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Q.1. What is Islamic Finance? How does it work? How has Islamic banking progressed in recent years? What restricts the growth of Islamic Finance? Ans: Unlike the conventional banking system, the Islamic banking system can be defined as a faith based system of financial management, which derives its principles from the Islamic law Sharia. It promotes profit sharing in the conduct of banking business as well as prohibiting paying or receiving interest on any transaction. It gave rise to reconceptualization in finance, the prohibition of receiving profit (interest) on borrowing and lending cash. The Islamic banking system has been criticized for what has been interpreted as the notion of a risk free reward or return and the lack of recognizing the time value of money. This argument is not totally correct because according to the modern economic theory and analysis, Islamic banking is based on equity based system not on the debt based system which is the base of conventional banking system. This means IFIs offer an uncertain rate of return to the investors and in case of incurring any risk; it should be shared between the bank and the investor. This system allows IFIs to adjust the value of their assets and liabilities according to any changes in the fair market value of the investment. This means the loss is always shared between the IFI and the investors. On the contrary, the conventional banking system does not reflect the changes in fair market value of the investment, instead the bank assumes the loss alone resulting in disequilibrium between the real value of assets and liabilities and ending by negative net worth of the bank. The prohibition of predetermined interest rate on loans puts pressure on IFIs to monitor the borrowers at a reasonable cost and get the exact information about the generated profit because the lender might provide asymmetric information about the real profit. Therefore, the portfolios of IFIs tend to be concentrated in short term, trade related assets. This emphasis on short term financing leads to an inimical effect on investment, growth and economic development. This concept reflects the social commitment between the bank and the investors in enhancing the economy.

Progress in recent years The Arabian Gulf countries constitute the foundation for IFIs because of their similarity in religion, culture, language and arid geography. They have four out of five largest Islamic banks in the world and maintain the highest concentration of Islamic deposits and capital due to the high income in the region. The members of GCC countries hold 20% of the worlds crude oil production and have a Gross Domestic Product (GDP) per capita of more than US$8,000. In addition, Saudi Arabia took the lead among the Islamic countries to promote the spirit of Islam through financial support to the Muslim communities in the form of establishing Islamic universities, institutes, and Islamic centers to strengthen the Arabic and Islamic identity. During that time, two Saudifunded financial firms have been founded (Dallah AlBaraka Group, 1969 and Dar AlMaal Al Islami Organization, 1981) to support the international development of Islamic banking. After the tragedy of September 11, most of the Arab investors preferred to hold a large portion of their investments in the Middle East in case of another similar event. The IFIs were the best agent to manage their investments. In addition, the central banks in GCC countries and especially in Bahrain, urged the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) to set up the accounting and auditing standards for IFIs to protect these investments. Malaysia and SouthEast Asia are additional financial regions of interest for IFIs, after GCC countries. Malaysia comes as a pioneer in Islamic banking industry for the whole Southeast Asian region. From the perspective of conventional banking, the success of IFIs can be gauged by the rush among the conventional banks to open their own Islamic windows, not only inside the Islamic world but in the rest of the world such as Citibank, ABN Amro, HSBC, BNP Paribas, and Bank of America.

Challenges faced by Islamic Finance 1) Since the conventional banking system is widely spread inside as well as outside the Islamic countries for decades, it gains the clients trust especially if it is well regulated and actively contributed to the economy. On the other side, IFIs are new player in the financial market; therefore, they strive to compete with the existing system inside the Islamic countries.

2) IFIs are currently recruiting their employees and management from those who work in conventional banks because of the serious shortage in their manpower. 3) In most of the Islamic countries the central banks are not in practice of their main role in leading the Islamic financial institutions into efficient mobilization of savings and allocation of resources. The central banks in most of the Islamic countries do not take their essential role of initiating and fostering the development of primary, secondary, and money markets that are approved by SSB. 4) They still lack new innovations which are based on profitsharing concept, not fixed interest rate. 5) The central banks do not have an effective role in regulating the standards and practices for IFIs. As a result, their accounting practices were inconsistent and the financial statements were not transparent and due to inadequate disclosure cannot take independent decisions. 6) IFIs cannot trade in shares or bonds of any company that generates revenue from alcohol, pork, and similar activities which are prohibited by Islam.

Q.2. What is the use of technology in banking operations? What are the technological initiatives taken by the banks? Ans: Technology brought a fundamental shift in the functioning of banks. It breaks all boundaries and encourage cross border banking business. The introduction of IT related products in internet banking, electronic payments, security investments, information exchanges, banks now can provide more diverse services to customers with less manpower. Seeing this pattern of growth, it seems obvious that IT can bring about equivalent contribution to profits. Entry of ATMs has changed the profile of front offices in bank branches. Customers no longer need to visit branches for their day to day banking transactions like cash deposits, withdrawals, Cheque collection, balance enquiry etc. E-banking and Internet banking have opened new avenues in convenience banking. Internet banking has also led to reduction in transaction costs for banks to about a tenth of branch banking.

Technology solutions make flow of information much faster, more accurate and enable quicker analysis of data received. This would make the decision making process faster and more efficient. For the Banks, this would also enable development of appraisal and monitoring tools which would make credit management much more effective. The result would be a definite reduction in transaction costs, the benefits of which would be shared between banks and customers.

While application of technology would help banks reduce their operating costs in the long run, the initial investments would be sizeable. IT spent by banking and financial services industry in USA is approximately 7% of the revenue as against around 1% by Indian Banks. With greater use of technology solutions, we expect IT spending of Indian banking system to go up significantly.

One area where the banking system can reduce the investment costs in technology applications is by sharing of facilities. The banks and FIs come together to share facilities in the area of payment and settlement, back office processing, data warehousing, etc.

Payment and Settlement system is the backbone of any financial market place. The present Payment and Settlement systems such as Structured Financial Messaging System (SFMS), Centralized Funds Management System (CFMS), Centralized Funds Transfer System (CFTS) and Real Time Gross Settlement System (RTGS) will undergo further fine-tuning to meet international standards.

Q.3. What are the strategic business reasons for the increased thrust on Housing Loan? What are the various risks associated with housing loans? Ans: The housing finance market is among the most important in the economy. It accounts for a sizeable portion of the production activity of a country, through its backward linkages to land markets, building materials, tools, durable goods, and labor markets. Housing markets have significant forward linkages with financial markets, as well. Mortgage debt accounts for a large proportion of household debt and, through secondary markets and securitization, supports the efficient functioning of domestic and international financial markets. Housing markets are routinely monitored as an important leading indicator of overall

macroeconomic activity. The housing finance sector has a tremendous developmental impact, both in terms of providing social stability and in promoting economic development. Social Stability: Housing finance contributes to social stability by enabling households to purchase an asset which will represent their largest single investment. Personal residences account for 75% to 90% of household wealth in emerging market countries, which amounts to 3 to 6 times their annual income. Furthermore, housing represents 15% to 40% of the monthly expenditure of households worldwide. Economic Development: Investment in housing accounts for 15% to 35% of aggregate investment worldwide. By supporting housing finance, the banks help to free personal savings which entrepreneurs can invest in small businesses. Housing construction and housing related sectors constitute approximately 9% of the labor force worldwide. Housing Finance and the World Bank: Housing finance plays an important role in the World Banks overall financial sector strategy and is clearly and inextricably linked to the overarching mission of reducing poverty and improves peoples lives. Given the rapid pace of innovation in this field, the Housing Finance group works closely with World Bank to develop an integrated approach to housing finance. Rise of Middle Income group: Increase in disposable income levels due to decrease in marginal tax rates and increase in total income levels have attracted more people to purchase property. Also, Tax benefits and other fiscal incentives are announced in the Union Budgets related to housing sector. There are changes in demographic profile including increase in the rate of household formation due to structural shift from joint family system to nuclear family.

Risks associated with housing loans The major areas of risk experienced in the housing finance process are legal/regulatory, market risks (demand factors and competition), credit risk (borrower and collateral), operations risk (for lending enterprises), interest rate risk, and liquidity risk. There are various legal and administrative impediments in India, which are hindering the growth of the mortgage securities market in India. These impediments are in the nature of

archaic laws such as Urban Land Ceiling (and Regulation) Act, Rent Control Act, varying and high rates of stamp duty across different states, restrictive foreclosure process etc. Management of credit and operations risk is the foundation of any strong housing finance system. This is because, regardless of the source of funding, or the macro-economic and legal conditions, effective lending techniques and strong loan management skills are the first line of defense against loss. The Indian housing finance industry has one of the lowest credit loss rates as a retail customer rarely defaults on the payments of loans, which is the largest investment for an individual. The first line of defense against loss is making good loan decisions; the second is managing the asset effectively, with risk sharing entities coming last. Credit risk insurance is only activated after the lender has done everything possible to avoid a loss on the loan. Credit risk management in the Indian context means the housing finance company has to develop certain in-house/local standards for measurement of borrowers ability and willingness to repay the loan for the long term. Operations risk management means establishing the internal capacity to make good credit decisions (reduce risk of loss), while at the same time managing the assets so that costs are minimized. Asset liability mismatch increases the interest rate and liquidity risk profile of the HFCs and Banks. Banks have the ability to largely mitigate this risk due to access to diversified resources and lending options. However differences in the maturity profiles of assets and liabilities continue to be of major concern for HFCs.

Q.4. What is Risk Based Supervision? Explain the importance of Risk focused internal audit. Ans: Risk Based Supervision can be defined in both a broad and narrow scope. Under its broad interpretation RBS relates to both policy and implementation of the whole bank supervision approach. At the policy level the emphasis is put on banks board and senior management responsibility for managing risks in their banks and keeping adequate capital to absorb any losses that may arise. At the implementation level supervisory activities are prioritized and resources allocated according to perceived risks i.e. supervisory resources are first allocated to areas where risk is the greatest. The supervisory approach is also focused on evaluating

the adequacy of banks risk management systems. Under its narrower interpretation RBS relates to the methodology adopted increasingly to guide on-site inspections of banks. Thus RBS may be defined as a supervisory approach that is designed to identify activities and practices of greater risk to the soundness of banks and accordingly deploying supervisory resources towards the assessment of how those risks are being managed by banks. Risk-Based Supervision (RBS) is a relatively new approach to supervision that is fast gaining recognition as the preferred approach to supervision over that of the traditional approach that focuses largely on determining the current financial condition of a bank, based on historical financial data and on quantifying a banks current problems through the use of audit-like examination procedures. By contrast, RBS focuses on qualifying problems by identifying poor risk management practices as this approach places strong emphasis on understanding and assessing the quality of risk management systems in banks that are in place to identify, measure, monitor and control risks in an appropriate and timely manner. One thing that bank supervisors would wish to have is an approach that would help them focus and dedicate supervisory resources to identify areas of greater risk to banks soundness and safety; and identify higher-risk banks. Once those areas and banks are identified, supervisory attention is turned to assessing those risks and how they are mitigated. The key to effective RBS is to identify primary risks affecting a bank and to evaluate the significance of those risks for the bank in question. Once this is done supervisory resources can be deployed more efficiently to address those identified risks. RBS thus meets the supervisors need to rationalize the use of scarce supervisory resources. Basel II norms require banks to design and implement effective risk management systems. Similarly, supervisors are required to assess those systems as to their effectiveness. Risk Focused Internal Audit A sound internal audit function plays an important role in contributing to the effectiveness of the internal control system. It should provide the management with accurate information on the effectiveness of risk management and internal controls including regulatory compliance by the bank. However, it does not provide any opinion on the qualitative dimension of business management including risk management. Thus there

is a need to modify the approach towards audit, making it risk based. While focusing on effective risk management and controls, RBIA would not only offer suggestions for mitigating current risks but also anticipate areas of potential risks and play an important role in protecting the bank from various risks. Thus, the focus of the proposed RBIA will be on risk identification, prioritization of audit areas and allocation of audit resources in accordance with the risk assessment. This also includes a certain amount of transaction testing to confirm or modify the pre-audit risk assessment. According to the plan of action put forward by the RBI, banks are expected to take various steps to introduce RBIA which include Development of a well defined policy for risk based internal audit. Adoption of a risk assessment methodology for formulating risk based audit plan Development of risk profile and drawing up of risk matrix taking inherent business risk and effectiveness of the control system for monitoring the risk Preparation of annual audit plan, covering all risks and their prioritization based on the level and direction of each risk Setting up of communication channels between the audit staff and the management, such as Risk Based Internal Audit Report Identification of appropriate personnel to undertake risk based audit and imparting them with relevant training Addressing transitional and change management issues.

Q.5. Write an elaborate note on Securitization and Syndication of loans. SECURITIZATION


Securitization is the financial practice of pooling various types of contractual debt such as residential mortgages, commercial mortgages, auto loans or credit card debt obligations and selling said consolidated debt as bonds, pass-through securities, or Collateralized mortgage obligation (CMOs), to various investors. The principal and interest on the debt, underlying the security, is paid back to the various investors regularly. Securities backed by mortgage

receivables are called mortgage-backed securities (MBS), while those backed by other types of receivables are asset-backed securities (ABS). When a company securitizes a loan, it sells interests in that loan to multiple investors, and pays those investors over time. By offering investors the long-term profits (or losses) associated with an asset, the selling company (the "originator") can thereby protect itself from all risk associated with the asset. Securitization can also allow a company to remove financial liabilities, such as loans, from its balance sheet. The investor who buys an interest in a securitized asset will then bear all of the loss if the asset fails to perform. Companies also may wish to sell an asset with a long-term rate of return (such as a mortgage) for a quick up-front profit. Although the profit is less than the mortgage holder would reap in the long run from the payments, a company in need of quick cash may be willing to make that trade. Beyond mortgage-backed securities, many different types of assets can be securitized, so long as those assets promise a reasonably predictable rate of return. Companies have securitized such assets as credit card loans, lottery winnings, proceeds from a lawsuit, royalties for songs, and partnership interests. Process of securitization

First, an entity (the originator) desiring financing identifies an asset that is suitable to use. Loans or receivables are common examples of payment streams that are securitized. Second, a special

legal entity or Special Purpose Vehicles ("SPV") is created and the originator sells the assets to that SPV. This effectively separates the risk related to the original entities operations from the risk associated with collection. When done properly the loans owned by the SPV are beyond the reach of creditors in the case of bankruptcy or other financial crisis; i.e. the SPV is bankruptcy remote. Next, to raise funds to purchase these assets the SPV issues asset-backed securities to investors in the capital markets in a private placement or pursuant to a public offering. These securities are structured to provide maximum protection from anticipated losses using credit enhancements like letters of credit, internal credit support or reserve accounts. The securities are also reviewed by credit rating agencies that conduct extensive analyses of bad-debts experiences, cash flow certainties, and rates of default. The agencies then rate the securities and they are ready for sale - usually in the form of mid-term notes with a term of three to ten years. Finally, because the underlying assets are streams of future income, a Pooling and Servicing Agreement establishes a servicing agent on behalf of the security holders. The services generally include mailing monthly statements, collecting payments and remitting them to the investors, investor reporting, and accounting, collecting on delinquent accounts, and conducting repossession and foreclosure proceedings. Benefits of securitization for banks a) Access to a wider investor base and cheaper sources of funding: Securities issued by a special purpose vehicle will normally have a good credit rating. Consequently the cost of obtaining funding can be lower than it would be if the bank raised funds directly by taking deposits. b) Freeing up capital and improvement in return on capital: Securitization removes assets from the originating bank's balance sheet so that it frees up capital for other uses. It may also improve the return on capital as the bank will continue to earn fee income on the securitized assets. c) Assistance management of assets/liability mismatches: With traditional on-balance sheet borrowing and lending, the maturity of assets tends to be much longer than the liabilities. Securitization effectively makes banks assets more liquid, providing scope to more flexibly managed maturity mismatches


d) Reduction of credit risk, interest rate and liquidity risk: Where securitization is structured appropriately, the originating bank can transfer credit, interest rate and liquidity risks to third parties. e) Generation of fee income: By securitizing its assets but retaining responsibility for servicing them, a bank can earn fee income, an income stream unaffected by shifts in interest rates. f) Economies of scale: A bank which does not have the capacity to increase its loan may nevertheless be able to take advantage of economies of scale in its loan origination and servicing operations if it can increase its capacity by securitizing assets, while continuing to service them in return for a fee income. Risks attached with securitization a) Provision of services on other than arms length terms: Banks which have securitized loans often provide various administration and banking services to the SPV, which holds the loans. Where such services are provided on more favourable terms and conditions than would apply to an unrelated party, the bank may be effectively absorbing credit losses on the loans without explicitly recognizing that this is what is happening b) Implicit risk: If a securitized pool of loans does not behave as expected and losses rise to a level where security holders could lose money, the bank may feel morally obliged to bail out the SPV or to make good investors losses, even though it is not legally obliged to do so. This may happen because the bank needs to protect its good name and its relationship with customers. c) Reduction in asset quality: There is a risk that banks will securitize all of their best assets, thereby lowering the overall quality of assets on the balance sheet, since the better quality assets are more likely to be suitable for securitization. The issue for supervisors here is not only whether capital requirements on a banks residual risk in securities assets are appropriate. They also need to be concerned with the sufficiency of regulatory capital requirements on the riskier assets remaining on the books. d) Costs: Securitization schemes can be expensive to set up and operate, particularly where the volume of assets to be securitized is not large. There are legal and rating agencies costs and other costs involved. In practice this can make securitization uneconomic.


e) Complexity. Securitization schemes can be extremely complex. As a result, it may be difficult for the bank to ensure that all risks arising from securitization are recognized and appropriately managed.


Borrowing by way of a loan facility can provide a borrower with a flexible and efficient source of funding. If a borrower requires a large or sophisticated facility or multiple types of facility this is commonly provided by a group of lenders known as a syndicate under a syndicated loan agreement. A syndicated loan agreement simplifies the borrowing process as the borrower uses one agreement covering the whole group of banks and different types of facility rather than entering into a series of separate bilateral loans, each with different terms and conditions.

Two types of loan facility are commonly syndicated: a) Term Loan Facility: Under a term loan facility the lenders provide a specified capital sum over a set period of time, known as the "term". Typically, the borrower is allowed a short period after executing the loan (the "availability" or "commitment" period), during which time it can draw loans up to a specified maximum facility limit. Repayment may be in installments (in which case the facility is commonly described as "amortizing") or there may be one payment at the end of the facility (in which case the facility is commonly described as having "bullet" repayment terms). Once a term loan has been repaid by the borrower, it cannot be re-drawn. b) Revolving Loan Facility: A revolving loan facility provides a borrower with a maximum aggregate amount of capital, available over a specified period of time. However, unlike a term loan, the revolving loan facility allows the borrower to drawdown, repay and re-draw loans advanced to it of the available capital during the term of the facility. Each loan is borrowed for a set period of time, usually one, three or six months, after which time it is technically repayable. Repayment of a revolving loan is achieved either by scheduled reductions in the total amount of the facility over time, or by all outstanding loans being repaid on the date of termination. A revolving loan made to refinance another revolving loan which matures on the same date as the drawing of the second revolving loan is known as a "rollover loan", if made in the same currency and drawn by the same borrower as the first revolving loan. The conditions to be satisfied for

drawing a rollover loan are typically less onerous than for other loans. A revolving loan facility is a particularly flexible financing tool as it may be drawn by a borrower by way of straightforward loans, but it is also possible to incorporate different types of financial accommodation within it - for example, it is possible to incorporate a letter of credit facility, swingline facility or overdraft facility within the terms of a revolving credit facility. This is often achieved by creating a sublimit within the overall revolving facility, allowing a certain amount of the lenders' commitment to be drawn in the form of these different facilities.

Parties to a syndicated loan a) The syndication process is initiated by the borrower, who appoints a lender through the grant of a mandate to act as the Arranger (also often called a Mandated Lead Arranger) on the deal. There is often more than one Arranger on any transaction but for the purposes of this note we will refer to this role in the singular. b) The Arranger is responsible for advising the borrower as to the type of facilities it requires and then negotiating the broad terms of those facilities. By the very nature of this appointment, it is likely that the Arranger will be a lender with which the borrower already has an established relationship, although it does not have to be. At the same time the Arranger is negotiating the terms of the proposed facility, one of the Arrangers appointed by the Borrower to act as Bookrunner also starts to put together a syndicate of banks to provide that facility. c) The initial group of lenders agreeing to provide a share of the facility is often referred to as Co-Arranger. The Co-Arrangers then find more lenders to participate in the facility, who agree to take a share of the Co- Arrangers' commitment. d) To facilitate the process of administering the loan on a daily basis, one bank from the syndicate is appointed as Agent. The Agent who is appointed acts as the agent of the lenders not of the borrower and has a number of important functions: - Point of Contact: maintaining contact with the borrower and representing the views of the syndicate - Monitor: monitoring the compliance of the borrower with certain terms of the facility - Postman and Record-keeper: it is the agent to whom the borrower is usually required to give notices

- Paying Agent: the borrower makes all payments of interest and repayments of principal and any other payments required under the Loan Agreement to the Agent. The Agent passes these monies back to the banks to which they are due. e) If the syndicated loan is to be secured, a lender from the syndicate is usually appointed to act as Security Trustee to hold the security on trust for the benefit of all the lenders. The duties imposed upon the Security Trustee are typically more extensive than those of an agent. f) In large syndicates, some decision making power is delegated to the majority from time to time (often referred to as the 'majority lenders' or 'instructing group'). This group usually consists of members of the syndicate at the relevant time that holds a specified percentage of the total commitments under the facility. By delegating some of the decision-making, the mechanics of the loan are able to work more effectively than if each and every member of the syndicate had to be consulted and subsequently reach unanimous agreement on every request from the borrower.

Q.6 Write an extensive note on External Commercial Borrowings (ECB). Ans: External Commercial Borrowings (ECB) are defined to include commercial bank loans, buyers' credit, suppliers' credit, securitized instruments such as Floating Rate Notes and Fixed Rate Bonds etc., credit from official export credit agencies and commercial borrowings from the private sector window of Multilateral Financial Institutions such as International Finance Corporation (Washington), ADB, AFIC, CDC etc. ECBs are being permitted by the Government as a source of finance for Indian Corporates for expansion of existing capacity as well as for fresh investment. The policy seeks to keep an annual cap or ceiling on access to ECB, consistent with prudent debt management. The policy also seeks to give greater priority for projects in the infrastructure and core sectors such as Power, oil Exploration, Telecom, Railways, Roads & Bridges, Ports, Industrial Parks and Urban Infrastructure etc. and the export sector. Development Financial Institutions, through their sublending against the ECB approvals are also expected to give priority to the needs of medium and small scale units. Certified applicant companies are free to raise ECB from any internationally recognized source such as banks, export credit agencies; suppliers of equipment, foreign


collaborators, foreign equity-holders, international capital markets etc. but offers from unrecognized sources will not be entertained.

Eligible Borrowers: Under the extant policy, corporates registered under the Companies Act, 1956, except financial intermediaries such as banks, financial institutions (FIs), housing finance companies and NonBanking Finance Companies (NBFCs), are eligible. Subsequently, NGOs engaged in microfinance activities have been permitted to raise ECB up to USD 5 million during a financial year for permitted end-use, under the automatic route. Detailed guidelines have been issued by RBI. It has now been decided to further expand the eligibility/end-use as follows: a) ECB by NBFCs will be permitted under the Approval Route from multilateral financial institutions, reputed regional financial institutions, official export agencies and international banks towards import of infrastructure equipment for leasing to infrastructure projects with a minimum average maturity of 5 years. b) Foreign Currency Convertible Bonds (FCCBs) by Housing Finance Companies with strong financials satisfying criteria to be notified by RBI, will be permitted under the Approval Route. c) Individuals, Trusts and non-profit making organizations, except NGOs are not eligible to raise ECB. d) Financial institutions dealing exclusively with infrastructure or export finance such as IDFC, IL&FS, Power Finance Corporation, Power Trading Corporation, IRCON and EXIM Bank are considered on a case-by-case basis i.e. through the approval route. e) Banks and financial institutions which had participated in the textile or steel sector restructuring package as approved by the Government are permitted to the extent of their investment in the package and assessment by RBI based on prudential norms. Any ECB availed for this purpose so far is deducted from their entitlement.


Modes of Raising ECBs: Basically ECB suggests any kind of funding other than Equity (considered FDI) be it Bonds, Credit notes, Asset Backed Securities, Mortgage Backed Securities or anything of that nature, satisfying the norms of the ECB regulations. a) Commercial Bank Loans : in the form of term loans from banks outside India b) Buyer's Credit c) Supplier's Credit d) Securitized instruments such as Floating Rate Notes (FRNs), Fixed Rate Bonds (FRBs), Syndicated Loans etc. e) Credit from official export credit agencies f) Commercial borrowings from the private sector window of multilateral financial institutions such as International Finance Corporation (Washington), ADB, AFIC, CDC


g) Loan from foreign collaborator/equity holder, etc and corporate/institutions with a good credit rating from internationally recognized credit rating agency h) Lines of Credit from foreign banks and financial institutions i) Financial Leases j) Import Loans k) Investment by Foreign Institutional Investors (FIIs) in dedicated debt funds l) External assistance, NRI deposits, short-term credit and Rupee debt m) Foreign Currency Convertible Bonds n) Non convertible or optionally convertible or partially convertible debentures o) Redeemable preference shares are considered as part of ECBs p) Bonds, Credit notes, Asset Backed Securities, Mortgage Backed securities

Exclusions from ECB a) Investment made towards core capital of an organization viz. investment in equity shares, convertible preference share and convertible debentures b) Equity capital c) Reinvested earnings (retained earnings of FDI companies) d) Other direct capital (inter-corporate debt transactions between related entities)

Average maturities for ECB: a) Minimum average maturity of three years for external commercial borrowings equal to or less than USD 20 million equivalent in respect of all sectors except 100% EOUs b) Minimum average maturity of five years for external commercial borrowings greater than USD 20 million equivalent in respect of all sectors except 100% EOUs c) 100% Export oriented Units (EOUs) are permitted ECB at a minimum average maturity of three years for any amount. d) Bonds and FRNs can be raised in tranches of different maturities as long as the average maturity of the different tranches within the same overall approval taken together satisfies the maturity criteria prescribed in the ECB guidelines. In such cases, it is expected that longer

term borrowings would necessarily precede that of the shorter tenors. The longer the initial tenor the shorter the subsequent tranches can be within the average maturity. USD 5 Million Scheme All Corporates and Institutions are permitted to raise ECB up to USD 5 million equivalents at a minimum simple maturity of 3 years. Borrowers may utilize the proceeds under this window for general corporate objectives without any end-use use restrictions excluding investments in stockmarkets or in real estate. The loan amount may be raised in one or more tranches subject to the caveat that the total outstanding loan under this scheme at any point of time should not exceed USD 5 million. Each tranche should have a minimum simple maturity of 3 years. As a measure of simplification and de-regulation for the benefit of Corporates and institutions, Government has delegated the sanctioning powers to Reserve Bank of India (RBI).

Significance of ECB: For Investor 1) ECB is for specific period, which can be as short as three years 2) Fixed Return, usually the rates of interest are fixed 3) The interest and the borrowed amount are repatriable 4) No owners risk as in case of Equity Investment For Borrower 1) No dilution in ownership 2) Considerably large funds can be raised as per requirements of borrower 3) Usually only a fixed rate of interest is to be paid 4) Easy Availability of funds because ECB is more appealing to Investors


Q.7 Explain the important Accounting Standards Operational in banks and in need for disclosure of significant Accounting policies. Ans: The Reserve Bank of India has been continuously making efforts to ensure convergence of its supervisory norms and practices with the international best practices with a view to aligning standards adopted by the Indian banking system with global standards. There are a total of 32 Indian accounting standards practiced by every organization in India. Some of the important accounting standards operational in banks are

AS 5 Net Profit /Loss for the period, prior period items and changes in accounting policies. The objective of this Standard is to prescribe the classification and disclosure of certain items in the statement of profit and loss so that all enterprises prepare and present such a statement on a uniform basis. Accordingly, this Standard requires the classification and disclosure of certain

items within profit or loss from ordinary activities. It also specifies the accounting treatment for changes in accounting estimates and the disclosures to be made in the financial statements regarding changes in accounting policies. AS 9 Revenue Recognition This Standard deals with the bases for recognition of revenue in the statement of profit and loss of an enterprise. The Standard is concerned with the recognition of revenue arising in the course of the ordinary activities of the enterprise from the sale of goods, the rendering of services, and the use by others of enterprise resources yielding interest, royalties and dividends. This Standard requires that revenue arising from the use by others of enterprise resources yielding interest, royalties and dividends should only be recognized when no significant uncertainty as to measurability or collectability exists. AS 15 Accounting for Retirement Benefits in the Financial Statements of Employers. This Standard applies to retirement benefits in the form of provident fund,

superannuation/pension and gratuity provided by an employer to employees, whether in pursuance of requirements of any law or otherwise. It also applies to retirement benefits in the

form of leave encashment benefit, health and welfare schemes and other retirement benefits, if the predominant characteristics of these benefits are the same as those of provident fund, superannuation/pension or gratuity benefit. This Standard does not apply to those retirement benefits for which the employers obligation cannot be reasonably estimated, e.g., ad hoc exgratia payments made to employees on retirement. Accounting for retirement benefit cost only when employees retire or receive benefit payments, does not achieve the objective of allocation of those costs to the periods in which the services were rendered AS 17 Segment Reporting The Standard establishes principles for reporting financial information, about the different types of products and services an enterprise produces and the different geographical areas in which it operates. As per the Standard, for reporting the financial information, business and geographical segments are required to be identified. It provides that one basis of segmentation is primary and the other is secondary, with considerably less information required to be disclosed for secondary segments. It contains requirements for identifying reportable segments and lays down disclosures required for reportable segments for primary segment reporting format of an enterprise as well as the disclosures required for secondary reporting format of the enterprise. AS 18 Related Party disclosures This Standard is applied in reporting related party relationships and transactions between a reporting enterprise and its related parties. This Standard requires that name of the related party and nature of the related party relationship where control exists should be disclosed irrespective of whether or not there have been transactions between the related parties. The Standard requires that where control does not exist, certain disclosures have to be made by the reporting enterprise if there have been transactions between related parties, during the existence of a related party relationship. As per the Statement, items of a similar nature may be disclosed in aggregate by type of related party

AS 22 Accounting for Taxes on Income


This Standard is applied in accounting for taxes on income. This includes the determination of the amount of the expense or saving related to taxes on income in respect of an accounting period and the disclosure of such an amount in the financial statements. The Standard requires that tax expense for the period, comprising current tax and deferred tax, should be included in the determination of the net profit or loss for the period. The Standard requires that current tax should be measured at the amount expected to be paid to (recovered from) the taxation authorities, using the applicable tax rates and tax laws. Deferred tax assets and liabilities should be measured using the tax rates and tax laws that have been enacted or substantively enacted by the balance sheet date. AS 25 Interim Financial Reporting This Standard prescribes the minimum content of an interim financial report and the principles for recognition and measurement in complete or condensed financial statements for an interim period. As per the Standard, a statute governing an enterprise or a regulator may require an enterprise to prepare and present certain information at an interim date which may be different in form and/or content as required by this Standard. In such a case, the recognition and measurement principles as laid down in this Standard are applied in respect of such information, unless otherwise specified in the statute or by the regulator. The Standard defines interim financial report as a financial report containing either a complete set of financial statements or a set of condensed financial statements (as described in this Standard) for an interim period.

AS 1 - Disclosure of Accounting Policies To ensure proper understanding of financial statements, it is necessary that all significant accounting policies adopted in the preparation and presentation of financial statements should be disclosed. Such disclosure should form part of the financial statements. It would be helpful to the reader of financial statements if they are all disclosed as such in one place instead of being scattered over several statements, schedules and notes. Any change in an accounting policy which has a material effect should be disclosed. The amount by which any item in the financial statements is affected by such change should also be disclosed to the extent ascertainable. Where such amount is not ascertainable, wholly or in part, the fact should be indicated. If a change is

made in the accounting policies which has no material effect on the financial statements for the current period but which is reasonably expected to have a material effect in later periods, the fact of such change should be appropriately disclosed in the period in which the change is adopted. Disclosure of accounting policies or of changes therein cannot remedy a wrong or inappropriate treatment of the item in the accounts. If the fundamental accounting assumptions, viz. Going Concern, Consistency and Accrual are followed in financial statements, specific disclosure is not required. If a fundamental accounting assumption is not followed, the fact should be disclosed.

Q.8 Give a detailed note on the Monetary and Credit policy of RBI. Ans: The Monetary is the policy statement, traditionally announced twice a year, through which the Reserve Bank of India seeks to ensure price stability for the economy. These factors include money supply, interest rates and the inflation. Besides, the RBI also announces norms for the banking and financial sector and the institutions which are governed by it. The Monetary Policy regulates the supply of money and the cost and availability of credit in the economy. It deals with both the lending and borrowing rates of interest for commercial banks. The Monetary Policy aims to maintain price stability, full employment and economic growth. The Reserve Bank of India is responsible for formulating and implementing Monetary Policy. It can increase or decrease the supply of currency as well as interest rate, carry out open market operations, control credit and vary the reserve requirements.

Objectives of monetary and credit policy: a) Rapid Economic Growth: It is the most important objective of a monetary policy. The monetary policy can influence economic growth by controlling real interest rate and its resultant impact on the investment. If the RBI opts for a cheap or easy credit policy by reducing interest rates, the investment level in the economy can be encouraged. This increased investment can speed up economic growth. b) Price Stability: It keeps the value of money stable. It helps in reducing the income and wealth inequalities. When the economy suffers from recession the monetary policy should be an

expansionary policy but when there is inflationary situation there should be a contractionary policy. c) Exchange Rate Stability: If the exchange rate is very volatile leading to frequent ups and downs rate, the international community might lose confidence in our economy. The monetary policy aims at maintaining the relative stability in the exchange rate. The RBI by altering the foreign exchange reserves tries to influence the demand for foreign exchange and tries to maintain the exchange rate stability. d) Balance of Payments Equilibrium: Many developing countries like India suffers from the disequilibrium in the BOP. The Reserve Bank of India through its monetary policy tries to maintain equilibrium in the balance of payments. The BOP has two aspects i.e. the 'BOP Surplus' and the 'BOP Deficit'. The former reflects an excess money supply in the domestic economy, while the later stands for stringency of money. If the monetary policy succeeds in maintaining monetary equilibrium, then the BOP equilibrium can be achieved. e) Full Employment: Full Employment stands for a situation in which everybody who wants jobs get jobs. Monetary policy can be used for achieving full employment. If the monetary policy is expansionary then credit supply can be encouraged. It could help in creating more jobs in different sector of the economy. f) Equal Income Distribution: The monetary policy can help and play a supplementary role in attainting an economic equality. It can make special provisions for the neglect supply such as agriculture, small-scale industries, village industries, etc. and provide them with cheaper credit for longer term. This can prove fruitful for these sectors to come up. Thus in recent period, monetary policy can help in reducing economic inequalities among different sections of society.

Monetary policy instruments a) Open Market Operations: An open market operation is an instrument of monetary policy which involves buying or selling of government securities from or to the public and banks. The RBI sells government securities to contract the flow of credit and buys government securities to increase credit flow.

b) Cash Reserve Ratio: Cash Reserve Ratio is a certain percentage of bank deposits which banks are required to keep with RBI in the form of reserves or balances .Higher the CRR with the RBI lower will be the liquidity in the system and vice-versa. c) Statutory Liquidity Ratio: Every financial institute have to maintain a certain amount of liquid assets from their time and demand liabilities with the RBI. These liquid assets can be cash, precious metals, approved securities like bonds etc. The ratio of the liquid assets to time and demand liabilities is termed as Statutory Liquidity Ratio. d) Bank Rate Policy: Bank rate is the rate of interest charged by the RBI for providing funds or loans to the banking system. Increase in Bank Rate increases the cost of borrowing by commercial banks which results into the reduction in credit volume to the banks and hence declines the supply of money. Increase in the bank rate is the symbol of tightening of RBI monetary policy. e) Credit Ceiling: In this operation RBI issues prior information or direction that loans to the commercial banks will be given up to a certain limit. In this case commercial bank will be tight in advancing loans to the public. They will allocate loans to limited sectors. Few example of ceiling are agriculture sector advances, priority sector lending. f) Repo Rate and Reverse Repo Rate: Repo rate is the rate at which RBI lends to commercial banks generally against government securities. Reduction in Repo rate helps the commercial banks to get money at a cheaper rate and increase in Repo rate discourages the commercial banks to get money as the rate increases and becomes expensive. Reverse Repo rate is the rate at which RBI borrows money from the commercial banks. The increase in the Repo rate will increase the cost of borrowing and lending of the banks which will discourage the public to borrow money and will encourage them to deposit. As the rates are high the availability of credit and demand decreases resulting to decrease in inflation. This increase in Repo Rate and Reverse Repo Rate is a symbol of tightening of the policy.


Q.9 Write a detailed note on the concept of corporate governance and its efficacy in the banks. Ans: The corporate governance in its wider connotation covers a range of issues such as protection of shareholders rights, enhancing shareholders value, Board issues including its composition and role, disclosure requirements, integrity of accounting practices, the control systems, in particular internal control systems. Corporate governance especially in the banking sector has come into sharp focus because more and more banks in India, both in urban and rural areas, have experienced grave problems in recent times which have in a mild way had threatened the profile and identity of the entire banking system. These problems include mismanagement, financial impropriety, poor investment decisions and the growing distance between members and their co-operative society. The banking sector is not necessarily totally corporate. Some part of it is, of course, but a segment of banks is mostly government owned as statutory corporations or run as cooperatives. Banking as a sector has been unique and the interests of other stake holders appear more important to it than in the case of non-banking and non-finance organizations. In the case of traditional manufacturing corporations, the issue has been that of safeguarding and maximizing the shareholders value. In the case of banking, the risk involved for depositors and the possibility of contagion assumes greater importance than that of consumers of manufactured products. Further, the involvement of government is discernibly higher in banks due to importance of stability of financial system and the larger interests of the public. Since the market control is not sufficient to ensure proper governance in banks, the government does see reason in regulating and controlling the nature of activities, the structure of bonds, the ownership pattern, capital adequacy norms, liquidity ratios, etc. There are three reasons for degree of government oversight in this sector. Firstly, it is believed that the depositors, particularly retail depositors, cannot effectively

protect themselves as they do not have adequate information, nor are they in a position to coordinate with each other.


Secondly, bank assets are unusually opaque, and lack transparency as well as liquidity.

This condition arises due to the fact that most bank loans, unlike other products and services, are usually customized and privately negotiated. Thirdly, it is believed that that there could be a contagion effect resulting from the

instability of one bank, which would affect a class of banks or even the entire financial system and the economy. As one bank becomes unstable, there may be a heightened perception of risk among depositors for the entire class of such banks, resulting in a run on the deposits and putting the entire financial system in jeopardy. In comparison to other sectors, governance in banks is significantly more intricate. Public Sector Banks (PSBs) endeavor to conform to the same system of board governance as other organizations, however, other elements such as risk management, capital adequacy and funding, internal control affect their matrix of governance. It has been observed that many of PSBs have potentials for profitability increase through efficiency improvement, which ultimately depends on the quality of governance. Being under government control PSBs are handicapped in many respects. Corporate governance in PSBs is important, not only because they dominate the banking industry, but also because, they are unlikely to exit from banking business though they may get transformed.

Q. 10 Write a detailed note on Fair Banking Practices and lenders liability laws Ans: Fair Banking Practices is a voluntary Code, which sets minimum standards of banking practices for banks to follow when they are dealing with individual customers. It provides protection to you and explains how banks are expected to deal with you for your day-to-day operations.

Objectives of the code a) Promote good and fair banking practices by setting minimum standards in dealing with customers


b) Increase transparency so that customers can have a better understanding of what they can reasonably expect of the services c) Encourage market forces, through competition, to achieve higher operating standards d) Promote a fair and cordial relationship between customers and their bank e) Foster confidence in the banking system.

Application of Code All the parts of the fair banking code apply to all the products and services listed below, whether they are provided by branches or subsidiaries across the counter, over the phone, by post, through interactive electronic devices, on the internet or by any other method. However, all products discussed here may or may not be offered by all banks. a. Current accounts, savings account, term deposits, recurring deposit, PPF accounts and all other deposit accounts. b. Payment services such as pension, payment orders, and remittances by way of Demand Drafts and wire transfers. c. Banking services related to Government transactions. d. Demat accounts, equity, government bonds. e. Indian currency notes exchange facility. f. Collection of cheques, safe custody services, safe deposit locker facility g. Loans and overdrafts h. Foreign exchange services including money changing. i. Third party insurance and investment products sold through our branches. j. Card products including credit cards, debits cards, ATM cards and services

Key commitments given by banks under fair banking practices are: a) To act fairly and reasonably in all their dealings with customers b) To help customers to understand how banks financial products and services work by c) To help customers use their account or service keeping them informed about changes in the interest rates, charges or terms and conditions.

d) To deal quickly and sympathetically with things that go wrong and handle complaints e) To treat their personal information as private and confidential f) To adopt and practice a non - discrimination policy on the basis of age, race, gender, marital status, religion or disability.

LENDERS LIABILITY LAWS Lender liability law says lenders must treat their borrowers fairly, and when they don't, they can be subject to borrower litigation under a variety of legal claims. The guidelines have since been finalized and banks/ all India Financial Institutions are advised to adopt the following broad guidelines and frame the Fair Practices Code duly approved by their Board of Directors. Following are the main constituents of Lenders liability laws: (i) Applications for loans and their processing (a) Loan application forms in respect of priority sector advances up to Rs.2.00 lakhs should be comprehensive. It should include information about the fees/charges, if any, payable for processing, the amount of such fees refundable in the case of non acceptance of application, prepayment options and any other matter which affects the interest of the borrower, so that a meaningful comparison with that of other banks can be made and informed decision can be taken by the borrower. (b) Banks and financial institutions should devise a system of giving acknowledgement for receipt of all loan applications. Time frame within which loan applications will be disposed of should also be indicated in acknowledgement of such applications. (c) Banks / financial institutions should verify the loan applications within a reasonable period of time. If additional details / documents are required, they should intimate the borrowers immediately. (d) In the case of small borrowers seeking loans up to Rs. 2 lakhs the lenders should convey in writing, the main reason/reasons which, in the opinion of the bank after due consideration, have led to rejection of the loan applications within stipulated time.


(ii) Loan appraisal and terms/conditions a) Lenders should ensure that there is proper assessment of credit application by borrowers. They should not use margin and security stipulation as a substitute for due diligence on credit worthiness of the borrower. b) The lender should convey to the borrower the credit limit along with the terms and conditions thereof and keep the borrower's acceptance of these terms and conditions given with his full knowledge on record. c) Terms and conditions and other caveats governing credit facilities given by banks/ financial institutions arrived at after negotiation by lending institution and the borrower should be reduced in writing and duly certified by the authorised official. A copy of the loan agreement along with a copy each of all enclosures quoted in the loan agreement should be furnished to the borrower. d) As far as possible, the loan agreement should clearly stipulate credit facilities that are solely at the discretion of lenders. These may include approval or disallowance of facilities, such as, drawings beyond the sanctioned limits, honoring cheques issued for the purpose other than specifically agreed to in the credit sanction, and disallowing drawing on a borrowal account on its classification as a non-performing asset or on account of non-compliance with the terms of sanction. e) In the case of lending under consortium arrangement, the participating lenders should evolve procedures to complete appraisal of proposals in the time bound manner to the extent feasible, and communicate their decisions on financing or otherwise within a reasonable time.

(iii) Disbursement of loans including changes in terms and conditions Lenders should ensure timely disbursement of loans sanctioned in conformity with the terms and conditions governing such sanction. Lenders should give notice of any change in the terms and conditions including interest rates, service charges etc. Lenders should also ensure that changes in interest rates and charges are affected only prospectively.


(iv) Post disbursement supervision a) Post disbursement supervision by lenders should be constructive with a view to taking care of any" lender-related" genuine difficulty that the borrower may face. b) Before taking a decision to recall / accelerate payment or performance under the agreement or seeking additional securities, lenders should give notice to borrowers, as specified in the loan agreement or a reasonable period, if no such condition exits in the loan agreement. c) Lenders should release all securities on receiving payment of loan or realisation of loan subject to any legitimate right or lien for any other claim lenders may have against borrowers. If such right of set off is to be exercised, borrowers shall be given notice about the same with full particulars about the remaining claims and the documents under which lenders are entitled to retain the securities till the relevant claim is settled/paid.

(v) General a) Lenders should restrain from interference in the affairs of the borrowers except for what is provided in the terms and conditions of the loan sanction documents (unless new information, not earlier disclosed by the borrower, has come to the notice of the lender). b) Lenders must not discriminate on grounds of sex, caste and religion in the matter of lending. However, this does not preclude lenders from participating in credit-linked schemes framed for weaker sections of the society. c) In the matter of recovery of loans, the lenders should not resort to undue harassment viz. persistently bothering the borrowers at odd hours, use of muscle power for recovery of loans, etc. d) In case of receipt of request for transfer of borrowal account, either from the borrower or from a bank/financial institution, which proposes to take- over the account, the consent or otherwise i.e, objection of the lender, if any, should be conveyed within 21 days from the date of receipt of request.