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RISK MANAGEMENT
The last few years have witnessed sea changes in the Indian banking sector. Indian banking and financial system has been gradually liberalised. Interest rates have been deregulated, new players, new instruments and new institutions have been introduced. Moreover, prudential regulations have been expanded and supervision has been strengthened at various levels. In the sphere of external financial policy, the exchange rate is market driven, there has been a progressive liberalisation of FDI and FII investment, and there are now only minimum restrictions on inflow of capital into the economy, or its repatriation and servicing.
In the new liberalized economy in India, Banks and regulators in recent years have been making sustained efforts to understand and measure the increasing risks they are exposed to. With the Indian economy becoming global, the Banks are realising the importance of different types of risks. Some of the risk are credit risks, market risks, operational risks, reputational risks and legal risks, using quantitative techniques in risk modeling. RBI issued the first set of guidelines to Banks on Risk Management on October 20, 1999.
A BRIEF HISTORY OF BANKING IN INDIA
1. From the ancient times in India, an indigenous banking system has prevailed. The businessmen called Shroffs, Seths, Sahukars, Mahajans, Chettis etc. had been carrying on the business of banking since ancient times. These indigenous bankers included very small money lenders to shroffs with huge businesses, who carried on the large and specialized business even greater than the business of banks.
• The origin of western type commercial Banking in India dates back to the 18th century.
2. The story of banking starts from Bank of Hindusthan established in 1779 and it was first bank at Calcutta under European management.
• In 1786 General Bank of India was set up.
3. Since Calcutta was the most active trading port in India, mainly due to the trade of the British Empire, it became a banking center.
• Three Presidency banks were set up under charters from the British East India Company- Bank of Calcutta, Bank of Bombay and the Bank of Madras. These worked as quasi central banks in India for many years.
• The Bank of Calcutta established in 1806 immediately became Bank of Bengal.
• In 1921 these 3 banks merged with each other and Imperial Bank of India got birth. It is today’s State Bank of India.
• The name was changed after India’s Independence in 1955. So State bank of India is the oldest Bank of India.
4. In 1839, there was a fruitless effort by Indian merchants to establish a Bank called Union Bank. It failed within a decade.
5. Next came Allahabad Bank which was established in 1865 and working even today.
• The oldest Public Sector Bank in India having branches all over India and serving the customers for the last 145 years is Allahabad Bank. Allahabad bank is also known as one of India’s Oldest Joint Stock Bank.
6. The Oldest Joint Stock bank of India was Bank of Upper India established in 1863 and failed in 1913.
7. The first Bank of India with Limited Liability to be managed by Indian Board was Oudh Commercial Bank. It was established in 1881 at Faizabad. This bank failed in 1958.
8. The first bank purely managed by Indian was Punjab National Bank, established in Lahore in 1895. The Punjab national Bank has not only survived till date but also is one of the largest banks in India.
9. However, the first Indian commercial bank which was wholly owned and managed by Indians was Central Bank of India which was established in 1911.
• Central Bank of India was dreams come true of Sir Sorabji Pochkhanawala, founder of the Bank.
• Sir Pherozesha Mehta was the first Chairman of this Bank.
10. Many more Indian banks were established between 1906-1911. This was the era of the Swadeshi Movement in India. Some of the banks are Bank of India, Corporation Bank, Indian Bank, Bank of Baroda, Canara Bank and Central Bank of India.
• Bank of India was the first Indian bank to open a branch outside India in London in 1946 and the first to open a branch in continental Europe at Paris in 1974.
• The Bank was founded in September 1906 as a private entity and was nationalized in July 1969. Since the logo of this Bank is a star, its head office in Mumbai is located in Star House, Bandra East, Mumbai.
11. There was a district in Today’s Karnataka state called South Canara under the British empire. It was bifurcated in 1859 from Canara district , thus making Dakshina Kannada and Udupi district. It was the undivided Dakshina Kannada district. It was renamed as Dakshina Kannada in 1947. Four banks started operation during the period of Swadeshi Movement and so this was known as “Cradle of Indian Banking.
• This was the first phase of Indian banking which was a very slow in development. This era saw many ups and downs in the banking scenario of the country.
12. The Second Phase starts from 1935 when Reserve bank of India was established.
• Between the period of 1911-1948, there were more than 1000 banks in India, almost all small banks. The Reserve Bank of India was constituted in 1934 as an apex Bank, however without major government ownership. Government of India came up with the Banking Companies Act 1949. This act was later changed to Banking Regulation (Amendment) Act 1949.
• The Banking Regulation (Amendment) Act of 1965 gave extensive powers to the Reserve Bank of India. The Reserve Bank of India was made the Central Banking Authority.
13. The banking sector reforms started immediately after the independence. These reforms were basically aimed at improving the confidence level of the public as most banks were not trusted by the majority of the people. Instead, the deposits with the Postal department were considered safe.
14. The first major step was Nationalization of the Imperial Bank of India in 1955 via State Bank of India Act.
• State Bank of India was made to act as the principal agent of RBI and handle banking transactions of the Union and State Governments.
15. In a major process of nationalization, 7 subsidiaries of the State Bank of India were nationalized by the Indira Gandhi regime. In 1969, 14 major private commercial banks were nationalized. These 14 banks Nationalized in 1969 are as follows:
o Central Bank of India
o Bank of Maharastra
o Dena Bank
o Punjab National Bank
o Syndicate Bank
o Canara Bank
o Indian Bank
o Indian Overseas Bank
o Bank of Baroda
o Union Bank
o Allahabad Bank
o Union Bank of India
o UCO Bank
o Bank of India.
16. The above was followed by a second phase of nationalization in 1980, when Government of India acquired the ownership of 6 more banks, thus bringing the total number of Nationalised Banks to 20. The private banks at that time were allowed to function side by side with nationalized banks and the foreign banks were allowed to work under strict regulation.
17. After the two major phases of nationalization in India, the 80% of the banking sector came under the public sector / government ownership.
18. Please note the following sequence of events:
Creation of Reserve bank of India: 1935
Nationalization of Reserve Bank of India : 1949 (January )
Enactment of Banking Regulation Act : 1949 (March)
Nationalization of State Bank of India : 1955
Nationalization of SBI Subsidiaries : 1959
Nationalization of 14 major Banks : 1969
Creation of Credit Guarantee Corporation: 1971
Creation of Regional Rural Banks : 1975
Nationalization of 7 more banks with deposits over Rs. 200 Crore: 1980
19. The result was outstanding. The public deposits in these banks increased by 800% , as the government ownership gave the public faith and trust.
20. The third phase of development of banking in India started in the early 1990s when India started its economic liberalization.
Indian Banks' Association (IBA)
Ordinary
119
Associate
47
Total:166
The members comprise of
- Public Sector Banks
- Private Sector Banks
- Foreign Banks having offices in India and
- Urban Co-operative Banks.
What is YTM? / Define YIELD TO MATURITY
YTM means Yield to Maturity. Academically YTM is defined as the market interest rate that equates a bond's present value of interest payments and principal repayment with its price.
To understand it better, YTM can be defined as the compound rate of return that investors will receive for a bond with a maturity greater than one year if they hold the bond to maturity and reinvest all cash flows at the same rate of interest. It takes into account purchase price, redemption value, coupon yield, and the time between interest payment.
Relation between Inflation and Bank interest Rates ?
Inflation, in simple terms is a sustained increase in general price level. In other words, it can also be described as a situation in which excess money chases fewer goods, causing increase in demand of goods and thus leading to an increase in price. Thus if this demand created by excess money can be curtailed, inflation would be contained. This is the genesis behind controlling inflation through monetary policy.
If inflation is high, interest rates are increased. If repo, ie rates at which banks borrow from RBI, is increased, such borrowing will become costly and banks would thus either borrow less or pass on this increased cost to their borrowers. Again if reverse repo is increased, banks would divert more funds towards RBI and excess liquidity will be absorbed by RBI rather than going at cheaper cost in the economy. In either of the cases, actual lending will be less and demand for goods and services will be less
In the case of CRR, if the rate is increased, it affects in two ways. First, immediate liquidity in the system is absorbed to the extent CRR is increased as more money needs to be placed with the regulator. Second, in the incremental lending, potential capacity of banks to lend is curtailed. This again leads to less lending by banks.
Another ratio which does not directly affect inflation but is important for banking is statutory liquidity ratio.
TAN (Tax Deduction and Collection Account Number)
What is TAN?
TAN or Tax Deduction and Collection Account Number is a 10 digit alpha numeric number required to be obtained by all persons who are responsible for deducting or collecting tax. It is compulsory to quote TAN in TDS / TCS return (including any e-TDS / TCS return), any TDS / TCS payment challan and TDS/TCS certificates.
Who needs to apply for TAN? What law requires it to be obtained?
All those persons who are required to deduct tax at source or collect tax at source on behalf of Income Tax Department are required to apply for and obtain TAN.
The provisions of section 203A of the Income-tax Act require all persons who deduct or collect tax at source to apply for the allotment of a TAN. The section also makes it mandatory for TAN to be quoted in all TDS/TCS returns, all TDS/TCS payment challans and all TDS/TCS certificates to be issued. Failure to apply for TAN or comply with any of the other provisions of the section attracts a penalty of Rs. 10,000/-
TAN or Tax Deduction and Collection Account Number is a 10 digit alpha numeric number required to be obtained by all persons who are responsible for deducting or collecting tax. It is compulsory to quote TAN in TDS / TCS return (including any e-TDS / TCS return), any TDS / TCS payment challan and TDS/TCS certificates.
Who needs to apply for TAN? What law requires it to be obtained?
All those persons who are required to deduct tax at source or collect tax at source on behalf of Income Tax Department are required to apply for and obtain TAN.
The provisions of section 203A of the Income-tax Act require all persons who deduct or collect tax at source to apply for the allotment of a TAN. The section also makes it mandatory for TAN to be quoted in all TDS/TCS returns, all TDS/TCS payment challans and all TDS/TCS certificates to be issued. Failure to apply for TAN or comply with any of the other provisions of the section attracts a penalty of Rs. 10,000/-
PAN (PERMANENT ACCOUNT NUMBER)
Permanent Account Number (PAN) is a ten-digit alphanumeric number allotted by Income Tax Department. Normally it is, issued in the form of a laminated card, by the IT Department.
It is mandatory w.e.f.1 January 2005 to quote PAN on challans for any payments due to Income Tax Department. Moreover, now it is mandatory to quote PAN on return of income, all correspondence with any income tax authority.
In all documents pertaining to financial transactions notified from time-to-time by the Central Board of Direct Taxes.it is necessary to quote PAN. Some of the transactions where it is compulsory to quote PAN are as follows-
Sale and purchase of immovable property or motor vehicle;
Payments in cash, of amounts exceeding Rs. 25,000/-to hotels and restaurants;
In connection with travel to any foreign country.
For obtaining a telephone or cellular telephone connection.
For making a time deposit exceeding Rs. 50,000/- with a Bank Post Office;
depositing cash of Rs. 50,000/- or more in a Bank.
It is mandatory w.e.f.1 January 2005 to quote PAN on challans for any payments due to Income Tax Department. Moreover, now it is mandatory to quote PAN on return of income, all correspondence with any income tax authority.
In all documents pertaining to financial transactions notified from time-to-time by the Central Board of Direct Taxes.it is necessary to quote PAN. Some of the transactions where it is compulsory to quote PAN are as follows-
Sale and purchase of immovable property or motor vehicle;
Payments in cash, of amounts exceeding Rs. 25,000/-to hotels and restaurants;
In connection with travel to any foreign country.
For obtaining a telephone or cellular telephone connection.
For making a time deposit exceeding Rs. 50,000/- with a Bank Post Office;
depositing cash of Rs. 50,000/- or more in a Bank.
ASSET LIABILITY MANAGEMENT IN BANKS (ALM)
What is ALM ?
ALM is a comprehensive and dynamic framework for measuring, monitoring and managing the market risk of a bank. It is the management of structure of balance sheet (liabilities and assets) in such a way that the net earning from interest is maximised within the overall risk-preference (present and future) of the institutions. The ALM functions extend to liquidly risk management, management of market risk, trading risk management, funding and capital planning and profit planning and growth projection.
Benefits of ALM - It is a tool that enables bank managements to take business decisions in a more informed framework with an eye on the risks that bank is exposed to. It is an integrated approach to financial management, requiring simultaneous decisions about the types of amounts of financial assets and liabilities - both mix and volume - with the complexities of the financial markets in which the institution operates
The concept of ALM is of recent origin in India. It has been introduced in Indian Banking industry w.e.f. 1st April, 1999. ALM is concerned with risk management and provides a comprehensive and dynamic framework for measuring, monitoring and managing liquidity, interest rate, foreign exchange and equity and commodity price risks of a bank that needs to be closely integrated with the banks’ business strategy.
Therefore, ALM is considered as an important tool for monitoring, measuring and managing the market risk of a bank. With the deregulation of interest regime in India, the Banking industry has been exposed to the market risks. To manage such risks, ALM is used so that the management is able to assess the risks and cover some of these by taking appropriate decisions.
The assets and liabilities of the bank’s balance sheet are nothing but future cash inflows or outflows. With a view to measure the liquidity and interest rate risk, banks use of maturity ladder and then calculate cumulative surplus or deficit of funds in different time slots on the basis of statutory reserve cycle, which are termed as time buckets.
As a measure of liquidity management, banks are required to monitor their cumulative mismatches across all time buckets in their Statement of Structural Liquidity by establishing internal prudential limits with the approval of the Board / Management Committee.
The ALM process rests on three pillars:
ALM Information Systems
Management Information Systems
Information availability, accuracy, adequacy and expediency
ALM Organisation
Structure and responsibilities
Level of top management involvement
ALM Process
Risk parameters
Risk identification
Risk measurement
Risk management
Risk policies and tolerance levels.
As per RBI guidelines, commercial banks are to distribute the outflows/inflows in different residual maturity period known as time buckets. The Assets and Liabilities were earlier divided into 8 maturity buckets (1-14 days; 15-28 days; 29-90 days; 91-180 days; 181-365 days, 1-3 years and 3-5 years and above 5 years), based on the remaining period to their maturity (also called residual maturity). All the liability figures are outflows while the asset figures are inflows. In September, 2007, having regard to the international practices, the level of sophistication of banks in India, the need for a sharper assessment of the efficacy of liquidity management and with a view to providing a stimulus for development of the term-money market, RBI revised these guidelines and it was provided that
(a) the banks may adopt a more granular approach to measurement of liquidity risk by splitting the first time bucket (1-14 days at present) in the Statement of Structural Liquidity into three time buckets viz., next day , 2-7 days and 8-14 days. Thus, now we have 10 time buckets.
After such an exercise, each bucket of assets is matched with the corresponding bucket of the liabililty. When in a particular maturity bucket, the amount of maturing liabilities or assets does not match, such position is called a mismatch position, which creates liquidity surplus or liquidity crunch position and depending upon the interest rate movement, such situation may turnout to be risky for the bank. Banks are required to monitor such mismatches and take appropriate steps so that bank is not exposed to risks due to the interest rate movements during that period.
(b) The net cumulative negative mismatches during the Next day, 2-7 days, 8-14 days and 15-28 days buckets should not exceed 5 % ,10%, 15 % and 20 % of the cumulative cash outflows in the respective time buckets in order to recognise the cumulative impact on liquidity.
The Board’s of the Banks have been entrusted with the overall responsibility for the management of risks and is required to decide the risk management policy and set limits for liquidity, interest rate, foreign exchange and equity price risks.
Asset-Liability Committee (ALCO) is the top most committee to oversee the implementation of ALM system and it is to be headed by CMD or ED. ALCO considers product pricing for both deposits and advances, the desired maturity profile of the incremental assets and liabilities in addition to monitoring the risk levels of the bank. It will have to articulate current interest rates view of the bank and base its decisions for future business strategy on this view.
Rate Sensitive Assets & Liabilities : An asset or liability is termed as rate sensitive when
(a) Within the time interval under consideration, there is a cash flow,
(b) The interest rate resets/reprices contractually during the interval,
(c) RBI changes interest rates where rates are administered and,
(d) It is contractually pre-payable or withdrawal before the stated maturities.
Assets and liabilities which receive / pay interest that vary with a benchmark rate are re-priced at pre-determined intervals and are rate sensitive at the time of re-pricing.
INTEREST RISK :
The phased deregulation of interest rates and the operational flexibility given to banks in pricing most of the assets and liabilities imply the need for the banking system to hedge the Interest-Rate Risk. Interest Rate Risk is the risk where changes in market interest rates might adversely affect the Bank’s Net Interest Income. The gap report should be generated by grouping interest rate sensitive liabilities, assets and off balance sheet positions into time buckets according to residual maturity or next repricing period, whichever is earlier. Interest rates on term deposits are fixed during their currency while the advance interest rates are floating rates. The gaps on the assets and liabilities are to be identified on different time buckets from 1–28 days, 29 days upto 3 months and so on. The interest changes should be studied vis-a-vis the impact on profitability on different time buckets to assess the interest rate risk.
GAP ANALYSIS :
The various items of rate sensitive assets and liabilities and off-balance sheet items are classified into time buckets such as 1-28 days, 29 days and upto 3 months etc. and items non-sensitive to interest based on the probable date for change in interest.
The gap is the difference between Rate Sensitive Assets (RSA) and Rate Sensitive Liabilities (RSL) in various time buckets. The positive gap indicates that it has more RSAS than RSLS whereas the negative gap indicates that it has more RSLS. The gap reports indicate whether the institution is in a position to benefit from rising interest rates by having a Positive Gap (RSA > RSL) or whether it is a position to benefit from declining interest rate by a negative Gap (RSL > RSA).
REPORTS :
The following reports are used for ALM:
Structual Liquidity Profile (SLP);
Interest Rate Sensitivity
Maturity and Position (MAP)
Statement of Interest Rae Sensitivity (SIR)
ALM is a comprehensive and dynamic framework for measuring, monitoring and managing the market risk of a bank. It is the management of structure of balance sheet (liabilities and assets) in such a way that the net earning from interest is maximised within the overall risk-preference (present and future) of the institutions. The ALM functions extend to liquidly risk management, management of market risk, trading risk management, funding and capital planning and profit planning and growth projection.
Benefits of ALM - It is a tool that enables bank managements to take business decisions in a more informed framework with an eye on the risks that bank is exposed to. It is an integrated approach to financial management, requiring simultaneous decisions about the types of amounts of financial assets and liabilities - both mix and volume - with the complexities of the financial markets in which the institution operates
The concept of ALM is of recent origin in India. It has been introduced in Indian Banking industry w.e.f. 1st April, 1999. ALM is concerned with risk management and provides a comprehensive and dynamic framework for measuring, monitoring and managing liquidity, interest rate, foreign exchange and equity and commodity price risks of a bank that needs to be closely integrated with the banks’ business strategy.
Therefore, ALM is considered as an important tool for monitoring, measuring and managing the market risk of a bank. With the deregulation of interest regime in India, the Banking industry has been exposed to the market risks. To manage such risks, ALM is used so that the management is able to assess the risks and cover some of these by taking appropriate decisions.
The assets and liabilities of the bank’s balance sheet are nothing but future cash inflows or outflows. With a view to measure the liquidity and interest rate risk, banks use of maturity ladder and then calculate cumulative surplus or deficit of funds in different time slots on the basis of statutory reserve cycle, which are termed as time buckets.
As a measure of liquidity management, banks are required to monitor their cumulative mismatches across all time buckets in their Statement of Structural Liquidity by establishing internal prudential limits with the approval of the Board / Management Committee.
The ALM process rests on three pillars:
ALM Information Systems
Management Information Systems
Information availability, accuracy, adequacy and expediency
ALM Organisation
Structure and responsibilities
Level of top management involvement
ALM Process
Risk parameters
Risk identification
Risk measurement
Risk management
Risk policies and tolerance levels.
As per RBI guidelines, commercial banks are to distribute the outflows/inflows in different residual maturity period known as time buckets. The Assets and Liabilities were earlier divided into 8 maturity buckets (1-14 days; 15-28 days; 29-90 days; 91-180 days; 181-365 days, 1-3 years and 3-5 years and above 5 years), based on the remaining period to their maturity (also called residual maturity). All the liability figures are outflows while the asset figures are inflows. In September, 2007, having regard to the international practices, the level of sophistication of banks in India, the need for a sharper assessment of the efficacy of liquidity management and with a view to providing a stimulus for development of the term-money market, RBI revised these guidelines and it was provided that
(a) the banks may adopt a more granular approach to measurement of liquidity risk by splitting the first time bucket (1-14 days at present) in the Statement of Structural Liquidity into three time buckets viz., next day , 2-7 days and 8-14 days. Thus, now we have 10 time buckets.
After such an exercise, each bucket of assets is matched with the corresponding bucket of the liabililty. When in a particular maturity bucket, the amount of maturing liabilities or assets does not match, such position is called a mismatch position, which creates liquidity surplus or liquidity crunch position and depending upon the interest rate movement, such situation may turnout to be risky for the bank. Banks are required to monitor such mismatches and take appropriate steps so that bank is not exposed to risks due to the interest rate movements during that period.
(b) The net cumulative negative mismatches during the Next day, 2-7 days, 8-14 days and 15-28 days buckets should not exceed 5 % ,10%, 15 % and 20 % of the cumulative cash outflows in the respective time buckets in order to recognise the cumulative impact on liquidity.
The Board’s of the Banks have been entrusted with the overall responsibility for the management of risks and is required to decide the risk management policy and set limits for liquidity, interest rate, foreign exchange and equity price risks.
Asset-Liability Committee (ALCO) is the top most committee to oversee the implementation of ALM system and it is to be headed by CMD or ED. ALCO considers product pricing for both deposits and advances, the desired maturity profile of the incremental assets and liabilities in addition to monitoring the risk levels of the bank. It will have to articulate current interest rates view of the bank and base its decisions for future business strategy on this view.
Rate Sensitive Assets & Liabilities : An asset or liability is termed as rate sensitive when
(a) Within the time interval under consideration, there is a cash flow,
(b) The interest rate resets/reprices contractually during the interval,
(c) RBI changes interest rates where rates are administered and,
(d) It is contractually pre-payable or withdrawal before the stated maturities.
Assets and liabilities which receive / pay interest that vary with a benchmark rate are re-priced at pre-determined intervals and are rate sensitive at the time of re-pricing.
INTEREST RISK :
The phased deregulation of interest rates and the operational flexibility given to banks in pricing most of the assets and liabilities imply the need for the banking system to hedge the Interest-Rate Risk. Interest Rate Risk is the risk where changes in market interest rates might adversely affect the Bank’s Net Interest Income. The gap report should be generated by grouping interest rate sensitive liabilities, assets and off balance sheet positions into time buckets according to residual maturity or next repricing period, whichever is earlier. Interest rates on term deposits are fixed during their currency while the advance interest rates are floating rates. The gaps on the assets and liabilities are to be identified on different time buckets from 1–28 days, 29 days upto 3 months and so on. The interest changes should be studied vis-a-vis the impact on profitability on different time buckets to assess the interest rate risk.
GAP ANALYSIS :
The various items of rate sensitive assets and liabilities and off-balance sheet items are classified into time buckets such as 1-28 days, 29 days and upto 3 months etc. and items non-sensitive to interest based on the probable date for change in interest.
The gap is the difference between Rate Sensitive Assets (RSA) and Rate Sensitive Liabilities (RSL) in various time buckets. The positive gap indicates that it has more RSAS than RSLS whereas the negative gap indicates that it has more RSLS. The gap reports indicate whether the institution is in a position to benefit from rising interest rates by having a Positive Gap (RSA > RSL) or whether it is a position to benefit from declining interest rate by a negative Gap (RSL > RSA).
REPORTS :
The following reports are used for ALM:
Structual Liquidity Profile (SLP);
Interest Rate Sensitivity
Maturity and Position (MAP)
Statement of Interest Rae Sensitivity (SIR)
What is a Balanced budget ?
A government budget surplus that is zero, thus with net tax revenue equaling expenditure. A balanced budget change in policy or behavior is one in which a component of the government budget, usually taxes, is adjusted as necessary to maintain a balanced budget.
What is balanced growth of an Economy?
Growth of an economy in which all aspects of it, especially factors of production, grow at the same rate.
A government budget surplus that is zero, thus with net tax revenue equaling expenditure. A balanced budget change in policy or behavior is one in which a component of the government budget, usually taxes, is adjusted as necessary to maintain a balanced budget.
What is balanced growth of an Economy?
Growth of an economy in which all aspects of it, especially factors of production, grow at the same rate.
Capital Adequacy vs. Risk Management under Basel Accords
Capital Adequacy Under Basel I :
Under Basel Accords - I and II, capital is considered as the key component to ensure health of banking system . Capital adequacy ratios prescribed under these Accords are mainly intended to ensure that banks maintain a minimum amount of own funds in relation to the risks they face so that in times of crisis these Banks can absorb the unexpected losses.
However, from the Supervisor’s perspective (i.e. RBI in India), , capital is the last line of defense in a bank. The risk weighted capital adequacy framework (Basel 1) requires banks to hold different categories of capital against both on balance sheet assets and off balance sheet items with different risk weights. The 1988 Basel Capital Accord is considered as a watershed in this regard. Under this Accord, supervisors in the major banking markets for the first time agreed on a definition of capital and the minimum requirement. Under Basel I, it was very simple approach and was easy to apply. Thus, it was widely accepted and slowly adopted by more than 100 countries. The scope of the Accord was widened in 1996 to incorporate market risks.
However, soon it was felt that with advances in technology and telecommunications, innovation in banking products and services, and the increasing globalisation of financial markets have changed the way banks used to measure and manage risks. The Banks were taking much bigger risks in derivatives and new innovative products. The explosive growth in the markets for securitised assets and for credit derivatives has offered banks new ways to manage and transfer credit risk . Operational risk was considered as another threat to the banking, due to failures in internal processes or systems or from damage caused by an external disruption.
Thus it was felt that 1988 Accord no longer provides the internationally active banks - and their supervisors - with reliable measures of the actual risks they face. The 1988 Accord was considered as too broad brush and not enough sensitive to the risks which the banks are exposed to. The 1988 Accord was considered to be too simple an approach to capital regulation.
BASEL II :
Thus, the new Accord (popularly known as Basel II) was released by Basel Committee. The new accord seeks to capture the relationship between capital adequacy and risk management . This new Accord includes not only quantitative measures of risk but also incorporates supervisory review and public disclosure (market discipline).
Basel II framework is popular discussed under three pillars.
Under Pillar One : Minimum capital : The definition of risk weighted assets in the New Accord have two primary elements:
(i) substantial changes to the treatment of credit risk relative to the current accord; and
(ii) the introduction of an explicit treatment of operational risk.
In both cases a major innovation of the new Accord is the introduction of three distinct options for the calculation of credit risk and three for operational risk. The Committee believes that it is not feasible or desirable to adopt a one-size-fits all approach to the measurement of either risk. Instead for both credit and operational risk there are three approaches of increasing risk sensitivity to allow banks and supervisors to select the approach or approaches that they believe are most appropriate to the stage of development of banks operations and of the financial market infrastructure.
The standardized approach allows use of external credit assessments to enhance risk sensitivity compared to the current accord. The risk weights for sovereign inter-bank and corporate exposures are differentiated based on external credit assessments. Where no external rating is applied to an exposure a risk weight of 100% can be used. Loans considered past due will be risk weighted at 150% unless a threshold amount of specific provisions has already been set aside by the bank against that loan. Certain types of mainly financial collateral are allowed as credit risk mitigants.
Retail exposures are given a specific treatment. The risk weights for residential mortgage exposures are at 35% and other retail exposures including SME’s can be risk weighted at 75 percent subject to meeting certain criteria.
The IRB approach to credit risk includes two variants; a foundation approach and an advanced approach. The approach differs substantially from the standardized approach in that banks’ internal assessments of key risk drivers serve as primary inputs to the capital calculation. They are based on modern risk management techniques that involve a statistical and thus quantitative assessment of risk. Under Basel II banks are required to hold capital against operational risk – this is not an option but a fundamental part of Basel II.
Operational Risk is defined as the risk of losses resulting from inadequate or failed internal processes, people and systems or external events. There are two simple approaches to Operational risk; the basic indicator and the standardized approach which are targeted to banks with less significant operational risk exposures. In general terms the basic indicator and standardized approaches require banks to hold capital for operational risk equal to a fixed percentage of a specified risk measure. The advanced approach allows banks to use their own method for assessing their exposure to operational risk so long as it is sufficiently comprehensive and systematic
Under PILLAR Two : An important dimension of Basel II is the supervisory review The supervisory review contains a set of four principles all of which point to the need for banks to assess their capital adequacy positions relative to their overall risks and for supervisors to review and take appropriate actions in response to those assessments. Pillar 2 recogniises that banks face risks not included in pillar 1 and that banks choose to operate at capital levels above those implied by pillar 1 minimum. Supervisors should seek to intervene at an early stage to prevent capital falling below minimum levels
Under PILLAR THREE : Market discipline is sought to be encouraged by developing a set of disclosure requirements that allow market participants to assess key information about a bank’s risk profile and level of capitalization. Market discipline reinforces efforts to promote safety and soundness in banks
What is Marginal Standing Facility - msf ? What is MSF?
Define Marginal Standing Facility in India
What is Marginal Standing Facility ? / Definition of Marginal Standing Facility - RBI (we give below details in plain language for non bankers) :-
RBI in its Monetary Policy announced on 03rd May, 2011 that it will soon be introducing Marginal Standing Facility (MSF). Later on RBI announced that MSF scheme has become effective from 09th May, 2011.
Marginal Standing Facility Rate : Under this scheme, Banks will be able to borrow upto 1% of their respective Net Demand and Time Liabilities". The rate of interest on the amount accessed from this facility will be 100 basis points (i.e. 1%) above the repo rate. This scheme is likely to reduce volatility in the overnight rates and improve monetary transmission.
In the policy statement RBI has also declared "The stance of monetary policy is, among other things, to manage liquidity to ensure that it remains broadly in balance, with neither a large surplus diluting monetary transmission nor a large deficit choking off fund flows."
What is Marginal Standing Facility - RBI circular ? (The below details are for Bankers, who needs the technical language):-
What are the Economic functions of Banks?
The economic functions of banks include:
1. issue of money, in the form of banknotes and current accounts subject to cheque or payment at the customer’s order. These claims on banks can act as money because they are negotiable and/or repayable on demand, and hence valued at par and effectively transferable by mere delivery in the case of banknotes, or by drawing a cheque, delivering it to the payee to bank or cash.
2. netting and settlement of payments — banks act both as collection agent and paying agents for customers, and participate in inter-bank clearing and settlement systems to collect, present, be presented with, and pay payment instruments. This enables banks to economise on reserves held for settlement of payments, since inward and outward payments offset each other. It also enables payment flows between geographical areas to offset, reducing the cost of settling payments between geographical areas.
3. credit intermediation – banks borrow and lend back-to-back on their own account as middle men
4. credit quality improvement – banks lend money to ordinary commercial and personal borrowers (ordinary credit quality), but are high quality borrowers. The improvement comes from diversification of the bank’s assets and the bank’s own capital which provides a buffer to absorb losses without defaulting on its own obligations. However, since banknotes and deposits are generally unsecured, if the bank gets into difficulty and pledges assets as security to try to get the funding it needs to continue to operate, this puts the note holders and depositors in an economically subordinated position.
5. maturity transformation — banks borrow more on demand debt and short term debt, but provide more long term loans. In other words; banks borrow short and lend long. Bank can do this because they can aggregate issues (e.g. accepting deposits and issuing banknotes) and redemptions (e.g. withdrawals and redemptions of banknotes), maintain reserves of cash, invest in marketable securities that can be readily converted to cash if needed, and raise replacement funding as needed from various sources (e.g. wholesale cash markets and securities markets) because they have a high and more well known credit quality than most other borrowers.
What is MFN?
MFN stands for Most Favoured Nation. The principle, fundamental to the GATT, of treating imports from a country on the same basis as that given to the most favored other nation. That is, and with some exceptions, every country gets the lowest tariff that any country gets, and reductions in tariffs to one country are provided also to others.
What is Gold Standard?
A monetary system in which both the value of a unit of the currency and the quantity of it in circulation are specified in terms of gold. If two currencies are both on the gold standard, then the exchange rate between them is approximately determined by their two prices in terms of gold.
1. What is Balance of Trade?
The value of a country’s exports minus the value of its imports. Unless specified as the balance of merchandise trade, it normally incorporates trade in services, including earnings (interest, dividends, etc.) on financial assets.
2. What is Balanced Trade?
When A balance of trade equal to zero. (exports-imports=0)
3. What is Balance of merchandise trade?
The value of a country’s merchandise exports minus the value of its merchandise imports.
4. What is a favorable balance of trade?
It is the difference between exports and imports. Debit items include imports, foreign aid, domestic spending abroad and domestic investments abroad. Credit items include exports, foreign spending in the domestic economy and foreign investments in the domestic economy. A country has a trade deficit if it imports more than it exports; the opposite scenario is a trade surplus.
5. What is Balance of Payments?
A list, or accounting, of all of a country’s international transactions for a given time period, usually one year. Payments into the country (receipts) are entered as positive numbers, called credits; payments out of the country (payments) are entered as negative numbers called debits. A single number summarizing all of a country’s international transactions: the balance of payments surplus.
6. What is Balance of payments adjustment mechanism?
Any process, especially any automatic one, by which a country with a payments imbalance moves toward balance of payments equilibrium
Probationary Officer
Probationary Officer is one of the post regularly advertised for bank recruitments, but many candidates do not know the work involved or the exact meaning of PO.One of our readers had asked a question regarding the role of probationary officer in banks.
Hence we felt it would be better to analyze the job profile in detail, enabling freshers to understand the position better before applying for upcoming bank exams.So, what are the functions of a Probationary Officer in bank ?
Probationary Officer is the first entry point for a job in bank, especially to fresh graduates & those without prior experience.The PO will report to their immediate senior officer,who will closely monitor & evaluate the performance of him/her for a certain period.
While on job, Probationary officers will have to take up assignments given by their managers.Along with training,they will also be deployed across various departments of the bank to gain exposure in operations & working of bank.So,in short,the PO must be willing to take up any work during the probation period in order to understand the process effectively & to scale greater heights and reach higher positions.
Probation period : Normally,the probation period for PO`s will be for 2 years.The probation period can also considered as the learning phase. Hence it is extremely important to be in good conduct,during probation.Banks have the right to terminate the employee during the probation,if he/she does not fit the position.
Financial Literacy and Credit Counselling Centres
Introduction
1. The Working Group to Examine the Procedures and Processes of Agricultural Loans (Chairman: Shri C. P. Swarnkar), appointed by Reserve Bank, had recommended in its report (April 2007) that banks should actively consider opening of counselling centres, either individually or with pooled resources, for credit and technological counselling. This would make the farmers aware of their rights and responsibilities to a great extent. Bank branches should also display as much information as possible for the benefit of the farmers. The counselling centres should have the facility for on-line submission of applications, which may be forwarded to the branches.
2. Further, another Working Group constituted by Reserve Bank to suggest measures for assisting distressed farmers (Chairman: Shri S.S. Johl) had also suggested that financial and livelihood counselling are important for increasing viability of credit.
3. Based on the recommendations of the above working groups, and, as announced in the Annual Policy Statement for the year 2007-08, Reserve Bank advised the SLBC convenor banks, vide its circular dated May 10, 2007, to set up a Financial Literacy and Credit Counselling Centre on a pilot basis in any one district in the State/ Union Territory coming under their jurisdiction.
4. In the Mid-term Review of the Annual Policy for the year 2007-08, it was stated that a concept paper on Financial Literacy and Counselling Centres would be prepared detailing the future course of action and placed on the Reserve Bank’s website for feedback. Accordingly, this concept paper has been prepared so that the Reserve Bank can take further action after obtaining feedback from the public. The paper has three parts: Part-A deals with matters relating to financial literacy, Part-B deals with those relating to credit counselling and Part-C outlines the suggested Scheme for Financial Literacy and Counselling centres.
Part - A
Financial Literacy
5. Financial literacy or financial education can broadly be defined as 'providing familiarity with and understanding of financial market products, especially rewards and risks, in order to make informed choices. Viewed from this standpoint, financial education primarily relates to personal finance to enable individuals to take effective action to improve overall well-being and avoid distress in matters that are financial'1.
6. Financial literacy goes beyond the provision of financial information and advice. The focus of any discussion on financial literacy is primarily on the individual, who usually has limited resources and skills to appreciate the complexities of financial dealings with financial intermediaries on a day to day basis.
7. Organization for Economic Co-operation and Development (OECD) has defined financial education as 'the process by which financial consumers/ investors improve their understanding of financial products, concepts and risks, and through information, instruction and/or objective advice, develop the skills and confidence to become more aware of financial risks and opportunities, to make informed choices, to know where to go for help, and to take other effective actions to improve their financial well-being'2.
8. Thus, financial literacy is the ability to know, monitor, and effectively use financial resources to enhance the well-being and economic security of oneself, one's family, and one's business.
Need for Financial Literacy
9. Financial literacy has assumed greater importance in the recent years, as financial markets have become increasingly complex and as there is information asymmetry between markets and the common person, leading to the latter finding it increasingly difficult to make informed choices.
10. Financial literacy is considered an important adjunct for promoting financial inclusion and ultimately financial stability. Both developed and developing countries, therefore, are focusing on programmes for financial literacy/education. In India, the need for financial literacy is even greater considering the low levels of literacy and the large section of the population, which still remains out of the formal financial set-up. In the context of 'financial inclusion', the scope of financial literacy is relatively broader and it acquires greater significance since it could be an important factor in the very access of such excluded groups to finance. Further, the process of educating may invariably involve addressing deep entrenched behavioural and psychological factors that could be major barriers. In countries with diverse social and economic profile like India, financial literacy is particularly relevant for people who are resource-poor and who operate at the margin and are vulnerable to persistent downward financial pressures. With no established banking relationship, the un-banked poor are pushed towards expensive alternatives. The challenges of household cash management under difficult circumstances with few resources to fall back on, could be accentuated by the lack of skills or knowledge to make well informed financial decisions. Financial literacy can help them prepare ahead of time for life cycle needs and deal with unexpected emergencies without assuming unnecessary debt.
11. The OECD has brought out 'Recommendations on Principles and Good Practices for Financial Education and Awareness'3, a brief summary of which is furnished at Annex-I. These recommendations are intended to help countries, both developed and developing, in designing and implementing effective financial education programmes.
Initiatives taken by Reserve Bank of India
12. The Reserve Bank has undertaken a project titled 'Project Financial Literacy'. The objective of the project is to disseminate information regarding the central bank and general banking concepts to various target groups, such as, school and college going children, women, rural and urban poor, defence personnel and senior citizens. It would be disseminated to the target audience with the help, among others, of banks, local government machinery, NGOs, schools, and colleges through presentations, pamphlets, brochures, films, as also through the Reserve Bank's website. The Reserve Bank has already created a link on its web site for the common person to give him/her the ease of access to financial information in English and Hindi, and 12 Indian regional languages.
13. A financial education site was launched on November 14, 2007 commemorating the Children’s Day. Mainly aimed at teaching basics of banking, finance and central banking to children in different age groups, the site will also eventually have information useful to other target groups, such as, women, rural and urban poor, defence personnel and senior citizens. The comic books format has been used to explain complexities of banking, finance and central banking in a simple and interesting way for children. The site has films on security features of currency notes of different denominations and a games section. The games currently on display have been especially designed to familiarise school children with India’s various currency notes. The site will soon be available in Hindi and twelve regional languages.
14. In addition, with a view to promoting financial awareness, the Reserve Bank conducted essay competitions for school children on topics related to banking and financial inclusion. The Bank has also been participating in exhibitions to spread financial literacy. Last year, it participated in the exhibition aboard the 'Azadi Express' a train to commemorate 150 years of India’s freedom struggle which began in the year 1857. The train during a year’s run will cover several places in the country. Recently, the Reserve Bank launched ‘RBI Young Scholars Award’ Scheme amongst students undergoing undergraduate studies to generate interest in and create awareness about the banking sector and the Reserve Bank. Under the scheme, up to 150 young scholars would be selected through country-wide competitive examination and awarded scholarships to work on short duration projects at Reserve Bank.
Part - B
Credit Counselling
15. Credit Counselling can be defined as 'counselling that explores the possibility of repaying debts outside bankruptcy and educates the debtor about credit, budgeting, and financial management'4. It serves three purposes. First, it examines the ways to solve current financial problems. Second, by educating about the costs of misusing a credit, it improves financial management. Third, it encourages the distressed people to access the formal financial system.
16. Credit counselling (known in the United Kingdom as debt counselling) is a process of offering education to consumers about how to avoid incurring debts that cannot be repaid. Credit counselling often involves negotiating with creditors to establish a Debt Management Plan (DMP) for a consumer. A DMP may help the debtor repay his or her debt by working out a repayment plan with the creditor. DMPs, set up by credit counsellors, usually offer reduced payments, fees and interest rates to the client. Credit counsellors refer to the terms dictated by the creditors to determine payments or interest reductions offered to consumers in a debt management plan5.
17. Thus, credit counsellors help their clients find realistic solutions to their problems and agree on repayments that are achievable. Credit counselling is kept confidential. Counselling services are generally offered free or for a very nominal charge, so that no undue additional burden is put on the already indebted customer.
Global Scenario
18. There are a variety of ways in which credit counselling has been accomplished in different countries. While the first well-known counselling agency was created in the United State in 1951, the concept quickly caught the attention of other countries and over the last several years, a host of countries have taken significant initiatives towards credit counselling. The international experiences with regard to credit counselling are indicated in Annex-II.
Need for Credit Counselling in India
19. Recent times have seen a significant transformation of the financial landscape shaped by the forces of globalization, advances in technology, and greater market orientation and financial innovation. Retail lending has increased phenomenally in the commercial banking sector in recent years. As commercial banks shifted their focus from traditional need-based lending to a broad-based portfolio, retail lending became a mainstream business. There has been a rapid growth in consumer loans, housing loans, credit cards and personal loans. Bank credit to housing, consumer durables and personal loans (including credit cards) in urban and metropolitan areas, which covered 8.71 million accounts and stood at Rs.42,700 crore in 2001 rose to 25.5 million accounts totalling to Rs..2,58,000 crore in 2006. The credit growth to these sectors grew at a Compound Annualised Growth Rate (CAGR) of 43.3 per cent during 2001-06 compared to overall growth of credit of 23.4 per cent in the same period6.
20. In urban areas, with a burgeoning middle-class and changing lifestyle aspirations, more and more people are resorting to debt to finance their consumption needs, besides asset creation. In some cases, this could potentially lead to excesses, precipitating defaults. Such defaults could also be the fall out of circumstances beyond one’s control. Costly medical emergencies, retrenchment from job, hardening of interest rates, etc could inadvertently raise debt burdens in some cases, not easily manageable within a given income stream. The aggressive marketing of personal loans and credit cards to vulnerable section of borrowers could also have consequences of over- indebtedness and rising NPAs.
21. In rural areas, especially in areas of rain-fed agriculture, vagaries of monsoon, coupled with lack of adequate risk mitigation policies lead to hardship for the rain-dependent segment of the farming population. This needs to be considered in conjunction with the fact that the levels of literacy in our country are still relatively modest at 65.4 per cent in 2001, with wide differentials between urban and rural areas. In 2001, the proportion of rural literate was about 59 per cent as compared to 80.3 per cent in the urban areas7.
22. The sharp growth in credit has accentuated indebtedness of households. In the case of farmers, as per the Situation Assessment Survey (SAS) of farmers conducted by the NSSO, of the 89.33 million farmer households estimated in 2003, 43.42 million (48.6 per cent) were indebted. The average outstanding debt per farmer household was at Rs.12,585. A State-wise analysis showed that in 2003, incidence of indebtedness was higher in states that had input-intensive or diversified agriculture. Total debt of farmer households was estimated at Rs. 1.12 lakh crore in 2003; of which Rs.65,000 crore was from institutional sources and Rs.48,000 crore from non-institutional agencies. Private moneylenders accounted for Rs.29,000 crore and traders Rs.6,000 crore. About Rs.18,000 crore of debt from non-institutional sources, a major portion of which was from moneylenders carried an interest rate greater than 30 per cent8. Although credit to agriculture from the banking system has substantially increased after June 2004, the informal finance still plays a significant part in rural areas.
23. As observed in the Report of the Expert Group on Agricultural Indebtedness (Chairman: R. Radhakrishna), indebtedness, in particular farmers' indebtedness, has long been treated as a distress phenomenon. It is indeed so if debt taken is not used for productive purposes. Debt can also become a distress phenomenon if the borrower's crop fails due to natural calamities, pests, use of spurious inputs, imprudent investments or other unforeseen reasons, or if production becomes uneconomic because of high input costs, stagnant technology and lack of remunerative prices which makes it impossible for the farmer to repay his capital and interest. The interest becomes a high liability if loan is taken from non-institutional sources like moneylenders at high rates of interest.
24. Regulatory and supervisory initiatives, on an ongoing basis, are being taken by the Reserve Bank to ensure soundness of the financial system and to bring the masses within the fold of the formal financial system. However, maintaining stability of the financial system also requires adequate consumer protection and education framework. Consumer protection and education initiatives empower consumers to be better positioned to take responsibility for their own well-being. In this context, financial literacy and credit counselling assume great relevance. There is an increasing need to develop follow-up services to enable distressed borrowers overcome credit delinquencies. Credit counsellors, thus serve as a viable and task-specific advisory and as an ad hoc intermediary between the borrower and the bank concerned. By providing sound advice to arrest deterioration of incomes by restructuring their debt, credit counselling offers a meaningful solution for borrowers to gradually overcome their debt burden and improve their money management skills. It needs to be recognized that financial products and services differ significantly from most other goods/services. Specifically, there is asymmetry in the access to information and bargaining power between the consumers and financial service providers.
25. In many cases, especially amongst the more vulnerable sections, individuals may not be able to articulate their financial situation adequately with the banks and negotiate a settlement. It will, therefore, be in the interest of the banks themselves to help individual borrowers through appropriate financial education and credit counselling.
26. Mechanisms in the form of Corporate Debt Restructuring (CDR) in regard to loans by banks and DFIs to large corporates are already in place to overcome their debt burden. Somewhat similar framework has also been provided to micro, small and medium enterprises. The extent of active interaction between individual borrowers and banks is, however, not readily available. Credit counselling is intended for individual borrowers and not for institutional borrowers.
Measures taken by Reserve Bank of India
27. As stated earlier, the working groups chaired by Shri C.P. Swarnkar and Shri S.S. Johl, constituted by the Reserve Bank had emphasized the need for credit and technical counselling for increasing the viability of credit, particularly in the relatively under-developed regions. In the light of the recommendations of the two groups, and in terms of the Annual Policy Statement of 2007-08, the convenor banks of the State/Union Territory Level Bankers’ Committees were advised in May 2007 to set up, on a pilot basis, a financial literacy and credit counselling centre in the State/Union Territory, coming under their jurisdiction. Further, based on the experience gained, the concerned Lead Banks were advised to set up such centres in other districts.
Initiatives taken by some Banks
28. A few banks have already taken initiatives in opening credit counselling centres in the country. An Internal Group constituted by the Reserve Bank to study credit counselling initiatives, visited some of the counselling centres in the state of Maharashtra viz., ‘ABHAY’ counselling centre8 (an initiative of Bank of India); Disha Trust9 (an initiative of ICICI Bank Ltd.) and Grameen Paramarsh Kendras10 (an initiative of Bank of Baroda). The observations of the Internal Group are summarized in paragraphs 29 to 33 below.
29. The counsellors at these centres assist people on a face to face basis as well those who approach them over telephone, email, or by means of letters. Customers facing credit problems arising out of multiple credit cards, personal loans, housing loans and loans from societies approach the counselling centres for advice and guidance. The counsellors guide their customers and help them to take up with the banks concerned for rescheduling/ restructuring of loans.
30. Some of the common features of these centres are as under:
The counselling centres are mainly funded by Trusts set up by banks or funded by the banks themselves.
The counsellors manning the centres are retired or serving bank employees.
Counselling is provided free of cost.
The counselling presently provided by most of the centres is mainly curative in nature, being given after a crisis event had occurred.
31. The unique features observed in some of these counselling centres are:
Arrangement for experts to guide farmers on modern farming methods, cooperative farming, marketing strategy, etc.
Focus on credit related problems of urban clientele on account of credit card, personal loans, housing loans, and defaults on account of business failures.
Manned by Agricultural Officers of the bank to provide awareness on various products and services of the bank.
32. Training and awareness camps are organised by some of these counselling centres to educate people of the need to save and to familiarize them with the concept of credit cards, impact of minimum charges, etc. As these counselling centres are housed mainly in the banks' premises, expenses incurred are mainly on account of payment of honorarium to counsellors; such honorarium ranged from Rs.12,000 to Rs.30,000 per month.
33. Although efforts are being made to hold training camps and creating awareness among the masses on the need for saving, planning expenditure and also about various banking facilities, etc., a lot more is yet to be done to popularise and scale-up the effort.
Issues in setting up of Credit Counselling Centres
34. Some issues relating to setting up of counselling centres in India that need to be addressed are as follows:
As credit counselling initiatives, presently, are individualistic efforts of the banks that have set up counselling centres as Trusts fully funded by them, there is an apprehension that these centres might be perceived as debt collection wings of the banks concerned. Thus, although it could be argued that a bank, by virtue of its nature of business, is, indeed, better placed to take up credit counselling initiatives, there is a need for appropriate 'firewall' between a bank and the counselling centre set up by it..
A major constraint faced by the counselling centres in their effort to bring about a solution for the distressed borrowers is the lack of credence attached to the references made by these centres to banks, on the grounds that they have no 'locus standi' in the matter. Therefore, there is a need for credit counselling centres to be empowered for liaising and negotiating with banks on behalf of their customers.
As quality of service is an important aspect, it is desirable to have appropriately bench-marked quality standards for credit counsellors and counselling agencies. Like-wise, it would also be desirable to have a system of accreditation of counsellors. Once setting up of counselling centres gather momentum, they could consider forming an association of credit counsellors.
Enlisting committed and well-trained personnel is crucial for success of counselling centres – this needs to be addressed/ ensured.
Inadequate credit information/credit history of the borrowers or total lack of such information is another area of concern, which needs to be addressed.
As lack of awareness is major stumbling block in such initiatives, it is necessary to give wide publicity to the concept of credit counselling and the free availability of such services.
Part - C
Scheme for Financial Literacy and Counselling Centres (FLCC)
35. In the light of the various aspects/issues outlined in Part A and Part B above, and in order to make credit counselling more effective and popular, a scheme for setting up of FLCCs is suggested:
Objectives
36. The broad objective of the FLCCs will be to provide free financial literacy/education and credit counselling. The specific objectives of the FLCCs would be:
(i). To educate the people in rural and urban areas with regard to various financial products and services available from the formal financial sector ;
(ii). To make the people aware of the advantages of being connected with the formal financial sector ;
(iii). To provide face-to-face financial counselling services, including education on responsible borrowing and offering debt counselling to individuals who are indebted to formal and/or informal financial sectors;
(iv). To formulate debt restructuring plans for borrowers in distress and recommend the same to formal financial institutions, including cooperatives, for consideration ;
(v). To take up any such activity that promotes financial literacy, awareness of the banking products, financial planning and amelioration of debt-related distress of an individual; and
(vi). To take up any other activity that facilitates the above.
FLCCs should not, however, act as investment advice centres.
37. Debt counselling/credit counselling can be both preventive and curative. In case of preventive counselling, the centre would provide awareness regarding cost of credit, availability of backward and forward linkages where warranted, etc. The clients would be encouraged to avail of credit on the basis of their repaying capacity. Preventive counselling can be through the media, workshops and seminars. In the case of curative counselling, the clients may approach the counselling centres to work out individual debt management plans for resolving their unmanageable debt portfolio. Here, the centre could work out effective debt restructuring plans that could include repayment of debt to informal sources, if necessary, in consultation with the bank branch.
38. While the FLCCs centres would provide financial literacy and credit counselling, the activities of the Rural Development and Self employed Training Institutes (RUDSETI) towards skill development/capacity building could be dovetailed with FLCCs initiatives, for increasing the earnings/debt repaying ability of the distressed borrowers' families.
Coverage
39. While credit counselling services may be provided by banks both in rural and urban areas, it may observed that a large segment of the Indian population is resident in rural areas with literacy levels lower than in urban areas. The rural population is also more dependent on the informal sector for its financing needs. It is necessary that a segmented approach, rather than broad-based generalised approach to counselling for all types of borrowers, is adopted. The centres in rural areas could concentrate on financial literacy and counselling for farming communities and those engaged in allied activities. The centres in Metro/Urban areas could focus on individuals with overdue in credit cards, personal loans, housing loans, etc. Given the their network and reach, the public sector banks could consider focusing on the rural areas, while the private and foreign banks could consider setting up counselling centres in urban areas.
Organisational / Administrative Set-up
40. To start with, banks may set up Trusts/Societies for running the FLCCs, singly or jointly with other banks. A bank may induct respected local citizens on the Board of such Trust/Society. However, serving bankers may not be included in the Board. FLCCs may be funded fully by the bank/banks to begin with. In order to have maximum coverage, FLCCs may need to be set up at all levels viz. block, district, town and city levels. SLBCs may discuss and coordinate with banks, both in public and private sectors, and arrive at a plan for setting up of FLCCs at different levels in a phased manner. However, to start with, lead banks may take the initiative for setting up FLCCs in the district headquarters. While the endeavour should be to keep costs as low as possible, in order to support banks in setting up FLCCs in rural and in urban areas where there is concentration of low income borrowers, cost-sharing through the Financial Inclusion Fund set up in NABARD could be considered. Once the system stabilizes the counselling centres could cover part of the cost by levying nominal charges on the banks whose borrowers have commenced repayments due to the credit counselling and debt management plan drawn up by the counselling centre. This would, in the long run, help the FLCCs to operate on self-sustaining basis. The counselling centres should maintain arms length relationship with the bank and preferably not be located in the bank's premises. In the rural areas, if for the sake of minimizing cost, the branch premises is used, to start with, it should be kept completely separate. The idea is that these centres should not be perceived as a recovery or marketing agent of the bank concerned, and bank clientele, even of other banks, should feel comfortable in voluntarily approaching the centres.
41. Counselling and debt management services may be provided free of charge to the customers so as to put no additional burden on them.
Infrastructure
42. Proper infrastructure would have to be put in place by banks with adequate communication and networking facilities. Separate cubicles for the customers could be set up to maintain the privacy/ confidentiality of the discussions with the borrowers.
Types of Credit Counselling
43. In Australia, the Victorian Consumer Credit Review Report 2006 recommended that financial counselling services should include early intervention (preventive) counselling as well as counselling for consumers in financial crisis (curative counselling). In the US, the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 made credit counselling a requirement for consumer debtors filing for bankruptcy. Banks may evolve trigger points to refer cases where there are early warning signals to the counselling centres before taking measures for recovery. Timely intervention will help to arrest any further financial deterioration of the borrower.
Mechanism for Credit Counselling and Debt Settlement
44. Banks may encourage their own customers in distress or customers of any bank to approach the FLCCs set up by it. Information about such FLCCs can be provided through the various fora available under the Lead Bank Scheme.
45. The FLCCs may conduct open-house seminars either at the centre or at various places in the district for group counselling. Banks operating in the district can sponsor, wholly or partly, such seminars in areas predominantly covered by them.
46. For single-creditor-debts, the FLCCs could assist the borrower in negotiating with the bank concerned. In case of multiple credits availed of by individuals, the FLCCs may negotiate with the bank/s having the largest exposure to restructure the debt and the recoveries to be shared on a pro-rata basis. The FLCCs would, however, not involve themselves in recovering and distributing money. This would be left to the bank concerned, or the bank having the largest exposure to act on behalf of all the banks.
Accreditation
47. In Australia, practicing credit counsellors are required to be 'accredited'. The Financial Counselling Association of New South Wales oversees the accreditation process. This helps to ensure the quality and reliability of their service. Accreditation would require the credit counsellors to meet benchmarked quality standards to ensure optimum outcome for consumers. The banks may consider suitable accreditation process, either through an existing organization like IBPS, or through an association of financial counsellors, when formed.
Qualification and Training – Counsellors
48. As counselling centres will play a crucial and responsible role in assisting and guiding the distressed individual-borrowers, it is necessary that only well qualified / trained counsellors are selected to man the centre on a full time basis. In his Budget speech for the year 2008-09, the Finance Minister indicated that individuals such as retired bank officers, ex-servicemen, etc. will be allowed to be appointed, among others, as credit counsellors. Credit counsellors should have sound knowledge of banking, law, finance, excellent communication and team building skills, etc. At present, knowledge and skill upgradation is mostly dependant on the initiative of the individual counsellors. Some training at the time of joining is being given by the banks, but this is focused only on the services provided rather than a full course on financial management. Proper training and skill upgradation is essential for the counsellors to keep themselves abreast of the latest developments in the banking industry. Training is also required to be provided to the counsellors on an on going basis to constantly upgrade their skills. To ensure a regular supply of trained counsellors, it would also be useful if specialised courses on credit counselling and debt management are conducted by IIBF and professional institutions offering courses on banking and finance.
Types of interface
49. Counselling centres should be equipped to deal with requests received in person, by phone, e-mails, post, etc. They should have a toll free line, e-mail and fax facilities for easy contact. To maximize the outreach of the counselling centre, mobile units could also be set up to service all the blocks in the districts.
RBI Guidelines
50. Credit counsellors, at present, merely render advisory services to their clients and cannot directly approach banks/creditors to discuss/negotiate on behalf of their clients. In order that the system of credit counselling is taken forward, RBI may issue guidelines to facilitate the setting up of FLCCs by banks for group and individual counselling and to whom banks could also refer cases, apart from encouraging individuals to directly approach such centres. In its advice, RBI may sensitise banks to give due consideration to the Debt Management Plan prepared by such FLCCs before resorting to recovery measures. RBI may evolve a mechanism for dissemination of information on FLCCs set up by banks.
Monitoring
51. The functioning of the FLCCs in each State may be monitored by a Committee headed by the Regional Director of the Reserve Bank of India and feedback provided to the banks on a regular basis.
Transparency / Disclosure of Information
52. To help the customers make informed decisions, all banks may display on their websites particulars of all fees, interest rates, yields and other features of standard products offered by them. The Reserve Bank may also display the consolidated data on its website for one-stop information on all banks, and develop, in association with the Indian Institute of Banking and Finance (IIBF)/IBA, a dictionary of common terms used to describe and compare products so that they are easily understood.
Information Sharing
53. At present, there is relatively easy access to personal finance, particularly availability of multiple credit cards to a customer, though he may be a defaulter to some of his banks. It is imperative that credit information companies are set up and up-scaled quickly to provide both positive and negative information to the banks. The FLCCs, in turn, could obtain comprehensive credit information from the concerned bank or the bank having the largest exposure to the defaulting borrower.
Publicity
54. A great deal of emphasis needs to be given by all the institutions to educate the public of the various schemes/ facilities. All forms of publicity, viz. press conferences, workshops, publications, websites, road shows, mobile units, village fairs, etc. should be actively explored. A suitable budget needs to be provided by all banks for the purpose. In order to go ahead in a planned manner, a Standing Committee on Financial Literacy and Counselling may be set up by the Reserve Bank with members from the Reserve Bank, NABARD, IBA, BCSBI, CIBIL, NGOs working in the area and consumer organizations; this will foster greater collaboration in areas relating to consumer education and protection of consumers’ interest.
55. The list of counselling centres should be placed on the websites of IBA, BCSBI, RBI, etc., and regularly updated.
56. In order to make Financial Literacy and Credit Counselling a success, it is necessary to create widespread awareness about the concept .and, more importantly, for banks to appreciate the overall benefits of such initiatives. It is necessary to have the total and complete involvement of the top management of banks in this initiative. The Reserve Bank, therefore, may convene a meeting of CEOs of major commercial banks, IBA, NABARD, and national level associations of cooperative banks, apart from experts and leading NGOs working in this field to discuss the concept, scope, modus operandi, etc. of providing financial literacy and credit counselling services, and thereafter issue detailed guidelines on the subject. Offering credit counselling could be made a part of fair lending code for banks in due course.
ANNEX - I
The OECD’s 'Recommendation on Principles and Good Practices for Financial Education and Awareness'
(i). Governments and all concerned stakeholders should promote unbiased, fair and coordinated financial education.
(ii). Financial education should start at school, for people to be educated as early as possible.
(iii). Financial education should be part of the good governance of financial institutions, whose accountability and responsibility should be encouraged.
(iv). Financial education should be clearly distinguished from commercial advice; codes of conduct for the staff of financial institutions should be developed.
(v). Financial institutions should be encouraged to check that clients read and understand information, especially when related to long-term commitments or financial services with potentially significant financial consequences: small print and abstruse documentation should be discouraged.
(vi). Financial education programmes should focus particularly on important life-planning aspects, such as basic savings, debt, insurance and pensions.
(vii). Programmes should be oriented towards financial capacity building, and appropriately targeted on specific groups, and made as personalised as possible.
(viii). Future retirees should be made aware of the need to assess the financial adequacy of their current public and private pension schemes.
(ix). National campaigns, specific websites, free information services, and warning systems on high-risk issues for financial consumers (such as fraud) should be promoted.
Annex- II
Credit Counselling- Global Scenario
There are a variety of ways in which credit counselling has been accomplished in different countries. The first well-known credit counselling agencies were created in 1951 in the United States when credit grantors created the National Foundation for Credit Counselling (NFCC). Their stated objective was to promote financial literacy and help consumers to avoid bankruptcy. Credit counselling, however, came into its own as a result of the passing of the Housing and Urban Development Act in 1968. Under this Act, the US Department of Housing and Urban Development was allowed to authorize public and private organizations to provide counselling to mortgagors. The resulting services and infrastructure led to the development of the credit counselling industry.
In 1993, the Association of Independent Consumer Credit counselling Agencies (AICCCA) was founded in the United States, citing a need for industry-wide standards of excellence and ethical conduct. This formally organized the NFCC’s competition. The AICCCA was formed from the group of counsellors who favoured telephone delivery of debt management programmes. The NFCC was, in the beginning, strongly opposed to this telephone business model, primarily favouring face-to-face counselling as a more effective solution. Eventually, all organizations practised both phone and face-to-face processes with some agencies using large inbound call centres driven by mass media advertising.
The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 made credit counselling a requirement for consumer debtors filing for bankruptcy in the United States. In order to meet this requirement, during the 180-day period preceding the filing of bankruptcy, the debtor must complete a programme with an approved non-profit budget and credit counselling agency. Such a programme may include, but is not limited to, one counselling session conducted by phone or over the internet.
Quickly, the concept caught the attention of other countries and over the last several years, a whole host of countries have undertaken significant initiatives towards credit counselling. The Consumer Credit Counselling Service (CCCS) in the UK, established in 1993, helps consumers with budgeting and better money management as also their debt repayment plans. Funding for CCCS comes from the businesses in the community, which benefit from repayment they would not receive if the debtor defaulted. In addition, there is also a National Debt Line through which a bank customer can get free financial advice. In fact, the Banking Code in the U.K provides that member banks shall discuss financial problems with customers and together evolve a plan for resolving these problems.
Canada established a non-profit counselling organization in 2000. Termed Credit Counselling Canada (CCC), the organization seeks to enhance the quality and availability of not-for-profit credit counselling for all its citizens.
The Bank Negara Malaysia has established a Credit Counselling and Debt Management Agency (CCDMA) to provide credit counselling and loan restructuring advice to individuals. The establishment of CCDMA is to proactively ensure that the household sector continue to be resilient by providing an avenue for existing and potential individual borrowers to seek advice and assistance on managing their credit while at the same time promoting a sound and robust banking system by facilitating debt repayment efforts and minimizing incidence of non-payment arising from poor debt management. The CCDMA will provide free credit counselling, education and debt settlement services to consumers. The CCDMA will also assist consumers to proactively manage their debt via out-of-court procedures based on agreed repayment plans between the creditors and the debtors.
With rising personal bankruptcies, primarily on unsecured debt, Credit Counselling of Singapore (CCS), established in 2003, is meant to assist financially distressed consumers.
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