Market Value Rs.1200 In this case Coupon rate is 10% Yield is 8.33% = 1200*10 ­­­­­­­­­­­­­­­ 1000 Call Money Call Money The money that is lent for one day is known as "Call Money", If it exceeds one day (but less than 15 days) it is referred to as "Notice Money". Call Money Market Call Money Market Banks borrow in this market for the following purpose To fill the gaps or temporary mismatches in funds To meet the CRR & SLR mandatory requirements as stipulated by the Central bank To meet sudden demand for funds arising out of large outflows. Factors influencing interest rates Factors influencing interest rates The factors which govern the interest rates are mostly economy related and are commonly referred to as macroeconomic factors. Some of these factors are: 1) Demand for money 2) Government borrowings 3) Supply of money 4) Inflation rate 5) The Reserve Bank of India and the Government policies which determine some of the variables mentioned above. Gilt edged securities Gilt edged securities The term government securities encompass all Bonds & T­bills issued by the Central Government, and state governments. These securities are normally referred to, as "gilt­ edged" as repayments of principal as well as interest are totally secured by sovereign guarantee. Treasury Bills Treasury Bills Treasury bills, commonly referred to as T­Bills are issued by Government of India against their short term borrowing requirements with maturities ranging between 14 to 364 days. All these are issued at a discount­to­face value. For example a Treasury bill of Rs. 100.00 face value issued for Rs. 91.50 gets redeemed at the end of it's tenure at Rs. 100.00. Who can invest in T­Bill Who can invest in T­Bill Banks, Primary Dealers, State Governments, Provident Funds, Financial Institutions, Insurance Companies, NBFCs, FIIs (as per prescribed norms), NRIs & OCBs can invest in T­Bills. What is auction of Securities What is auction of Securities Auction is a process of calling of bids with an objective of arriving at the market price. It is basically a price discovery mechanism Debenture Debenture A Debenture is a debt security issued by a company (called the Issuer), which offers to pay interest in lieu of the money borrowed for a certain period. These are long­term debt instruments issued by private sector companies. These are issued in denominations as low as Rs 1000 and have maturities ranging between one and ten years. Difference between debenture and Difference between debenture and bond Long­term debt securities issued by the Government of India or any of the State Government’s or undertakings owned by them or by development financial institutions are called as bonds. Instruments issued by other entities are called debentures. Current yield Current yield It is calculated by dividing the coupon rate by the purchase price of the bond . For e. g: If an investor buys a 10% Rs 100 debenture of ABC company at Rs 90, his current Yield on the instrument would be computed as: Current Yield = (10%*100)/90 X 100 , That is 11.11% p.a. Primary Dealers Primary Dealers Primary Dealers can be referred to as Merchant Bankers to Government of India, comprising the first tier of the government securities market. These were formed during the year 1994­96 to strengthen the market infrastructure What role do Primary Dealers What role do Primary Dealers play? The role of Primary Dealers is to; (i) commit participation as Principals in Government of India issues through bidding in auctions (ii) provide underwriting services (iii) offer firm buy ­ sell / bid ask quotes for T­Bills & dated securities (v) Development of Secondary Debt Market OMO OMO OMO or Open Market Operations is a market regulating mechanism often resorted to by Reserve Bank of India. Under OMO Operations Reserve Bank of India as a market regulator keeps buying or/and selling securities through it's open market window. It's decision to sell or/and buy securities is influenced by factors such as overall liquidity in the system etc YIELD CURVE YIELD CURVE The relationship between time and yield on a homogenous risk class of securities is called the Yield Curve. The relationship represents the time value of money ­ showing that people would demand a positive rate of return on the money they are willing to part today for a payback into the future A yield curve can be positive, neutral or flat. A positive yield curve, which is most natural, is when the positive which slope of the curve is positive, i.e. the yield at the longer end is higher than that at the shorter end of the time axis. This results, as people demand higher compensation for parting their money for a longer time into the future. their A neutral yield curve is that which has a zero slope, i.e. is flat across time. T his occurs when people are willing to accept more or less the same returns across maturities. more The negative yield curve (also called an inverted yield The curve) is one of which the slope is negative, i.e. the long term yield is lower than the short term yield SHAPE OF YIELD CURVE SHAPE OF YIELD CURVE Shape of Yield curve Shape of Yield curve LIBOR LIBOR LIBOR stands for the London Interbank Offered Rate and is the rate of interest at which banks borrow funds from other banks, in marketable size, in the London interbank market. LIBOR is the most widely used "benchmark" or reference rate for short term interest rates. It is compiled by the British Bankers Association as a free service and released to the market at about 11.00[London time] each day. Calculation of Duration Calculation of Duration Face Value Rs.100 Tenor 7 years Coupon 7% Market Interest rate 8% Answer:543.0642/94.7941= 5.72888 yrs Calculation of Duration Calculation of Duration Answer:543.0642/94.7941= 5.72888 Sl No Coupo Dis.Fa PV OF n ctor cOUPON At 8% 1 2 3 4 5 6 7 7 7 7 7 7 7 7 .9259 6.4813 .8573 6.0011 .7938 5.5566 .7350 5.1450 .6806 4.7642 .6302 4.4114 We PV*Wt ight in yrs 1 6.4813 2 3 4 5 6 7 12.0022 16.6698 20.5800 23.8210 .5835 62.4345 26.4684 437.0415 CRR & SLR CRR & SLR The minimum and maximum levels of CRR are prescribed at 3% and 20% of demand and term liabilities (DTL) of the bank, respectively, under Reserve Bank of India Act of 1934. The minimum and maximum SLR are prescribed at 25% and 40% of DTL respectively, under Banking Regulation Act of 1949. The CRR and SLR are to be maintained on fortnightly basis. Demand and Time Liabilities Demand and Time Liabilities Main components of DTL are: Demand deposits (held in current and savings Demand accounts, margin money for LCs, overdue fixed deposits etc.) deposits Time deposits (in fixed deposits, recurring deposits, Time reinvestment deposits etc.) reinvestment Overseas borrowings Foreign outward remittances in transit (FC liabilities Foreign net of FC assets) net Other demand and time liabilities (accrued interest, Other credit balances in suspense account etc. ) credit SLR SLR SLR is to be maintained in the form of the following assets: Cash balances (excluding balances maintained for CRR) Gold (valued at price not exceeding current market price) Approved securities valued as per norms prescribed by RBI. VaR VaR Value at Risk (VaR) is the most probable loss that we may incur in normal market conditions over a given period due to the volatility of a factor, exchange rates, interest rates or commodity prices. The probability of loss is expressed as a percentage – VaR at 95% confidence level, implies a 5% probability of incurring the loss; at 99% confidence level the VaR implies 1% probability of the stated loss. The loss is generally stated in absolute amounts for a given transaction value (or value of a investment portfolio). VaR VaR The VaR is an estimate of potential loss, always for a given The period, at a given confidence level.. A VaR of 5p in USD / INR rate for a 30- day period at 95% confidence level means that Rupee is likely to lose 5p in exchange value with 5% probability, or in other words, Rupee is likely to depreciate by maximum 5p on 1.5 days of the period (30*5% ) . A VaR of Rs. 100,000 at 99% confidence level for one week for a investment portfolio of Rs. 10,000,000 similarly means that the market value of the portfolio is most likely to drop by maximum Rs. 100,000 with 1% probability over one week, or , 99% of the time the portfolio will stand at or above its current value. portfolio Exchange Rate Quotation Exchange Rate Quotation Exchange Quotations : There are two methods Exchange rate is expressed as the price per unit of foreign currency in terms of the home currency is known as the “Home currency quotation” or “Direct Quotation” Exchange rate is expressed as the price per unit of home currency in terms of the foreign currency is known as the “Foreign Currency Quotation” or “Indirect Quotation” Direct Quotation is used in New York and other foreign exchange markets and Indirect Quotation is used in London foreign exchange market. Principles Principles Direct Quotation: Buy Low, Sell High: 1USD= Rs.42.60 42.65 Indirect Quotation: Buy High, Sell Low: Rs.100 = USD 2.5600 – 2.5650 Spot and Forward Transactions Spot and Forward Transactions ‘A’ Bank agrees to buy from ‘B’ Bank USD 100000. The actual exchange of currencies i.e. payment of rupees and receipt of US Dollars, under the contract may take place : on the same day or two days later or some day later, say after a month. Interpretation of Quotation Interpretation of Quotation The market quotation for a currency consists of the spot rate and the forward margin. The outright forward rate has to be calculated by loading the forward margin into the spot rate. For example US Dollar is quoted as under in the inter­bank market on a given day as under : Spot 1 USD = Rs.44.1000/1300 Spot/November 0200/0500 Spot/December 1500/1800 TT Buying Rate TT Buying Rate TT Buying Rate (TT stands for Telegraphic Transfer) This is the rate applied when the transaction does not involve any delay in realization of the foreign exchange by the bank. In other words, the nostro account of the bank would already have been credited. The rate is calculated by deducting from the inter­bank buying rate the exchange margin as determined by the Bank. Bills Buying Rate Bills Buying Rate This is the rate to be applied when a foreign bill is purchased. When a bill is purchased, the proceeds will be realized by the Bank after the bill is presented to the drawee at the overseas center. In the case of a usance bill the proceeds will be realized on the due date of the bill which includes the transit period and the usance period of the bill. Problem Problem You would like to import machinery from USA worth USD 100000 to be payable to the overseas supplier on 31st Oct [a] Spot Rate USD = Rs.45.8500/8600 Forward Premium September 0.2950/3000 October 0.5400/5450 November 0.7600/7650 [b] exchange margin 0.125% [c] Last two digits in multiples of nearest 25 paise Calculate the rate to be quoted by the bank ? Solution Solution This is an example Forward Sale Contract . Inter Bank Spot Selling Rate Rs. 45.8600 Add Forward Margin .5450 --------------------------46.4050 46.4050 Add Exchange Margin .0580 ----------------------------Forward Rate 46.4630 Rounded Off to multiple of 25 paise Rs.46.4625 Amount Payable to the bank Rs.46,46,250 Amount Swap Swap A swap agreement between two parties commits each counterparty to exchange an amount of funds, determined by a formula, at regular intervals, until the swap expires. In the case of a currency swap, there is an initial exchange of currency and a reverse exchange at maturity. Mechanics Mechanics Firm A needs fixed rate loan –AAA rated Firm B needs floating rate ­A rated Firm A enjoys an absolute advantage in both credit markets. Fixedrate finance Floatingrate finance Firm A Firm B 9% 11% LIBOR LIBOR +0.0% +1% Mechanics Mechanics STEP ! Firm A will borrow at Fixed rate 9% Firm B will borrow at floating rate (LIBOR +1)% STEP 2 Firm A will pay Floating rate [LIBOR] to Firm B Firm B will Pay Fixed rate [9.5%] only Gain Net interest cost LIBOR­ .5% Net Interest cost 9+[ 1%+0.5%]=10.5% Mechanics Mechanics Gain A 9.5% Borrows at 9.0% fixed for 7 years Interest payments to each other in years t 1 to t 7. B Borrows at LIBOR + 1% floating for 7 years LIBOR Basel I to Basel II Basel I to Basel II Minimum capital requirements → 3 Pillars New credit risk approaches Market risk ­ unchanged Add operational risk portion The Basel II Framework The Basel II Framework Pillar 1: Minimum capital requirements • • • Credit Risk Market Risk Operational Risk • A guiding principle for banking supervision • Pillar 2: Supervisory review Pillar 3: Market discipline Disclosure requirements Pillar 1: Minimum Capital Pillar 1: Minimum Capital Requirements The calculation of regulatory minimum capital requirements: the amount of capital ≥ 8% Total risk - weighted assets The Capital and Assets The Capital and Assets Definition of capital: Tier 1 capital + Tier 2 capital + adjustments Total risk­weighted assets are determined by: multiplying the capital requirements for market risk and operational risk by 12.5 and adding the resulting figures to the sum of risk­weighted assets for credit risk. Credit Risk Credit Risk Standardised Approach Foundation IRB Approach Advanced IRB Approach Credit Risk ­ Credit Risk ­ Standardised Approach In determining the risk weights in the standardised approach, banks may use assessments by external credit assessment institutions. ∑ ( Risk Weight for Assets × Book Valus of Assets) Risk Weight for Assets Risk Weight for Assets Claims on sovereigns Credit Assessment Claims on banks and securities firms Credit assessment of Banks Risk weight Risk weight for shortterm 20% 20% 20% 50% 50% 150% 20% 20% 50% 100% 100% 150% 150% 100% Claims on corporates ECA risk scores Risk Weight Credit assessment of Sovereign AAA to AAA+ to ABBB+ to BBBBB+ to BBB+ to BBelow BUnrated 1 2 3 4~6 4~6 7 - 0% 20% 50% 100% 100% 150% 100% 20% 50% 100% 100% 100% 150% 100% 20% 50% 50% 100% 100% 150% 50% Credit Risk ­ IRB Approach Credit Risk ­ IRB Approach In the internal ratings­based(IRB) approach, it’s based on banks’ internal assessment. The approach combines the quantitative inputs provides by banks and formula specified by the Committee. Credit Risk ­ IRB Approach Credit Risk ­ IRB Approach Four quantitative inputs (risk components): Probability of default (PD) Loss given default (LGD) Exposure at default (EAD) Maturity (M) Use formula of the Committee to calculate the minimum requirements. Credit Risk ­ IRB Approach Credit Risk ­ IRB Approach Data Input Probability of default (PD) Loss given default (LGD) Exposure at default (EAD) Maturity (M) Foundation IRB From banks Advanced IRB From banks From banks From banks Set by the Committee Set by the Committee Set by the Committee or from banks From banks Market Risk Market Risk Standardised method ­ the standards of the Committee Internal models ­ use banks’ internal assessments ­ Value at Risk (VaR) Operational Risk Operational Risk The risk of losses results from inadequate or failed internal processes, people and system, or external events. Basic Indicator Approach Standardised Approach Advanced Measurement Approaches(AMA) Operational Risk ­ Operational Risk ­ Basic Indicator Approach K = GI ×α BIA GI = average annual gross income(three years, excepted the negative amounts) α = 15% Operational Risk ­ Operational Risk ­ Standardised Approach GI 1­8 = average annual gross income from K = ∑(GI ×β TSA 1 −8 1−8 ) business line from one to eight (three years, excepted the negative amounts) β = A fixed percentage set by the Committee Beta of Business Lines Beta of Business Lines Business Lines Corporate finance (β1) Trading and sales (β2) Retail banking (β3) Commercial banking (β4) Payment and settlement (β5) Agency services (β6) Asset management (β7) Retail brokerage (β8) Beta Factors 18% 18% 12% 15% 18% 15% 12% 12% Operational Risk ­ Advanced Operational Risk ­ Advanced Measurement Approaches Under the AMA, the regulatory capital requirement will equal the risk measure generated by the bank’s internal operational risk measurement system using the quantitative and qualitative criteria for the AMA. Use of the AMA is subject to supervisory approval. Pillar 2: Supervisory Review Pillar 2: Supervisory Review Principle 1: Banks should have a process for assessing and maintaining their overall capital adequacy. Principle 2: Supervisors should review and evaluate banks’ internal capital adequacy assessments and strategies. Supervisory Review Supervisory Review Principle 3: Supervisors should expect banks to operate above the minimum regulatory capital ratios. Principle 4: Supervisors should intervene at an early stage to prevent capital from falling below the minimum levels. Pillar 3: Market Discipline Pillar 3: Market Discipline The purpose of pillar three is to complement the pillar one and pillar two. Develop a set of disclosure requirements to allow market participants to assess information about a bank’s risk profile and level of capitalization. Minimum Capital Adequacy Ratios Minimum Capital Adequacy Ratios Tier one capital to total risk weighted credit exposures to be not less than 4 %; Total capital (i.e. tier one plus tier two less certain deductions) to total risk weighted credit exposures to be not less than 8% Calculation of Capital Calculation of Capital Tier One Capital the ordinary share capital (or equity) of the bank; and audited revenue reserves e.g.. retained earnings; less current year's losses; future tax benefits; and intangible assets, e.g. goodwill. Calculation of Capital Calculation of Capital Upper Tier Two Capital revaluation reserves; Un­audited retained earnings; general provisions for bad debts; perpetual cumulative preference shares (i.e. preference shares with no maturity date whose dividends accrue for future payment even if the bank's financial condition does not support immediate payment); perpetual subordinated debt (i.e. debt with no maturity date which ranks in priority behind all creditors except shareholders). Calculation of Capital Calculation of Capital Lower Tier Two Capital Subordinated debt with a term of at least 5 years; Sedeemable preference shares which may not be redeemed for at least 5 years. Restrictions Restrictions Tier two capital may not exceed 100% of tier one capital; Lower tier two capital may not exceed 50% of tier one capital; Lower tier two capital is amortized on a straight line basis over the last five years of its life. Total Capital Total Capital This is the sum of tier 1 and tier 2 capital less the following deductions: equity investments in subsidiaries; shareholdings in other banks that exceed 10 percent of that bank's capital; unrealized revaluation losses on securities holdings. Module D Module D Capital Management Provisioning Norms Loans & Advances EVOLUTION OF CONCEPT OF IRAC NORMS EVOLUTION OF CONCEPT OF IRAC NORMS RBI introduced IRAC norms in the year 1992-93. Based on recommendations of Narasihmam committee To be in line with the international practices and To move towards greater consistency & transparency in balance sheets of banks. UNDER IRAC NORMS… The income is not recognized on accrual basis as was done prior to 1992­ 93, but is recognized based on the record of actual recovery. And The assets are classified into different categories mainly based on record of recovery. ASSET CLASSIFICATION Assets PERFORMING ASSETS NON PERFORMING ASSETS PERFORMING ASSETS: Assets which are earning income to the Bank on an actual realisation basis. These include regular and temporarily irregular accounts. NON­PERFORMING ASSETS: NON­PERFORMING ASSETS: An asset becomes non­ performing when it ceases to generate income for the bank on an actual realization basis. CLASSIFICATION OF ASSETS Assets Assets STANDARD SUB STANDARD NPA Age upto1year DOUBTFUL NPA Age > 1 yr LOSS Not linked to age DOUBTFUL-1 (DA1) Doubtful for < or = 1 Yr DOUBTFUL-2 (DA2)Doubtful for >1 & = 3 Yrs DOUBTFUL-3 (DA-3) Doubtful for > 3Yrs STANDARD ASSET: A standard asset is one which A standard asset is one which does not disclose any problem and also does not carry more than normal risks attached to the business. SUB–STANDARD ASSET: SUB–STANDARD It is It a Non-Performing Asset. A sub-standard asset would be one, which has remained NPA for a period less than or equal to 12 months. months Eg: If an asset slips down to NPA category on Eg: 31.03.2005, it would be in Sub-Standard category for next one year i.e. up to 30.03.2006. On 31.03.2006 it would further slip down to Doubtful category. Doubtful DOUBTFUL ASSET: DOUBTFUL An asset would be classified as doubtful An if it remains in the sub-standard category for more than 12 months. for Example: If an account has become Sub-Standard on 31.03.2005, it would slip down to Doubtful category on 31.03.2006. 31.03.2006. DOUBTFUL ASSET: STANDARD Normal movement Contd… Contd… SUB-STANDARD Normal movement Erosion in realisable value of security DOUBTFUL Further, if there is any erosion in value of the security and if the Further, realisable value thereof is less than 50% of the value assessed by the bank or accepted by RBI at the time of last inspection, as the case may be, such an asset should straightaway be classified as A loss asset is one where, LOSS ASSET: loss has been identified by the Bank or internal or external auditors or the RBI inspectors but the amount has not yet been written off Classification as a Loss asset wholly. is not linked to the age of NPA, but linked to the realisable value of the security and also the chances of recovery of full amount. Loss Asset Loss - contd….. If there is any erosion in value of the security and if the realisable value of such security, as if assessed by the Branch/ approved valuers/RBI auditors is less than 10% of the outstandings in the borrowal account, the asset should straight away be classified as a Loss Asset. away - A standard or sub-standard asset can directly be standard MOVEMENT OF ASSETS: MOVEMENT More than 50% erosion in value of security SSTANDARD TANDARD SMA SUBSUB-STANDARD EX:31.03.2005 STANDARD Ex: 31.03.2005 DOUBTFUL- DA-1 DOUBTFUL- DA1 31.03.2006 31.03.2006 DOUBTFUL- DA-2 31.03.2007 DOUBTFUL- DA-3 31.03.2009 Realisable value of security <10% of outstandings As per norms for ifferent segments After 12 months After 12 months LOSS ASSET Realisable value of security <10% of outstandings After 24 months (contd..) Commencement of season Due date Not Not Paid Paid Remains unpaid NPA June 2005 2005 ILLUSTRATION: 30.11.05 2 seasons of 12 months each 30.11.2007 -Crops grown : Paddy -Short or Long Duration crop : Short duration ( upto 12 months) -Duration in months as per SLBC :12 months (for mono cropped areas the crop duration is taken as 12 months ) -Since the account became overdue on 30.11 2005 it would become NPA if it remains overdue for 2 crop seasons of SBIRD SHORT DURATION CROP SHORT DURATION CROP EXAMPLE­II: ­Nature of facility : KCC or ATL ­Crops grown by farmer : Padd 6 y ­Duration as per SLBC :months ­Beginning of season : June every y ­Date of sanction/Disbursement :ear 01.06.2005 30.11.2005 ­Due date * : (*For ATL : Instalment amount & For KCC: Full amount availed for Paddy cultivation) OTHER THAN MONO CROPPED AREAS AREAS Short Duration Crops : Paddy­ Double Crop Short Duration Crops : Commencement of season Due for payment Not Paid Remains unpaid NPA June 2005 ILLUSTRATIO N: 30.11.200 2 seasons of 6 months each 30.11.200 5 6 -Crops grown : Paddy -Short or Long Duration crop : Short duration (<12 months Crop) -Duration in months as per SLBC: 6 months ( suppose SLBC says so) -Since the account became overdue on 30.11 2005 it would become NPA if it remains overdue for 2 crop seasons of 6 months each ( 6+6 = 12 months), i.e on 30.11.2006. TERM LOANS TERM Instalment/ Interest due Remains overdue NOT PAID 91st Day NPA 31.03.2006 Overdue for > 90 days 30.06.2006* * April 30 days + May 31 Days + June 30 Days = 91 April days. days. Therefore, the account becomes NPA on 30.06.2006 Therefore, i.e. on 91st day. on ASSET CLASSIFICATION ASSET CLASSIFICATION An advance can be classified under only one category. All accounts of a borrower require to be classified under a single category. borrower in the case of loan account classified as NPA, the account should no longer be treated as NPA and may SBIRD straight If arrears of interest and principal are paid by the ASSET CLASSIFICATION Identification of NPA is to be done on the basis of position of the account as on the date of Balance Sheet, i.e. based on position of the account as on 31st March of every year. Age of NPA is reckoned from the date on which the a/c has slipped from Standard Category to NPA category and not from the date of sanction or date of irregularity. Date of sanction Due, but not paid ( A/c becomes irregular) Account becomes NPA 30.11.2004 30.11.2005 01.06.200 4 In the above example age of the NPA will be reckoned from 30.11.2005 & not from 01.06.2004 or SBIRD PROVISIONING PROVISIONING In In conformity with the prudential norms, provisions should be made on NPAs. provisions to make provision against sub-standard assets, doubtful assets and loss assets. addition to this, the Banks are required to make certain amount of provision against Standard Assets also. Standard Banks are required Banks In In SBIRD PROVISIONS TO BE MADE PROVISIONS TO BE MADE -Standard : 0. 40% of outstandings : 10% of net -Sub-Standard (secured) outstandings -Sub-standard (unsecured)* : 20% of net outstandings Details -- next screen -Doubtful -Loss : : 100% of outstandings. * UNSECURED ASSET: Where Realisable Value of the tangible security is less than 10% of total dues. SBIRD PROVISION FOR DOUBTFUL ASSETS PROVISION FOR DOUBTFUL ASSETS Period for which the advance has Period remained in ‘doubtful’ category remained Provision requirement (%) 20 % on Secured portion & 20 100% on Unsecured portion 100% 30 % on Secured portion & 30 100 % on Unsecured portion 100 100 % on unsecured and secured portion both after March 2007 both Up to one year (DA-1) Up One to three years (DA-2) More than three years (DA3) (I) Outstanding stock of DA-3 Outstanding as on March 31, 2004 (II) Advances classified as DA-3 on or after April 1, 2004 on 100 % 0n unsecured portion wef March 31, 2005 SBIRD Capital Management Capital Management & Profit Planning Basel II Basel II Tier I-Core Capital Paid up capital ,Free Reserves and unallocated surpluses Tier II-Supplementary Capital Subordinated debt of more than 5 years maturity ,loan Subordinated loss reserve, revaluation reserve,investment fluctuation reserve,limited life preference sharefluctuation restricted to 100% of tier I capital Tier III Capital subordinated debt with shot term maturity [min 2 subordinated years] for market risk Total Risk weighted Assets Total Risk weighted Assets Risk weighted assets of credit risk plus 12.5* Capital requirement for market risk plus 12.5* capital requirement for for operational risk Three pillars Three pillars First Pillar­minimum capital requirements Second pillar­supervisory process Third pillar­market discipline Capital Charge for Credit Risk Capital Charge for Credit Risk Standardized Approach Internal rating based approach [1]Foundation Approach [2]Advanced IRB Approach Credit rating of Risk weight for Credit rating of sovereign sovereign AAA TO AA A+ TO A 0% 20% Risk weight for banks in that country 20% 50% 100% 100% 150% BBB+ TO BBB­ 50% BB+ TO BB­ BELOW B­ 100% 150% Risk Weight Risk Weight Retail & SME EXPOSURE Mortgage on Residential Property Past Due Loans 75% 35% 150% When specific provisions are less than 20% of the loan amount If provision is higher than 20% ­do­ 100% Capital Charge for Operational Capital Charge for Operational Risk The Basic Indicator Approach The Standardized Approach Advanced Management Approach Standardized Approach Standardized Approach for Operational Risk Beta factor­ a fixed percentage set by Basel committee Maximum 18% Minimum 12% Banks activities are divided into 8 business lines­corporate finance,trading,retail banking, commercial banking, payment &settlement, agency services, asset management, retail brokering Asset Classification Asset Classification Standard Assets Doubtful Assts Loss Assets Sub Standard Assets Provisioning Provisioning Standard Assts 0.40% Substandard­ Secured ­provision 10% Unsecured[realisable value is not more than 10% of o/s] –provision 20% Provision Provision Doubtful I­ first 12 months Provision 20% realizable value of security plus 100% shortfall of security Doubtful II­further 24 months Provision 30% realizable value of security plus 100% shortfall of security Doubtful III­for over 36 months 100% provision Loss Assets 100% Thank you Thank you With Best Wishes ...
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This note was uploaded on 01/28/2011 for the course FIN 315 taught by Professor Welker during the Spring '09 term at IUP.

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