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Banking Foundation Basics of Banking Supratik Nag
Content • What is Market? • What is Financial Market? • Basic definition • Flow of funds • Functions of Financial Markets • Structure of Financial Markets • Financial Intermediaries • Types of Financial Intermediaries • Functions of Financial Intermediaries
What is Market? A market is a location where buyers and sellers come into contact to exchange goods or services. Markets can exist in various forms depending on demand and supply.
What is ‘Financial Market’ The financial market is a broad term describing any marketplace where trading of financial products including loan, deposits, equities, bonds, currencies and derivatives occurs.
Basic Definitions of Financial Market There are two forms of exchange in Financial Market: • Direct Finance: in which lenders and borrowers meet directly to exchange securities. • Securities: are claims on the borrower’s future income or assets. Common examples are stock, bonds or foreign exchange. • Indirect Finance: The second type of financial trade occurs with the help of financial intermediaries and is known as indirect finance. In this scenario borrowers and lenders never meet directly, but lenders provide funds to a financial intermediary such as a bank and those intermediaries independently pass these funds on to borrowers
Debt and Equity Market Financial Markets are divided into Debt and Equity Markets • Debt titles are the most commonly traded security. In these arrangements, the issuer of the title (borrower) earns some initial amount of money (such as the price of a bond) and the holder (lender) subsequently receives a fixed amount of payments over a specified period of time, known as the maturity of a debt title. • Debt titles can be issued on short term (maturity < 1 yr.), long term (maturity >10 yrs.) and intermediate terms (1 yr. < maturity < 10 yrs.). • The holder of a debt title does not achieve ownership of the borrower’s enterprise. • Common debt titles are bonds or mortgages.
Debt and Equity Market – contd… • Equity titles are somewhat different from bonds. The most common equity title is (common) stock. • First and foremost, an equity instruments makes its buyer (lender) an owner of the borrower’s enterprise. • Formally this entitles the holder of an equity instrument to earn a share of the borrower’s enterprise’s income, but only some firms actually pay (more or less) periodic payments to their equity holders known as dividends. Often these titles, thus, are held primarily to be sold and resold. • Equity titles do not expire and their maturity is, thus, infinite. Hence they are considered long term securities.
Primary and Secondary Market • Primary markets are markets in which financial instruments are newly issued by borrowers. • Secondary markets are markets in which financial instruments already in existence are traded among lenders. • Secondary markets can be organized as exchanges, in which titles are traded in a central location, such as a stock exchange, or alternatively as over-the-counter markets in which titles are sold in several locations.
Financial Intermediaries • A financial intermediary is an entity that acts as the middleman between two parties in a financial transaction, such as a commercial bank, investment banks, mutual funds and pension funds. • A financial intermediary offers a service to help an individual/ firm to save or borrow money. A financial intermediary helps to facilitate the different needs of lenders and borrowers.
Functions of Financial Intermediaries • Lower transaction costs (time and money spent in carrying out financial transactions) • Economies of scale • Liquidity services • Reduce the exposure of investors to risk • Risk Sharing (Asset Transformation) • Diversification • Deal with asymmetric information problems • Adverse Selection: try to avoid selecting the risky borrower. • Gather information about potential borrower. • (after the transaction) Moral Hazard: ensure borrower will not engage in activities that will prevent him/her to repay the loan. • Sign a contract with restrictive covenants.
Content • What is a Bank? • Banking in India – A Brief History • Reserve Bank of India • Source of Bank’s income
What is a Bank? • Basic Definition: A system of trading money which provides a safe place to save excess cash, known as deposits. supplies liquidity to the economy by loaning this money out to help businesses grow and to allow consumers to purchase consumer products, homes, cars etc. • As per Banking Act in India: A Bank is a financial institution which accepts money from the public for the purpose of lending or investment repayable on demand or otherwise withdrawable by cheques, drafts or order or otherwise
Banking in India – A Brief History • Banking in India in the modern sense originated in the last decades of the 18th century • Among the first banks were the Bank of Hindustan, which was established in 1770 General Bank of India, established 1786 • The largest bank, and the oldest still in existence, is the State Bank of India. It originated as the Bank of Calcutta in June 1806. In 1809, it was renamed as the Bank of Bengal. • This was one of the three banks funded by a presidency government, the other two were the Bank of Bombay and the Bank of Madras. The three banks were merged in 1921 to form the Imperial Bank of India, which upon India's independence, became the State Bank of India in 1955
Banking in India – A Brief History • Reserve Bank of India was established in 1935, under the Reserve Bank of India Act, 1934. • In 1960, the State Banks of India was given control of eight state-associated banks under the State Bank of India (Subsidiary Banks) Act, 1959. These are now called its associate banks. • In 1969 the Indian government nationalised 14 major private banks. In 1980, 6 more private banks were nationalized. These nationalized banks are the majority of lenders in the Indian economy • The Indian banking sector is broadly classified into scheduled banks and non-scheduled banks • The scheduled banks are those which are included under the 2nd Schedule of the Reserve Bank of India Act, 1934.
Banking in India – A Brief History • The scheduled banks are further classified into: nationalised banks; State Bank of India and its associates; Regional Rural Banks (RRBs); foreign banks; and other Indian private sector banks. • The term commercial banks refers to both scheduled and non-scheduled commercial banks which are regulated under the Banking Regulation Act, 1949.
Banking in India – Post Liberalization in 1990 • In the early 1990s, the then government embarked on a policy of liberalization, licensing a small number of private banks. • These came to be known as New Generation tech-savvy banks, and included Global Trust Bank (the first of such new generation banks to be set up), which later amalgamated with Oriental Bank of Commerce, UTI Bank (since renamed Axis Bank), ICICI Bank and HDFC Bank. • The new policy shook the Banking sector in India completely. Bankers, till this time, were used to the 4–6–4 method (borrow at 4%; lend at 6%; go home at 4 o’clock) of functioning
Reserve Bank of India RBI is an apex institution in the banking and financial structure of the country which plays a crucial role in organizing, running, supervising, regulating and developing the banking and financial structure of the economy. India’s Central Bank is known as the Reserve Bank of India. It has four Zonal offices at Delhi, Kolkata, Chennai and Mumbai for four regions: Northern, Eastern, Southern and Western regions respectively. RBI has 19 offices, which are located in state capitals and a few major cities in India. In addition, there are 9 sub-offices of RBI.
Reserve Bank of India - Functions • Bank of Issue: It has a sole authority to issue currency notes and coins through the issue department, which is solely responsible for the issue of notes and coins. • Banker to Banks and Government: As the Banker’s bank, RBI acts as the custodian of cash reserves of commercial and other Banks. • Lender to Last Resort: RBI helps commercial banks when they have exhausted their resources and are in financial need. In its capacity as the lender of the last resort, the central bank provides, directly or indirectly all reasonable financial assistance to commercial banks. • Controller of Credit: RBI controls the credit creation by the commercial banks which are regarded as the most important function of Central Bank.
Content • Types of Bank in Indian scenarios • Functions of different types of Banks
Types of Bank in India - Function • Universal Bank – e.g. ICICI Bank, HDFC Bank, SBI etc. • Development Bank – IDBI, NABARD, IFCI, SIDBI etc. • Payment Bank – e.g. Airtel Payments Bank, PayTM Payments Bank • Small Finance Bank – e.g. AU Financiers Ltd, DishaMicroFin
Universal Bank It is financial supermarket where all financial products are sold under one roof. • It is a system of banking where bank undertake a blanket of financial services like investment banking, commercial banking, development banking, insurance and other financial services including functions of merchant banking, mutual funds, factoring, housing finance etc. • As per the World Bank, the definition of the Universal Bank is as follows: In Universal banking, the large banks operate extensive network of branches, provide many different services, hold several claims on firms (including equity and debt) and participate directly in the Corporate Governance of firms that rely on the banks for funding or as insurance underwriters.
Universal Bank – Advantages • Increased diversions and increased profitability. • Better Resource Utilization. • Brand name leverage. • Existing clientele leverage. • Value added services. • ‘One-stop shopping’ saves a lot of transaction costs. • Easy Marketing • Profit Diversification
Development Bank • Development bank is essentially a multi-purpose financial institution with a broad development outlook. • A development bank may, thus, be defined as a financial institution concerned with providing all types of financial assistance (medium as well as long term) to business units, in the form of loans, underwriting, investment and guarantee operations, and promotional activities — economic development in general, and industrial development, in particular.
Payment Bank • A payments bank is like any other bank, but operating on a smaller scale without involving any credit risk. • In simple words, it can carry out most banking operations but can’t advance loans or issue credit cards. • It can accept demand deposits (up to Rs 1 Lakh), offer remittance services, mobile payments/transfers/purchases and other banking services like ATM/debit cards, net banking and third party fund transfers. Objectives of Payment Bank • To widen the spread of payment and financial services to small businesses, low income households, migrant labour workforce in secured technology driven environment. • With payments banks, RBI seeks to increase the penetration level of financial services to the remote areas of the country.
Small Finance Bank • Small finance banks are a type of niche banks in India. • The main purpose of the small banks will be to provide a whole suite of basic banking products such as bank deposits and supply of credit, but in a limited area of operation. • The objective for these Small Banks is to increase financial inclusion by provision of savings vehicles to under-served and unserved sections of the population, supply of credit to small farmers, micro and small industries, and other unorganized sector entities through high technology-low cost operations. • The firms must have a capital of Indian Rupees 100 crore. Existing Non-Banking Financial Companies (NBFC), Micro-Finance Institutions (MFI) and Local Area Banks (LAB) are allowed to set up small finance banks.
Content • Banking Regulation in India • Some important Global Banking Regulation
Banking Regulation in India • Banking Regulation Act 1949: • Banking system in India is governed by Reserve Bank of India, through the provisions of Banking Regulation Act 1949. • In 1965, the act was amended to include Cooperative Banks, where were mainly run by state governments. • This act was enacted owning to safeguard the interest of depositors, control abuse of power by some bank personnel controlling banks in particular and to the interest of Indian economy in general
Some Important Global Banking Regulations • Anti Money Laundering: Money laundering is the process of transforming the profits of crime and corruption into ostensibly "legitimate" assets. • Basel Accords: The Basel Accords are three sets of banking regulations (Basel I, II and III) set by the Basel Committee on Bank Supervision (BCBS), which provides recommendations on banking regulations in regards to capital risk, market risk and operational risk. • Know Your Customers - Know your customer ('KYC') is the process of a bank to identify and verify the identity of its clients. The term is also used to refer to the Anti-Money Laundering regulation which governs these activities. • Credit Rating Agency: A credit rating agency is a company that assigns credit ratings/ score, which rate a debtor's ability to pay back debt by making timely interest payments and the likelihood of default.
Content • Product/ Service line of Banks • Fee based product/service • Retail Fee Based Products/Service • Corporate Fee Based Products/Services • Fund based product/service
Product/ Service Lines of Banks The product mix for consumer banking services is very broad and product lines are deep, with many product items. Products are often customized to the needs of the customer. There can be two type of banking products; • Fee based products/services • Fund based products/ services
Fee Based Products/Services Fee Based Products/ Services Bank earns fees or charges
Fund Based Products/ Service Bank earns interest
Retail Lending Products Process Flow
Retail Banking Lending Products in Details • Home Loan • Vehicle Loan • Personal Loan • Educational Loan • Consumer Loan • Loan against Securities (Deposits, Shares)
Housing Loan • Housing loans are referred to the loans provided by the banks for the following purposes: • For construction/purchase of flat/house • Repairs/Renovation of existing house/flat • Purchase of flat/house resold • Purchase of land • The criteria for providing housing loans differs from bank to bank. • The eligibility is mainly for Individuals Salaried class, businessmen, professionals with minimum period of service.
Housing Loan Sanction • The loan amount will be calculated based on the value of property the customer is going to buy and also based on the earnings of the customer. • The loan amount would be 36 times gross salary or 60 times net salary of the customer which ever is higher. Spouse income also considered • Margin: 15% on total project cost ( cost of land + cost of construction); 30% - For repairs • There are 2 options for Interest rate of Housing Loan • Fixed rate • Floating rate
Housing Loan Sanction … • The rate also varies with the tenure selected by customer. There is maximum of 20 years tenure offered by banks
Housing Loan Repayment • Repayment methods: • for purchase/ construction – 20 yrs EMI • For repairs / renovation – 10 yrs EMI • Processing Fee: • 0.5% to 1% from Bank to bank • Security: Mortgage of house to be purchased
Housing Loan Cycle • Origination • Verification • Sanction • Disbursal • Closure
