Professional Documents
Culture Documents
Short Notes For Caiib Afm
Short Notes For Caiib Afm
CAIIB
Creation of these short notes is the efforts of so many persons. First of all we thank all of them for
their valuable contribution. Though we had taken enough care to go through the notes provided
here, we request everyone to go through the Macmillan book and update yourself with the latest
information through RBI website and other authenticated sources. In case you find any
incorrect/doubtful information, kindly update us also (along with the source link/reference for the
correct information).
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MODULE A
INTERNATIONAL BANKING:
UNIT 1: EXCHANGE RATES AND FOREX BUSINESS
1. Foreign Exchange: Conversion of currencies from the currency of invoice to the home currency of
the exporters is called as
Foreign Exchange.
2. Foreign Exchange Management Act
defines Foreign Exchange as o ll deposits,
(FEMA),1999
credits and balances payable in foreign currency and any drafts, travelers Cheques, LCs and Bills of
Exchange, expressed or drawn in Indian Currency and payable in any foreign currency
Any instrument payable at the option of the drawee or holder, thereof or any other party
thereto, either in Indian Currency or in foreign currency, or partly in one and partly in the
other.
3. A Foreign Exchange transaction
is a contract to exchange funds in one currency for funds in
another currency at an agreed rate and arranged basis.
4. Exchange Rate
another currency.
means the price or the ratio or the value at which one currency is exchanged for
are
# Commercial Banks
# Investment Funds/Banks
# Forex Brokers
# Corporations
# Individuals
6. The Forex Markets are highly dynamic, that on an average the exchange rates of ma jor currencies
fluctuate
every 4 Seconds
21,600 changes
in a day (15X60X24)
Monday to Friday
7. Forex markets usually operate from
globally, except for the Middle East or
other Islamic Countries which function on Saturday and Sunday with restrictions, to cater to the local
needs, but are closed on Friday.
8. The bulk of the Forex markets are
a) Fundamental Reasons
# Balance of Payment
# Economic Growth rate
# Fiscal policy
# Monetary Policy
# Interest Rates
# Political Issues
b) Technical Reasons
- Government Control can lead to unrealistic value.
- Free flow of Capital from lower interest rate to higher interest rates
c) Speculative
10. Due to vastness of the market, operating in different time zones, most of the Forex deals in
general are done on
11. The delivery of
SPOT basis.
FX deals can be settled
# Ready or Cash
# TOM
# Spot
# Forward
# Spot and Forward
12. Ready or Cash
13. TOM: Settlement of funds takes place on the next working day of the deal. If the settlement day Is
holiday in any of the 2 countries, the settlement date will be next working day in both the countries.
14. Spot : Settlement of funds takes place on the second working day after/following the date of
Contract/deal. If the settlement day is holiday in any of the 2 countries, the settlement date will be
next working day in both the countries.
15. Forward: Delivery of funds takes place on any day after SPOT date.
16. Spot and Forward Rates
: On the other hand, when the delivery of the currencies is to take place
at a date beyond the Spot date, it is Forward Transaction and rate applied is called Forward Rate.
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19. If the value of the currency is more than being quoted for Spot, then it is said to be
at a premium.
20. If the currency is cheaper at a later date than Spot, then it is called
at a Discount.
21. The forward premium and discount are generally based on the
two currencies involved.
interest factor
23. The Forward price of a currency against another can be worked out with the following
of the
factors:
as Direct Quotes
GBP (Great Britain Pound) , , U$ and NZ$, the currencies are quoted as
indirect rates.
30. Japanese Yen being quoted
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: When dealing in a market where rates for a particular currency pair are not
directly available, the price for the said currency pair is then obtained indirectly with the help of Cross
rate mechanism.
32. How to calculate Cross Rate?:
The math is simple algebra:
[a/b] x [b/c] = a/c
Substitute currency pairs for the fractions shown above, and you get, for instance,
GBP/AUD x AUD/JPY = GBP/JPY.
This is the implied (or theoretical) value of the GBP/JPY, based on the value of the other two pairs.
The actual value of the GBP/JPY will vary around this implied value,as the following calculation shows.
Here are Friday's actual closing BID prices for the 3 currency pairs in this example (taken from FXCM's
Trading Station platform): GBP/AUD = 1.73449, AUD/JPY = 0.85535 and GBP/JPY =
1.48417
1.4836 , which is not exactly the same as the actual market price
Here's why. During market hours (Sunday afternoon to Friday afternoon, EST), all prices are LIVE, and
small departures from the mathematical relationships can exist momentarily.
33. Fixed Vs Floating Rates:
# The fixed exchange rate is the official rate set by the monetary authorities
for one or more currencies. It is usually pegged to one or more currencies.
# Under floating exchange rate, the value of the currency is decided by supply and demand factors for
a particular currency.
34. Since
rate system.
floating exchange
in 1993.
The buying rates and selling rates are referred to as Bid & Offered rate.
Theoretical Overview:
# Chain Rule: It is used in attaining a comparison or ratio between two quantities linked together
through another or other quantities and consists of a series of equations.
# Per Cent or Per mille:
38. Value Date:
A percentage (%) is a proportion per hundred. Per Mille means per thousand.
effective and/or subjected to interest, if any. In the case of TT, the value date is usually the same in
both centers.
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39. The payments made in same day, so that no gain or loss of interest accrues to either party is
called as
Valuer Compense
are :
# Exchange Risk
# Credit Risk
# Settlement Risk
# Liquidity Risk
# Gap Risk/ Interest/ Rate Risk
# Market Risk
# Legal Risk
# Systemic Risk
# Country Risk
# Sovereign Risk
50. The
Operation Risk
is the most common and obvious risk in foreign exchange dealing operations
Exchange Risk
and arise mainly on account of fluctuations in exchange rates and/ or when mismatches occur in
assets/ liabilities and receivables/ payables.
52. Credit risk arises due to inability or unwillingness of the counterpart to meet the obligations at
maturity of the underlying transactions.
53. Credit Risk is classified into
# Pre- Settlement Risk
# Settlement Risk
54. Pre Settlement Risk
is the risk of failure of the counter party before maturity of the contract
thereby exposing the other party to cover the transaction at the ongoing market rates.
55. Settlement Risk
is Failure of the counter party during the course of settlement, due to the time
is the potential for liabilities to drain from the bank at a faster rate than assets. The
mismatches in the maturity patterns of assets and liabilities give rise to liquidity risk.
57. Gap Risk/ Interest Rate Risk
This is arises out of adverse movement of market variables when the players are
is the possibility of a major bank failing and the resultant losses to counter parties
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is risk of counter party situated in a different country unable to perform its part of
the contractual obligations despite its willingness to do so due to local government regularizations or
political or economic instability in that country.
62. Sovereign Risk
63. RBI has prescribed guidelines for authorized dealers, permitted by it, to deal in foreign exchange
and handle foreign currency transactions.
64. FEMA 1999
also prescribes rules for persons, corporate etc in handing foreign currencies, as also
RBI is issued
licenses
India.
66. The RBI has also issued
companies, hotels, shops etc. to deal in foreign currency notes, coins and TCs
67. Full Fledged Money Changers (FFMC)
coins and TCs
68. Restricted Money Changers (RMCs):
69. Categories of Authorized Dealers; in the year 2005, the categorization of dealers authorized to
deal in foreign exchange has been changed.
Category
Entities
AD - Category I Banks, FIs and other entities allowed to handle all types of Forex
AD - Category II Money Changers (FFMCs)
AD - Category III Money Changers (RMCs)
70. Foreign Exchange Dealers Association of India, FEDAI (ESTD 1958)
of the game for market operations, merchant rates, quotations, delivery dates, holiday, interest on
defaults , Handling of export Import Bills, Transit period, crystallization of Bills and other related
issues.
71. Export bills drawn in foreign currency, purchased/ Discounted/ negotiated, must be crystallized
into rupee liability. The same would be done at
TT selling rate.
72. The crystallization period can vary from Bank to bank, (For Export Bills Generally on
customers to customer but
75. All contracts, which have matured and have not been picked up, shall be automatically cancelled
on the 7th working day, after the maturity date.
76. All cancellations shall be at
Sale contracts.
common risks
i. Exchange Risk
ii. Settlement Risk/ Temporal Risk/ Herstatt Risk (Named after the 1974 failure of the Bankhaus
Herstatt in Germany)
iii. Liquidity Risk
iv. Country Risk
v. Sovereign risk
vi. Intrest Rate Risk
vii. Operational Risk
loss for the dealers
open position.
long position
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6. Country risk
is a dynamic risk
and can be
7. Sovereign risk can be managed by suitable disclaimer clauses in the documentation and
also by subjecting such sovereign entities to third jurisdiction.
8. Operational risk can be controlled by putting in place state of art system, specified contingencies.
9. RBI has issued Internal Control Guidelines (ICG) for Foreign Exchange Business.
10. Various Dealing Limits are as follows:
a. Overnight Limit : Maximum amount of open position or exposure, a bank can keep overnight, when
markets in its time zone are closed.
b. Daylight Limit : Maximum amount of open position or exposure, the bank can expose itself at any
time during the day, to meet customers needs or
for its trading operations
c. Gap Limits : Maximum inter period/month exposures which a bank can keep, are called gap limits
d. Counter Party Limit
: Maximum amount that a bank can expose itself to a particular counter party.
e. Country Risk: Maximum exposure on a single country
f. Dealer Limits:
Maximum amount a dealer can keep exposure during the operating hours.
g. Stop-Loss Limit : Maximum movement of rate against the position held, so as to trigger the limit or
say maximum loss limit for adverse movement of rates.
h. Settlement Loss Limit:
i. Deal Size Limit: Highest amount for which a deal can be entered. The limits are fixed to restrict the
operational risk on large deals.
11. CCIL (Clearing Corporation of India Ltd)
takes over the Settlement Risk,
large pool of resources, called settlement Guarantee Fund, which is used to cover outstanding of any
participant.
12. The Clearing Corporation of India Ltd. (CCIL) was set up in April, 2001
clearing and settlement for transactions in Money, GSecs and Foreign Exchange.
February 15, 2002 Negotiated Dealing System (NDS)
November 2002 settlement of Forex transactions
January 2003 Collateralized Borrowing and Lending Obligation (CBLO), a money market product
based on Gilts as collaterals
August 7, 2003 Forex trading platform FX-CLE R
April 6, 2005. settlement of cross-currency deals through the CLS Bank
13. Six 'core
(IDBI), ICICI Ltd., LIC (Life Insurance Corporation of India), Bank of Baroda, and HDFC Bank.
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14. Derivatives:
A security whose price is dependent upon or derived from one or more underlying
assets. The derivative itself is merely a contract between two or more parties. Its value is determined
by fluctuations in the underlying asset. The most common underlying assets include stocks, bonds,
commodities, currencies, interest rates and market indexes. Most derivatives are characterized by
high leverage.
worlds first Exchange traded
Our ccount with you DLB maintains an US $ account with Bank of Wachovia,
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5. Vostro Account:
Your account with us Say merican Express Bank maintain a Indian Rupee
account with SBI is Vostro Account in the books of American Express bank
6. Loro Account:
It refers to accounts of other banks i.e. His account with them. E.g. Citi Bank
referring to Rupee account of American Express Bank, with SBI Mumbai or some other bank referring
to the USD account of SBI, Mumbai with Citi Bank, New York.
7. Mirror Account:
While a Bank maintains Nostro Account with a foreign Bank, (Mostly in foreign
currency), it has to keep an account of the same in its books. The mirror account is maintained in two
currencies, one in foreign currency and one in Home currency.
8. Electronic Modes of transmission/ payment gateways
SWIFT, CHIPS, CHAPPS, RTGS, NEFT
9. SWIFT: Society for Worldwide Interbank Financial Telecommunications.
10. SWIFT has introduced new system of authentication of messages between banks by use of
Relationship Management Application (RMA) also called as
1970. It is established by New York Clearing House. Present membership is 48. CHIPS are operative
only in New York.
12. FEDWIRE: This is payment system of Federal Reserve Bank, operated all over the US since 1918.
Used for domestic payments.
13. All US banks maintain accounts with
identify senders and receivers of payment
What Does
B number
Mean?
A unique number assigned by the American Bankers Association (ABA) that identifies a specific
federal or state chartered bank or savings institution. In order to qualify for an ABA transit number,
the financial institution must be eligible to hold an account at a Federal Reserve Bank. ABA transit
numbers are also known as ABA routing numbers, and are used to identify which bank will facilitate
the payment of the check.
14. CHAPS: Clearing House Automated Payments system is British Equivalent to CHIPS, handling
receipts and payments in LONDON
15. TARGET: Trans-European Automated Real Time Gross Settlement Express Transfer System is a
EURO payment system working in Europe. And facilitates fund transfers in Euro Zone.
to
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16. RTGS + and EBA: RTGS+ is Euro German Based hybrid Clearing System. RTGS+ has 60 participants.
17. EBA-Euro 1 is a cross Border Euro Payments
18. RTGS/NEFT in India:
The RTGS system is managed by IDRBT- Hyderabad. Real Time Gross
Settlement takes place in RTGS. NEFT settlement takes place in batches.
19. NRI: (Non- resident Indian) definition
: As per FEMA 1999
A person resident outside India who is a citizen of India i.e.
a) Indian Citizen who proceed abroad for employment or for carrying on any business or vocation or
for any other purpose in cirucumstances indicating indefinite period of stay outside India.
b) Indian Citizens working abroad on assignment with Foreign government, government agencies or
International MNC
c) Officials of Central and State Governments and Public Sector Undertaking deputed abroad on
assignments with Foreign Govt Agencies/ organization or posted to their own offices including Indian
Diplomatic Missions abroad.
20. NRI is a Person of Indian
Nationality or Origin,
employment, or intention of employment or vocation, and the period of stay abroad is indefinite. And
a person is of Indian origin if he has held an Indian passport, or he/she or any of his/hers parents or
grandparents was a citizen of India.
21. A spouse , who is a foreign citizen
purpose of opening of Bank Account, and other facilities granted for investments into India, provided
such accounts or investments are in the joint names of spouse.
22. NRE Accounts Rupee and Foreign Currency Accounts
23. NRI has provided with various schemes to open Bank A/cs an invest in India.
1) Non Resident (External) Rupee Account (NRE);
2) Non- Resident (Ordinary) Rupee Account (NRO);
3)Foreign Currency (Non-Resident) Account (Banks) {FCNR(B)}
When resident becomes NRI,
account.
For NRE Rupee A/cs , w.e.f 15-3-2005 an attorney can withdraw for
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(ICC)was established in
1933
recently in 2007.
UCPDC 600.
w.e.f 1-7-2007.
instrument issued by the buyers Banker, embodying an undertaking to pay to the seller a certain
amount of money, upon presentation of documents, evidencing shipment of goods, as specified, and
compliance of other terms and conditions..
7. IN an LC Parties are as follows:
a. The buyers/ Importers or the applicant on whose behalf LC is opened.
b. The Sellers/Exporters or the
Beneficary of the LC
c. The opening Bank (Buyers Bank),
who establishes the LC
d. The advising
who acts as an agent of the issuing bank and
bank (Bank in sellers country),
authenticates the LC.
e. The confirming Bank-
Applicant of LC
- Mr Ram, Khammam
can be amended or cancelled at any moment by the issuing bank without the
consent of any other party, as long as the LC has not been drawn or documents taken up.
10. In case the Negotiating Bank has taken up the documents under revocable LC, prior to receipt of
cancellation notice, the issuing bank is liable to compensate/reimburse the same to the negotiating
bank.
11. Irrevocable LC
which holds a commitment by the issuing bank to pay or reimburse the negotiating
irrevocable LC
is an L/c which has been confirmed by a bank, other than the issuing a
bank, usually situated in the country of the exporter, thereby taking an additional undertaking to pay
on receipt of documents conforming to the terms & conditions of the LC
16. The
Conforming Bank
can be
advising Bank
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issuing bank.
18. Transferrable LC
is available for transfer in full or in part, in favour of any party other than
conforming to the terms and conditions of the LC at the nominated banks countries
21. Under the Acceptance Credit
, the bill of exchange or drafts are drawn with certain Usance period
and are payable upon acceptance, at a future date, subject to receipt of documents conforming to
the terms and condition of the LC.
22. A Deferred Payment Credit
is similar to Acceptance Credit, except that there is no bill of
exchange or draft drawn and is payable on certain future date, subject to submission of credit
confirmed documents. The due date is generally mentione d in the LC
23. A Negotiation Credit,
the issuing Bank undertakes to make payment to the Bank, which has
27. Important Changes in the Articles of UCP 600 and their implication for the Banks:# A reduction in the number of articles from
# New articles
rules
49 to 39
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r refusal of documents by a
A statement
any verbiage regarding revocable letters of credit, which can be amended or canceled at any time
without notice to the seller. .Actually,
Article 2 explicitly defines a credit as "any arrangement,
however named or described, that is irrevocable and thereby constitutes a definite undertaking of
the issuing bank to honour a complying presentation."
30. Article 3
authenticity of the credit that it has advised. Under art 9(b) it has to certify that the document that it
and
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k.
:- The position under article 9(d)(iii) of UCP 500 has been maintained in
Article 10 under UCP 600. Article 10 now deals exclusively with amendments and article 10(c)
provides '
The beneficiary should give notification of acceptance or rejection of an amendment
the beneficiary fails to give such notification, a presentation that complies with the credit and to any
not yet accepted amendment will be deemed
such amendment
. If
banking day as
."
Article 14(d) provides the standard for examination of
documents generally. It seeks to resolve the problem of inconsistency in data by clarifying that there
is no need for a mirror image but rather
39. Regarding addresses on the various documents, Article 14
exactly match as long as the country is the same. The only exception is when addresses appear as
part of the consignee or notify party details on a transport document, in which case they must be the
same as stated in the credit.
40. Examination of documents:
41. The period for presentation (usually 21 days) only applies to original transport documents.
42. Addresses of beneficiaries and applicants need no longer be as mentioned in the documentary
credit. They must however be within the same country.
43. Non-Documentary Requirements
requirements. This means that any requirement in the credit that is not specifically part of a required
document will be ignored by the bank in determining conformity.
which
:- Under UCP 600 it is clear that this begins when the bank
documents has the option of holding them at the presenter's disposal or handling them in accordance
with the presenter's prior instructions, such as to return them. Article 16 now encompasses
additional options designed to avoid banks sitting on discrepant documents and issues relating to
forced waivers.
The options (which are alternatives) are as follows:
# Hold documents pending further instructions from the presenter; or
# Hold documents until it receives a waiver from the applicant and agrees to accept it, or receives
further instructions from the presenter prior to agreeing to accept a waiver; or return the documents;
or act in accordance with instructions previously received from the presenter. There is no provision
for payment under reserve or indemnity.
46. Original Documents (Article 17)
documents with more precision.
"Charterer"
49. Under UCP 600 a generic set of rules generally applies to all transport documents (other than
charter party bills of lading). These include the following:
# The document must indicate the name of the carrier and be signed by: (a) the carrier or named
agent for or on behalf of the carrier; or (b) the master or named agent for or on behalf of the master.
# Any signature by the carrier, master or agent must be identified as that of the carrier, master or
agent.
# Any signature of an agent must indicate whether the agent has signed for or on behalf of the carrier
for or on behalf of the master.
# There is no need to name the master.
# In the case of charter party bills of lading :
# These no longer need to indicate the name of the carrier.
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# They may now also be signed by the charterer, although it is difficult to envisage a situation where
an FOB buyer/ applicant would wish to rely on a bill of lading signed by the seller/beneficiary and vice
versa in the case of a CIF sale.
# Transport documents also no longer need to bear the clause 'clean' in order to comply with any
credits that require a document to be 'clean on board'.
50. Insurance documents - article 28
credit will be acceptable. Banks will also be able to accept an insurance document that
reference to any exclusion clause
contains
51. For the insurance documents the following has been changed:
of the insurance company
or underwriter.
on behalf
banks will not honour or negotiate under a credit that expired during the force
majeure event.
53. It is the responsibility of the
Negotiating bank
payment.
54. In case the advising bank does not advise the LC, it must inform of its decision to the
Opening
Bank immediately.
55. The
must ensure the authenticity of LC before advising the same to the beneficiary.
advising bank
56. In case the reimbursing bank does not pay to the negotiating bank, the ultimate
liability
Letter of Credit :
a. Bill of Exchange
b. Invoice
c. Bill of Lading
d. Insurance Policy/Certificate
e. Certificate of Origin
f. Packing List, Weight List and other Documents
58. Bill of exchange
lies with
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59. Invoice
acceptance to port of destination. It is a receipt issued by the ship owner or its authorized agent.
Exports
RBI and DGFT
RBI controls Foreign Exchange and DGFT (Directorate General of Foreign Trade)
controls Foreign Trade. Exim Policy as framed in accordance with FEMA is implemented by DGFT.
DGFT functions under direct control of Ministry of Commerce and Industry. It regulates Imports and
Exports through EXIM Policy.
On the other hand, RBI keeps Forex Reserves, Finances Export trade and Regulates exchange control.
Receipts and Payments of Forex are also handled by RBI.
IEC Importer Exporter Code
One has to apply for IEC to become eligible for Imports and Exports. DGFT allots IEC to Exporters and
Importers in accordance with RBI guidelines and FEMA regulations. EXIM Policy is also considered
before allotting IEC.
Export Declaration Form
All exports (physically or otherwise) shall be declared in the following Form.
GR form--- meant for exports made otherwise than by post.
PP Form---meant for exports by post parcel.
Softex form---meant for export of software.
SDF (Statutory Declaration Form)----replaced GR form in order to submit declaration electronically.
SDF is submitted in duplicate with Custom Commissioned who puts its stamp and hands over the
same to exporter marked Exchange Control Copy for submission thereof to D
Exceptions
Trade Samples, Personal effects and Central Govt. goods.
Up to USD 25000 (value) Goods or services as declared by exporter.
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On 8th Sep, an exporter tenders a demand bill for USD 100000 drawn on New York. The
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Spot---------USD 1 =34.3000/3500
Spot Sep-------------------6000/7000
Spot Oct--------------------8000/9000
Spot Nov------------------10000/11000
Transit Period is 20 days and Exchange margin 0.15%
Calculate Rupee payable to the customer. Customer wants to retain 15% in Dollars
Solution
Since, the currency is at premium, the transit period will be rounded off to the lower month (i.e. NIL).
And the rate to the customer will be based on Spot Rate. If interest rate is 13%, how much interest
will be recovered from the exporter.
Spot Buying rate = 34.3000
Less Exchange Margin = 0.0515
34.2485 or 34.25 per dollar.
Amount in Indian Rupee = 85000(85% of 100000) x 34.25 = 2911250/Interest will be charged on 2911250/- @ 13% for 20 days = 20738/-.
Q. 6. On 26th Aug, an exporter tenders for purchase a bill payable 60 days from sight and drawn on
New York for USD 25650. The dollar rupee rate is as under:
Spot----------------------1USD = 34.6525/6850
Spot Sep--------------------------------1500/1400
Spot Oct---------------------------------2800/2700
Spot Nov--------------------------------4200/4100
Spot Dec--------------------------------5600/5500
Exchange Margin is 0.15%, Transit Period is 20 days. Rate of Intere st is 13%.
What will be the exchange rate payable to the customer and Rupee amount payable?
Solution
Notional due Date = 20+60 days from 26th Aug i.e. 14th Nov. Since, the currency is at discount, the
period will be rounded off to the same month (higher of Oct or Nov). Obviously, the discount of Nov
will be more and it will make the Buy Rate Lower.
Dollar/Rupee market spot Buying Rate = 34.6525
Less Discount for August to November = 0.4200 = 34.2325
Less Exchange Margin @.15% .0513 = 34.1812
Rupee Amount payable to exporter = 25650 X 34.18 = 876717.00
Less Interest for 80 days @ 13% = 24980.00
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from date of remittance. Otherwise, one months notice will be served If there is still default of 21
days after serving notice, Ad will forward Statement to RBI on Half yearly basis on BEF Form.
Import Finance
Letter of Credit
Import Loans against Pledge/Hypothecation of stocks.
Trade Credit Supplier Credit or Buyer Credit
Trade Credit If the Import proceeds are not remitted, within 6 months, it is treated as Trade Credit up
to the period less than 3 years. For period 3 years and above, the credit is called ECB (External
Comme rcial Borrowings).
Suppliers Credit
It is credit extended by Overseas suppliers to Importer normally beyond 6 months up to period of 3
years.
Up to 1 year for Current Account Transactions
Up to 3 years for Capital Account Transactions
Monetary Limit is USD 20 million per transaction.
Buyers Credit
It is credit arranged by Importer from Banks/Fis outside countries. Banks can approve proposals of
Buyers Credit with period of Maturity
Up to 1 year for Current Account Transactions
Up to 3 years for Capital Account Transactions
Monetary Limit is USD 20 million per transaction.
Crystallization of Foreign Currency Liability into INR
In case the importer fails to make payment,
crystallization of Foreign Exchange liability into Indian Rupees is done on 10th day at TT selling
Rate.
In case of Retirement of Import Bill
The crystallization is done at current Bill Selling Rate or Contracted Bill Selling Rate (Whichever
is higher).
DP Bill: On 10th Day from date of receipt of Import Bill.
DA Bill: On Actual Due Date.
All-in Cost Ceiling
The present Ceilings for all-in-cost, including interest for buyers/suppliers credit, as fixed by
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RBI is as under:
Up to 365 days --------------------- LIBOR + 350 bps
Above 1 year up to 3 years --------LIBOR + 350 bps
These ceilings include management fees, arrangement fees etc.
Example
On 12th Feb, a customer has received an Import bill for USD 10000/-. He asks you to retire
the bill to the debit of the account. Considering Exchange margin 0.15% for TT sales and 0.20% on Bill
Selling Rate. What amount will be debited to the account. Spot rate is 34.6500/34.7200
Spot march = 5000/4500
Rate applied will be Bill Selling Rate
Spot Rate = 34.7200
Add Margin for TT selling (0.15%) = 0.0520
TT selling Rate = 34.7720
Add margin for Bill selling@ 0.20% = 0.0695
Bill Selling Rate = 34.8415
Customers account will be debited with Rs 348400/ - (10000X 34.84)
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The policy provides cover against Commercial risks and Political risks covering insolvency of the
buyer, failure of the borrower to make payment due within 2 months from due date, borrowers
failure to accept the goods due to no fault of exporter.
Specific Shipment Policy
Comme rcial risks Failure to pay within 4M. It covers short term credit not exceeding 180 days
Exports Specific Buyer Policy
Comme rcial risks Failure to pay within 4M and Political Risks
The other Policies are Exports (specific buyers Policy), Buyers Exposure Policy, Export Turnover
Policy (exporters who pay minimum 10 lac premium to ECGC are eligible) and Consignment export
Policy.
Financial Guarantees
ECGC issues following types of Guarantees for the benefit of Exporters:
Packing Credit Insurance
ECIB (WT-PC) Exporters Credit Insurance for Banks (whole Turnover Packing Credit)
This policy is issued to banks to guarantee export risks:
For all exporters
Minimum 25 accounts should be there.
Minimum assured premium is Rs. 5.00 lac.
Period of cover is 12M.
The claim is payable if there is default of 4 Months.
Premium for fresh covers is 8 paisa per month and for others is 6-9.5 paisa percent. It is calculated on
average outstanding.
Percentage of cover ranges from 50-75%
If due date of export proceeds is extended beyond 360 days, approval of ECGC is required.
Claim is to be filed within 6M of report of default to ECGC.
ECIB PC for individual exporters.
period of coverage is 12M and %age of cover is 66-2/3 %. The premium is 12 paisa% on highest
outstanding.
Monthly declaration by banks before 10th.
Approval of Corporation beyond 360 days PC.
Report of default within 4M from due date.
Filing of claim within 6M of the report.
ECIB (WT- PS) Whole Turnover Post Shipment Credit Policy
It is a common policy for all exporters.
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Unit 7 : Role of Exim Bank, Reserve Bank of India, Exchange Control in India - FEMA and FEDAI
and Others
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FEMA provisions
Business Purpose
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The scheme is meant for Resident Indians individuals. They can freely remit up to USD 200000 per
financial year in respect of any current or capital account transaction (e.g. to acquire property outside
India) without prior approval of RBI. The precondition is that the remitter should have been a
customer of the bank for the last 1 year. PAN is mandatory.
Not Applicable
The scheme is not applicable for remittance to Nepal, Bhutan, Pak, Mauritius or other counties
identified by FATF.
The scheme is not meant for remittance by Corporate.
Import and Export of Indian Rupees
Limit is Rs. 7500/- while leaving India and while coming to India.
RETURNS TO BE SUBMITTED TO RBI
Following important returns are submitted to RBI
R- Returns - Forex Operations (Fortnightly)
BAL statement - Balance in Nostro/Vostro account
STAT 5 - Transactions in FCNR B accounts
STAT 8 - Transactions in NRE/NRO accounts
LRS Statement - UP to USD 200000 (monthly)
Trade Credit Statement - Buyers and Suppliers Credit
XOS O/S - Overdue Export bills
BEF - Import Remittance effected but Bill of Entry not submitted for >3M.
ETX Form - Seeking relaxation from RBI after expiry of 12M when export proceeds are not received.
RFC accounts Resident Foreign Currency account is opened by Indian residents who were earlier NRIs
and forex is received by them from their overseas dues:
The accounts can be opened as SB/CA/FD type.
Proceeds are received from overseas.
Out of Monetary benefits accruing abroad
The funds are freely repatriable.
Minimum amount is USD 5000.
RFC- D accounts Resident Foreign Currency (Domestic) accounts are opened:
By Indian residents who visit abroad: and
Bring with them Foreign Exchange;
As honorarium, gift etc.
Unspent money can also be deposited.
These are CA nature accounts and no interest is paid.
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FEDAI Foreign Exchange association of India is a non-profit body established in 1958 by RBI. All public
sector banks, Private Banks, Foreign Banks and Cooperative banks are its members. The functions of
FEDAI are:
Forming uniform rules
Providing training to bankers; and
Providing guidance and information from time to time.
The important rules are:
Export Transactions : Forex liability must be crystallized into Indian rupees on 30th day after expiry of
NTP (Notional Transit Period) in case of Sight bills and on 30th day after notional due date in case of
Usance bills. The rule has since been relaxed and bank can frame its own rule for nos. of days for
crystallization.
Concessional rate of interest is applied up to Notional due date or up to value date of realization of
export dues (whichever is earlier)
Import Transactions: For retirement of Import bills whether under LC or otherwise, banks Bill selling
rate on date of retirement or the Forward rate will be applied.
DP Bills (sight) are retired after crystallization on 10th day after receipt.
DA Bills are retired (crystallized) on Due Date.
All Foreign Currency bills under LC, if not retired on receipt, shall be crystallized into Rupee liability on
10th day after date of receipt of documents at TT Selling Rate.
Normal Transit Period is:
- 25 days for export bills,
- 3 days for Rupee bills drawn under LC and payable locally
- 7 days for rupee bills drawn under LC and payable at other centers
- 20 days for Rupee bills not drawn under LC.
- For exports to Iraq, normal transit period is 60 days.
Compensation on Delayed payment:
All Foreign Inward remittances up to Rs.1.00 lac should be converted into Indian Rupees immediately
The proceeds of any Inward remittance should be credited to the account within 10 days and advice
of receipt is to be sent within 3 days, failing which, compensation @2% above SB rate will be paid to
the beneficiary.
Forward Contracts
Exchange contracts will be for definite amount and period.
Contracts must state first and last date of contracts e.g. from 1-31 Jan or from 17th Jan to 16
For contracts up to 1 month, option period for delivery may be specified.
In case of extension of contract, previous contract will be cancelled at TT Buying rate or TT selling rate
as the case may be.
th Feb.
Overdue contracts are liable to be cancelled on 7th working day after maturity date if no instructions
are received. The contracts must state first and last date of the contract.
Banks are now free to fix their own rates of commission and margin etc.
ECBs External Commercial Borrowings are medium and long term loans as permitted by RBI for the
purpose of :
Fresh investments
Expansion of existing facilities
Trade Credit (Buyers Credit and Sellers Credit) for 3 years ar more
Automatic Rout
ECB for investment in Real Estate sector , Industrial sector and Infrastructure do not require RBI
approval
It can be availed by Companies registered under Indian Company Act.
Funds to be raised from Internationally recognized sources such as banks, Capital markets etc.
Maximum amount is USD 20 million with minimum average maturity of 3 years and USD 50 million
with average maturity of 5 years.
All in cost ceiling is LIBOR+350 bps for ECB up to 5 years and LIBOR+500 bps for ECBs above 5 years.
Approval Route
Under this route, funds are borrowed after seeking approval from RBI.
The ECBs not falling under Automatic route are covered under Approval Route.
Under this route, Issuance of guarantees and Standby LC are not allowed.
Funds are to be raised from recognized lenders with similar caps of all-in-cost ceiling.
ADRs American Depository Receipts are Receipts or Certificates issued by US Bank representing
specified number of shares of non-US Companies. defined as under:
These are issued in capital market of USA alone.
These represent securities of companies of other countries.
These securities are traded in US market.
The US Bank is depository in this case.
ADR is the evidence of ownership of the underlying shares.
Unsponsored ADRs
It is the arrangement initiated by US brokers. US Depository banks create such ADRs. The depository
has to Register ADRs with SEC (Security Exchange Commission).
Sponsored ADRs
Issuing Company initiates the process It promotes the companys DRs in the US It chooses single
Depository bank. Registration with SEC is not compulsory. However, unregistered ADRs are not listed
in US exchanges.
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GDRs Global Depository Receipt is a Dollar dominated instrument with following features:
Traded in Stock exchanges of Europe.
Represents shares of other countries.
Depository bank in Europe acquires these shares and issues Receipts to investors
GDRs do-not carry voting rights.
Dividend is paid in local currency and there is no exchange risk for the issuing company.
Issuing Co. collects proceeds in foreign currency which can be used locally for meeting Foreign
exchange requirements of Import.
GDRS are normally listed on Luxembourg Exchange and traded in OTC market London and private
placement in USA.
It can be converted in underlying shares.
IDRs Indian Depository Receipts are traded in local exchanges and represent security of Overseas
Companies.
CDF (Currency Declaration Form)
CDF is required to be submitted by the person on his arrival to India at the Airport to the custom
Authorities in the following cases:
If aggregate of Foreign Exchange including Foreign currency/TCs exceeds USD 10000 or its equivalent.
If aggregate value of currency notes (cash portion) exceeds USD 5000 or its equivalent.
Interest Subvention on Export Credit @2%
Reserve Bank of India has now decided to extend the interest subvention of 2% on rupee export
credit for the period 1.4.2012 to 31.3.2013 on the same terms and conditions to the following
sectors:
i. Handicrafts
ii. Carpet
iii. Handlooms
iv. Small and Medium Enterprises (SMEs) (as defined in Annexure-I)
v. Readymade Garments
vi. Processed Agriculture Products
vii. Sport Goods
viii. Toys
Interest subvention of up to 2% may be allowed on pre -shipment credit up to 270 days and postshipment credit up to 180 days on the outstanding amount for the period 1.4.2012 to 31.3.2013 to
the above mentioned sectors subject to the condition that the rate of interest shall not fall below 7%
after allowing the aforesaid subvention. Further, it should be ensured that the benefit of interest
subvention is passed on completely to the eligible exporters.
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It is common statistical measure of dispersion around the average of any random variable such as
earnings, Markto market values, losses due to default etc.
Stati stically Volatility is Standard deviation of Value of Variables
Calculation
Example 1 : We have to find volatility of Given Stock price over a given period. Volatility may be
weekly or monthly. Suppose we want to calculate weekly volatility. We will note down Stock price of
nos. of weeks.
Mean Price = 123.62 and
Variance (sum of Squared deviation from mean) is 82.70
(extracted from weekly Stock prices)
Volatility i e sd = Variance = 82 70 = 9 09
Volatility over Time Horizon T = Daily Volatility X T
,
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Example 2
Daily Volatility =1.5%
Monthly Volatility = 1 5 X 30 = 1 5 X 5 48 = 8 22
Volatility will be more if Time horizon is more
Downside Potential
It captures only possible losses ignoring profits and risk calculation is done keeping in view two
components:
1. Potential losses
2. Probability of Occurrence.
The measure is more relied upon by banks/FIs/RBI. VaR (Value at Risk is a downside Risk Measure.)
Risk Pricing
Risk Mitigation
can be mitigated by accepting Collaterals, 3rd party guarantees, Diversification of
Credit Risk
Advances and Credit Derivatives.
can be reduced by Derivatives of Interest Rate Swaps.
Interest rate Risk
Forex Risk can be reduced by entering into Forward Contracts and Futures etc.
If we make advances to different types of business with different Risk percentage, the overall risk will
be reduced through diversification of Portfolio.
Banking Book, Trading Book and Off Balance Sheet Items
,
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Banking Book
It includes all advances, deposits and borrowings which arise from Commercial and Retail Banking.
These are Held till maturity and Accrual system of accounting is applied. The Risks involved are:
Liquidity Risk, Interest Rate Risk, Credit Default Risk, Market Risk and Operational Risk.
Trading Book
It includes Assets which are traded in market.
The se are not held till maturity.
The positions are liquidated from time to time.
These are Mark- to market i.e. Difference between market price and book value is taken as profit.
Trading Book comprises of Equities, Foreign Exchange Holdings and Commodities etc
These also include Derivatives
The Risks involved are Market Risks. However Credit Risks and Liquidity Risks can also be there.
Off Balance Sheet Exposures
The Off Balance sheet exposures are Contingent Liabilities, Guarantees, LC and other obligations. It
includes Derivatives also. These may form part of Trading Book or Banking Book after they become
Fund based exposure.
Types of Risks
1. Liquidity Risk
It is inability to obtain funds at reasonable rates for meeting Cash flow obligations. Liquidity Risk is of
following types:
Funding Risk: It is risk of unanticipated withdrawals and non-renewal of FDs which are raw material
for Fund based facilities.
Time Risk:
It is risk of non-receipt of expected inflows from loans in time due to high rate NPAs which
The risk of Gap between maturities of Assets and Liabilities. Sometimes, Long
term loans are funded by short term deposits. After maturity of deposits, these liabilities are get
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repriced and Gap of Interest rates between Assets and Liabilities may become narrowed thereby
reduction of profits.
Basis Risks:
Change of Interest rates on Assets and Liabilities may change in different magnitudes
and TL. It may also result into pre-mature withdrawal of TDs/RDs. This will also result into reduced
NII. This is called Embedded Risk.
Re-investment Risk:
reinvested.
It is uncertainty with regard to interest rate at which future cash flows could be
3. Market Risk
Market Risk is Risk of Reduction in Mark-to-Market value of Trading portfolio i.e. equities,
commodities and currencies etc. due to adverse market sensex. Market Risk comprises of:
- Price Risk occurs when assets are sold before maturity. Bond prices and Yield are inversely related.
- IRR affects the price of the instruments.
- Price of Other commodities like Gold etc,. is also affected by the market trends.
- Forex Risks are also Market Risks.
- Liquidity Risk or Settlement Risk is also present in the market.
4. Credit Risk or Default Risk
Credit Risk is the risk of default by a borrower to meet commitment as per agreed terms and
conditions. There are two types of credit Risks:
Counter party Risk:
Country Risk :
imposed by a country.
5. Operational Risk
Operation Risk is the risk of loss due to inadequate or Failed Internal procedures, people and the
system. The external factors like dacoity, floods, fire etc. may also cause operational loss. It includes
Frauds Risk, Communication Risk, Documentation Risk, Regulatory Risk, Compliance Risk and legal
risks but excludes strategic /reputation risks.
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Risk arising from fraud, failed business processes and inability to maintain Business
Continuity.
Failure to comply with applicable laws, regulations, Code of Conduct may attract
Compliance Risk:
penalties and compensation.
Other Risks are:
1. Strategic Risk: Adverse Business Decisions, Lack of Responsiveness to business changes and no
strategy to achieve business goals.
2. Reputation Risk ; Negative public opinions, Decline in Customer base and litigations etc.
3. Systemic Risks ; Single bank failure may cause collapse of whole Banking System and result into
large scale failure of banks.
In 1974, closure of HERSTATT Bank in Germany posed a threat for the entire Banking system
BASELI
Bank for International Settlements (BIS) is situated at Basel (name of the city in Switzerland). Moved
by collapse of HERSTATT bank, BCBS Basel Committee on Banking Supervision consisting of 13
members of G10 met at Basel and released guidelines on Capital Adequacy in July 1988. These
guidelines were implemented in India by RBI w.e.f. 1.4.1992 on the recommendations of Narsimham
Committee. The basic objective was to strengthen soundness and stability of Banking system in India
in order to win confidence of investors, to create healthy environment and meet international
standards.
BCBS meets 4 times in a year. Presently, there are 27 members.
BCBS does not possess any formal supervisory authority.
1996 Amendment
llowed banks to use Internal Risk Rating Model
Computation of VaR daily using 99th percentile
Use of back-testing
llowing banks to issue short term subordinate debts with lock-in clause.
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Capital funds(Tier I & Tier II)/(Credit Risk Weighted Assets + Market RWAs + Operational RWAs) X 100
Minimum requirement of CRAR is as under:
As per BASEL-II recommendations 8%
As per RBI guidelines 9%
Banks undertaking Insurance business 10%
New Private Sector Banks 10%
Local Area banks 15%
For dividend declaration by the banks (during previous 2 years and current year) 9%
Tier I & Tier II Capital
Tier I Capital
Tier I Capital includes:
Paid up capital, Statutory reserves, Other disclosed free reserves, Capital Reserve representing
surplus out of sale proceeds of assets.
Investment fluctuation reserve without ceiling
Innovative perpetual Debt instruments (Max 15% of Tier I capital)
Perpetual non-cumulative Preference shares
Less Intangible assets & Losses.
Sum total of Innovative Perpetual Instruments and Preference shares as stated above should not
exceed 40% of Tier I capital. Rest amount will be treated as Tier II capital.
Tier II Capital
It includes:
Redeemable Cumulative Preference shares, Redeemable non-cumulative Preference shares &
Perpetual cumulative Preference shares,
Revaluation reserves at a discount of 55%,
General Provisions & Loss reserves up to 1 25 % of RW s
Hybrid debts (say bonds) & Subordinate debts (Long term Unsecured loans) limited to 50% of Tier I
Capital.
Tier III Capital
Banks may at the discretion of the National Authority, employ 3rd tier of Capital consisting of short
term subordinate debts for the sole purpose of meeting a proportion of capital requirements for
only
market risks Tier III capital will be limited to 250% of banks Tier I Capital (Minimum of 28.5%) that
is required to support market risks.
Tier II capital should not be more than 50% of Total Capital.
Capital adequacy in RRBs
The committee on financial sector assessment has suggested introducing CRAR in RRBs also in a
phased manner.
Two ways to improve CRAR
1. By raising more capital. Raising Tier I capital will dilute the equity stake of existing investors
including Govt. Raising Tier II Capital is definitely a costly affair and it will affect our profits.
2. Reduction of risk weighted assets by implementing Risk mitigation Policy.
Risk Weights on different Assets
Cash and Bank Balance 0%
Advances against NSC/KVC/FDs/LIC 0%
Govt. guaranteed Advances 0%
Central Govt. Guarantees 0%
State Govt. Guarantees 20%
Govt. approved securities 2.5%
Balance with other scheduled banks having CRR at least 9% 20%
Other banks having CRR at least 9% 100%
Secured loan to staff 20%
Other Staff loans -not covered by retirement dues 75%
Loans upto 1.00 lac against Gold/Silver 50%
Residential Housing Loans O/S above 30 lac 75%
Residential Housing loans O/S upto 30 lac 50%
Residential property if LTV ratio is above 75% 100%
Residential Housing Loans O/S above 75 lac 125%
Mortgage based securitization of assets 77.5%
Consumer Credit / Credit Cards/Shares loan 125%
Claims secured by NBFC-non-deposit taking (other than AFCs) 100%
Venture Capital 150%
Comme rcial Real Estates 100%
Education Loans (Basel II -75%) 100%
Other loans (Agriculture, Exports) 100%
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Indian Banks having overseas presence and Foreign banks will be on parallel run (Basel -I) and Basel-II
for 3 years commencing from 31.3.2010 up to 31.3.2013. These banks will ensure that :
Basel-II minimum capital requirement
requirement for credit Risk and Market Risk
80% of Basel-I
minimum capital
8% up to 31.3.2011
BASEL II
The Committee on Banking Regulations and Supervisory Practices released revised version in the year
2004. These guidelines have been got implemented by RBI in all the banks of India. Parallel run was
started from 1.4.2006. In banks having overseas presence and foreign banks (except RRBs and local
area banks.
In banks with no foreign branch,
Complete switchover has taken place w.e.f. 31.3.2008.
switchover will took place w.e.f. 31.3.2009.
Distinction between Basel I and Basel II
Basel I measures credit risks and market risks only whereas Basel II measures 3 types of risks i.e.
Risk weights are allocated on the basis of rating of the
Credit Risk, Operational Risk and Market Risk.
borrower i.e. AAA, AA, A, BBB, BB and B etc. Basel II also recognized CRM such as Derivatives,
Collaterals etc.
Three Pillars of BASEL-II
Pillar I Minimum Capital Requirement
Pillar II Supervisory Review Process
Pillar III Market Discipline
Pillar - I Minimum Capital Requirement
CRAR will be calculated by adopting same method as discussed above under Basel I with the only
difference that Denominator will be arrived at by adding 3 types of risks i.e. Credit Risks, Market Risks
and Operational Risks.
Credit Risk
Credit Risk is the risk of default by a borrower to meet commitment as per agreed terms and
conditions. In terms of extant guidelines contained in BASEL-II, there are three approaches to
measure Credit Risk given as under:
1. Standardized approach
2. IRB (Internal Rating Based) Foundation approach
3. IRB (Internal Rating Based) Advanced approach
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1. Standardized Approach
RBI has directed all banks to adopt Standardized approach in respect of Credit Risks
Under standardized approach
for external rating:
, risk rating will be done by credit agencies. Four Agencies are approved
Example:
( mount in 000)
Fund Based Exposure
Nature of loan Limit Outstanding Undrawn portion
CC 200 100 100
Bills Purchased 60 30 30
Packing Credit 40 30 10
Term Loan 200 40 160
Total Outstanding 200
Out of Undrawn portion of TL, 60 is to drawn in a year and balance beyond 1 year.
Adjusted Exposure
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Standby LC 50 100% 50
Clean LC 50 100% 50
Unconditional Take out finance 100 100% 100
Performance Guarantee 80 50% 40
Bid Bonds 20 50% 10
Conditional Take out finance 50 50% 25
Documentary LC 40 20% 8
Total Adjusted Exposure FB limits = 453
Total Adjusted Exposure = 290000+453000 = 7,43,000
after adjusting CRMs (
2nd Step : Allowable Reduction
Reduction from adjusted exposure is made on account of following eligible financial collaterals:
.
Eligible Financial Collaterals
Deposits being maintained by a borrower under lien
Cash (including CDs or FDs), Gold, Govt Securities, KVP, NSC, LIC Policy, Debt Securities, Mutual
Funds
Equity and convertible bonds are no more eligible CRMs
@ 12%, will be Rs 112 and the volatility adjusted collateral value would be Rs 80, (after applying
haircut @ 12% as per issue rating and 8% for currency mismatch) for the purpose of arriving at the
value of risk weighted asset & calculating charge on capital.
There is an exposure of Rs 100 to an unrated Corporate (having no rating from any external agency)
having a maturity of 3 years, which is secured by Equity shares outside the main index having a
market value of Rs 100.
The haircut for exposure as well as collateral will be 25%. There is no currency mi smatch in this case.
The volatility adjusted exposure and collateral after application of haircuts works out to Rs 125 and Rs
75 respectively. Therefore, the net exposure for calculating RWA works out to Rs 50.
There is a demand loan of Rs 100 secured by banks own deposit of Rs 125 The haircuts for exposure
and collateral would be zero. There is no maturity mismatch. Adjusted exposure and collateral after
application of haircuts would be Rs 100 and Rs 125 respectively. Net exposure for the purpose of
RWA would be zero
Other Examples
No. 1:
1. Exposure----------------------------------------- 100 lac with tenure 3 years
2. Eligible Collateral in A+ Debt Security -----30 lac with Residual maturity 2 years
3. Hair cut on Collateral is 6%
4. Table of Maturity factor shows hair cut as 25% for remaining maturity of 2 years/
Calculate Value of Exposure after Risk Mitigation:
Solution:
Value of Exposure after Risk Mitigation =
Current Value of Exposure Value of adjusted collateral for Hair cut and maturity mismatch
Value of Adjusted Collateral for Hair cut = C*(1-Hc) = 30(1-6%) = 30*94% = 28.20
Value of Adjusted Collateral for Hair cut and Maturity Mismatch = C*(t-0.25) / (T-0.25)
= 28.20*(2-.25)/(3-.25) = 17.95
(Where t = Remaining maturity of Collateral T= Tenure of loan )
Value of Exposure after Risk Mitigation = 100-17.95= 82.05 lac.
No. 2
An exposure of Rs. 100 lac is backed by lien on FD of 30 lac. There is no mismatch of maturity.
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Solution:
Hair Cut for CRM i.e. FDR is zero.
Hence Value of Exposure after Risk Mitigation is 100 lac 30 lac = 70 lac
Computation of CRAR
In a bank ; Tier 1 Capital = 1000 crore
Tier II Capital = 1200 crore
RWAs for Credit Risk = 10000 crore
Capital Charge for Market Risk = 500 crore
Capital Charge for Op Risk = 300 crore
Find Tier I CRAR and Total CRAR.
Solution:
RWAs for Credit Risk = 10000 crore
RWAs for Market Risk = 500/.09 = 5556 crore
RWAs for Op Risk = 300/.09 = 3333 crore
Total RWS = 10000+5556+3333 = 18889 crore
Tier I Capital = 1000 crore
Tier II Capital can be up to maximum 1000 crore
Total Capital = 2000 crore
Tier I CRAR = Eligible Tier I Capital /Total RWAs = 1000/18889=5.29%
Total CRAR = Eligible Total Capital /Total RWAs = 2000/18889 = 10.59%
We may conclude that Tier I Capital is less than the required level.
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It is process/transactions in which financial securities are issued against cash flow generated from
pool of assets.
Cash flow arising from receipt of Interest and Principal of loans are used to pay interest and
repayment of securities.
is created for the said purpose. Originating
SPV (Special Purpose Vehicle)
bank transfers assets to SPV and it issues financial securities.
2. Collateral Loan Obligations (CLO) and Credit Linked Notes (CLN)
It is also a form of securitization. Through CLO, bank removes assets from Balance Sheet and issues
tradable securities. They become free from Regulatory Capital.
CLO differs from CLN (Credit link notes in the following manner.
CLO provide credit Exposure to diverse pool of credit where CLN relates to s ingle credit.
CLO result in transfer of ownership whereas CLN do not provide such transfer
CLO may enjoy higher credit rating than that of originating bank
3. Credit Derivatives
It is managing risks without affecting portfolio size. Risk is transferred without transfer of assets from
the Balance Sheet though OTC bilateral contract. These are Off Balance Sheet Financial Instruments.
Credit Insurance and LC are similar to Credit derivatives. Under a Credit Derivative PB (Prospective
buyer) enter into an agreement with PS (Prospective seller) for transfer of risks at notional value by
making of Premium payments. In case of delinquencies, default, Foreclosure, prepayments, PS
compensates PB for the losses. Settlement can be Physical or Cash. Under physical settlement, asset
is transferred whereas under Cash settlement, only loss is compensated.
Credit Derivatives are generally OTC instruments. ISDA (International Swaps and Derivatives
Association) has come out with documentation evidencing such transaction. Credit Derivatives are:
1. Credit Default Swaps
2. Total Return Swaps
3. Credit Linked Notes
4. Credit Spread Options
Operational Risk
Operational Risk is the risk of loss resulting from
Inadequate or failed internal processes, people and system.
External events such as dacoity, burglary, fire etc
It includes legal risks but excludes strategic /reputation risks.
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Identification
ctual Loss Data Base
RBI reports
Risk Control & Self Assessment Survey
Key Risk indicators
Scenario analysis
Four ways to manage Risk
Prevent
Reduce
Transfer
Carry/ ccept
Operational Risk Measurement
Three approaches have been defined to measure Operational Risk at the bank:
1. Basic Indicator approach
2. Standardized approach
3. AMA i.e. Advanced measurement approach
Basic Indicator Approach
15% of Average positive gross annual income of previous 3 years will be requirement of capital.
To start with banks will have to adopt this approach and huge capital is required to be maintained. In
our bank, estimated requirement of capital will be about Rs. 1000 crore.
The Standardized Approach
All banking activities are to be divided in 8 business lines. 1) Corporate finance 2) Trading & Sales 3)
Retail Banking 4) Commercial Banking 5) Asset Management 6) Retail brokerage 7) Agency service 8)
Payment settlement
Within each business line, Capital requirement will be calculated as under:
By multiplying the average gross income generated by a business over previous 3 years by a factor
ranging from 12 % to 18 % depending upon industry-wise relationships as under:
Retail Banking, Retail Brokerage and Asset Management-----------12%
Comme rcial Banking and Agency Services---------------------------15%
Corporate, Trading and Payment Settlement------------------------18%
Advanced Measurement Approach
Capital requirement is calculated by the actual risk measurement system devised by banks own
internal Operational Risk Measurement methods using quantitative and qualitative criteria. Our bank
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has started measuring actual losses and estimating future losses by introducing statement of
Operational Risk Loss data w.e.f. 1.4.2005. Minimum 5 year data is required for a bank to switch over
to AMA.
How to calculate RWAs for Operational Risk?
RWAs for Operational Risk = Capital Charge / 0.09% (If required CAR is 9%)
Operational Risk Scenario Analysis
It is a term used in measurement of Operational Risk on the basis of scenario estimates.
Banks use scenario analysis based on expert opinion in conjunction with external data to evaluate its
exposure to high severity events.
In addition, scenario analysis is used to assess impact of deviations from correlation assumptions in
the banks Operational Risk measurement framework to evaluate potential losses arising from
operational risk loss events.
Operational Risk Mitigation
Insurance cover, if available can reduce the operational risk only when AMA is adopted for estimating
capital requirements. The recognition of insurance mitigation is limited to
20% of total Operational
Risk Capital Charge
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Example:
Probability of occurrence = 2 (medium)
Probability of Financial impact = 4 (very high)
Impact of Financial control = 50%
Solution
[ 2x4x(1-0 5)] ^0 5 = 4 =
2 (Low)
Market Risk
It is simply risk of losses on Balance sheet and Off Balance sheet items basically in investments due to
movement in market prices. It is risk of adverse deviation of
portfolio during the period. Any decline in the market value will result into loss.
mark to Market
value of trading
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RWAs for Market Risk = Capital Charge / 0.09 (If required CAR is 9%)
Other Risks and Capital Requirement
Other Risks like Liquidity Risks, Interest Rate Risk, Strategic Risk, Reputational Risks and Systemic
Risks are not taken care of while calculating Capital Adequacy in banks.
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150%
100%
100%
50%
50%
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- 100%
01.04.2012
31.3.2014
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It is planned to implement BASEL-III w.e.f. 1.1.2013. The propose reforms are as under:
Capital
Minimum
6% 8%
2.5% 2.5%
Transition Arrangement
As on 1.1.2013, the banks will meet new minimum requirement in relation to Risk Weighted Assets as
under:
3.5% of Common Equity + 4.5% of Tier I Capital = .8% of Total Capital /Risk Weighted Assets.
VaR (Value at Risk)
Value at Risk is how much can we expect to lose? What is potential loss?
We can lose maximum up to VaR (value at Risk) over a given time at a given confidence level.
Calculation of VaR
Market Factor Sensitivity X Daily Volatility X Probability at given confidence level
Suppose impact of 1% change of interest rate (Price) = 6000/Daily Volatility = 3% : Confidence level is 99%
Probability of occurrence at 99% confidence level is 2.326
Defeasance period = 1 day
VaR = 6000x3x2.326 = 41874/-
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CREDIT RISK
How to find Risk Weighted Assets?
Fixed Assets : 500 Crore
Govt. Securities : 5000 crore
Standard Assets
Retail ---3000 crore
HL -------2000 crore
Other loans 10000 cr
Sub-Standard Assets
Secured ----500 crore
Unsecured -----150 crore
Doubtful (DAI) -----800 crore
Solution:
Retail----------------3000*75/100 = 2250 crore
HL---------------------2000*50/100=1000 crore
Other loans---------10000*100/100 = 10000 crore
Gsec------------------5000*0/100=0
SS Secured----------500*150/100=750 crore
SS Unsecured ------150*100/100=150 crore
Doubtful D1 --------800*100/100=800 crore
Total RWAs = 2250+1000+750+150+800 = 4950 crore
OPERATIONAL RISK
How to find Risk Weighted Assets
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10.95%
Ex.2
If per annum volatility is 30% and nos. of trading days per annum be 250, how much will be daily
volatility?
Solution
nnual Volatility = Daily Volatility * 250 = Daily Volatility * 15 81
30 = Daily Volatility *15.81
Daily volatility = 30/15.81 =
1.90%
Ex.3
If 1 day VaR of a portfolio is Rs. 50000/- with 97% confidence level. In a period of 1 year of 300
trading days, how many times the loss on the portfolio may exceed Rs. 50000/-.
Solution
97% confidence level means loss may exceed the given level (50000)on 3 days out of 100.
If out of 100 days loss exceeds the given level on days =3
Then out of 300 days, loss exceeds the given level = 3/100*300 =
9 days.
Ex.4
A 5 year 5% Bond has a BPV of Rs. 50/-, how much the bond will gain or lose due to increase in the
yield of bond by 2 bps
Solution
Increase in yield will affect the bond adversely and the bond will lose.
Since BPV of the bond is Rs. 50/-. Increase in yield by 2 bps will result into loss of value of Bond by
50*2=100.
Ex.5
1 day VaR of a portfolio is Rs. 50000/- with 90% confidence level. In a period of 1 year (250 days) how
many times the loss on the portfolio may not exceed Rs.50000/Ans. 90% confidence level means on 10 days out of 100, the loss will be more than Rs. 50000/ -.
Out of 250 days, loss will be more than 50000/- on
25 days Ans
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100
Annual Coupon 8%
10%
4 yrs
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1. Fund management has been the primary activity of treasury, but treasury is also responsible for
Risk Management & plays an active part in ALM.
2. D-mat accounts are maintained by depository participants to hold securities in electronic form.
3.
center.
4.
From an organizational point of view treasury was considered as a service center but due to
economic reforms & deregulation of markets treasury has evolved as a profit center.
5. Treasury connects core activity of the bank with the financial markets.
6. Investment in securities & Foreign Exchange business are part of integrated treasury.
7. Integrated treasury refers to integration of money market, Securities market and Foreign
Exchange operations.
8. Banks have been allowed large limits in proportion of their net worth for overseas borrowings and
investment.
9. Banks can also source funds in global markets and Swap the funds into domestic currency or vice
versa.
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27. Middle office monitors exposure limits and stop loss limits of treasury and reports to the
management on key parameters of performance.
28. Minimum marketable investment is Rs. 5.00 Crores.
2)
3)
4)
Trading is a speculative activity, where profits arise out of favorable price movements during
the interval between buying and selling.
7. ARBITRAGE: is the benefit accruing to traders, who play in different markets simultaneously.
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8. DERIVATIVES are financial contracts to buy or sell or to exchange a cash flow in any manner at a
future date, the price of which is based on market price of an underlying assets which may be
financial or a real asset with or with out an obligation to exercise the contract.
are countries with a fast developing economy, which are largely
form, so that transfer of securities can be affected by debit or credit to the respective account
holders without any physical document.
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12. Nostro accounts are current accounts maintained in Foreign Currency by the banks with their
correspondent banks in the home currency of the country.
13. Balance held in Nostro accounts do not earn any interest.
14. Rediscounting of Foreign Bills is an inter bank advance.
15. RBI has allowed banks to include rediscounting of bills in their credit portfolio
16. Money market refers to raising and developing short term resources.
17. Inter bank market is subdivided into Call Money, Notice Money & Term Money.
18. Call Money refers to overnight placement.
19. Notice Money refers to placement beyond overnight for periods not exceeding 14 days.
20. Term Money refers placement beyond 14 days but not exceeding one year.
21. RBI pays interest on CRR balance in excess of 3% at Reverse Repo Rate.
22. Inter bank market carries lowest risk next to Sovereign risk.
23. The interest on treasury bills is by way of discount i.e. Bills are priced below face value, this is
known as implicit yielding.
24. Each issue of 91 days T -bills is for Rs.500 Crores and auction is conducted on Weekly basis I.e. on
every Wednesday.
25. Each issue of 364 days T-bills is Rs.1000 Crores and auction is conducted on Fortnightly basis i.e.
on alternate Wednesday.
26. The payment of T-bills is made and received through Clearing Corporation of India Limited ( CCIL )
27. Commercial paper is short term debt market paper.
28. The Commercial Paper issuing company should have minimum P2 credit rating.
29. Banks can invest in Commercial Paper only if it is issued in D-mat form.
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47. Banks are permitted to invest in equities subject to a ceiling presently 5% of its total assets.
48. Foreign Institutional Investors are now allowed to invest in debt market subject to an overall
ceiling currently USD 1.75 Billion.
49. Index Futures, Index Options, Stock futures and Stock Options etc. are the Derivative products
recently introduce.
50. The Derivative Products are highly popular for Risk Management as well as for speculation.
51. Banks are also permitted to borrow or invest in overseas markets with in a ceiling subject to
guidelines issued by RBI presently 25% of Tier I capital or minimum USD 10 Million.
52. The treasury operates in exchange market, Money market and Securities market.
53. Foreign Exchange transaction includes Spot, Forward and Swap trades.
54. Money market is used for deployment of surplus funds and also to raise short term funds to
bridge gaps in the cash flow of bank.
55. Money market products include T-bills, Commercial paper, Certificate of Deposit and Repo.
56. Under EEFC exporters are allowed to hold a portion of the export proceeds in current account
with the bank.
57. GILTS are securities issued by Government which do not have any risk.
58. SGL accounts are maintained by Public Debt Office of RBI in electronic form.
59. FCNR deposit is denominated in four major currencies maintained by NRIs.
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8. Trading limits are of three kinds, they are 1) Limits on deal size 2) Limits on open positions and 3)
Stop loss limits.
9. Open position refers to the trading positions, where the buy / sell positions are not matched.
10. All the forward contracts are revalued periodically ( Every month )
11. The stop loss limits prevent the dealer from waiting indefinitely and limit the losses to a level
which is acceptable to the management.
12. The Stop loss limits are prescribed per deal, per day, per month as also an aggregate loss limit per
year.
13. Two main components of market risk are Liquidity risk and Interest rate risk.
14. Liquidity risk implies cash flow gaps which could not be bridged.
15. Liquidity risk and Interest rate risk are like two sides of a coin.
16. The Interest rate risk refers to rise in interest costs eroding the business profits or resulting in fall
in assets prices.
17. The interest rate risk is present where ever there is mismatch in assets and liabilities.
18. If the currency is convertible, the exchange rate and interest rate changes play greater role in
attracting foreign investment inflows into the secondary market.
19. Marker Risk is a confluence of liquidity risk, interest rate risk, Exchange rate risk, Equity risk and
Commodity risk.
20 BIS defines Market Risk as, The Risk that the value of on- or off Balance Sheet positions will be
adversely affected by movements in equity and interest rate markets, Currency exchange rates and
Commodity prices
21. The Market Risk is closely connected with ALM.
22. The Market Risk is also known as Price Risk.
23. Two important measures of risk are Value at Risk and Duration method.
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24. Value at Risk (VAR) at 95% confidence level implies a 5% probability of incurring the loss.
25. VAR is an estimate of potential loss always for a given period at a confidence level.
26. There are three approaches to calculate the AVR i.e. Parametric Approach, Monte Carlo
Approach and Historical Data.
27. VAR is derived from a statistical formulae based on volatility of the market.
28. Parametric Approach is based on sensitivity of various Risk components.
29. Under Monte Carlo model a number of scenarios are generated at random and their impact on
the subject is studied.
30. Duration is widely used in investment business.
31. The rate at which the present value equals the market price of a bond is known as YTM.
32. Yield & price of a bond moves in inverse proportion.
33. Duration is weighted average measure of life of a bond, where the time of receipt of a cash flow
is weighted by the present value of the cash flow.
34. Duration method is also known as Mecalay Duration, its originator is Frederic Mecalay.
35. Longer the duration, greater is the sensitivity of bond price to changes in interest rate.
36. A proportionate change in prices corresponding to the change in yields is possible, only when the
yield curve is linear.
37. Derivatives are used to protect treasury transactions from Market Risk.
38. Derivatives are also useful in managing Balance Sheet risk in ALM.
39. Treasury transactions are of high value & relatively need low capital.
40. Market movements are mainly due speculation.
41. VAR is the maximum loss that may take place with in a time horizon at a given confidence level.
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42. Leverage is Capital Adequacy Ratio incase of companies it is expressed as Debt / Equity Ratio.
1. Treasury Risk is sensitive because 1) The Risk of loosing capital is much higher than the risk in the
credit business 2) Large size of transactions done at the discretion of treasurer 3) Losses in treasury
business materialize in very short term and the transactions once confirmed are irrevocable.
2. The conventional control and supervisory measures of treasury can be divided in to three parts 1)
Organizational controls 2) Exposure ceiling and 3) Limits on trading portions and stop loss limits.
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10. Call option gives a right to the holder to sell the underlying product at a pre-fixed rate on a
specified date or during a specified period.
11. The pre-fixed rate is known as Strike Rate.
12. Options are two types, an American type option can be executed at any time before expiry date
and European type option can be exercised only on expiry date. In India we use only European type
of Option.
13. A Dollar put Option gives right to the holder to sell Dollars.
14. If the strike price is same as the spot price, it is known as at the money.
15. The option is in the money (ITM), if the strike price is less than the forward rate in case of a Call
Option or strike price is more than the forward rate in case of a put option.
16. The Option is out of Money (OTM) if the strike price is more than the forward rate in case of call
option or if the strike price is less than forward rate in case of a put Option.
17. In the context of Options spot rate is the rate prevailing on the date of maturity.
18. The profit potential of buyer of an option is unlimited .
19 The option sellers potential loss is unlimited
20. Payment of differences between strike price & market price on expiry is known as cash
settlement.
21. The buyer of an option pays premium to the seller for purchase of Option.
22. The option premium is paid upfront.
23 USD put Option on TJY is right to sell USD against JPY at X price
24. A stock option is the right to buy or sell equity of a company at the strike price.
25. Options are used to hedge against price fluctuations.
26. A convertible option may be the bond holder option of converting the debt into equity on
specified terms.
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27. A bond with call option gives right to the issuer to prepay the debt on specified date.
28. Futures are forward contracts.
29. Under Futures contract the seller agrees to deliver to the buyer specified security / Currency or
commodity on a specified date.
30. Future Contracts are of standard size with prefixed settlement dates.
31. A distinct feature of Futures is the contracts are marked to market daily and members are
required to pay margin equivalent to daily loss if any.
32. In case of Futures the exchange guarantees all trades roughted through its members and in case
of default or insolvency of any member the exchange will meet the payment out of its trade
protection fund.
33. Currency Futures serve the same purpose as Forward Contracts, conventionally issued by banks
in foreign exchange business.
34. Futures are standardized and traded on exchanges but Forward Contracts are customized OTC
Contracts.
35. The Futures can be bought only for fixed amounts and fixed periods.
36. A Swap is an exchange of cash flow.
37. An interest rate Swap is an exchange of interest flows on an underlying asset or liability.
38. The cash flows representing the intere st payments during the Swap period are exchanged.
39. For USD the bench mark rates are generally LIBOR ( London Inter Bank Offer Rate)
40. MIBOR is announced daily at 9.50 A.M by NSE.
41. MIBOR is used as a base rate for short term and Medium Term lending.
42. Interest rate Swap is shifting of interest rate calculation from fixed rate to floating or floating rate
to fixed rate or floating rate to floating rate.
43. A Floating to Floating rate Swap involves change of bench mark.
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44. Quanto Swaps refer to paying interest in home currency at rate s applicable to foreign currency.
45. Coupon Swaps refer to floating rate in one currency exchanged to fixed rate in another currency.
46. In Indian Rupee market only plain vanilla type Swaps are permitted.
47. A Currency Swap is an exchange of cash flow in one currency with that of another currency.
48. The need for Currency Swap arises when loan raised in one currency is actually required to be
used in another currency.
49. The Interest rate Swaps (IRS) and Forward rate agreements (FRA) were first allowed by RBI in
1998.
50. Banks and counter parties need to execute ISDA master agreement before entering into any
derivative contracts.
51. A right to buy is Call Option and a right to Sell is Put Option.
52. Swaps are used to minimize cost of borrowings and also to benefit from arbitrage in two
currencies.
53. Currency and interest rate Swaps with basic structure without in built positions or knock-out
levels are plain vanills type Swaps.
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5. The difference between sources and uses of funds in specific time band is known as Liquidity Gap
which may be positive or negative.
6. Interest rate risk is measured by the gap between interest rate sensitive asset and interest rate
sensitive liability in a given time band.
7. The Assets & Liabilities are rate sensitive when their value changes in reverse direction
corresponding to a change in market rate of interest.
8. The Gap management is only way of monitoring ALM.
9. The Duration and Simulation methods are used to make ALM more effective.
10. Derivatives are useful in reducing the Liquidity & Interest rate Risk.
11. Derivatives replicate market movements.
12. Derivatives can be used to hedge high value individual transactions.
13. The Derivative transaction is independent of the banking transaction.
14. Treasury products such as Bonds & Commercial papers are subject to credit risk.
15. Credit Risk in a loan & bond are similar, unlike a loan bond is tradable and hence it is more liquid
asset.
16. Now a days the conventional credit is converted into tradable treasury product through
Securitisation process by issue of PTC.
17. Securitisation infuses liquidity into the issuing bank & frees blocked capital.
18. Transfer pricing refers to fixing the cost of resources and return on Assets of the bank in a
rational manner.
19. In a multi branch transfer pricing is particularly useful to assess the branch profitability.
20. ALM policy prescribes composition of ALCO & operational assets of ALM.
21. Liquidity policy prescribes minimum liquidity to be maintained.
22. Modern banking may be defined as Risk Intermediation.
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The impact of volatility on the short-term profit is measured by Net Interest Income.Net Interest
Income = Interest Income - Interest Expenses.
Minimizing fluctuations in NII stabilizes the short term profits of the banks.
Net Interest Margin is defined as net interest income divided by average total assets. Net Interest
Margin (NIM) = Net Interest Income/Average total Assets.
Net Interest Margin can be viewed as the 'Spread' on earning assets. The higher the spread the
more will be the NIM
The ratio of the shareholders funds to the total assets(Economic Equity Ratio) measures the shifts
in the ratio of owned funds to total funds. This fact assesses the sustenance capacity of the bank.
Price Matching basically aims to maintain spreads by ensuring that deployment of liabilities will
be at a rate higher than the costs.
Liquidity is ensured by grouping the assets/liabilities based on their maturing profiles. The gap is
then assessed to identify future financing requirements
Profit = Interest Income - Interest expense - provision for loan loss + non-interest revenue - noninterest expense taxes
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Tier-II capital on the other hand consists of certain reserves and certain types of subordinated
debt. The loss absorption capacity of Tier-II capital is lower than that of Tier-I capital.
The elements of Tier-I capital include Paid-up capital (ordinary share s), statutory reserves, and
other disclosed free reserves.
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Banks shall continue to apply the Standardised Duration Approach (SDA) for computing capital
requirement for market risks.
The term capital would include Tier-I or core capital, Tier-II or supplemental capital, and TierIll capital
Core capital consists of paid up capital, free reserves and unallocated surpluses, less specified
deductions.
Supplementary capital comprises subordinated debt of more than five years' maturity, loan
loss reserves, revaluation reserves, investment fluctuation reserves, and limited life
preference shares.
Tier-II capital is restricted to 100% of Tier-I capital as before and long-term subordinated debt
may not exceed 50% of Tier-I capital.
Tier-Ill capital will be limited to 250% of a bank's Tier-1 capital that is required to support
market risk. This means that a minimum of about 28.5% of market risk needs to be supported
by Tier-I capital. Any capital requirement arising in respect of credit and counter-party risk
needs to be met by Tier-I and Tier-II capital.
Capital adequacy ratio(C) = Regulatory capital(R)/Total risk weighted assets(T).
Regulatory Capital R=C*T and Total Risk weighted ssets T= R/C
Total Risk weighted assets =(Risk weighted assets for credit risk) +(12.5*Capital requirement
for market risk)+(12.5*Capital requirement for operational risk)
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Any amount due to the bank under any credit facility is 'overdue' if it is not paid on the due
date fixed by the bank.
Interest on advances against term deposits, NSCs, IVPs, KVPs and life policies may be taken to
income account on the due date, provided adequate margin is available in the accounts.
A substandard asset would be one, which has remained NPA for a period less than or equal to
12 months. a substandard asset would be one, which has remained NPA for a period less than
or equal to 12 months.
If arrears of interest and principal are paid by the borrower in the case of loan accounts
classified as NPAs, the account should no longer be treated as nonperforming and may be
classified as 'standard' accounts.
Advances against Term Deposits, NSCs, KVP/IVP, etc, need not be treated as NPAs. Advances
against gold ornaments, Government securities and all other securities are not covered by this
exemption.
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Ratio of Core Deposit to Total Assets: - Core Deposit/Total Assets: More the ratio, better it is.
Net Loans to Totals Deposits Ratio:- Net Loans/Total Deposits: It reflects the ratio of loans to
public deposits or core deposits. Loan is treated to be less liquid asset and therefore lower
the ratio, better it is.
Ratio of Time Deposits to Total Deposits:-Time deposits provide stable level of liquidity and
negligible volatility. Therefore, higher the ratio better it is.
Ratio of Volatile Liabilities to Total Assets:- Higher portion of volatile assets will pose higher
problems of liquidity. Therefore, lower the ratio better it is.
Ratio of Short-Term Liabilities to Liquid Assets:- Short-term liabilities are required to be
redeemed at the earliest. It is expected to be lower in the interest of liquidity.
Ratio of Liquid Assets to Total Assets:-Higher level of liquid assets in total assets will ensure
better liquidity. Therefore, higher the ratio, better it is.
Liquid assets may include bank balances, money at call and short notice, inter bank
placements due within one month, securities held for trading and available for sale having
ready market.
Ratio of Short-Term Liabilities to Total Assets:-A lower ratio is desirable
Short-term liabilities may include balances in current account, volatile portion of savings
accounts leaving behind core portion of saving which is constantly maintained. Maturing
deposits within a short period of one month.
Ratio of Prime Asset to Total Asset - Prime Asset/Total Assets:-More or higher the, ratio better
it is.
Prime assets may include cash balances with the bank and balances with banks including
central bank which can be withdrawn at any time without any notice.
Ratio of Market Liabilities to Total Assets:-Lower the ratio, better it is.
Market liabilities may include money market borrowings, inter-bank liabilities repayable
within a short period.
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A maturity ladder should be used to compare a bank's future cash inflows to its future cash
outflows over a series of specified time periods.
The need to replace net outflows due to unanticipated withdrawal of deposits is known as
Funding risk.
The need to compensate for non-receipt of expected inflows of funds is classified as Time Risk
Call risk arises due to crystallisation of Contingent liabilities
Maturity ladders enables the bank to estimate the difference between Cash inflows and Cash
Outflows in predetermined periods.
Liquidity management methodology of evaluating whether a bank has sufficient liquid funds
based on the behaviour of cash flows under the different 'what if scenarios is known as
Alternative Scenarios
The capability of bank to withstand a net funding requirement in a bank specific or general
market liquidity crisis is denoted as Contingency planning
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When assets and liabilities fall due to repricing in different periods, they can create a
mismatch. Such a mismatch or gap may lead to gain or loss depending upon how interest rate
in the market tend to move.
The degree of basis risk is fairly high in respect of banks that create composite assets out of
composite liabilities
When the variation in market interest rate causes the Nil to expand, the banks have
experienced a favourable basis shift and if the interest rate movement causes the Nil to
contract, the basis has moved against the bank.
An yield curve is a line on a graph plotting the yield of all maturities of a particular instrument
Price risk occurs when assets are sold before their maturity dates.
The price risk is closely associated with the trading book which is created for making profit out
of short-term movements in interest rates.
Uncertainty with regard to interest rate at which the future cash flows can be reinvested is
called reinvestment risk.
When the interest rate goes up, the bonds price decreases
When the interest rate declines the bond price increases resulting in a capital gain but the
realised compound yield decreases because of lower coupon reinvestment income.
Duration is a measure of the percentage change in the economic value of a position that will
occur, given a small change in the level of interest rates.
Higher duration implies that a given change in the level of interest rates will have a larger
impact on economic value.
Interest Rate Sensitive Gap: Interest Rate Sensitive Assets(RSA) - Interest Rate Sensitive
Liabilities (RSL).
Positive Gap or Asset Sensitive Gap - RSA - RSL > 0 & Negative Gap or Liability Sensitive - RSA RSL < 0
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Important Formulas
---------------------------Some of these Formulas may not be applicable for BFM, but I request all of you to go through all of them to
understand the concepts clear for both ABM and BFM.
1. Raw material Turnover Ratio = Cost of RM used / Average stock of R M
2. SIP Turnover = Cost of Goods manufactured / Average stock of SIP
3. Debt Collection period = No. days or months or Weeks in a year/Debt Turnover Ratio.
4. Average Payment Period = No. days or months or Weeks in a year/Creditors Turnover Ratio.
5. Inventory Turnover Ratio = Cost of Goods Sold / Average Inventory.
6. Debtors Turnover Ratio = Net Credit Sales / Average Debtors.
7. Creditors Turnover Ratio = Net Credit Purchases / Average Credits.
8. Defensive Interval Ratio = Liquid Assets / Projected Daily Cash Requirement
9. Projected daily cash requirement = Projected operating cash expenses / 365.
10. Debt Equity Ratio = Long Term Debt / Equity.
11. Debt Equity Ratio = Total outside Liability / Tangible Net Worth.
12. Debt to Total Capital Ratio = Total Debts or Total Assets/(Permanent Capital + Current Liabilities)
13. Interest Coverage Ratio = EBIT / Interest.
14. Dividend Coverage Ratio = N. P. after Interest & Tax / Preferential dividend
15. Gross Profit Margin = Gross Profit / Net Sales * 100
16. Net Profit Margin = Net Profit / Net Sales * 100
17. Cost of Goods Sold Ratio = Cost of Goods Sold / Net Sales * 100.
18. Operating Profit Ratio = Earnings Before Interest Tax / Net Sales * 100
19. Expenses Ratio or Operating Ratio = Expenses / Net Sales * 100
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20. Net Profit Ratio = Net Profit After interest and Tax / Net Sales * 100
21. Operating Expenses Ratio = (Administrative + Selling expenses) / Net Sales * 100
22. Administrative Expenses Ratio =(Administrative Expenses / Net Sales ) * 100
23. Selling Expenses Ratio =(Selling Expenses / Net Sales ) * 100
24. Financial Expenses Ratio = ( Financial Expenses / Net Sales ) * 100
25. Return on Assets = Net Profit After Tax / Total Assets.
26. Total Assets = Net Fixed Assets + Net Working Capital.
27. Net Fixed Assets = Total Fixed Assets Accumulated Depreciation.
28. Net Working Capital = ( CA CL ) ( Intangible Assets + Fictitious Assets + Idle Stock + Bad Debts )
29. Return on Capital Employed = Net Profit Before Interest and Tax / Average Capital Employed.
30. Average Capital employed = Equity Capital + Long Term Funds provided by Owners & Creditors at the
beginning & at the end of the accounting period divided by two.
31. Return on Ordinary Share Holders Equity = (NPAT Preferential Dividends) / Average Ordinary Share
Holders Equity or Net Worth.
32. Earnings Per Share = Net Profit After Taxes and Preferential dividends / Number of Equity Share.
33. Dividend per Share = Net Profit After Taxes and distributable dividend / Number of Equity Shares.
34. Dividend Pay Out Ratio = Dividend per Equity Share / Earnings per Equity Share.
35. Dividend Pay Out Ratio = Dividend paid to Equity Share holders / Net Profit available for Equity Share
Holders.
36. Price Earning Ratio = Market Price per equity Share / Earning per Share.
37. Total Asset Turnover = Cost of Goods Sold / Average Total Assets.
38. Fixed Asset Turnover = Cost of Goods Sold / Average Fixed Assets.
39. Capital Turnover = Cost of Goods Sold / Average Capital employed.
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40. Current Asset Turnover = Cost of Goods Sold / Average Current Assets.
41. Working Capital Turnover = Cost of Goods Sold / Net Working Capital.
42. Return on Net Worth = ( Net Profit / Net Worth ) * 100
43. DSCR = Profit after Tax & Depreciation + Int. on T L & Differed Credit + Lease Rentals if any divided by
Repayment of Interest & Installments on T L & Differed Credits + Lease Rentals if any.
44. Factory Cost = Prime cost + Production Overheads.
45. Cost of Goods Sold = Factory Cost + Selling, distribution & administrative overheads
46. Contribution = Sales Marginal Costs.
47. Percentage of contribution to sales = ( Contribution / Sales ) * 100
48. Break Even Analysis = F / ( 1 VC / S )
F = Fixed costs, VC = Total variable operating costs & S = Total sales revenue
49. Break Even Margin or Margin of Safety = Sales Break Even Point / Sales.
50. Cash Break Even = F N / P R or F N / 1 ( VC / S )
51. BEP = Fixed Costs / Contribution per unit.
52. Sales volume requires = Fixed cost + Required profit / Contribution per unit.
53. BEP in Sales = ( Fixed Costs / Contribution per unit ) * Price per unit.
54. Contribution Sales Ratio = ( Contribution per unit / Sale price per unit ) * 100
55. Level of sales to result in target profit after Tax = (Target Profit) / (1 Tax rate / Contribution per unit)
56. Level of sales to result in target profit = (Fixed Cost + Target profit) * sales price per unit Contribution per
unit.
57. Net Present Value = - Co + C1 / (1 + r)
58. Future expected value of a present cash flow = Cash Flow ( 1 + r ) ^ t
59. Present value of a simple future cash flow = Cash Flow / (1 + r) ^ t
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CAIIB
Creation of these short notes is the efforts of so many persons. First of all we thank all of them for
their valuable contribution. Though we had taken enough care to go through the notes provided
here, we request everyone to go through the Macmillan book and update yourself with the latest
information through RBI website and other authenticated sources. In case you find any
incorrect/doubtful information, kindly update us also (along with the source link/reference for the
correct information).
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