CBM

Term IV --Session 5
2016
PGP 19 Batch
Pankaj Baag
Faculty Block 01, Room No 21
Mob: 8943716269
Ph (O): 0495-2809121
Ext. 121
Email: baagpankaj@iimk.ac.in

Assignment allotment for 15th July

Case no C2 assigned to Group 1, Group 2
Case no C10 assigned to Group 3, Group 4

Basel II framework
In June 2006, Basel II accord was brought in
which also included operational risk.
It suggested three pillars approach:
P1 Minimum capital requirement- credit,
operational and market risk
P2 Supervisory review process to monitor
banks capital adequacy and internal
assessment process.
P3 Market discipline requirements by effective
disclosure to encourage safe and sound
banking practices

 Pillar 2: Supervisory Review:

Basel II had given powers to the regulators to
supervise and check banks risk management
system and capital assessment policy.
The regulators can also ask for buffer capital
apart from minimum capital requirement by BCBS.
RBI has asked for 9% CRAR, which is more than
8% prescribed by BCBS.
Regulators are given the power to oversee the
internal risk evaluation regimes proposed in Pillar
I.

 Pillar 3: Market Discipline

The Pillar III had made disclosure of a
banks risk taking positions & capital,
mandatory.
This step was targeted to introduce
market discipline through disclosure.

Basel II failure
Depended on good underlying data
Inadequate level of capital
Incorrect assumptions like mortgage
related risk calculations
No independent standard
Most of the institutional cogs in credit
crisis were not covered
Banks defined their own risk
metrics/derivative investments

Basel III
Guidelines released in December 2010. (G20)
The financial crisis of 2008 was the main
reason
The quantity and quality of capital under Basel
II were deemed insufficient to contain any
further risk.
These norms aim at making most banking
activities such as their trading book activities
more capital intensive.
The purpose is to promote a more resilient
banking system by focusing on four vital
banking parameters viz. Capital, Leverage,
Funding and Liquidity.

Features pillar 1

Enhanced Capital Requirement: Common

Equity requirements raised to 4.5% from 2% at
present.
Tier 1 Capital requirements: raised from 4% to
6% by 2015.
Introduction of a Capital Conservation Buffer
which is an additional reserve buffer of 2.5% to
"withstand future periods of stress", bringing the
total Tier 1 Capital reserves required to 7%.
To meet the key objectives of Strengthening the
resilience of the banking sector; conserve enough
capital to build buffers at individual banks and the
entire banking sector which can then be used in
times of stress.

 Introduction of Countercyclical Buffer

According to the new rules local regulators are not
only responsible for controlling banks compliance
with the Basel requirements but also for regulating
credit volume in their national economies.
If credit is expanding faster than GDP, bank
regulators can increase their capital requirements
with the help of the Countercyclical Buffer.
Varying between 0% - 2.5% it can thus, preserve
national economies from excess credit growth.

 Leverage Ratio (Ratio of Tier 1 Capital to

Total Assets): serve as a backstop to the
risk-based measures.
According to Basel III; Tier 1 Capital has to be
at least 3% of Total Assets even where there is
no risk weighting.
The Basel III rules agree to test a minimum
Tier 1 leverage ratio of 3% during the parallel
run period by 2017.
For the Indian Banks during the period of
parallel run, banks should strive to maintain
their existing level of leverage ratio but, in no
case the leverage ratio should fall below 4.5%.
Leverage ratio >= 3%

 Liquidity Risk Measurement: Basel III

introduces a new instrument for liquidity risk
measurement Liquidity Coverage Ratio(LCR).
It is designed to ensure that a bank maintains
an adequate level of unencumbered, highquality assets that can be converted into cash
to meet its liquidity needs for a 30-day time
horizon under an acute liquidity stress scenario
specified by supervisors.
The standard requires that the ratio be no lower
than 100%. Its implementation is planned for
2015-16.
Liquidity coverage ratio = (stock of high quality
liquid assets/net cash outflows over a 30 day
period) >=100%

 To ensure that investment banking

inventories, off-balance sheet exposures,
securitization pipelines and other assets and
activities are funded with at least a minimum
amount of stable liabilities in relation to their
liquidity risk profiles the new Accord
introduces Net Funding Stability Ratio (NFSR).
It is defined as the ratio, for a bank, of its
available amount of stable funding divided
by its required amount of stable funding.
The standard requires that the ratio be no
lower than 100%.
NSFR= (available amount of stable
funding/required amount of stable funding)
>=100%

 The enhancements of Basel III over

Basel II come primarily in four areas:
(i)augmentation in the level and
quality of capital;
(ii) introduction of liquidity standards;
(iii) modifications in provisioning
norms; and
(iv) better and more comprehensive
disclosures.

Comparision of Basel
Requirements

Min ratio of total

capital to RWA
Min ratio of common
equity to RWA
Tier I capital
Core Tier I capital to
RWA
Capital conservation
buffers to RWA
Leverage ratio
Countercyclical
buffer
Min liquidity
coverage ratio
Minimum net stable

II and Basel III

Basel II
Basel III

8%
11.5%
2%

4.5% to 7%

4%
2%

6%
5%

None

2.5%

none
none

3%
Upto 2.5%

none

TBD 20152016
TBD 2018

none

 Supplemental Pillar 2 requirements.

Address firm-wide governance and risk
management;
capturing the risk of off-balance sheet
exposures and securitisation activities;
managing risk concentrations;
providing incentives for banks to better manage
risk and returns over the long term;
sound compensation practices;
valuation practices;
stress testing;
accounting standards for financial instruments;
corporate governance; and
supervisory colleges.

 Revised Pillar 3 disclosures requirements

The requirements introduced relate to
securitisation exposures and sponsorship of
off-balance sheet vehicles.
Enhanced disclosures on the detail of the
components of regulatory capital and their
reconciliation to the reported accounts will be
required, including a comprehensive
explanation of how a bank calculates its
regulatory capital ratios.

CAR and IRAC Norms

Prudential norms on income

recognition, asset classification and
provisioning- 1992-93
Reflect true position through uniform,
consistent, transparent norms
including CAR norms
Typically Guidelines on CAR

Norms on income
recognition

loans and advance

classification

provisions for loss

IRAC norms
Also commonly known as the prudence norms were
designed to strengthen the financial prudence of the banks
Focuses on asset quality, income recognition and
provisioning norms of assets
IR norms: income recognised on actual basis except interest
due on government securities, for others accrued interest
not realised should be reversed
Assets classification: for making provisions
Standard assets: 90 days
Sub standard assets: 31.3.2005 -12 months NPA;
(reschedule 12 months); secured and unsecured
Doubtful assets: above 12 months NPA
Loss assets: identified by bank/auditors/RBI after adjusting
for any security

Contd..
NPA: gross and Net
Gross: amount O/s w/o interest
Net NPA: interest debited and not recovered (int.
Suspense) SSA less provisions made less claims
received from ECGC/DICGC
Provision: SA: General-0.4%; CRE-1%; Agl/SME-0.25%
SSA- secured-unsecured-unsecured Infra10/20/15%
DA- upto 12 months -20%; 3 yrs-30%;
above 3 yrs- 100, unsecured portion-100%
Loss A- 100%

Contd..
Impact of IRAC norms and CRAR:
Asset classification have direct bearing
on Capital fund requirement and cost
Provision are made from income, this
increases with rise in NPA
NPA accounts-one cannot charge interest
as well as provision required
Normal accounts: interest not an income
unless realised
Impacts operations/profitability

Assignment allotment for 15th July

Case no C2 assigned to Group 1, Group 2
Case no C10 assigned to Group 3, Group 4

Chapter 3

Banking technology
Factors that brought transformation/changes .
Post liberalisation era-1991
New private sector banks with 100%
computerisation and latest tech in operations
which helped improve NIM
Financial development across globe
Communication efficiency
Deregulation and diversification
Competition
Customer demand and becoming more
discerning
Diverse distribution channels, customised and

Contd..
All these led to increased use of sophisticated information
and communication technology; higher degree of
computerisation
Achieved better customer service, reliable information,
self operated services, sustained competitive advantages
Data mining is used to assess customer behaviourdemographic, psychographic and transactional detailshelps in profit/sustainable CA
AIM: handle large volume of business with efficiency
max profit with cost control
Need: customer retention, cost effectiveness, competition
Priorities redefined: cost reduction/profit margin increase;
product differentiation including operational excellence;
customer central model-from transaction based to
relationship

Benefits

Bank: strengthen back/front office, customer

satisfaction, increase in business/profit
Fast and up to date info transfer, speedy
decisions, interconnected branches/controlling
office
Adequate preventive, detective and corrective
control to prevent fraud/financial irregularities
Single point data entry helps in avoidance of
duplication
Inquiry, follow up
Timely immediate response
Employees productivity, better market
infrastructure, development of new products

 Customer: innovation in products and services

Anytime/anywhere banking, multiple channels-ATM,
online, mobile, electronic, tele..access banking
transaction from anywhere/anytime per choice
Single window services-centralised info, updated
simultaneously in all branches, less time
consumption, faster & easy banking
24X7 hours banking-any time through PCs, call
routines, less errors
CDM
Competition- integrate tech with business models
to satisfy customers, new products/services, build
relationship, faster accurate info flow, less cost
which is good for customers because of wider use
Satisfaction of customer/retention of customer

Types of tech platform implemented

ATMs-onsite, offsite, online, offline, standalone,

networked, cash, enquiry, transfer and CDM
Online/internet banking- (threats)
Tele banking (interactive voice response
system, operator)
Electronic banking(GUI-graphical user
interface)
Mobile banking (personal digital assistant)
Video banking
Cash management services Vsat, collection
center, multiple city cheques
Remittances services (EFT, SWIFT-society for

Contd..

Point of sales terminal- cash withdrawal, centralisation with

(national payments corporation of India)
Call centres
BPR-Business Process Re-engineering (BPR) means
transforming the select processes and procedures with a view
to empower the bank with contemporary technologies,
business solutions and innovations that enhances the
competitive advantage
Objective : to create and enhance the value of the bank for
the customers. 4 Cs -customer (to given him enhanced value),
competition (to meet it successfully), change (to manage it)
and cost (to reduce).
Process : three key parameters -customer service, product
innovation and operational excellence.
The process involves identification of the business processes
to be redesigned, understanding and measuring the existing
processes, identifying the information technology levers and
designing and building a prototype of new process.

Contd..

Benefits : further the strategic goals of banks.

benefit the customers through significantly
reduced transaction time, flexibility in servicing
and improved value.
banks can be benefited by increased volume of
business and higher productivity, reduced
operational cost leading to higher profits,
improved employee loyalty and sense of
belongingness and establishment of bank within
a branch concept.
Employees benefit through empowerment
leading to higher job satisfaction, effective job
rotation as an additional incentive and effective
interface with customers as work load is evenly
distributed

Contd..
CRM: a process which can make the right offer to right customer
at right time through right channel
Help to cope the emerging realities around risk, regulation and
customer retentionby offering a unified view of customers,
provide a consistent msg to customers, provide end to end
customer care, build long term customer relationship,
identification of best customers
Process calls for in depth understanding of customer life cycle and
value proposition at each stage
Starts with knowledge discovery about needs, preferences,
behaviour which gets into product and market planning,
interaction with customer which leads to intensive analysis and
informed refinement of the original for fine tuning
Stage-operational (data storage), analytical (mining),
collaborative
Data mining- marketing strategy, card holder pricing and
profitability, predictive lifecycle management, forensic analysis,
cross sell/upsell, churning signals, laundering, technology diffusion

Other issues
Security-Privacy, trust, authenticity, integrity,
environmental based issues like physical threats,
human threats, software threats
Measures- computer audit, IS audit,
IT act, 2000
BCBS principles : 3 on Board and management
oversight; 7 on security controls; 4 legal and
reputational risk management
RBI: Jilanee committee- bring IS audit under inspection
dept of banks

Narasimham- importance of IS audit

Vasudevan- importance of computerisation

Internet banking- IS audit

Burman- checklist

Chapter 4

Evolution of payment system in India

Coins
Mughal period BOE
Pay order-barattes
Hundies
Paper currency
1861-paper currency act
Clearing house

Mechanism of national Payment System

Through the NPS, payment services are

provided in an economy
Goal i. circulation of money through
consolidating and integrating multiple
system with varying service levels into
nation wide uniform and standard
business process
ii. Facilitate an affordable payment
mechanism to benefit common man and
improve financial inclusion

Contd..
To fulfill these objectives, National
Payment Corporation on India-2008
Benefit to all banks and customers
Operate on high volume, create
infrastructure of large dimension
Fraction of present cost structure

Purpose of payment system

Protect key existing assets of banking systembrand name, customer relationshiphelps in
keeping the cash flows within the banking
system
Customer base strengthening-phone company
vs bank for younger generation; excluding
tech.underclass people
Reducing existing cost and generating new
income-remove legacy systems; bring in
internationally compatible, open system,
platform independent payment standards to
keep existing client and new customers; cheap
transition, electronic commerce; IdenTrust

The Payment and Settlement

Systems (PSS) Act 2007
Objective- to provide for the regulation
and supervision of payment system in
India
RBI is the authority
Important feature Only RBI can operate/commence an
payment system, others offence unless
authorised by RBI

Core Principles for Systemically

Important Payment Systems
G10 central banks develop these guidelines
To encourage the design and operation of safer
and efficient systematically important payment
systems worldwide
Develop international standards acceptable
Some Core Principles A legal basis under relevant jurisdictions (legal
risk)
Participant should know the financial risk attached
to this (credit risk, liquidity risk)
Clearly defined procedure for management of the
risk

Contd..
Value date-prompt settlement
Multilateral netting, daily settlements
through Central bank
Security, reliability, contingencies
(operational risk)
Practical means of making
payment/efficient to economy
CorpGov-Transparency, fair, open,
accountable, effective (systematic risk)

Definition
Payment system- a set of instruments,
procedures and rules for transfer of funds
among system participants
Essentials- payment instruments acceptable
for making payments; institutional
framework; operating procedures;
communication network for transmission of
payment/information
Modern payment system-subsystem for
different customers, valueretail payment
system, wholesale payment system

Features
familiarit
y
customer
s
focus
nature

RPS
yes
Individuals, small
business, non-FI
B2C, P2P
Routine personal
and business
transactions
lower
high
Non time critical

size
volume
processi
ng
payment Paper, plastic,
electronic
settleme multilateral
nt

WPS
Unaware, not directly
involved
Large corporates,
banks, FI
B2B, G2G, inter bank
High value business,
interbank securities,
money market, forex
high
low
Time critical
electronic
Real time gross

Payment methods /instruments

Paper
Plastic
Electronic
Paper based methods:
To pay paper instruments; cheques
Pre-paid payment instruments-bank draft,
bankers cheque, payment order
Legal basis- NI Act 1881
NI means a promissory note, BOE/cheque
payable either to order or bearer

Contd.. Some common paper

instruments

Cheque- BOE drawn on a specified

banker, payable on demand
(order/bearer); drawer- account holder,
maker of the cheque; Drawee- directed
to pay (bank where the accountholder
has the account); Payee- beneficiary.
It is a NI, must be presented for payment
by the payee/holder/holder in due course
to the acceptor/maker/drawer
It is not cash, does not assume finality of
payment
Multicity cheques

Contd..

BOE- written order from one party (drawer) to

another (drawee) instructing it to pay a specified
sum on demand or on a specified date to the
drawer or a third party specified by the drawer;
used in trade / obtain credit facility using bills
discounting
Bank draft- pre paid NI where the drawee bank
undertakes to make payment in full when
presented to payee, made payable on a specified
branch. Used when drawer/drawee in two
separate place; buyer/seller dont trust/high
value, payment is guaranteed . Beneficiary is
payee, applicant , issuing branch, paying branch,
same bank