CAIIB-BFM-CHAP 16-FUNDING AND REGULATORY ASPECTS

CHAP 16-FUNDING AND REGULATORY ASPECTS

·         The Reserve Bank of India is the Note Issuing Authority.

·         The money in circulation is indicated by 'Broad Money' or M3, which includes currency in circulation, demand and time deposits with banks and post office saving deposits.

·         Cash reserve ratio (CRR)  is intended to reduce the multiplier effect.

·         CRR and SLR are important instruments in the hands of RBI to control liquidity in the inter-bank market. The liquidity in turn impacts overall money supply, inflation, interest rates and exchange rates.

·         Reserve assets refer to the cash deposited by scheduled commercial banks with RBI to comply with Cash Reserve Ratio (CRR) requirement. The reserve ratios are calculated on the basis of demand and time liabilities (DTL) of the banks.

·         Exemptions from DTL are the “Transactions in CBLO and CCIL”

·         Funds invested in Government securities and other approved securities to comply with the Statutory Liquidity Ratio (SLR) requirement.

·         Liquidity refers to surplus funds available with banks, which is an indicator of money supply that has not been absorbed by the real economy.

·         Treasury back-office should report relevant information to RBI in the fortnightly return (Form A).

·         The CRR is to be calculated on the basis of DTL, with a lag of one fortnight, i.e. on the reporting Friday, the DTL as at the end of previous fortnight will form the basis for CRR calculation.

·         An increase in the reserve ratios will reduce money supply (excess liquidity) and reduction in the reserve ratios will increase the money supply.

·         LIQUIDITY ADJUSTMENT FACILITY (LAF) is used to monitor day-to-day liquidity in the market.

·         LAF refers to RBI lending funds to banking sector through Repo instrument. RBI also accepts deposits from banks under Reverse Repo.

·         Real Time Gross Settlement System (RTGS) has been fully activated by RBI from October 2004.

·         RTGS is a paperless clearing system, where settlements are on gross basis.

·         The Institute for Development and Research in Banking Technology (IDRBT) has developed the Indian Financial Net Work (INFINET) as a secure communication backbone for the banking and financial sectors.

·         The INFINET has helped introduction of Structured Financial Messaging System (SFMS) which facilitates domestic transfer of funds and authenticated messages, similar to the SWIFT used by banks for international messaging.

·         Negotiated Dealing System(February 2002) is an electronic platform for facilitating dealing in Government securities and money market instruments.

·         CCIL a specialized institution promoted by major banks for clearing of securities, repo trades and trades in CBLO (securities borrowing and lending scheme).

·         FX Clear is a forex dealing system developed by CCIL for foreign exchange transactions (USD/ INR as well as cross currencies).

·         Repo/Reverse Repo rates dictate the liquidity parameters.

·         NSDL and CSDL facilitate delivery Vs payment(DVP) for secondary market deals in equity and debt paper.

·         CCIL as an intermediary settles inter-bank USD/Rupee deals on net basis, so that individual banks need not exchange payments for each transaction.

CAIIB-BFM-CHAP 8- Risk and Basic Risk Management Framework

CHAP 8- Risk and Basic Risk Management Framework

·         'Risks' are uncertainties resulting in adverse outcome, adverse in relation to planned objective or expectations.

·         'Financial Risks' are uncertainties resulting in adverse variation of profitability or outright losses.

·         Factors that are responsible for creating uncertainties in cash outflows and cash inflows are the risk elements.

·         Minimum capital required for a business should be such that it is able to meet the maximum loss that may arise from the business to avoid bankruptcy.

·         Lower risk implies lower variability in net cash flow with lower upside and downside potential. Higher risk would imply higher upside and downside potential.

·         Zero-Risk would imply no variation in net cash flow. Return on zero-risk investment would he low as compared to other opportunities available in the market.

·         Risk in a business or investment is netted against the return from it and is called Risk Adjusted Return on investment

·         Key driver in managing a business is seeking enhancement in risk-adjusted return on capital (RAROC). Higher the RAROC, higher is the reward to investors/shareholders and more preferable such investment would be to the market.

·         Although all the risks are contracted at the transaction level, certain risks such as liquidity risk and interest rate risk are managed at the aggregate or portfolio level.

·         Risks such as credit risk, operational risk and market risk arising from individual transactions are taken cognizance of at transaction- level as well as at the portfolio-level.

·         Volatility over a time horizon 'T' = Daily Volatility x Square root of'T'

·         Downside potential is the most comprehensive measure of risk as it integrates sensitivity and volatility with the adverse effect of uncertainty

·         The value at risk (VaR) is a downside risk measure.

CAIIB-BFM-CHAP 18-DERIVATIVE PRODUCTS

·         Derivatives always refer to a future price and the value of derivative depends on spot market.

 

·         The derivative products that can be directly negotiated and obtained from banks and investment institutions are known as Over-the-Counter (OTC) products.

 

·         Forward contract is a contract to deliver foreign currency on a future date at a fixed exchange rate. This is a OTC product where the counterparty is always a bank.

 

·         Forward rate, as we stated earlier, represents interest rate differential of the two currencies. The forward rate is either at premium or discount to the spot rate

 

·         Options refer to contracts where the buyer of an option has a right but no obligation to exercise the contract.

 

·         Options are either put options or call options. Call option gives a right to the holder to buy an underlying product (currency/bonds/commodities) at a prefixed rate on a specified future date. Put option gives a similar right to the holder to sell the underlying at a prefixed rate on a specified future date or during a specified period.

 

·         The prefixed rate is known as the strike price. The specified time is known as expiry date.

 

·         In India we use only European type of options wherein option can be exercised only on the expiry date

·         The option is known to be at-the-money (ATM) if the strike price is same as the spot price of the currency.

·         The option is in-the-money (ITM), if the strike price is less than the forward rate in case of a call option, or, if the strike price is more than forward rate in case of a put option.

·         The option is out-of-money (OTM), if the strike price is more than the forward rate in case of a call option, or, if the strike price is less than forward rate in case of a put option.

·         ITM is when the strike price is better than the market price, and OTM is when the strike price is worse than the market price.

·         Intrinsic value of an ITM option is the difference between the strike price and current forward rate of the currency, or zero whichever is less. Intrinsic value cannot be negative.

·         The option price less the intrinsic value is time value of the option.

·         The time value is maximum for an ATM option, and decreases with the option becoming more and more ITM or OTM, as the expiry date approaches.

·         An option without any conditionalities is called plain vanilla option, which is ideal for hedging.

·          A convertible option may give the bond-holder option of converting the debt into equity on specified terms. Such options are called embedded options and have a direct effect on pricing of the bond.

·         An interest rate swap is an exchange of interest flows on an underlying asset or liability, the value of which is the notional amount of the swap.

·         Interest Rate Swap (IRS) is a OTC instrument normally issued by a bank.

·         Quanto swaps refer to paying interest in home currency at rates applicable to a foreign currency (now prohibited in India).

·         Coupon swaps refer to floating rate in one currency exchanged to fixed rate in another currency.

·         In Indian Rupee market only plain vanilla type swaps are permitted.

·         Banks and counterparties (other banks/clients) need to execute ISDA Master Agreement before entering into any derivative contracts.

 

CAIIB-BFM-Chap 26-Liquidity Management

·         Bank's liquidity management is the process of generating funds to meet contractual or relationship obligations at reasonable prices at all times.

·         good management information systems, central liquidity control, analysis of net funding requirements under alternative scenarios, diversification of funding sources, and contingency planning are crucial elements of strong liquidity management at a bank of any size or scope of operations.

·         The residual maturity profile of assets and liabilities will be such that mismatch level for time bucket of 1-14 days and 15-88 days remains around 80% of cash outflows in each time bucket.

·         Flow approach is the basic approach being followed by Indian banks. It is called gap method of measuring and managing liquidity

·         Stock approach is based on the level of assets and liabilities as well as off-balance sheet exposures on a particular date.

·         Ratio of Core Deposit toTotal Assets: - Core Deposit/Total Assets: More the ratio, better it is.

·         Net Loans to Totals Deposits Ratio:- Net Loans/Total Deposits: It reflects the ratio of loans to public deposits or core deposits.  Loan is treated to be less liquid asset and therefore lower the ratio, better it is.

·         Ratio of Time Deposits to Total Deposits:-Time deposits provide stable level of liquidity and negligible volatility. Therefore, higher the ratio better it is.

·         Ratio of Volatile Liabilities to Total Assets:- Higher portion of volatile assets will pose higher problems of liquidity. Therefore, lower the ratio better it is.

·         Ratio of Short-Term Liabilities to Liquid Assets:- Short-term liabilities are required to be redeemed at the earliest. It is expected to be lower in the interest of liquidity.

·         Ratio of Liquid Assets to Total Assets:- Higher level of liquid assets in total assets will ensure better liquidity. Therefore, higher the ratio, better it is.

·         Liquid assets may include bank balances, money at call and short notice, inter bank placements due within one month, securities held for trading and available for sale having ready market.

·         Ratio of Short-Term Liabilities to Total Assets:- A lower ratio is desirable

·         Short-term liabilities may include balances in current account, volatile portion of savings accounts leaving behind core portion of saving which is constantly maintained. Maturing deposits within a short period of one month.

·         Ratio of Prime Asset to Total Asset - Prime Asset/Total Assets:- More or higher the, ratio better it is.

·         Prime assets may include cash balances with the bank and balances with banks including central bank which can be withdrawn at any time without any notice.

·         Ratio of Market Liabilities to Total Assets:- Lower the ratio, better it is.

·         Market liabilities may include money market borrowings, inter-bank liabilities repayable within a short period.

·         A maturity ladder should be used to compare a bank's future cash inflows to its future cash outflows over a series of specified time periods.

·         The need to replace net outflows due to unanticipated withdrawal of deposits is known as Funding risk.

·         The need to compensate for non-receipt of expected inflows of funds is classified as Time Risk

·         Call risk arises due to crystallisation of Contingent liabilities

·         Maturity ladders enables the bank to estimate the difference between Cash inflows and Cash Outflows  in predetermined periods.

·         Liquidity management methodology of evaluating whether a bank has sufficient liquid funds based on the behaviour of cash flows under the different 'what if scenarios is known as Alternative Scenarios

·         The capability of bank to withstand a net funding requirement in a bank specific or general market liquidity crisis is denoted as  Contingency planning