Bank is an institution which collects money from those who have in spare or who are saving it out of their

income; and lend this money out to those who require it. All those institutions which are in the business of banking are called financial institutions.

Banking System in India

Scheduled Banks

Non-Scheduled Banks

State Coop. Banks

Commercial Banks

Central Coop. Banks and primary credit societies

Commercial Banks

Public Sector Banks

Foreign Banks

Private Sector Banks

SBI & Associate Banks(7)

Other Nationalized Banks

Scheduled banks :- Banks which have been included in the Second Schedule of RBI Act 1934. They are categorized as follows: Public Sector Banks :- E.g.. SBI, PNB, Syndicate Bank, Union Bank of India etc. Private Sector Banks :- E.g.. ICICI Bank, IDBI Bank, HDFC Bank, AXIS Bank etc. Foreign Banks :- E.g.. Citi Bank, Standard Chartered Bank, Bank of Tokyo Ltd. etc. Non scheduled banks :- Banks which are not included in the Second Schedule of RBI Act 1934.

Commercial Banks are those profit seeking institutions which accept deposits from general public and advance money to individuals like household, entrepreneurs, businessmen etc. with the prime objective of earning profit in the form of interest, commission etc. Examples of commercial banks ICICI Bank, State Bank of India, Axis Bank, and HDFC Bank

Commercial banks are an organisation which normally performs certain financial transactions. It performs the twin task of accepting deposits from members of public and make advances to needy and worthy people form the society. When banks accept deposits its liabilities increase and it becomes a debtor, but when it makes advances its assets increases and it becomes a creditor. Banking transactions are socially and legally approved. It is responsible in maintaining the deposits of its account holders.

A. 1.

2.

3.

Accepting deposits Demand or current account deposits- a depositor can withdraw it in part or in full at any time he likes without notice. It carries no interest. Fixed deposits- it can be done from 15 days to few years with high rate of interest which can be withdrawn at expiry of term. Saving deposits- it is for the purpose of small saving deposits by salaried people. These deposits carry less rate of interest and money can be withdrawn through cheques.

B. Advancing loans
1.

2.

Overdraft facility- this facility is provided to the businessmen only even if the deposits are less, the transaction can be done . Banks charge interest on this facility. Loans by creating deposits- it can be done in following ways Cash credit Demand loans Short term loans

The tendency of the commercial banks to make loans several times of the excess cash reserves kept by the bank is called creation of credit. Creation of credit means that the commercial banks by taking in deposits and making loans expand the money supply.

The process of 'Credit Creation' begins with banks lending money out of primary deposits. Primary deposits are those deposits which are deposited in banks. In fact banks cannot lend the entire primary deposits as they are required to maintain a certain proportion of primary deposits in the form of reserves with the RBI under RBI & Banking Regulation Act.

Bank M receives a cash deposit of $2000. This is the cash in hand with the bank which is its assets and this amount is also the liability of the bank by way of deposits it holds. Given the reserve ratio of 10 % the bank holds $200 in reserves and lends $1800 to one of its customers.

Commercial bank's balance sheet has two main sides i.e. the liabilities and the assets. From the study of the balance sheet of a bank we come to know about a system which a bank has followed for raising funds and allocation of these funds in different asset categories. Bank can have others money with it. It can be in terms of shareholders share capital or depositors deposits. This money is the bank's liabilities. On the other hand bank's own sources of income leads to generation of assets for bank.

Liabilities a. Share Capital

Assets a. i. Cash in Hand

b. Reserve Funds
c. Deposits i. Fixed Deposits ii. Saving Deposits iii.Current Deposits iv. Other Deposits

ii. Cash with the Central Bank (RBI)

iii. Cash with the other banks b. Money at short c. Bills and securities discounted d. Investment of bank e. Loans and Advances given

d. Borrowings
e. Other liabilities

f. Other Assets

Capital Adequacy Ratio (CAR) is a ratio that regulators in the banking system use to watch bank's health, specifically bank's capital to its risk. Regulators in the banking system track a bank's CAR to ensure that it can absorb a reasonable amount of loss. Regulators in most countries define and monitor CAR to protect depositors, thereby maintaining confidence in the banking system.

Capital adequacy ratio is the ratio which determines the capacity of a bank in terms of meeting the time liabilities and other risk such as credit risk, market risk, operational risk, and others. It is a measure of how much capital is used to support the banks' risk assets.

The ratio is calculated by dividing Tier1 + Tier2 capital by the risk weighted assets. Capital Capital Adequacy Ratio = -----------Risk Tier1 + Tier2 capital = ----------------------------Risk Weighted Assets

* 8%

Tier 1 Capital: This is the bank's core capital comprising of share capital, disclosed reserves and minority interests. Some institutions expand this definition to include restricted forms of "equity-like" capital instruments. Tier 2 Capital: This includes supplementary Capital consisting of general loan loss reserves and revaluation reserves on investments and properties held for investment purposes.

Risk-Weighted Assets: This includes the total assets owned. The value of each asset is assigned a risk weight (for example 100% for corporate loans and 50% for mortgage loans) and the credit equivalent amount of all off-balance sheet activities. Each credit equivalent amount is also assigned a risk weight.

Takes risk into account. Since different types of assets have different risk profiles, CAR primarily adjusts for assets that are less risky by allowing banks to "discount" lower-risk assets.

Classification of Risk

RISKS
FINANCIAL RISK NON FINANCIAL RISK
OPERATING RISK

CREDIT RISK

MARKET RISK

SYSTEMATIC RISK POLITICAL RISK

TRANSACTION RISK

INTEREST RATE RISK

HUMAN RISK
PORTFOLIO RISK LIQUIDITY RISK

TECHNOLOGY RISK
FOREX RISK

Risks Faced by Banks

Credit Risk Market Risk Liquidity Risk Interest Rate Risk Foreign Exchange Risk Operational Risk Solvency Risk

Credit default risk occurs when a borrower cannot repay the loan. Eventually, usually after a period of 90 days of nonpayment, the loan is written off. Banks are required by law to maintain an account for loan loss reserves to cover these losses. Banks reduce credit risk by screening loan applicants, requiring collateral for a loan, credit risk analysis, and by diversification. A bank can also reduce credit risk by diversifying making loans to businesses in different industries or to borrowers in different locations.

Transaction Risk Risk relating to specific trade transactions, sectors or groups. Portfolio Risk Risk arising from lending to sectors non related to the core competencies of the Bank / concentrated credits to a particular sector / lending to a few big borrowers.

Market risk is the risk to a banks financial condition that could result from adverse movements in market price. The risk that an un-expected happening ,which is extreme sudden or dramatic will cause an all-round fall in market prices. It signifies the adverse movement in the market value of trading portfolio during period required to liquidate the transaction

TYPES OF MARKET RISK Interest Rate Risk Risk felt, when changes in the interest rate structure put pressure on the net interest margin of the Bank. This risk is the possibility that assets or liabilities have to be repriced on account of changes in the market rates and its impact on the income of the bank.

For instance, if a bank has a loan for $100 for which it receives $7 annually in interest, and a deposit of $100 for which it pays $3 per year in interest, that is a net interest margin of $4. But if current market interest rates for deposits rises to 4%, then the bank will have to start paying $4 for the $100 deposit while still receiving 7% on the long-term loan, decreasing its profit in this scenario by $1.

Liquidity Risk: Risk arising due to the potential for liabilities to drain from the Bank at a faster rate than assets. Liquidity risk is when the bank is unable to meet a financial commitment arising out of a variety of situations. However, there are times when an FI can face a liquidity crisis. When all or many FIs are facing similar abnormally large cash demands, the cost of additional funds rises as their supply becomes restricted or unavailable. Such serious liquidity problems may eventually result in a run in which all liability claimholders seek to withdraw their funds simultaneously from the FI. This turns the FIs liquidity problem into a solvency problem and could cause it to fail.

Forex Risk: To the extent that the returns on domestic and foreign investments are imperfectly correlated, there are potential gains for an FI that expands its asset holdings and liability funding beyond the domestic frontier.

NON-FINANCIAL RISKS
Operational Risk :arises as a result of failure of operating system in the bank due to certain reasons like fraudulent activities, natural disaster, human error, omission etc. Systemic Risk: is seen when the failure of one financial institution spreads as chain reaction to threaten the financial stability of the financial system as a whole. Political Risk arises due to introduction of Service tax or increase in income tax, freezing the assets of the bank by the legal authority etc. Human Risk: Labour unrest, lack of motivation, inadequate skills, etc Technology Risk: Obsolescence, mismatches, breakdowns, adoption of latest technology by competitors, etc, come under technology risk

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