BFM Short Notes

CAIIB MADE EASY : PAPER - 2
BANK FINANCIAL MANAGEMENT

( ONLY 24 HOUR BOOK - BEFORE CAIIB- 2 PAPER EXAMS )
[THIS BOOK IS MADE FOR LAST MINUTE FINAL

REVISION HAVING ALL FEATURES OF NORMAL BOOK
CONTAINS ALL TOPICS INCLUDING LATEST CHANGES
& RECALLED QUESTION– A 108 PAGE BOOKLET ]
INDEX
PARTICULARS PAGE NO.
SYLLABUS 02-02
MODULE – A ( INTERNATIONAL BANKING ) 03-42
MODULE - B ( RISK MANAGEMENT ) 42-60
MODULE - C ( TREASURY MANAGEMENT ) 60-69
MODULE –D ( BALANCE SHEET MANAGEMENT ) 70-86
QUESTIONS BANK ( RECALLED QUESTIONS & PRACTICE TEST ) 87-108
Compiled by Mr. Sanjay Kumar Trivedy, Sr. Mgr., RSTC, mumbai

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SYLLABUS : PAPER - 2 : BANK FINANCIAL MANAGEMENT
MODULE - A : International Banking :
Forex Business; factors determining exchange rates, Direct and indirect quotations,
spot / forward rates, premium and discount, cross rates. Basics of forex derivatives;
forward exchange rate contracts, Options, Swaps. Correspondent banking, NRI
accounts,Documentary letters of Credit - UCPDC 600, various facilities to exporters
and importers. Risks in foreign trade, role of ECGC, types of insurance and guarantee
covers or ECGC. Role of Exim Bank - Role of RBI and exchange control - Regulations
in India, Role and rules of FEDAI - Role of FEMA and its rules
MODULE - B : Risk Management :
Risk-Concept - Risk in Banks - Risk Management Framework - Organisational

Structure - Risk Identification - Risk Measurement / - Sensitivity - Basis Point Value
(BPV) - Duration -Downside Potential - Value at Risk, Back Testing - Stress Testing -
Risk Monitoring and Control - Risk Reporting - Market Risk identification, Measurement
and management / credit risk - rating methodology, risk weights, eligible collateral for
mitigation, guarantees; credit ratings, transition matrices, default probabilities, Credit
risk spreads, risk migration and credit metrics , Counterparty risk. Credit exposures,
recovery rates, risk mitigation techniques, - / Operational and integrated Risk
Management - Risk management and capital Management - Basel-II - Current
guidelines on risk management
MODULE - C : Treasury Management :
Concepts and function; instruments in the treasury market, development of new

financial products, control and supervision of treasury management, linkage of
domestic operations with foreign operations. Interest rate risk, interest rate futures
Mix / Pricing of Assets, Liabilities - On-Balance Sheet Investment and Funding
Strategies - Stock options, debt instruments, bond portfolio strategy, risk control and
hedging instruments. Investments - Treasury bills, money market instruments such as
CDs, CPs, IBPs,Securitisation and Forfaiting; refinance and rediscounting facilities.
Derivatives - Credit Default Swaps / Options
MODULE - D : Balance Sheet Management :
Prudential norms-Capital Adequacy. Implementation of Basel-II guidelines : RBI

guidelines. Banks Balance Sheet - Components of assets / Liabilities / ALM
Implementation - RBI Guidelines - Gap Analysis - Mechanics, Assumptions, and
Limitations - Illustrations of Actual Gap Reports - The Relationship Between Gap and
Income Statement - Funding Liquidity - Trading / Managing Liquidity - Contingency
Funding - Business Strategies : Profit and profitability analysis, Asset Classification -
provisioning - effect of NPA on profitability, Shareholder value maximization

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MODULE – A :INTERNATIONAL BANKING
FOREFOREIGN EXCHANGE MARKET
Foreign Exchange as defined in FEMA means foreign currency and includes: I) All deposits, credits, balances
payable in any foreign currency and any drafts, travelers cheques, letters of credit and bills of exchange
expressed or drawn in Indian currency and payable in foreign currency; ii) Any instruments payable at the option
of the drawee or holder, thereof or any other party thereto, either in Indian currency or in foreign currency or
partly in one and partly in ttie other. In short, the term 'Foreign Exchange' means the process of converting one
national currency into another national currency and transferring money. In such conversions, the foreign
currency is always treated as a commodity and the home currency as the medium of purchasing power.
Foreign Exchange Market and its Participants

Banks and Customers who have to buy or sell foreign exchange.Inter-Bank dealings where sale and purchase
business is transacted between the banks themselves within the country. Dealings between domestic banks and
foreign banks.
TYPES OF FOREIGN EXCHANGE TRANSACTIONS
Inter-Bank Transactions: Sale or Purchase of FX between Banks and other Financial Institutions (Market
Participants).
Merchant Transactions: Sale or Purchase transactions with the customers are called merchant transaction.
FACTORS AFFECTING EXCHANGE RATES: Exchange rates in the market are the outcome of the combined
effect of a multiple of factors. They can be classified as Fundamental, Technical and Speculative factors. The
factors are:
BoP: Surplus BOP in a country strengthens its currency.
Economic growth rate: High growth rate fuels imports and weakens the local currency.
Fiscal Policy: An expansionary policy, normally leads to a higher economic growth which in turn fuels imports.
Monetary Policy: Central banks determine monetary measures to influence and control interest and money supply.
Interest Rates: Domestic interest rates if high, attracts overseas capital (FDI, FII) leading to an excess supply of
foreign currencies resulting into appreciation of domestic currency in the short term. However if high interest
rates continue for a long term, economy will slow down, weakening the currency.
Political Issues: Without Political stability, there can be no economic stability (detrimental to the value of the
currency).
Technical reasons in Exchange Rate determination: Government controls, which determine the inflow and
outflow of capital, are considered technical reasons.
Speculation - a major factor in Exchange Rate determination: Speculative trading is a reality in Forex
markets. It is estimated that the speculative trade to daily forex turnover is above 90%.
CORRESPONDENTES OF ACCOUNTS
Banks dealing in international trade and foreign exchange maintain accounts in various foreign countries for the
purposes of settlements. They also enter into drawing arrangements such as overnight or regular overdrafts
limits, agency arrangements for international remittances, collection of cheques / bills etc. The international
banks involved are termed as foreign correspondents and the concept of providing such services is called as
Correspondent Banking. In a Correspondent banking relation, it is not always necessary that an account
relationship should exist. Some of the services can be rendered without an account. However, for arrangements
like Cheque clearing, OD arrangements, accounts are needed. The accounts when maintained by
banks in a Correspondent Relationship are classified as follows:
NOSTRO ACCOUNTS: NOSTRO Account means "OUR ACCOUNT WITH YOU". It is a foreign currency account
maintained by a bank in domestic country with a bank in foreign country.
VOSTRO ACCOUNT: VOSTRO Account means, "YOUR ACCOUNT WITH US". It is an account of a foreign bank
being
maintained in our country and with our bank. When. Vostro accounts are opened, KYC norms are compulsory in
India. Vostro accounts are to be operated in line with RBI guidelines.
LORO ACCOUNT: LORO Account means "THEIR ACCOUNT WITH THEM" This is an account of a third bank being
maintained by another or our bank.
MIRROR ACCOUNTS: These are dummy accounts maintained by banks to know actual position of their accounts
with the foreign correspondent banks. We may call it a pass-book of our accounts maintained with the
correspondents.
.INTERNATIONALCOMMUNICATIONSPAYMENTSYSTEMS
SOCIETY FOR WORLD WIDE INTER BANK FINANCIAL TELECOMMUNICATIONS (SWIFT)SWIFT an acronym for Society
for world wide inter-bank financial telecommunications is a joint, being exchanged physically. All foreign currency,
third country commercial payments are settled electronically.
FEDWIRE (USA): System of inter bank settlement operated by Federal Reserve Bank of USA. The facility is
available to member banks throughout USA. The .facility is available for paper instruments like cheques, demand
drafts also apart from online transactions. It is therefore available in both on-line and off-line formats. However, it
is restricted to US Dollar instruments only. It is not a general Inter-bank System but is restricted to Federal
Reserve Bank and Banks having their accounts with Federal Bank. It is meant for domestic settlements within
USA.
CHAPS (UK): Clearing House Automated Payments System (CHAPS) is the British equivalent to CHIPS, handling
receipts and payments in LONDON. This system also works on the net settlement system. non—profit co-
operative society owned by about 250 banks. Most of these are European and North American banks with
headquarter at Brussels. SWIFT is a world wide, computer based secure net work system and each member has
access to all the other members. It operates on a secure network. It is a large network of interconnected banks

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and financial institutes facilitating secure international dealings. It eliminates the need to maintain multiple coding
systems with various correspondents and totally removes the risk of theft of code books, errors creeping as a
result of not updating of code books etc. Messages are delivered in uniform perform or formats. This reduces the
chances of misinterpretation or confusion. Besides being confidential, safe, self authenticated and swift in real
sense, the system reduces the cost of the transaction too.
CHIPS (USA): CHIPS stand for Clearing House Inter bank Payment System. It is an electronic payment system
and is jointly owned by New York house clearing association members. It processes more than a million
instruments daily without
TARGET (EURO): Trans-European Automated Real-Time Gross Settlement Express Transfer system is a EURO.
payment system comprising 15 national RTGS systems working in EUROPE.
RTGS-PLUS AND EBA (EURO): These are other Euro clearing system. RTGS plus, is a German hybrid clearing
system operating as a European oriented real time gross settlement and payment system with over 60
participants. The EBA-EURO-1, with a membership of over 70 banks, in all EU member countries, works as,a
netting system with focus on cross border Euro payments. For retail payments, EBA has another system, called
STE01, Wit* over 200 members across EU zone. STEP 2 is also in use in EU zone, which facilitates straight
through processing (STP) to Member banks, using industry standards.
 RBI & EXCHANGE CONTROL IN INDIA
REPORTING TO RBI -STATEMENTS AND RETURNS,
For the purpose of monitoring, RBI calls for certain returns 8.‘ statements from ADs. Some important statements
are:
R Return — Fortnightly data for the purpose of compiling litalanceof .payments/monitoring transactions.
Authorized Dealers should report all transactions. made by them through. their Nostro Accounts abroad and
Vostro Accounts maintained with them inappropriate R Return, i.e. R Return (NOSTRO) and R Return (VOSTRO)
respectively, as laid down in the Guide to Authorized
Dealers for compilation of R Returns twice a month, at the close of business on 15th and the last day of calendar
month so as to reach Reserve Bank within seven calendar days from –the close .of reporting period to which they
relate.
AD Category - I Banks have to submit Bank-wise R-Retumpow (from the first fortnight of January 2009)
BAL STATEMENT - Statement showing balances in Nostro, Vostro accounts
NRDCSR-Consolidated _data on Non-resident deposits
INTERNATIONAL BANKING STATISTICS (IBS)-Quarterly data on all International Assets &Liabilities
XOS-Half yearly statement of Overdue Export RBI is empowered under statute to control and regulate the Foreign
exchange transactions, Forex reserves and policies related to inflows & outflows of Foreign exchange in the
country. It maintains the external value of the rupee both through policy measures and active intervention in the
markets when felt necessary. All transactions of Foreign exchange are governed by FEMA 1999', As per Se.c11
(1) of FEMA 1999, RE empowered to give directions in regard to Foreign Exchange transactions. Under Sec 11(3)
of FEMA 1999, RBI may after giving reasonable opportunities for hearing, impose on the authorized person, a
penalty which may extend to Rs.10,000/- (Rs. Ten thousand) for contravention of any direction given under FEMA
or failure to file any return under this act. In case of continuing contravention, an additional penalty which may
extend up to Rs.2,000/- per day for which such contravention continues may be imposed.
bills of US$ 25,000 and above
BEF-Half yearly Statement showing details of Import transactions where remittances have been effected but
evidence of Import not received (USD 100,000 & above).
FEMIS: Daily data on Forex dealing room operations
EBW: Half yearly statement showing Export Bills Written off (30 June & 31 December)
STAT-5: Statement of FCNR deposits (total inflow, outflow and outstanding under FCNR accounts)
STAT-8: Statement showing inflow/outflow of deposits under non-resident (external) rupee (NRE) accounts
scheme and NRO accounts scheme for the specified month
LRS- Liberalized Remittance Scheme of USD 2,00,000 for resident individuals: Monthly
FOREIGN MONNE MANAGEMENT ACT OF EMl)
With the country ushering in the 2nd phase of reforms, the Parliament passed the Foreign Exchange Management
Act (FEMA) 1999, on December 02, 1999, replacing FERA 1973. FEMA was implemented in India w.e.f. 1-6-2000.
Details of certain major departure made from FERA are provided hereunder:
1. The Govt. assumes the role of facilitator and promoters of the economic developments under FEMA.
2. There were 81 Sections in FERA while FEMA has 49 sections
3. FERA has Section 56 to deal with prosecutions stipulating a punishment of not less than 6 months and not
more than 7 years in addition to penalty for contravention of its provisions. FEMA holds out no threat of
prosecution and violations shall be treated as a civil offence.
4. Sec. 13 of FEMA provides for a penalty upto three times the amount involved for contravention and if the
amount is not quantifiable, the penalty can go up to Rs. 2 lac. A continuing offence can invite penalty, which
may extend uptoRs 5,000 per day. FERA provided penalty upto 3 times.
5. FEMA defines certain terms such as:
CAPITAL ACCOUNT TRANSACTION: One that alters the assets or liabilities outside India of a person
resident in India or assets or liability in India, of a person resident outside India.
CURRENT ACCOUNT TRANSACTION: Other than a capital a/c transaction and include payments due in
connection with foreign trade, other current business services and short term banking and credit facilities in
ordinary course of business.
EXPORT: Taking out of India to a place outside India, goods and services from India to any person outside India.
SERVICE: Service of any description which is made available to potential users and includes the provision of
facilities in connection with banking, financing, insurance, medical and legal assistance, real estate etc. FEMA
incorporates an inclusive definition of the term 'person' and takes in it any agency, office or branch owned or
controlled by such person. Any person residing in India for more than 182 days during the course of
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preceding financial year will be taken as resident in India. The definition also excludes persons going
outside India for taking up employment or for carrying on business outside India and those who go out with the
intention of staying abroad for an uncertain period. A body registered or incorporated in India is deemed resident
in India even if a foreigner or non-resident holds its entire share capital.
FEDAI AND ITS ROLE
Foreign Exchange Dealers Association of India (FEDAI) is registered under Companies Act 1956, and was
incorporated in the year 1958. The Association has been recognized by Reserve Bank of India, as well as Govt. of
India. The main functions of FEDAI are to lay down uniform rules and guidelines to be observed by all authorized
dealers in India. Some of its functions are:
1) Maintaining a close liaison with RBI and Govt. of India.
2) Maintaining a liaison with International Chamber of Commerce and other world bodies related to foreign trade
and business.
3) To circulate various policies matters and decisions related to foreign exchange business amongst the members.
4) Represents Indian foreign exchange dealers on policy matters related to foreign exchange dealings.
5) Maintaining of FEDAI rules regarding Transit period, Crystallization, Forward covers etc., that govern all the
members.
6) Other functions include approving Foreign Exchange brokers.
IMPORTANT FEDAI RULES:
1) All cancellations shall be at bank's opposite TT rates, TT selling rate for purchase contract and TT buying rate
for sale contract.-
2) In the event of delay in payment of Interbank foreign currency funds, interest at 2% above the prime rate of
the currency of the specified banks shall be paid by the seller bank.
3) In event of delay in payment of rupee settlement funds, interest for delayed period at 2% above NSE MIBOR
ruling on each day.
4) FEDAI, also prescribes code of conduct for Forex dealers, as also guidelines with regard to dealings with Forex
brokers. IMPORTANT FEDAI RULES:
HOURS OF BUSINESS: Left at the discretion of the banks now. Extended business hours for dealers, if any,
should be approved by respective management.
RATES: ADs will quote exchange rates in direct terms. All currencies to be quoted as — per unit of foreign
currency = INR, while JPY to be quoted as 100 units of JPY = INR.
EXPORT BILLS FOR COLLECTION: In the event of ADs delay of payment to the exporter, they will pay interest
from date of realization to the date of actual payment. ADs may utilize 1 to 3 claim to release payment depending
upon the distance/location of branch where payment has to be remitted.
CRYSTALLIZATION: Unpaid Export bills should be crystallized at TT selling rate. Earlier FEDAI rule made it
mandatory to crystallize unpaid demand bills 30 days after the transit period and Usance bills, 30 days after the
due date. However FEDAI has given the authorized dealers the freedom to decide-on the period for crystallization
which may be linked to risk factors like credit perception of different types of exporter clients, operational aspects
etc. In case the bills are realized after crystallization, TT Buying rate is to be applied.
IMPORTS: Unpaid foreign currency bills drawn under L/C will be crystallized on le day from due date at Bills
Selling Rates or Contracted rates.
INWARD REMITTANCES: All foreign currency inward remittances equivalent to Rs. one lac should immediately
be converted in Indian rupees. Inward remittance for more than Rs. one lac may be converted at the request of
the customer but within the ) permissible period. If the payment of inward remittance is delayed, ADs will pay
interest @ 2% over the applicable to SB accounts after a period of 10 days, for remittances up to Rs one lac and
for 3 days after remittance for more than Rs one lac.
FOREIGN CURRENCY FORWARD RATE CONTRACTS
All Forward contracts should be for a definite period and amount. In case delivery date has not been specified, an
option period of maximum one month may be given. In case the last date for delivery happens to be non-working
day for Forex dealing, preceding working day will be considered for effecting delivery.
All contracts, which have matured and have not been picked up, shall be automatically cancelled on the rh day
after the maturity
Date.
EXCHANGE RATES MECHANISM
Consequent to Liberalization, RBI has removed all restrictions on exchange rate quotations. Therefore, Indian
currency is on a boating rate system. Banks are now free to quote their own rates based on market rates. Market
rates are determined by forces I Demand and Supply. By convention, exchange rates can be quoted in two ways
viz.
DIRECT METHOD: A given number of units-of focal currencyper (47otioreign currency e.g. US$ 1= Rs. 45.00
INDIRECT METHOD: A given number of units of foreign currency per given units of local currency e.g. Rs. 100 =
US$ 2.222 India, it was the practice to use the Indirect method of quotation. The unit in India was Rs. 100.
However, with effect from 2ndus 1993 direct quotations are being used.
TWO- WAY QUOTATION: The foreign exchange quotation by the Bankbas two rates — one at which the quoting
Bank is willing buy and the other at-which it is willing to sell. For example: U S $ I = Rs 45.00 - 45,20 ere the
Bank will enter into purchase transaction at Rs 45.00 and Selftransaction at Rs 45.20. Hence the principle; Buy
low & all, high.
RATES: This rate is applied when the transaction does not involve-any -delay in realization of the foreign
exchange by the ink. In other words, the Nostro account of the bank would already have been credited. TT Buying
rate is arrived at each bankdeducting its required margin from the inter-bank buying rate that is being quoted in
the market. • w example, if SBI (market) is quoting US$1 = INR 44.20/25 in...the-market, JOB which needs to
arrive at its TT Buying rate pending on the market rate will quote as follows;
20 minus its desired margin of say 0 .15% as follows:
20 - 0.15% of 44.20 = 44.1337 (may be rounded to 44:1335)
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ire it is presumed that 10B will quote 44.1337 to the CUStoitier, buy dollars from him and sell it in the market SBI
in this ample) at 4.4 20.The difference goes in to the margin (profit) account of 10B.
BILL BUYING RATES: These rates apply when foreign bills, are purchased. Banks build in higher margins in Bill
buying to factor the higher risk and transaction costs. For Usance bills, banks quote rates taking the forward
premium or discount on the rrency for matching future periods also in to consideration.
FORAWARD RATES: When the delivery has to take place at a date farther than the spot date, then it is a
forward transaction 'aced out on Forward. rate. A currency could be quoted at a higher ('Premium') or a lower
('Discount') rate tar future liveries. Given the connection, between exchange rates and funds.cost in a totally free
market, the premium / discount on wards would tend to equal the difference in interest rates inthe IWO
currencies.
ARIVING AT FORWARD RATES: Forward rates are arrived as follows under normal circumstances
If the currency is quoted at a premium : Forward rate = Spot rate + Premium
If the currency is being quoted at a discount : Forward rate = Spot rate - Discount
Spot price.
Interestrate differentials in the currencies involved. -Term or tenor of the quote (One month, two month etc ).
Clean inward _remittances (PO, MT, TT, DD) for which cover has already been credited to ADs account abroad.
Conversion of proceeds of instruments sent for collection.
Cancellation of outward TT, MT, PO etc. Cancellation of a forward sale contract.'Bill Buying Rate Purchase /
Discounting of Bills and other Instruments.Where bank has to claim cover after payment. Where drawing bank at
one centre remits cover for credit to a different center. Foreign - TCs / Currency Notes:
Applied for purchase of Foreign TCs & Currency
EXCHANGE ARITHMETIC : During the course of their business, banks acquire FX from their Exporter/NRI and
other customers and sell FX to their Importer /other customers. They purchase and sell FX like any other
commodity. They have to cover their transaction costs after adding some profit too. Earlier the Foreign Exchange
Dealers' Association of India (FEDAI) used to issue guidelines for computing rates and bank charges for FX
transactions. However, FEDAI has given freedom to the banks for calculating rates / fixing charges for merchant
transactions. Therefore, in India, now FX rates are determined by market forces of Demand and Supply.
BANKS QUOTE BASED ON MARKET RATES: In practice, Exchange rates are quoted based on SPOT rates
available in the markets. Banks can choose from various sources and decide the market participant for their deal.
Let us say, the Market participant is quoting rates as follows for USD as: USD 1 = 46.25/35.
This means they will buy dollars at 46.25 and sell at 46.35.
SCENARIO-1: BANK HAS TO PURCHASE AN EXPORT BILL:
An Exporter has approached the bank with a bill denominated in US Dollars. He wants to know at whit rate the
Bank will buy the bill from him. The dealer knows once he buys the dollar bill from his customer, he has to sell it
in the market at Rs 46.25. If he has to make a profit in this transaction, he has to quote a figure lesser than Rs
46.25 to the customer. The difference which is called margin depends upon the Bank's policy. Assuming that the
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bank wants to make a 0.1% margin, the dealer will do the following calculations. Rate at which the Market buys
from him : 46.25000
Less 0.1% of 46.25 (46.25 X 0.10/100) : 0.04625
Rate to be quoted to Customer : 46.20375 rounded to 46.20
(Hint: Rounding off depends on the rule given in the problem) •
Thus, the bank will reduce its required margin from Market Buying rate and quote a suitable rate to the
customer.
SCENARIO-2: BANK HAS TO QUOTE A SELLING RATE TO AN IMPORTER
Let us say an Importer wants to retire a bill in US $. Bank has to now quote a selling rate to him. Once again the
Dealer will turn to the Market rates. This time, he needs to buy the Dollars from the market and sell them to the
Importer after making sure that his profits are assured Assuming that the Bank wants the same 0.1% margin
here also, the Dealer would do the following calculations: Rate at which the Market would sell him dollars : 46.35
Add Required Margin (46.35 X 0.1/100) : 0.04635
Rate at which Bank will sell to the customer : 46.39635 rounded to 46.40
SUMMARY : Margins are reduced from Market buying rates to arrive at Bank's buying rates.
Margins are added to Market selling rates to arrive at -Bank's selling rates:—
'Banks add different margins to different transactions depending on—their policy, risks. Transaction costs, stature
of the customer, current positions in the currency to be quoted under the same formula. In a Direct rate scenario,
the maxim is always "Buy low and Sell high"
EXAMPLES: If the market is quoting GBP 1=78.60/80, at what rate can your Bank buy GBP from the market?
Answer: GBP1=78.80
1. If you have to quote a TT buying rate for GBP with a 0.20% margin, what will be the quote if the market is
quotingGBP 1=78.50/70 round off to two decimals?
Answer:Market buying rate = 78.500, Less Margin @0.2% =0.157 , Rate to be quoted = 78.343 Rounded to
78.34
3.Inflow of USD 100,000.00 by TT for credit to your exporter’s account, being advance payment for exports
(credit received in Nostro statement received from New York correspondent). What rate will be applied if the
market is quoting 45.40/50 for USD. As the customer is very valuable, you are not collecting any margin in
this transaction:
Answer: When we apply rate to the TT received, we are purchasing USD from customer, we have to sell it in the
market. Market buys USD at Rs. 45.40. We shall have to quote rate based on 45.40, less our margin. Since we
don’t intend making any margin here as stated in the sum, the rate quoted will be USD1=45.40.
4.Your foreign correspondent maintaining a Nostro. Rupee account_ with your' bank, wants to fund his account
by purchase of Rs. 30.00 million, against US dollars. Assuming that the USD / INR interbank market is at
45.2550 .1 2650, what rate would be quoted to the correspondent, ignoring exchange margin. Calculate
amount of USD you would receive in your USD Nostra account, if the deal is struck.
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Answer: The Correspondent wants to credit INR 30 million i.e. INR 300,00,000 (Rs 3 crones). He will be placing
corresponding amount of dollars in our Nostro account with a request to convert and credit to his Rupee account
with us. In other words, we will be purchasing dollars from him and therefore have to quote a USD buying rate to
him.
Market rates (also called Inter-bank rates) are USD 45.2550/2650
Market buys from us at : 45.2550,Less margin (nil here) :,Rate to be quoted : 45.2550
Amount of dollars required for INR 30,00,00,00 is 30,00,00,00 = USD 662910.175 or USD 662,910.18 If the deal
is struck, the foreign bank would pay USD 662,910.18 to our USD Nostra account.
CROSS RATES : At times, direct quotes are not available for certain pairs of currencies in the market. For
example, we may have a quote for INR/USD and another for USD/GBP. However INR/GBP may not be readily
quoted. In such situations dealers arrive at INR/GBP rates using the Cross rate mechanism and the Chain rule.
CHAIN RULE
Rule for arriving at a comparison or ratiu between two quantities which are linked together through another
quantity and consists of a series of equations, commencing with a statement of the problem in the form of a
query and continuing the equation in the form of a chain so that each equation must start in terms of the same
quantity as that which concluded the previous equation. 1)You have to quote Cross rate for retirement of Import
bill for GBP 100,000by TT. Your margin is 0.15%. Market rate quotations are GBP / USD 1.8300 / 10, USD / INR
45.40/50.
Answer: This is an Import bill settlement, we have to sell the required FX i.e. GBP 100,000 to the customer. We
have to
thereforePuy this required sum of GBP 100,000 from the market. i--10.ru $ 1(Z-
The market is selling GBP as-I-GB11)1-.8300/83TrisFte-r3fore, first we need USD.
To buy USD, the rates quoted are 1USD = 45.40/50.
Since we are buying, the market rate will be USD 1=45.50.
We need to pay USD 1.8310 to get 1GBP.
Therefore we need (1.8310 X 45.50) INR. i.e. INR 83.3105 to buy 1 GBP. We have to add our margin which is
0.15% Final rate will be (INR 83.3105) plus ( 0.15% of 83.3105=0.1250) = 83.4355(TT selling rate)
2) M/s PQRS wants to remit JPY 10.00 million by TT value spot, as pa payment of an Import invoice.
Given that USD / INR is at 45.2500/45.2600 and USD / JPY is 108.15 / 108.25, and a margin of 0.15% is to be
loaded to the exchange rate, calculate rate to be quoted and the Rupee amount to be debited to the account of
M/s PQRS .
Answer: Since JPY is to be sold against Rupee, and the rate is not directly given, we would use cross rate
mechanism to calculate the same. We need to buy USD against INR and use the USD to buy JPY for the deal.
Thus, USD / INR rate would be 45.2600 (market USD selling rate — high) and USD / JPY at 108.15 (market JPY&
selling rate low). The JPY / INR rate would be 45.2600 / 108.15 = 0.418492 per JPY
100 JPY = 41.8492.
Add: Margin of 0.15 = 0.0628
41.9120
Rounded off to = 41.9100/100 JPY
Total rupee amount to be debited to the account of M/s PQRS would thus be 10,00,0000 X 41.9100= Rs.
41,91,000(Note: JPY is quoted as per 100 Yen, as per FEDAI guidelines)
FORWARD RATES : As we are aware, banks have to quote forward rates in certain cases such as:
While entering in to a Forward Sale or Forward.Purchase Contract, While discounting a Usance Bill.
By definition, Forward rates are rates quoted beyond Spot deliveries i.e. beyond T + two working days. While
quoting Forward rates, Banks take cognizance of Forward rates quoted by the markets.
The currency may be trading at a higher price (premium) or a lower price (discount) compared to the Spot prices.
The Forward rates are arrived at as follows: If !he Currency is at a Premium Forward rate = Spot rate + Premium
If the Currency is at Discount.Forward rate =Spot rate — Discount
After arriving at rates as above, Banks will build in their margins (add or reduce as the case may be) and quote
the final Forward rate to the customer.
1) On 5 January, Exporters tenders for discounting, e)pottbill_for US 500,000.00, drawn 90 days sight (transit
period 25 days) due date 30 April. Compute applicable rate and amount to be credited, presuming:
Exchange margin of 0.15%,
Spot Rupee 45.40/50 and premium Spot — April 40 paise,
Rate to be quoted to nearest 0.25 paise, and rupee amount to be rounded off, and
Interest to be charged at 7.50% for first 90 days and 10.50% thereafter. Answer:
Calculation of Bill buying rate
Spot Rate Rs. 45.4000
Less: 0.15% margin 0.06'$1 f
45.3319,Say 45.3325
Add: April Premium_ .4000
Rate of the transaction (Bill Buying Rate) 45.7325 ,Calculation of amount payable to the customer: USD
500,000.0J at 45.7325 = 2,28,66,250.00, Interest 90 days @ 7.50% = 4,22,869.00, 25 days @ 10.50 =
1,64,449.00
Amount payable to exporter = 2,22,78,932.00 (Commission and out of pocket expenses ignored)
2) On 15 September, a customer request for booking of a Forward contact for export bill of USD 150,000.00, to
be realized in the month of December. Answer:

7
For calculating rate for forward purchase contract, we need to take forward premium for November, the one that
the market would pay, i. e. 30 paise. Convention: For a sale contract premium for the full period, up to end date
of the contract shall be charged where as for Spot rate as 45.40, Premium : 0.30, Forward : Rate 45 .70
Forward Inter-bank rate arrived is 45.70 and deduct 0.05 paise as margin to arrive at 45.65 as customer forward
rate for delivery of export proceeds during December, full month at the option of the customer (Forward TT
Buying Rate).
3)On 1 January 2004, a customer requests to book Forward contract, for retirement of import bill for USD
100,000.00, due for payment on 15 March 2004. Given rates Spot / INA-4-6.00/95orward premium as under:
Spot January: 10/12, Spot February : 21/23, Spot March :32/34, Feb-15 to March: 5/6
Charge Margin of 0.20%, Answer: Being a merchant sale forward booking transaction, rate would be calculated as
under:
USD / INR spot to be taken as 46.05, Premium payable : Spot February 23 paise
Feb — 15th March 6 paise ,Add: Total premium 29 paise 0.29
Thus IB forward rate would be: 46.34
Add: Margin 0.20% 0.09,,patefor customer 46.43
FOREX DEALINIG ROOPLOPERIMONS
A Dealing Room in Bank is the nerve center of its Foreign Exchange activities. Some of the key functions are:
Quoting of daily rates for Merchant banking activities.
Managing the funds in the Nostro accounts.
Performing cover transactions for the positions resulting from Forex operations of all the branches after
aggregating figures.
Risk Management through limits, Derivatives and best practice.
Note: RBI lays general guidelines to banks for fixation of Open limit for daylight as well as Overnight positions.
The actual positions are fixed by Board of Directors now. A Day light limit is the level up to which the dealer can
take positions during the dealing operations. For exigencies, the dealer would refer to the Chief dealer and
'function accordingly. Overnight limits are also fixed currency wise, which would be much lower than the
Daylight limits Thisis because the dealers would require higher limits during the day to put through the
transactions based on merchant transaction by the branches and secondly, it is possible to make quick and
remedial transactions in case the market moves adversely. Since both these are not possible / required during the
night times, night time limits are lower always.
FEDAI has given Uniform Standard Accounting procedure for valuation of Foreign exchange profits and losses.
This valuation exercise is to be taken up once in quarter at, least. They also provide guidelines on the notional
exchange rates to be used for converting the FX positions to INR for balance sheet purposes
RISK ELEMENT & BRSICS OF DERIWITIVES
DEFINITION OF RISK
A risk can be defined as "uncertainties which may result in reduced earnings or outright loss" in the context of
financial transactions"
RISKS IN FOREIGN EXCHANGE OPERATIONS
Foreign exchange is a highly volatile commodity. The volume of foreign exchange transactions undertaken by the
banks is also increasing day by day because of liberalization of foreign trade and steps being initiated towards
globalization. Therefore, a strict discipline and internal controls emanating from Dealing Room are necessary to
avoid loss and to be on the safer side. The different types of Risks that exist in Forex operations are as follows:
EXCHANGE RISKForeign Exchange Risk is the risk which the banks face when they deal in multi-currencies and
take positions in these currencies. As is known, foreign market is open 24 hours of the day and the values of the
currencies are being determined every second by the markets factoring in all the information that come in to their
hands then and there. Demand, supply, balance of payments, trade deficit, government borrowings, inflation,
interest rate and political environment are the fundamentals which influence the markets. Using this information,
fluctuations in currencies are anticipated to a certain extent, but the element of uncertainty will always be there.
This element of uncertainty which may result in the value of the Currency ( in which the assets are held)
depreciating is called the Exchange risk. Banks necessarily get in to different positions in foreign currencies due to
merchant transactions entered with their constituents. An open position (open to risk) arises when the assets and
outstanding contracts to purchase that particular currency. (Forward purchase contracts) exceed the liability plus
outstanding sale contracts in that currency. Here, the bank has a long (overbought) _position. If the value of the
currency in terms of other currencies remains same, there is no risk. For example, let us say the ,,bank has an
open position in USD at USD 1 million. Today, it would get Rs.45 million against USD. Overnight if the rupee
appreciates against the dollar by a rupee (for example), the value of the holdings in USD in terms of the Indian
rupee would then
go down by one million rupees. Similar risks arise in oversold positions also. Thus exchange risks are inevitable if
there are open positions.
TYPES OF EXCHANGE RISK
TRANSACTION EXPOSURE: Transaction exposure measures the risk involved due to a change in the foreign
exchangerate between the time, the transaction is executed and the time it is settled..
TRANSLATION EXPOSURE: This relates to valuation of foreign currency assets and liabilities at the end of
accounting year
realizable values. These losses and gains are also known as accounting losses/gains. For example, if the bank has
granted a foreign currency loan (FCL or PCFC) for USD 100,000. to a customer and has accounted for the loan at
Rs.45 /USD in its books, The asset value would appear eroded if the rate at the end of the accounting year shows
Rs.44/USD. It may be noted that the asset° value continues at USD100,000 only but in the books of the bank
which is written in INR, there is value erosion. Translation losses affect a bank's accounting profits and
8
consequently valuations of banks in the market will suffer. This is significant for banks which have overseas
branches and subsidiaries. It is important to note that Translation exposures will ultimately become transaction
exposure when the asset or liability is actually converted / realized.
MANAGING FOREIGN EXCHANGE RISK
The magnitude of this risk is dependent on the level of exposures. Level of exposure is the only element, which is
within one's control. The first step in Forex risk management is therefore fixing its open foreign exchange open
position limits.
These open position limits are classified as two types. Daylight limit & Overnight limits
Overnight limits are the maximum amounts the bank is willing to put at risk at the time the foreign exchange
market is closed in the time-zone in which the bank is operating.
Daylight limits refers to the maximum amount that the bank is willing to put at risk at any point during the
dealing day.
The Daylight limit is normally higher because:
The dealers need a higher limit to accommodate client flows during business hours. It is easier to manage
exchange risk when the markets are open. Overnight position is lower being susceptible to uncertainty during the
time when the dealer is not viewing the markets which are active elsewhere in the world. The overall limits fixed
by the top management are further distributed amongst the various dealing rooms (if more than one is present),
within each centre, dealer wise limits are allocated such that the aggregates fall within the stipulated limits.
During the day real-time monitors are in place and overnight-day end positions are aggregated and checked.
Mismatched Positions and Gap limits: If the maturity spread between foreign currency assets and liabilities are at
variance, a mismatched position would arise. Mismatched positions lead to gaps which have to be bridged using
various hedge tools. Banks have to be particularly careful if liabilities mature earlier to assets as t he risk is higher
(It may become difficult to borrow funds at reasonable cost or conclude a deal & ensure that bank has necessary
foreign currency funds to meet the liability on due dates)
COUNTRY RISK: Country Risk may be defined as the risk to operating cash flows, or to the value of investment,
resulting from operating in a particular country. At the macro level, Country Risk includes both sovereign risk and
currency risk. The major elements of Country Risk are: Economic Risks • Political Risks • Social and Cultural
Risks.
Political stability, in itself may not be a sufficient reason for not doing business with or in a country. The Banks
need to look at all the dimensions of country before reaching a conclusion on whether or not to do business with a
particular country. Banks are required to formulate a Country Risk Management Policy (CRM) for dealing with the
country risk problems only in respect of that country, where a bank's net funded exposure is 2 per cent or more
of its total assets. The CRM policy should stipulate rigorous application of the 'Know Your Customer' (KYC)
principle in international activities
which should not be compromised by availability of collateral or shortening of maturities. Country risk element'
should be explicitly recognized while assessing the counter-party risk.
Provisioning I Capital requirement: Banks in India have to make provisions (with effect from the year ending
31 March 2003)on the net funded country exposures on a graded scale ranging from 0. 25 to 100 per cent,
according to the risk categories
CREDIT RISKS : Credit Risk arises when a party to a contract is either unable or unwilling to perform his
obligation of a contract. The failure to execute may also be due to official regulation. Thus the risk associated with
default is the element of credit risk in foreign exchange transactions. The default risk has: two elements
associated with it. These are termed as "Revaluation Risk" and Settlement Risk".
Revaluation Risk: It is the cost (in the event of a counter party default) of replacing non-settled contracts. For
example, if ABC
bank needs USD One million on a particular day and gets in to a contract with XYZ Bank for getting the dollars, it
will suffer the revaluation risk being the cost associated with arranging for USD One million at short notice if XYZ
Bank defaults in its contractual obligation of selling the required USD One million as per its contractual obligation
to ABC Bank.
Settlement Risk: Let us say that a bank buys USD 1 million from Bank B. What if after receiving the INR
equivalent, Bank B fails to deliver the foreign currency? This risk of the Counter-party failing to deliver is known
as Settlement risk. Famously known as the Herstatt or Temporal Risk, this risk is incurred 'By Chance" where one
party honors the contract but the other party fails to do so because it is across border and the business hours on
the other end are either over, or have not yet started. Such risks occur when counter parties are located in
different time zones. This is called Herstatt risk because in 1974, several banks that had entered in to
transactions with Bank Herstatt in Germany faced losses when Herstatt bank was put under liquidation after the
transactions were initiated by these banks but before they were settled by the German bank due to the difference
in the time-zone. Herstatt risk can be controlled by matching the time zones (notionally) and also by putting
counter-party limits in place.
LEGAL RISK: Legal risks are the risk of non-enforceability of a contract.
SYSTEMIC RISK: The risk of the entire system collapsing due to collapse of a major institution. In recent times-
Subprime crisis in major banks in U.S.A led to a chain of events but was fortunately halted by the US Fed & other
Investors taking prompt action)
OPERATIONAL RISK: Risk arising out of human errors, frauds, technology failures etc. Operational risk arises as
a result of human, machine failures, judgmental errors, frauds and so on. The very famous case of judgmental
errors and trading by a single individual (a dealer called Nick Lesson) resulting in the collapse of his bank itself
(Barings—UK) and recently Jerome Kerviel of Societe General resulting in multibillion losses are well known
examples of operational risk.
For effective control of suck risks few measures as follows are commonly taken: Segregating Dealing,
Accounting (Back-up) and Control (Audit). Each of these functions should be independent of the others such that
checks and balances are in place.
9
Proper information channels should be in place Selection, training and Job rotation of staff in key positions is
critical to risk management in these areas. Reconciliation of Nostro accounts (with mirror accounts) and control
Over Nostro transactions, funding. Concurrent and on-site audits. Review mechanism to analyze losses and
investigate reasons Proper security systems. Here Security involves both physical security of Hardware and digital
security.
DERIVATIVES- ORIGIN & ROLE IN RISK MANAGEMENT : Derivatives are hedging instruments derived from
the values of the underlying exposures such as commodities, currencies or shares and bonds. Derivatives are
financial contracts which derive their value off a spot price time-series, which is called the "underlying". Common
derivative instruments are Forward contracts, Options, Swaps, Forward rate agreements, and 'Futures.
Derivatives do not have independent existence without underlying product and market. The underlying assets
could be a stock index, a foreign currency, a commodity or an individual stock. The simplest form of derivatives is
the forward contract (known as the forefather of the derivatives).
FUNCTIONS OF DERIVATIVES: The primary purpose of the derivative instruments is not to borrow or lend
funds but to transfer prii risks associated with fluctuation in asset values. The derivatives provide three important
economic functions viz.
a) Risk Management. b) Price Discovery c) Transactional Efficiency.
TYPES OF DERIVATIVES: The commonly used derivatives are as follows: a) Forward contracts b) Futures
c) Options d) Swaps
.FORWARD CONTRACTS:'Authorised dealers (Banks) have been permitted under FEMA to enter in to Forward
contracts for sale or purchase of Foreign Currency with their customers who are exposed to foreign currency risks
arising out of their normal transactions which are permitted under current regulations. The mechanism of Forward
Contract is very simple. On being approached by a customer for a forward cover, the AD would satisfy himself
that there exists a genuine exposure and quote a rate. For example, if an Importer who is required to pay an
inward bill maturing after one month may approach his banker for a forward cover. This is because the importer is
either risk averse or feels that the rupee / dollar rate would move against him in the intervening month. The bank
would then quote a forward rate. If the customer is satisfied with the quotation, he would sign the contract which
would bind him to the rate and the date. Contract documents are signed and charges if any are collected. If the
customer fails to perform his part of the contract, the contract is cancelled and Swap charges are recovered
where necessary. Similar contracts can be entered in to different customers based on their requirements. In other
words subject to RBI / FEDAI guidelines, banks enter in to contracts to seli or buy specified amount of foreign
currency- on specified futUre dates.
Forward Contracts are either Forward purchase contracts or Forward Sale contracts depending on the nature of
the transaction. Exporters, NRIs, holders and so on would enter in to Forward purchase contracts. Importers,
Constituents who have to make payments under foreign currency loans and so on would enter in to Forward sale
contracts. It is again emphasized that the word purchase and Sale are used from the point of view of the Bank
and not the customer. Forward Contracts inIndia are governed by RBI guidelines and FEDAI rules RBI has
permitted all entities having Exchange risk exposures permission to enter in to Forward contracts subject to rules
and limits
FUTURE CONTRACTS: A future contract is defined as a "commitment to buy or sell at a specified future
settlement date a designated amount of commodity or a financial asset. It is a legally binding contract by two
parties to make / take delivery of commodity at Certain point of time in the future.
MAIN FEATURES OF FUTURES CONTRACTS FEATURES OF FUTURES MARKETS

1)Futures are traded on Security Exchanges. 1) High level counter trading
2)Futures contracts have standard contract terms. 2) Physical exchange rare.
3)Futures exchanges are associated with clearing 3) Very high degree of leverage as margin based trading
houses. takes place.
4)Futures' trading requires margin payments and daily 4) Low default levels
settlement.
5)Future positions can be exited easily
6)Futures markets are regulated by regulatory
authorities(SEBI in India)
DIFFERENCE BETWEEN FUTURES AND FORWARDS: Futures and forwards contracts are very similar to each
other in terms of contractual obligations. However there are certain distinguishing features which are as follows:
FUTURES CONTRACTS FORWARD CONTRACTS
Traded on organized stock exchanges. Over the Counter ( OTC) products. Offer flexibility
Issued in standard forms and do not have flexibility and are custom made.
regarding quantity or quality( of commodity to be delivered) Indian banks entering in to Forward contracts
Regulated by SEBI, RBI and other agencies. have to followRBI guidelines.
THE MARGIN PROCESS: Futures are traded on Exchanges which allow margin based trading. Future contracts
are marked to market on daily basis. Three types of margins are involved which form the backbone of Exchange
traded Future contracts.

10
Initial Margin: At the start of every contract initial margin is to be paid to the exchange either in cash or
approved / liquid securities. (Treasury bills, bonds, bank guarantees).The leverage allowed is quite high. For;
example, in London International Financial Futures Exchanges (LIFFE) initial margin for a Euro / Dollar Contract
size of USD 1 million is reported to be USD 500 only. Thus any person with only USD 500 can enter into a large
value future contract of USD 1.00 million.
Variable Margin: This is calculated on daily basis, by marking to market the contract at the end of each day.
This margin is normally to be deposited in cash only. The exchange makes the margin call, upon erosion in value
of the contract which is Normally to be deposited and made available in the margin account with the exchange by
next morning. In case of appreciation in value of the contract, the difference occurs to the buyer and the same is
credited by the exchange to this margin account.
Maintenance Margin: This margin is similar to minimum balance stipulation for undertaking and trades in the
Exchange and has to be maintained by the buyer / seller in the margin account with the exchange. The exchange
is also authorized to debit / credit the variable margin to this amount as such the party needs to constantly fund
the account to avoid continuous erosion in the value of contract.
CONCEPT OF OPTIONS: An option is a contract conveying the right but not the obligation to buy or sell a
specified financial
instrument fixed rice before or at a certain future date.
THE OPTIONS BUYER THE OPTION SELLER EXERCISE PRICE OR STRIKE PRICE
THE OPTIONS BUYER
The option buyer is also called as Also called Option writer, he deals in
holder/owner. The option has a Options. The Writer will sell asn
premium and purchases the Option (whether it is a Buy option or a
option which confers a right to The price at which the Option Buyer has
sell option as per the counterparty’s
buy or sell the currency(as the contractual rights to buy or sell the curre
requirement) for a fee called
case may be) at an agreed price Premium. He has to perform his is called the exercise price or strike price
in exchange for another currency commitment only if the holder
at a future date. chooses to exercise the option.
TYPES OF OPTIONS: 1. Classification based on underlying transaction

CALL OPTION: The owner / buyer has the right to purchase and the writer / seller has the obligation to sell
specified number of shares of the underlying stocks at a specified price prior to the option expiry date..
PUT OPTION: The owr,atir buyer has the tight to sell and the writer / seller has obligation to buy specified
number of the
underlying shares at a ified price prior to the options expiry date.
2). CLASSIFICATION BASED ON EXECUTION : Options are classified as follows depending on the time of
execution permitted:
1) American Options: Option holder can exercise the option any time during the option term. ';2) European
Option: Option holder can exercise the option only at the end of the Option period. Thus we can have four types
of Options;
a) American Call Option, b) American Put Option, c) European Call Option, d) European Put Option.
In India, earlier only European Options were permitted. However, recently, RBI has permitted American options
also. Recollected Question: In case of a put option, if the strike price is more than the spot price on the date of
maturity of option, it is known as:
a) In the money *b) Out of money c) At the money d) Above the money
IN-THE-MONEY OPTION I AT-THE-MONEY OPTION OUT-OF-THE-MONEY OPTION

11
An out-the-money- (OTM) option is an
An at-the-money
An in-the-money (ITM) option is an option option that would lead to a negative
(ATM)option is an option that
that would lead to a positive cash flow to the cash flow it was exercised immediatel
would lead to zero cash flow
holder if it ere exercised immediately. A call A call option on the currency (say USD
if it were exercised
option on the currency (say USD) is said to is said to be OTM when the current or
immediately. An option on
be in the money when the current value of market value of the currency stands a
the currency (say USD) is at-
currency (say USD) stands at a level higher level which is less than the stroke pric
the-money when the current
than the strike price , the call is said to be F the currency is much lower than the
value of the currency in the
deep ITM. On the other hand, a put option strike price, the call is said to be deep
market equals the strike
on currency is said to be ITM if the value of OTM. On the other hand, a put option
price (i.e. spot price= strike
currency is below the strike price. currency is OTM if the value of curren
price).
is above the strtike price.
SWAP & COVER DEALS : Swap literally means exchange of commodities. In banking, Swap in a foreign
exchange market refers to simultaneous sale and purchase of currencies.
CURRENCY SWAPS: Exchange of predetermined streams of payments in different currencies on pre-determined
dates, at pre-determined exchange rates. Here there are two simultaneous deals for the same amount as follows
One at the spot and other for future date or Both for future dates..
In other words, in Swan Deals, there are two different transaction / maturity dates for the same amount. Some
examples are as follows:
A transaction where bank buys Rs. 1 lac USD spot (against rupees) and sells 1 lac USD one month forward.
A transaction where bank sells Rs. 1 lac USD spot and buys 1 lac USD one month forward.
A transaction where bank buys Rs. 1 lac USD one month forward and sells 2 months forward.
A transaction where bank sells Rs. 1 lac USD one month forward and buys 2 months forward.
WHY SWAP DEALS?
Banks have to meet obligations arising .out of merchant transactions with customers such as Forward contracts
and normal Sale / Purchases where there is a time lag. They also have to manage their Foreign Currency holdings
(FCNR balances).They may go for swap operations for short-term interest arbitrage. Under such operations, they
buy one currency from a place where interest is low and sell at some other market to buy another currency where
interest is high. They also cover their cross currency future maturity deals by swap operations. The most
compelling reason being avoidance of exchange risk on their open positions. The Swap deals are made for future
coverings. Therefore, it is the future points or margins that affect the swap rates. Every swap operation has two
legs / aspects:
SODHANI COMMITTEE RECOMMENDATIONS 1992
The expert group on foreign exchange, headed by Shri OP. Sodhani, the then Executive Director of the RBI had
submitted following recommendations for enabling the market participants to hedge of Forex risks after studying
the existing facilities/regulations. These .would help develop and deepen the Forex markets in India. Some of the
important recommendations are' given hereunder: Corporates should be permitted to hedge upon declarations of
the underlying exposures.
Banks may be permitted to initiate overseas cross currency positions
Banks should be allowed to borrow, lend in the overseas markets.
To increase number of market participants (allow more entities to participate).
Corporates must be permitted to cancel and re-book Option contracts.
Banks to be permitted to use hedging instruments for their own assets / liability management (Proprietary).
Banks should be allowed to offer hedging products, like caps, collars, etc.
Banks to be allowed to fix interest rates on FCNRB deposits, subjects to caps, as prescribed by RBI.
Most of the recommendations of the expert group have since b. en implemented by the RBI, giving more freedom
to the market participants.
DERIWITIVES -1MPORTfitilr RBI. GUIDELINES
1) Resident Indians with underlying exchange exposures can book Forward contracts to the extent of USD
100,000 for a tenor not exceeding one year without any underlying documentary proof.
2) SMEs can book Forward contracts for their exposures. Banks need not insist on underlying documentary
evidence.
3) AD banks may enter into forward contracts with NRIs as per the following guidelines to hedge:
The amount of dividend due to him on shares held in an Indian company.
The balances held in the Foreign Currency Non-Resident (FCNR) account or the Non-Resident External.
Rupee(NRE) account. Forward contract with the rupee as one of the legs may be booked against balances in both
the accounts. With regard to balances in FCNR(B) accounts, cross currency (not involving the rupee) forward
contracts may also be booked to convert the balances in one foreign currency to another foreign currency in
which FCNR(B) deposits are permitted to be maintained.
Investment made under the portfolio scheme in accordance with the provisions of FERA / FEMA.
4) Exporters / Importers can book Forward covers to hedge their exposures based on Documentary evidence to
the extent of exposure. AD banks may also allow Importers and Exporters to book forward contracts on the basis
of a declaration of an exposure and based on past performance up to the average of the previous three financial
years' (April to March) actual import / export turnover or the previous year's actual import/export turnover,
whichever is higher, subject to the following conditions:

12
The forward contracts booked in the aggregate during the year and outstanding at any point of time should not
exceed the eligible limit i.e. the average of the previous three financial years' (April to March) actual import /
export turnover or the previous year's actual import/export turnover, whichever is higher.
In the case of exporters, the amount of overdue bills o/s should not be in excess of 10 % of the turnover.
Contracts booked in excess of 75 % of the eligible limit will be on deliverable basis and cannot be cancelled.
These limits shall be computed separately for import/export transactions. Any forward contract booked without
producing documentary evidence will be marked off against this limit.
Importers and exporters should furnish a declaration to the AD banks regarding amounts booked with other
authorized dealer category-I under this facility. An undertaking may be taken from the customer to produce
supporting documentary evidence before the maturity of the forward contract.
CONTRACTS OTHER THAN FORWARD CONTRACTS :AD banks may enter into Foreign Currency-Rupee Option
contracts with their customers on back-to-back basis. They are also permitted to run an options book subject to
prior approval from the Reserve Bank. All guidelines applicable for forward contracts are applicable on rupee
option contracts also...
Facilities for Authorized Dealers Category-I Management of Banks' Assets-Liabilities AD banks may use the
following instruments to hedge their asset-liability portfolio:Interest Rate Swaps,Currency. Swaps, and Forward
Rate Agreements.
AD banks may also purchase call or put options to hedge their cross currency proprietary trading positions subject
to a well formed policy at the Board level and after ensuring that the value and maturity of the hedge should not
exceed that of the underlying.
FOREIGN EXCHANGE_FOCILITIES_FOR RESIDENTS : As per Section 5 of FEMA resident- Indians are

permitted to buy or sell foreign exchange from any ADs/FFMC for any current account transactions (except for
those transactions where restrictions have been imposed by Central Govt.). Release of FX beyond these limits will
require prior approval from RBI. ADs can accept payment in cash up to Rs. 50,000 only against sale of foreign
exchange as per FEMA. Wherever the sale of foreign exchange exceeds the amount equivalent to Rs. 50.000, the
payment must be received only by a crossed cheque / BC/ Pay Order / DD or Credit / Debit / Prepaid cards
subject- to conditions (KYC norms to be fulfilled).
•
PURPOSE AMOUNT IN USD OR DETAILS
O EQUIVALENT
1. Tourism / Private US $ 10,000 Per Financial year per family member for one or more visits a
Visits (except Nepal Can avail foreign exchange through International credit cards
and Bhutan eligible. specified limits. The limit can be availed along with FX for trav
abroad for, any purpose, including employment / immigration
studies.
2. Gift/ Donations US $ 1.25 lac Now as Part of Liberalized Remittance Scheme LRS
3. Employment Abroad US $ 1 lac To Indian resident going abroad for gainful employment.
4. Immigration Abroad US $ 1 lac
To meet the incidental expenses in the country of migration.
Production of . evidence that the traveler has obtained immig
visa is necessary.
5. Education Abroad US $ 1 lac or the estimate Per academic year of the Institute where admission has been
whichever is higher. obtained.
6. Medical Treatment US $ 1 lac Self dedication basis without insisting on any estimate from a
. Abroad hospital/doctor in India/abroad.FX exceeding the limit of USD
is subject to the request being supported by an estimate from
hospital/doctor in India to abroad.
This (USD 100,000-treatment expenses) is in addition to USD
eligible for maintenance expenses of the patient or for accomp
as attendant...
. Maintenance of US $ 1 lac Declaration basis
close relative
Business Trip US $ 25,000 Available per trip except to Nepal and Bhutan
Covers visits for International trade conferences, Seminars, T
9. Small Value US $ 25000 For any permissible transaction on the basis of simple letter fr
Remittances applicant
without insisting on submission of Form A2.
OTHER IMPORTANT ASPECTS: The FX purchased should be utilized within 180 days. If not used, it has to be
surrendered to an Authorized Person.
CURRENCY NOTES / COINS UP. TO US $ 3000: -Resident Indians going abroad can avail a maximum of US $
3000 in currency notes (cash) and balance in the form of traveller cheques or bank DD. Exceptions: Iraq and
Libya - USD 5000 or its equivalent;Iran, Russian Federation and other Republics of CIS - Entire forex in the form
of foreign currency notes or coins.

13
INDIAN CURRENCY NOTES: (a) Indian Residents can carry Indian currency notes up to Rs. 7,500 to any
country except Nepal & Bhutan. For Nepal & Bhutan any amount in denomination not exceeding Rs. 100 can be
taken.
(b) Incoming Indians can bring INR currency notes up to Rs. 7,500 from any country except Nepal or Bhutan from
where the Resident Indian can bring any amount in denomination not exceeding Rs. 100.
UNSPENT FOREIGN EXCHANGE: Foreign exchange up to US $ 2000 in form of foreign currency notes or TCs
can be retained by Resident Indians (Optional) The balance (over and above USD 2000) has to be necessarily
surrendered to Authorized dealer within 180 days both in case of currency notes and traveller cheques to be
either deposited in a RFC (Domestic) account or converted back into Indian rupees.
CURRENCY DECLARATION FORM (CDF) :A person (including a Resident) can bring any amount of Foreign
Exchange from abroad, which may be in the form of currency notes or traveller cheques. However, if the amount
exceeds US $ 10,000 or its equivalent in TC/Currency and / or the value of foreign currency notes exceeds US $
5,000 or equivalent in any foreign currency. he has to declare his holdings to the Custom authority at the
port/Airport of arrival in Currency Declaration Form (CDF).
BORROWINGS BY INDIVIDUAL RESIDENTS: An Individual resident may borrow a sum not exceeding US $
2,50,000 or its equivalent from-close relatives residing outside India subject to the condition that the minimum
maturity period of loan is one year, the loan is free of interest and the amount of loan is received by way of
inward remittances in free, foreign exchange through normal banking channels or by debit to the NRE / FCNR (B)
account of the non-resident lenders.
GIFT OF GOODS: The limit for export of goods by way of gifts Rs five lass per annum.
RBI LIBERALISES FOREX NORMS FOR INDIVIDUALS LIBERALISED FOREX FACILITIES FOR
INDIVIDUALS UNDER THE FEMA 1999
A) NRIs can be Joint Holders in Resident's SB / EEFC / RFC Accounts: Individual residents in India are now
permitted to include non-resident close relative(s) as joint holder(s) in their resident bank accounts, namely,
Savings(SB), Exporter Earners’ Foreign Currency (EEFC) and Residents’ Foreign Currency (RFC) accounts, on
‘former or survivor’ basis.
B) Residents can be Joint Holders in NRE/FCNR Accounts: Non-Resident Indians (NRIs) / Person of Indian Origin
(PIO), are now permitted to open Non-Resident (External) (NRE) Rupee Account Scheme / Foreign Currency
(Non-Resident) (FCNR) Account (Banks) Scheme with their resident close relative(s) as joint holder(s) on
‘former or survivor’ basis.
C) Residents can gift Shares / Debentures upto USD 50,000 Value: A person resident in India can now give to a
person resident outside India, by way of gift, any security / shares / debentures of value upto USD 50,000 in
value per financial year subject to certain conditions. Earlier, a person resident in India could give to a person
resident outside India, by way of gift, any security / shares / debentures of value upto USD 25,000 per
calendar year.
D) Sale Proceeds of FDIs can be credited to NRE/FCNR (B) Account: Sale proceeds of Foreign Direct Investment
(FDI) can be credited to Non-Resident (External) Rupee (NRE) Account Scheme/Foreign Currency (Non-
Resident) Account FCNR (Banks) Scheme provided the original acquisition was by way of inward remittance or
funds held in their NRE/FCNR (B) accounts.
E) Gifts to NRIs can be credited to NRO Accounts in Rupees: Resident individuals are now permitted to make
rupee gifts within the overall limit of USD 1,25,000 per financial year as permitted under the Liberalised
Remittance Scheme (LRS) to an NRI/PIO who is a close relative by way of crossed cheque / electronic transfer
to the Non-Resident (Ordinary) Rupee Account (NRO) of the NRI / PIO.
F) Loans to NRI Close Relatives can be given in Rupees: Similarly, Resident individuals are now permitted to lend
in Rupees within the overall limit under the Liberalised Remittance Scheme of USD 1,25,000 per financial year
to a Non Resident Indian (NRI) / Person of Indian Origin (PIO) close relative by way of crossed
cheque/electronic transfer, subject to certain conditions.
G) Residents can repay the loans given to NRI Close Relatives: Resident individuals are now granted general
permission to repay loans availed of in Rupees from banks in India by their NRI close relatives. Earlier,
repayment of loans by close relative in respect of Rupee loan availed by NRIs was restricted only to housing
loans.
H) Residents can bear Medical Expenses of NRIs: Residents will now be allowed to bear the medical expenses of
visiting NRIs / PIOs close relatives. Earlier, residents were allowed to make payment in rupees towards
meeting expenses on a/c of boarding, lodging and services related to it or travel to and from and within India
of a person resident outside India and who is on a visit to India.
I) NRO accounts by Foreign Nationals: To facilitate the foreign nationals to collect their pending dues in India,
AD Cat-I banks may permit foreign nationals to re-designate their resident a/c maintained in India as NRO a/c
as under.
a) AD Category-I bank should obtain the full details from the account holder about his legitimate dues expected
to be received into his account.
b) AD Category-I bank has to satisfy itself as regards the credit of amounts which have to be bonafide dues of
the account holder when she / he was a resident in India.
c) The funds credited to the NRO account should be repatriated abroad immediately, subject to the AD Category-
I bank satisfying itself regarding the payment of the applicable Income tax and other taxes in India.
d) The amount repatriated abroad should not exceed USD one million per financial year.
e) The debit to the account should be only for the purpose of repatriation to the account holder’s account
maintained abroad. There should not be any other inflow / credit to this account other than that mentioned
above.
The account should be closed immediately after all the dues have been received and repatriated as per the
declaration made by the Account holder.
LIBERALIZED REMITTANCES SCHEME (LRS)
Resident Indian individuals are permitted to freely remit up to USD 125,000 per financial year for any current or
capital account transactions or a combination of both. (For example to acquire and hold immovable property or
shares or any other asset outside India) without prior approval of RBI. Individuals will also be able to open,
maintain and hold foreign currency accounts with a bank outside India for making remittances under this scheme.
The foreign currency account may be used for putting through all transactions connected with or arising from
remittances eligible under this scheme.
LRS facility is in addition to the Remittances allowed as above except in the case of Gifts / Donations.
Gifts/Donations are subsumed under LRS. No sub-limit within the overall limit of USD 125,000. Should have been
a Customer of the bank for a minimum of one year. PAN number is mandatory. For this facility, applicants should
designate one branch of one bank.
Remittances can be consolidated in respect of family members subject to the individual family members
complying with the terms & conditions of the Scheme. The LRS for Resident Individuals is available to all resident
14
individuals including minors. In case the remitter is a minor, the LRS declaration form should be countersigned by
the minor's natural guardian. Facility is available only for Resident individuals and is not to corporates,
partnership firms, HUFs, trusts, etc. Facility is not available for the following:
Prohibited purposes such as purchase of Lottery tickets, Sweepstakes, Proscribed (prohibited) magazines etc.
Remittances either directly or indirectly to Nepal, Bhutan, Pakistan or Mauritius or Countries identified by Financial
Action task force. Remittances directly or indirectly to Individuals /entities identified by RBI as posing significant
risk of terrorism.
FX FOCILMES TO RESIDENTS OTHER THAN INDIVIDUALS

ADs have been permitted to make remittances on account of donations by Corporates for some specified purposes
subject to a limit of one per cent of the foreign exchange earnings during the previous three financial years or
USD 5 million, whichever is less. Other residents like partnership firms, trusts etc., are free to remit up to USD
5,000 per annum per donor / remitter each as gift and donation. Remittances exceeding the limit will require prior
permission from the Reserve Bank
FOREIGN CURRENCY ACCOUNTS FOR RESIDENT INDIANS
PARTICULARS RESIDENT FOREIGN CURRENCY A/C RESIDENT FOREIGN EXCHANGE EARNER'S FORE
(RFC) CURRENCY (DOMESTIC) A/C CURRENCY A/C (EEFC)
(RFC-D)
Who can open For returning Indians, i.e. those who Resident Individuals A person resident in India w
an Account. were non residents of Indian includes individuals, firms,
Nationality or origin, who have been companies etc.
resident outside India for a
continuous period of not less than 1
year.

15
Source of fund By foreign inward remittances, Foreign exchange required Status Holder' Exporter.
transfer of FCNR While on a visit to any place Individual Professionals.
(B) deposits, NRE deposits. outside India by way of 100% Export Oriented Units
By inward remittances in foreign payment for services. Units in
currency of 0 From any person not Export Processing Zone
pensions, superannuation benefits resident / Software
etc., received from erstwhile in India or who is on a visit to Technology Parks / Electron
employers abroad. India Hardware
By surrender of Foreign Currency (FC) in settlement . of any Technology Parks
/ Foreign lawful Others
Currency Travellers' Cheques (FCTC) obligation. All can deposit 100% of thei
to the bank by the account holder in By way of honorarium or gift earnings in EEFC, subject to
person subject to CDF rules (Third while on a visit outside India. condition that the sum total
party TCs not permissible). From an authorized person the accrual in the a/c during
By surrender of balance of FCs / TCs for calendar month should be
availed travel abroad and converted into rupees on or
during visits abroad provided the represents before the last succeeding
original amount was paid out of unspent forex acquired during calendar month after adjust
repatriable funds. travel abroad. for utilization of the balance
Foreign exchange acquired as gift or approved purposes or forwa
inheritance commitments.
from person who was NRI. '
Types of
Savings, Current, Term Deposit Current Account Current Account
account
Currency of
Discretion &the Bank. Discretion of the Bank. Discretion of the Bank.
Account
Period for As per FCNR scheme Not Applicable. Not Applicable.

fixed
deposits
Rate of
As per FCNR scheme No interest is payable No interest is payable
Interest
End Use Balances can be used for local For permissible current and For bonafide purposes.
payments as well as for repatriation capital account transactions. Balance and interest freely
Funds can be transferred to NRE / Balance and • interest repatriable.
Loans & Not permitted Not permitted Not permitted
Overdrafts
In India &
Abroad
Nomination
Available _ Available _ Available
Facility
FORWARD CONTRACT FACILITIES FOR RESIDENTS: In order to enable Small and Medium Enterprises (SMEs
as per RBI definition), having direct and / or indirect exposures to foreign exchange risk to manage their
exposures effectively, it has been decided to allow them to book / cancel / rebook / roll over Forward Contracts
through AD Category - I banks without production of underlying documents, subject to the following conditions:
Such contracts may be booked through AD Category - I banks with whom the SMEs have credit facilities and the
total forward contracts booked should be in alignment with the credit facilities availed by them for their foreign
exchange requirements or their working capital requirements or capital expenditure.
AD Category - I bank should carry out due diligence regarding 'user appropriateness' and 'suitability of the
forward contracts to the SME customers as per RBI !s 'Comprehensive Guidelines on Derivatives'
The SMEs availing this facility should furnish a declaration to the AD Category - I bank regarding the amounts of
forward contracts already booked, if any, with other AD Category - I banks under this facility. SMEs are also
permitted to use foreign currency rupee options for hedging their exposures after production of underlying
documents or under past performance route.
RESIDENT INDIVIDUALS: In order to enable resident individuals to manage / hedge their foreign exchange
exposures arising out of actual or anticipated remittances, both inward and outward, RBI has now permitted them
to book forward contracts, without production of underlying documents, up to a limit of USD 100,000, based on
self declaration. The contracts booked under this facility would normally be on a deliverable basis. However, in
case of mismatches in cash flows or other exigencies, the contracts booked under this facility may be allowed to
be cancelled and re-booked. The notional value of the outstanding contracts should not exceed USD 100,000 at
any time. Further, the contracts may be permitted to be booked up to tenors of one year only.
SUMMARY OF BANK ACCOUNTS FOR NON - RESIDENT INDIANS

16
Foreign Currency Non-Resident (Bank) Account (FCNR (B) A/c) (wef 15.5.1993).Account holder: NRIs of Indian
nationality or origin.
Joint account: Can be in the names of two or more non-reside individuals.. With close resident relatives, joint
account can be opened FORMER or SURVIVOR account. Relatives can operate a/c as power of
attorne',Currencies: Any convertible currency.
Type of account: FDR only (a) one year and above less than 2 years (b; years and above less than 3 years (c)
3 years and above less than 4 years (d years and above less than 5 years (e) 5 years only.Repatriation of
principal and interest permitted.Source of funds: Foreign Inward remittance (FIR) or transfer from NREaccount
(at TT selling rate) •Interest rate and interest payment: Ceiling rate fixed by RBI (preser LIBRO + 2% (1 year
to less than 3 years and 3% for 3 years to 5 years w.( May 04, 2012) basis points. No interest payment if
cancellation before one ye For one year deposit, no compounding of interest. For above one ye compounding on
180 days basis. Interest payment on 360 days in year basis.Fund or non-fund Rupee loan against FDR: Up to
value of FDR w proper margin (Oct 12, 2012) to depositor or 3'd party. Margin / interest rate bank discretion.
Loans proceeds to be credited to NRO account. Loans can repaid from FCNR, NRE or NRO account balances.
Banks should not mark a type of lien, direct or indirect, against these deposits. Premature payment is allowed if
loan is granted.Nomination facility is available.Interest income is not taxable. TDS not applicable.Additional ROI
is not applicable to Staff/ Senior citizens.At the request of the depositor, authorised dealers to be allowed to
permit remittance of the maturity proceeds of FCNR (B) deposits to third parties outside India provided the
authorised dealer is satisfied about the bonafides of the transaction.
Non-Resident External (Rupee Account) :Account holder: NRIs of Indian nationality or origin.Joint account:
Can be in the names of two or more non-resident individuals. With dose resident relatives, joint account can be
opened as FORMER or SURVIVOR account. But the those relatives can operate the account as power of attorney
holders.Currencies: Account will be opened in rupee by converting the foreign currency at current spot rate.Type
of account: Current, saving or FDR. FDR period min 1 yr max 3 yrs normally.Repatriation of principal and interest
permitted.Source of funds: Foreign Inward remittance (FIR) or transfer from FCNR-B account (at TT buying
rate).Interest rate and interest payment : on FDR, and SB account — bank discretion but not more than dorhestic
deposit (deregulated w.e.f. Dec 16, 2011).Rupee loan: Max up to value of FDR with proper margin permitted to
the depositor or 3rd parties against FDR. Other conditions as above, in case of FCNRB account.Nomination facility
is available.Interest income is not taxable. TDS not applicable.Additional ROI not available to Staff w.e.f. Jul 18,
2012.
Non-Resident Ordinary Account (NRO) : Account holder: NRIs or Person of Indian Origin (individuals citizen
and not entities from Bangladesh can be allowed without RBI permission w.e.f. 11.2.13. Pakistan citizen not to be
allowed).Joint account: Allowed with resident and non-resident individuals.Currencies: In rupee by converting
foreign currency at current spot rate.Account: Current, saving or FOR. FDR min 7 days and max 10
years.Repatriation of interest and current income is permitted. Sale proceeds of immovable property can also be
remitted @ USD 1 million per financial year.Source of funds: New account can be• opened with Foreign Inward
remittance. Existing account of an NRI opened when he was resident, will be designated as NRO by the bank,
without any request from customer.Interest rate: on FDR, at discretion of bank. On SB account. Bank discretion
(deregulated w.e.f.16.12.11).Nomination facility is available.Interest is taxable and TDS provisions are applicable
both for term deposit and saving bank account.Transfer of repatriable amount from NRO to NRE permitted by
w.e.f. 8.5.12.Additional ROI not available to Staff w.e.f. Jul 18, 2012.Power of attorney: The facility of operation
of accounts by PA holder can be extended to NRO account holders. NRO Accounts of Foreign Nationals of Non-
Indian Origin on a visit to India.NRO (current/savings) a/c can be opened for max period of 6 months.Source and
use of funds: Funds remitted from outside India through banking channel or by sale of foreign exchange brought
into India. All payments to residents exceeding INR 50,000 can be made only by means of cheques / pay orders /
demand drafts. Repatriation: The balance may be converted by the AD bank into foreign currency for payment to
the account holder at the time of his departure from India provided the account has been maintained for a period
not exceeding six months and the account has not been credited with any local funds, other than interest accrued
thereon. In case the account has been maintained for a period more than six months, applications for repatriation
of balance will have to be made by the account holder concerned on plain paper to the Regional Office concerned
of the Reserve Bank.
Important Notes : PoA holders in NRE a/c cannot credit foreign currency notes and foreign travellers cheques in
NRE accounts. NRNR & NRSR scheme discontinued wef April 01, 2002. No new NRE/FCNR/NRO account in the
name of OCBs to be opened and no renewal of deposits should be made. Accounts of Foreign nationals resident in
India.Foreign nationals resident in India can open and maintain a resident Rupee account in India in terms of
Notification No.5/2000-RB dated May 3, 2000 viz., Foreign Exchange Management (Deposit) Regulations, 2000,
as amended from time to time.
Accounts of residents

17
Resident Foreign Currency Account (RFC) : Account holder: A resident in India who was earlier an NRI (at
least one year stay abroad) and became resident again on or after 18.04.92.Source of funds: (a) Foreign
exchange received as pension/ superannuation /other benefits from employer abroad (b) Realisation of assets
held abroad (c) Foreign exchange acquired as gift or inheritance from person who was NRI (d) Existing FCNR
account or NRE-FD to be converted to RFC FD at discretion of account holder before or after maturity.Joint
account: It can be single account. With close non-resident relatives, joint account can be opened as FORMER or
SURVIVOR account.Type of account: Savings, Current, Axed Deposit (min 7 days and max 10 years).Repatriation
is permitted.Interest rates: The banks are free to determine interest rates.Use of funds: No restrictions.Resident
Foreign Currency (Domestic) Account RFC (D) : Account holder: Resident Individuals.Source of funds:
Foreign exchange acquired, (a) while on a visit abroad (b) from any person on visit to India or honorarium or gift
or for services or settlement of any lawful obligation (c) by way of honorarium or gift while on a visit abroad (d)
representing unspent foreign exchange acquired during travel abroad. Amount to be converted in rupees, latest
by last day of next month.Type of account : Only current accountInterest : No interest payable on this
deposit.Use of funds: For all permitted transactions.Exchange
Earner's Foreign Currency Account(EEFC Account) :Account holder: Exporters of goods and services,
resident in India.Source of funds: Up to 100% of forex earnings can be kept in the account. But amount to be
converted in rupees, latest by last day of next month.Use of funds: Balance can be transferred to NRE/FCNR
account on change of status from resident to non-resident. Funds can be used for adjustment of pre-shipment
loans.Loan: No loan can be allowed against the balances in such account.Type of account: Only current account.
It can be a joint account (FORMER or SURVIVOR) with dose resident relatives.Interest: No interest is payable.
PERSON RESIDENT IN INDIA: Section 2 of FEMA i999 defines the term Resident in India as a person residing
in India for more than 182 days during the course of financial year.
PERSON RESIDENT OUTSIDE INDIA: Section 2 of FEMA defines person resident outside India as a person who is
not resident in India. Non-resident Indian generally fall under one of the following broad categories:
A) NON-RESIDENT INDIAN (NRI): An NRI is a person holding Indian Passport:
Who has gone abroad for a gainful employment or business or vocation, or for any other purpose indicating an
indefinite period of his stay outside India.
Who are working abroad on foreign assignments - persons employed by IMF / IBRD / UNO / UNESCO etc. or who
are employed in Central/State Government and Public Sector Undertakings and deputed abroad on temporary
assignments or for temporary period.
B) PERSON OF INDIAN ORIGIN (PI0) : For the purpose of being eligible for the facilities of opening and
maintenance of various types of bank accounts and making investments in shares and securities in India, a PIO
means a citizen of any country other than Bangladesh or Pakistan, if: a) He held Indian passport at any point of
time, or b) Whose parents or grand parent/s was citizens of India (undivided India), or Foreign National Spouse of
non-resident Indian (either NRI or PIO) is also given the status of a PIO .'PURPOSE OF LOANS FOR NRI AGAINST
NRE / FCNR IN INDIA: Personal purposes or for carrying on business activities The loans cannot be utilized for the
purpose of relending, or carrying on agriculture or plantation activities or for investment in real estate business.
Direct investment in India on non-repatriation basis by way of contribution to the capital of Indian firms /
companies. Acquisition of flat / house in India for his own residential use.
PURPOSE OF LOANS FOR THIRD PARTIES AGAINST NRE / FCNR IN INDIA: Fund based and / or non-fund
based facilities for personal purposes or for carrying on business activities. The loans cannot be utilized for the
purpose of relending, or carrying on agriculture or plantation activities or for investment in real estate business
PURPOSE OF LOANS ABROAD FOR NRI / THIRD PARTY AGAINST FCNR / NRE: Fund based and / or non-
fund based facilities for bonafide purposes.
PURPOSE OF LOANS TO ACCOUNT HOLDERS I THIRD PARTIES AGAINST NRO: Personal requirement and I
or business purpose. The loan cannot be utilized for the purpose of re-lending, or carrying on agriculture or
plantation activities or for investment in real estate business.
TREATMENT OF LOANS / OVERDRAFTS IN THE EVENT OF CHANGE IN THE RESIDENT STATUS OF THE
BORROWER: In case a Resident who had availed of loan / OD facilities subsequently becomes a person resident
outside India, banks may at their discretion and commercial judgment allow continuance of the loan/overdraft
facilities. Repayment may be made by inward remittance or out of legitimate resources in India of the person
concerned.
NEPAL & BHUTAN : (a) When a person resident in India leaves India for Nepal and Bhutan for taking up
employment or for carrying on business or vocation or for any other purpose indicating his intention to stay in
Nepal and Bhutan for an uncertain period, his existing a/c will continue as a resident a/c. Such account should not
be designated as Non-resident (Ordinary) Rupee Account (NRO). (b)ADs may open and maintain NRE / FCNR (B)
Accounts of persons resident in Nepal and Bhutan who are citizens of India or of Indian origin, provided the funds
for opening these accounts are remitted in free foreign exchange. Interest earned in NRE / FCNR (B) accounts can
be remitted only in Indian rupees to NRIs and PIO resident in Nepal and Bhutan.
OTHER IMPORTANT ASPECTS: Remittance / Credit to NRE SB: Current income like rent, dividend, pension,
interest etc. of NRIs / PIO who do not maintain NRO Account is freely allowed to be remitted abroad or credited to
NRE a/c based on appropriate certification by a CA certifying that the amount proposed to be remitted is eligible
for remittance and that applicable taxes have been paid / provided for.
a) Power of attorney permitted in NRO: RBI has advised that authorized Dealers are now permitted to extend
the facility of operation of NRO account by PoA granted in favour of a resident by the non-resident individual

18
a/c holder. Accordingly, the banksmay allow operations on an NRO account in terms of such a PoA ,
provided such operations are restricted to
All local payments in rupees including payments for eligible investments subject to compliance with relevant RBI
regulations.
Remittance outside India of current income in India of the non-resident individual account holder, net of
applicable taxes.
c) Power of attorney holders in NRE a/c :PoA in NRE accounts are allowed all transactions except the following:
Credit foreign currency notes and foreign travelers cheques in NRE a/c cannot be accepted from Power of
attorneys.
Repatriationexcept in favour of the Principal i.e. the NRI account holder.
d) Resident Indians can appoint a Non-Resident Indian as a nominee in his deposit account and vice-a-versa.
e) Repatriation of Sale proceeds of Residential property
Allowed through NRO a/c subject to an over-all annual ceiling of USD One million per Financial year(No lock-in
any more)
The remittances to be allowed on production of an undertaking by the remitter and a Certificate from a Chartered
Accountant in the formats prescribed. [cf. A. P. (DIR Series) Circular No.56 dated November 26, 2002].
The remittance facility of sale proceeds of immovable property is not available to a citizen of Pakistan,
Bangladesh, Sri Lanka, China, Afghanistan, Iran, Nepal and Bhutan.
Repatriation of sale proceeds of residential property purchased by NRI / PIO out of foreign exchange is restricted
to not more than two such properties.
EXCHANGE CONTROL RELATING TO EXPORTS

Export Import Code Number (IEC): Every person / firm / company engaged in export
business has to obtain an Export Import Code Number issued by the Director Genera! of
Foreign Trade (DGF1/.
Export Declaration Forms: Any export of goods from India should be declared in the
prescribed forms to the effect that full value of exports will be realized within the
GR /SDP Exports made otherwise than by
Form
PP Form post.
Exports made by post parcel.
Softex Form Exports of software in non-physical
SDF Forms: "Statutory Declaration forms" form.take the place of GR forms wherever the receiving us om s office is
computerized. Exemptions from Export Declarations: Certain categories of export are exempted from declaration.
The important items are:-
(i) Software exports of value not exceeding US $ 25,000 or its equivalent.
(ii) Gift of goods exceeding Rupees Five lakhs in value requires approval of the Reserve Bank.
(iii) AD banks may consider requests for grant of GR waiver from exporters for export or` goods free of cost, for
export promotion
Normal exporters- Rs 5 lakhs or up to 2% of the average annual exports during the preceding 3 years whichever
is lower.
Status holder exporters- Rs.10 lakhs or 2% of the average annual export realizationduring the preceding 3
licensing years, whichever is higher.
(iv) Export of goods not involving any forex directly or indirectly requires the waiver of GR / PP procedure from
the RBI.
TIME LIMIT FOR EXPORTERS TO RECEIVE EXPORT PAYMENTS
a) Normal exporters
Normal period - 12 months (earlier 180 days) - extended up to Sept. 30, 2012.
Extension to be sought from AD in form ETX. AD authorized to permit extension for six months at a time.
Cases which are beyond 6 months but the Exporter has not sought extension from AD should be reported to col
:1cerned RBI.
b) Units in EHTP/STP/BTP/100% EOU & Status holding Exporters: The above categories are permitted to r. aline
and
repatriate the full value of export proceeds within a period of 12 months from the date of export.
c) Units situated in Special Economic Zones: There is no time stipulation for units in SEZ.
REPORTING TO RBI : A.D.banks should furnish to the RO concerned of the Reserve Bank, on half-yearly basis, a
consolidated statement in Form XOS giving details of all export bills of value USD 25,000 or above, outstanding
beyond six months from the
dateof export as at the end of June and December every year within fifteen days from the close of the relative
half-year.
PRESCRIBED METHOD: The payment for export proceeds should be received through the medium of the
Authorised Dealers (ADs). However, in exceptional cases where the track record of the exporter is good, ADs can
accept the amount received by exporters direct by cheque, DD, etc. Exporters are also permitted to receive
payment from International tourists through TC/Currency international credit cards and to the debit of NRE/FCNR
accounts.
SUBMISSION OF EXPORT DOCUMENTS: All exporters have to submit duplicate copy of Statutory declaration form
(GR/PP etc) along with the shipping documents to an Authorised Dealer within 21 days of shipment. The ADs will
report all export bills (both purchased or accepted for collection) to RBI every fortnight in a statement called 'ENC'
along with 'R' returns.
CRYSTALLIZATION OF EXPORT BILLS: Crystallization is a process of conversion of foreign currency liability of the
customer into Rupee liability. FEDAI rules for crystallization have been amended and authorized dealers are now
free to fix the period after which crystallization has to take place after taking in to consideration various risk
factors such as the Credit risk of the exporter, Operational risk etc. Such rules must be transparent and should be

19
advised to the customer well in advance. Most banks however, follow the earlier procedure of crystallization on
30'h day after NTP (Normal Transit period for demand bills and after 30th day after due date/notional due date for
usance bills.
SELF WRITE-OFF AND EXTENSION OF TIME: For export proceeds due within the prescribed period during a
calendar year, All exporters (including Status Holder exporters) are now allowed to:
Write off (including reduction in invoice value) outstanding export dues and, Extend prescribed period of
realization beyond 180 days or further period as applicable, provided
The aggregate value of such export bills written-off (including reduction in invoice value) and bills extended for
realisation does not exceed 10 % of the export proceeds due during the calendar year. Such export bills are not a
subject of investigation by Enforcement Directorate / CBI or any other Investigating Agencies. DIAMOND DOLLAR
ACCOUNT FOR EXPORTERS:
AD Banks (Category-I) delegated powers to permit firms and companies to open and maintain DDA. The
maximum number of accountspermitted is five. DDA must be in the name of the exporter and can be maintained
in US Dollars only. The account must be in the form of current account and no interest should be paid. No intra-
account transfer should be allowed, between the DDAs maintained by the account holder. Balances are subject to
SLR/CRR requirements. Eligibility Track Record : 2 years. Average annual turnover Rs.3 crores or above during
preceding 3 licensing years. Exporter firms and companies maintaining foreign currency accounts, excluding EEFC
accounts, with Banks in India or abroad, are not eligible to open Diamond Dollar Accounts
OTHER FACILITIES AVAILABLE TO EXPORTERS: Trade Discount: Export Bills which fall short of value
declared on GR/SDF forms on account of trade discount may be accepted if the discount has been declared on
relative GR/SDF form at the time of shipment and accepted by Customs.
Part Drawings: In certain lines of export trade, it is the practice to leave a small part of the invoice value undrawn
for payment after adjustment due to differences in weight, quality, etc. to be ascertained after arrival for
inspection, or analysis of the goods. In such cases, AD banks may negotiate the bills, provided:
The amount of undrawn balance is normal in that line of export trade, subject to a maximum of 10 % of the full
export value. An undertaking is obtained from the exporter on the duplicate of GR/SDF/PP forms that he will
surrender/account for the balance proceeds of the shipment within the period prescribed for realisation.
CONSIGNMENT EXPORTS
(i) When goods have been exported on consignment basi,'AD bank, while forwarding shipping documents to
Overseas branch / Correspondent, should instruct the latter to deliver them only against trust receipt/undertaking
to deliver sale proceeds by a specified date within the period prescribed for realisatjbn of proceeds of the export.
This procedure should be followed even if, according to the practice in certain trades, a bill for p rt of the
estimated value is drawn in advance against the exports.
jai(ii) The agents/consignees may deduct from sale exceeds expenses normally incurred towards receipt, storage
and sale of the goods, such as landing charges, warehouse renti'handling charges etc. & remit the net proceeds.
(iii) Deductions in Account Sales should be supported by bills/receipts in original except in case of petty items like
postage/cable charges, stamp duty etc. .
CONSIGNMENT EXPORTS: OTHER IMPORTANT POINTS
In case of goods exported on consignment basis, freight and marine insurance must be arranged in India.
RBI may permit exporters with satisfactory track record, a longer period up to 12 months for realisation of export
proceeds on consignment basis made to CIS & East European countries financed in a permitted currency.
AD banks may consider the applications from exporters and grant permission for opening / hiring warehouses
abroad for an initial period of one year (subject to renewal) provided: Applicant's export outstanding does not
exceed 5% of exports made during the previous yearApplicant has a minimum export turnover of USD 1,00,000/-
during the last year.Period of realisation should be as applicable to the category of exporter.All transactions
should be routed through the designated branch of the AD.
DIRECT DISPATCH OF SHIPPING DOCUMENTS
AD Category - I banks, are now allowed to regularizes cases of dispatch of shipping documents by the exporter
direct to the consignee or his agent resident in the country of the final destination of goods, up to USD 1 million
or its equivalent, per export shipment, subject to the conditions: The export proceeds have been realized in full.
The exporter is a regular customer of the bank for a period of at least six months. The exporter's account is fully
compliant with RBI's KYC / AML guidelines and the AD is satisfied about the bona fides of the transaction.In case
of doubt, the bank may file Suspicious Transaction Report with FIU-IND (Financial Intelligence Unit of India)
REDUCTION IN INVOICE VALUE — PREPAYMENT OF USANCE BILLS:
In case of prepayment of Usance bills, A.D. banks may allow cash discount to the extent of amount of
proportionate interest on the unexpired period of usance, calculated at the rate of interest stipulated in the export
contract or at the prime rate / LIBOR of the currency of invoice if the rate of interest is not stipulated in the
contract.
REDUCTION IN VALUE (OTHER CASES): If, after a bill has been negotiated or sent for collection, its amount is to
be reduced for any reason, AD bank may approve such reduction, if satisfied about genuineness of the request,
provided:
The reduction does not exceed 25% (earlier 10 %) of invoice value.
If the exporters have been in the export business for more than three years, reduction in invoice' value may be
allowed, without any percentage ceiling subject to their track record being satisfactory i.e the- export outstanding
does not exceed 5% of the average annual export realisation during the preceding three calendar years. (For this
purpose outstanding of exports made to countries facing externalization problems may be ignored provided the
payments have been made by the buyers in the local currency AND. The request does not relate to commodities
subject to floor price stipulations The exporter is not on the exporters' caution list of RBIThe exporter should be
advised to surrender proportionate export incentives availed of, if any. • .

20
EXPORT CLAIMS:authorized Dealer banks may remit export claims provided the relative export proceeds have
already been realisedand repatriated to India and the exporter is not on the caution list of RBI. The exporter
should be advised to surrender proportionate export incentive, if any, received by him in all such cases.
CHANGE OF BUYER / CONSIGNEE: Prior approval of Rel is not required if, after goods have been shipped, they
are to be transferred to a buyer other than the original buyer in the event of default by the latter, provided the
reduction in value, if any, involved does not exceed 10 % and the realization of export proceeds is not delayed
beyond the period of six months from the date of export. Where the reduction in value exceeds 10 %, all other
relevant conditions as above for sanctioning a higher deduction have to be followed.
SHIPMENTS LOST IN TRANSIT: When shipments from India for which payment has not already been received
either by negotiation of bills under letters of credit or otherwise are lost in transit, the Authorised Dealer bank
must ensure that insurance claim is lodged as soon as the loss is known. The duplicate copy of GR/SDF/PP form
should be forwarded to Reserve Bank with following particulars: Amount for which shipment was insured.Name
and address of the insurance company.Place where the claim is payable.In cases where the claim is payable
abroad, the A.D. Bank must arrange to collect the full amount of claim due on the lost shipment and release the
duplicate copy of GR/SDF/PP form only after the amount has been collected .
PAYMENT OF CLAIMS BY ECGC:
Where ECGC pays the claims, A.D. Banks can write off the relative export bills and delete them from the XOS
statement. Such write-off will not be restricted to the limit of 10 per cent (see below). Surrender of incentives, if
any, in such cases will be as provided in the Foreign Trade Policy. The claims settled in rupees by ECGC should
not be construed as export realisation in foreign exchange.
"WRITE OFF" OF UNREALISED EXPORT BILLS
(i) Exporters can approach the A.D. Bank, who had handled the relevant shipping documents with a request for
write off of the unrealized portion. A.D. banks may accede to such requests subject to the under noted conditions:
The relevant amount has remained outstanding for a period of one year or more;
The aggregate amount of write off allowed by the A.D. bank during a calendar year does not exceed 10% of the
total export proceeds realized by the concerned exporter through the concerned authorized Dealer bank during
the previous calendar year; Satisfactory documentary evidence is furnished in support of the exporter having
made all efforts to realize the dues;The case is not the subject matter of any pending civil or criminal suit.
The exporter has not come to the adverse notice of the Enforcement Directorate or the Central Bureau of
Investigation or any such other law enforcement agency.
The exporter has surrendered proportionate export incentives, if any, availed of in respect of the relative
shipments. The AD bank should obtain documents evidencing surrender of export incentives availed of before
permitting the relevant bills to be written off.
AD banks are required to put in place a system under which internal inspectors or auditors carry out random
sample check / percentage check of outstanding export bills written- off.
(ii) Where there is no further amount to be realized against the GR/SDF/PP form covered by the write off, AD
bank should certify the duplicate form that the balance amount is written off. (iii) Status Holder exporters may
now write-off outstanding export dues to the extent of:
5% of their average annual realisation during the preceding three financial years or
10% of the export proceeds due during the financial year, whichever is higher. EXEMPTIONS FOR "WRITE OFF"
FACILITY
Exports made to countries with externalization problem i.e. where the overseas buyer has deposited the value of
export in local currency but the amount has not been allowed to be repatriated by the central banking authorities
of the country.
GR/SDF forms which are under investigation by agencies like, Enforcement Directorate, Directorate of Revenue
Intelligence, Central Bureau of Investigation, etc. as also the outstanding bills which are subject matter of civil /
criminal suit.
A Ds have to forward a statement of all Writing Offs in form EBW to RBI every half year ended 30th June & 31st
December REFUND OF EXPORT PROCEEDS: Refund of export proceeds may be allowed by the authorized Dealer
banks through whom the proceeds were originally received, provided such goods are re-imported into India on
account of poor quality etc. and evidence of re-import has been submitted. In all such cases, exporters should be
advised to surrender the proportionate incentives availed of, if any, against the relevant export.
EXPORTERS' CAUTION LIST: RBI advises the details of exporters who are cautioned in terms of provisions
contained in Regulation 17 of "Export Regulations" from time to time. AD banks may approve GR/SDF/PP forms of
exporters who have been placed on caution list only if the exporters concerned produce evidence of having
received an advance payment or. an irrevocable letter of credit in their favour covering the full value of the
proposed exports. Approval may also be given in cases where usance bills are to be drawn for the shipment
provided the relative letter of credit covers the full export value and also permits such drawings and the usance
bill mature within six months from the date of shipment. .
DEEMED EXPORTS: Deemed exports refer to those transactions in which the goods supplied do not leave the
country. Supply of goods by the main / sub-contractor against Advance Licensing / DFRC under the Duty
Exemption / Remission Scheme, supply of goods to EOUs, to units located EPZs, SEZs, STPs, EHTPs, Supply of
goods to projects financed by multi-lateral bilateral agencies and projects funded by UN agencies etc. are
regarded as deemed exports.
EXPORT_FACILITIES AND ITS TYPES : EXPORT FINANCE IS MAINLY OF TWO TYPES: PRE-SHIPMENT
ADVANCE POST-SHIPMENT ADVANCE, PRE,- SHIPMENTRDWINCE (POCKING CREDIT)
PARTICULARS PACKING CREDIT - EPC (RUPEE) PACKING CREDIT-PCFC (FOREIGN .CURRENCY)
Definition Any loan, advance or any other credit granted to Any loan, advance or any other credit granted to
an exporter for financing the purchase, an exporter for financing the purchase,
processing, manufacturing or packing of goods processing, manufacturing or packing of
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2 Basis for grant LC or Confirmed order in favour of exporter or ,1 ior confirmed order in favour of exporter or
of credit some other person by an overseas buyer, unless some other person
its lodgement has been waived. by an overseas buyer unless its lodgement has
been waived.
3 Allowed for Export of goods, services, Construction contracts, i

Consultancy V' Export of goods, services, Construction contracts,
Consultancy.
4 Type of Account Order to order basis, or Running a/c facility in Banks can
Order to extend
order PCFC
basis for export
or Running to ACUfacility in
account
genuine cases to exporters having very good genuine cases to exporters having very good past
past record. Export Oriented Units / Units in Free record.
Trade Zones EPZs and SEZs.
5 Extent . For FOB value For FOB value
. Only for exportable portion in case of Agri Only for exportable portion in case of Agri
products. products.
6 Disbursement Stage to stage or in lump sum, depending upon Stage to stage or in lump sum, depending upon
the needs Circumstances. the needs and circumstances
7 Choice of Indian Rupees Any convertible currency such as US$, Pound
Currency Sterling, Yen, Euro etc. To enable exporters to
have operational flexibility, they are allowed to
draw PCFC in one currency and draw the bill in
any other convertible currency. The risk and the
cot of the cross currency transaction will be on
the exporter.
8 Period of credit Period will depend upon the circumstances of the Initially for 180 days.
individual No Export refinance is provided by RBI
case. It is primarily for the banks to decide the
period for which a packing credit advance may be
given having regard to the various relevant
factors so that the period is sufficient to enable
exporter to ship the goods /render the services.
As per RBIJune
beginning guidelines, the concessional
30,. 2012) rate is
of the outstanding
export credit eligible for refinance for 180 days
Forward
9 Allowed Allowed in any of the four convertible currencies
Contracts
POST – SHIPMENT ADVANCE DIFFERENT TYPES :

S.NO ALLOWED AMOUNT LIMIT MAXIMUM PERIOD OTHER INFORMATION
TYPE OF AGAINST
ADVANCE
1 -Negotiation Bills drawn under No Limit-100% of Invoice Initially allowed for 6 Short Term Finance.Pre-
of Irrevocable Letter Value months from the date of shipment advance, if any,
Bills after of or value declared in shipment. Period to be to be liquidated by
Shipment Credit. GR/PP/ extended up to 1 year for way of
Shipping Softex forms genuine reasons. negotiation of bills.
2 Purchase documents
Shipping No Limit-100% of Invoice Initially allowed for 6 Allowed
Short Termin Rupees,
Finance.as well
Discounting of documents Value months .Pre shipment advance, ,
after evidencing export or value declared in from the date of if any,
Ellis after against GR/PP shipment. to be liquidated
I confirmed Period to be extended from the bills
1 shipment order/expired upto I purchased or discounted.
LC / year for genuine reasons Allowed in Rupees, as well
discrepant as in foreign currencies.
documents If bills are not
under LC payable at
Softex forms sight, ECGC cover should
be preferred.
3 Advance Bills, which have No Limit-100% of Invoice Initially for 6 months from Short Term Finance.
against. already been sent Value the Pre-shipment advance, if
bills sent on on collection basis, or value declared in date of shipment. any,
collection drawn GR/PP / Period to be extended to be liquidated
either. under Softex forms upto I from the bills
LC/discrepant yr for genuine reasons purchased.

22
4 Advance . Shipments already Within the market value Normally upto a period of In case of Advance
against made on of the 180 against
consignment consignment basis. goods' because actual days. Consignment Exports
exports Instructionsshould sale In deserving. cases. against
be amount or amount to be for Gems / precious stones,
given for realized -is not certain. exports in CIS and East packing credit advances
delivery European countries, upto be adjusted as
of a maximum of one year. soon as export takes
5 Advance Outstanding Duty 100% Normally Upto period of To be covered by ECGC
against Draw 90 days Guarantee
Govt Back entitlements underconcessional
Receivables supported by rate of
certificate from C.A interest.
6 Advance Balance of 100%. Because Such advances are Export proceeds
against un-raised there are eligible for must be
Un-drawn invoices and chances of deductions concessional rate of received within 180 days
Balances and Retention Money by the interest for a maximum after the expiry of NTP, in
Retention buyers, a margin period of 90 days only. case of demand
Money should be bills and due datein case
Forfaiting By way of maintained.
Minimum amount is 6 months and prior of
Forfaiting allowed through
rediscounting of USD permission of RBI or EXIM EXIM Bank only. Prior
Receivables (EBR) 1,00,000 Bank required for deferred involvement of EXIM bank
payment bills. required for each bill. It is
'Without Recourse'.
8 Factoring By way of 100% 6 months and prior It is with or without
- rediscounting of permission of recourse-
9 Export Receivables
Bill By way of(EBR) 100% RBI required for Bill to Bill rediscounting
Rediscounted banks deferred on an ongoing
Abroad EBR financing Export _Err e n t bills. 6 months arrangements. Just as
INTEREST RATES ON EXPORT ADVANCES
EXPORT CREDIT IN FOREIGN CURRENCY:Interest )Rates on Export Credit in Foreign Currency effective from
November 15, 2011.
TYPE OF CREDIT INTEREST RATE (% pa)
1) PRE-SHIPMENT CREDIT
A. ' Up to 180 days Not exceeding 350 basis points over LIBOR/EURO LIBOR I
B Beyond 180 days and up to 360 days EURIBOR
Rate lor initial period of 180 days prevailing at the time of
extension plus 200 basis
2) POST SHIPMENT CREDIT saints i.e. 1 a above • us 200 basis • e nts
A On Demand bills for transit period (as Not exceeding 350 basis points over LIBOR/EURO LIBOR I
specified by FEDAI). EURIBOR.
B Against Usance wills -Up to 6 months — Not exceeding 350 basis points over LIBOR / EURO LIBOR /
from the date of shipment. EURIBOR.
C Export Bills (Demand or Usance) Rate for (2) (b) above plus 200 basis points.
realized after nue date but up to date
of crystallization
INTEREST SUBVENTION ON EXPORT CREDIT:Govt has decided to extend interest subvention of 2% on rupee
export credit w.e.f. April t 2012 to March 31, 2013, on the same terms and conditions to the following sectors:
a) Handicrafts; b) Carpet c) Handlooms d) SMEs e) Readymade Garments g) Processed Agriculture Products
h) Sport Goods i) Toys
Accordingly, banks may reduce the interest rate chargeable to the exporters as per Base Rate system in the
above mentioned sectors eligible for export credit subvention by the amount of subvention available subject to a
floor rate of 7%. Banks to pass on the benefit of 2% interest subvention completely to the eligible exporters.
IMPORT MEIMIGEMEIMIT
Import trade is regulated by the Directorate General of Foreign Trade (DGFT) under Ministry of Commerce &
Industry, Department of Commerce: Authorised dealers, while undertaking import transactions, have to ensure
that the imports into India are in conformity with:
Foreign Trade Policy, 2009-14 and Foreign Exchange Management (Current Account Transactions) Rules,
2000.Provisions of Uniform Customs and Practices for Documentary Credits (UCP - 600), etc. while opening
letters of credit for imports into India on behalf of their constituents.Directions issued by Reserve Bank under
Foreign Exchange Management Act (FEMA) from time to time.
I/E CODE NUMBER: All Importers have to register themselves with DGFT, under Ministry of Commerce & Industry
and obtain a I/E code .I/E codes have life time validity
Approved Commodity / Capital goods: Only permitted imports can be undertaken. For this, Importers and Banks
have to ensure that either the item is not in The negative list or a specific import license is available.
IMPORT LICENCE: Authorized dealers may freely open letters of credit and allow remittances for import of goods
unless they are included in the negative list requiring license under the Foreign Trade Policy in force.

23
ADVANCE REMITTANCE: Authorised dealers may allow advance remittance for import of goods without any ceiling
subject to the following conditions:
The Cut off for making advance remittances without the backing of LG / SBLC increased to USD 5,00,000 for
Services and US$ 2,00,000 for Goods. For advance remittances exceeding USD 5,00,000, or its equivalent, Banks
require an unconditional, irrevocable standby Letter of Credit or a Bank Guarantee from an international bank /
AD Category — I bank in India.
Advance remittance without any limit and without bank guarantee or standby letter of credit is permitted to an
importer (other than a Public Sector Company or a Department / Undertaking of the Government of India / State
Government/s), for import of rough diamonds into India from the under noted mining companies, viz. a) Diamond
Trading Company Pvt. Ltd., UK, b) RIO TINTO, UK and so on as per RBI guidelines(six companies are listed) In
cases where the importer (other than a public sector company or a depts. / undertaking of govt. of India / state
govt.) is unable to obtain bank guarantee from overseas supplier and authorized dealers is satisfied about the
track record and bonafideof the importer, the requirement of the bank guarantee / stand by letter of credit may
not be insisted upon for advance remittance up to US $ 10,00,000 (US $ one million).
A Public Sector Company or a Department / Undertaking of the Government of India / State Government/s which
is not in a position to obtain a guarantee is required to obtain a specific waiver for the bank guarantee from the
Ministry of Finance, Government of India before making advance remittance exceeding USD 300,000.
Physical import of goods into India is made within six months (three years in case of capital goods) from the date
of remittance and the importer gives an undertaking to furnish documentary evidence of import within fifteen
days from the close of the relevent period.
In the event of non-import of goods, authorized dealer should ensure that the amount of advance remittance is
repatriated to India or is utilized for any other purposes for which release of exchange is permissible under the
Act Rules / Regulations.
RECEIPT OF IMPORT BILLS / DOCUMENTS
Normally, Import documents should be received through banking channels. Import bills and documents should be
received from
the banker of the supplier by the banker of the importer in India. AD bank should not, therefore, make
remittances where import bills have been received directly by the importers from the overseas supplier, except in
the following cases:
1)-Where the value of import bill does not exceed USD 3,00,000 (earlier it was USD 1,00,000) and US $ 5,00,000
for rough diamonds (USD 3,00,000 earlier).
Import bills received by wholly-owned Indian subsidiaries of foreign companies from their principals.
Import bills received by Status Holder Exporters as defined in the Foreign Trade Policy, 100% Export Oriented
Units / Units in Free Trade Zones, Public Sector Undertakings and Limited Companies.
Import bills received by all limited companies viz. public limited, deemed public limited and private limited
companies. Receipt of Import documents by the AD Bank directly from overseas suppliers
(i). At the request of importer clients, AD bank may receive bills directly from the overseas supplier as above,
provided the AD bank is fully satisfied about the financial standing/status and track record of the importer
customer.
(ii) Before extending the facility, the AD bank should obtain a report on each individual overseas supplier from the
overseas banker or a reputed credit agency. However, such a credit report on the overseas supplier need not be
obtained in cases where the invoice value does lot exceed USD 3,00,000 provided the AD bank is satisfied about
the bonafides of the transaction and track record of the importer constituent.
TIME LIMIT FOR SETTLEMENT OF IMPORT PAYMENTS
Normal imports: Remittances against imports should be completed within six months from the date of shipment,
except in cases where amounts are withheld towards guarantee of performance, etc. AD banks may permit
settlement of import duesdelayed due to disputes, financial difficulties, etc. Interest in respect of such delayed
payments may be permitted
Deferred payment arrangements: Deferred payment arrangements, including suppliers and buyers credit,
providing for payments beyond a period of six months from date of shipment up to a period of less than three
years, are treated as trade credits for which the procedural guidelines are laid down separately by RBI.
IMPORT OF INDIAN CURRENCY AND CURRENCY NOTES
(i) Any person resident in India who had gone out of India on a temporary visit, may bring into India at the time
of his return from any place outside India (other than from Nepal and Bhutan), currency notes of Government of
India and Reserve Bank notes up to an amount not exceeding Rs.7500/- per person.
(ii) A person may bring into India from Nepal or Bhutan, currency notes of Government of India and Reserve Bank
notes other than notes of denominations of above Rs.100 in either case.
Import of foreign exchange into India: Reserve Bank may allow 'a person to bring into India currency notes of
Government of India and / or of Reserve Bank subject to such terms and conditions as the Reserve Bank may
stipulate. A person may:CO Send into India without limit foreign exchange in any form other than currency notes.
bank notes and travelers cheques;
(ii), bring into India from any place outside India, without limit foreign exchange (other than unissued notes),
subject to the condition that such person makes, on arrival in India, a declaration to the Custom authorities in
Currency Declaration Form (CDF) ; provided further that it should not be necessary to make such declaration
where the aggregate value of the foreign
exchange in the form of currency notes, bank notes or travelers cheques brought in by such person at any one
time does not exceed USD10,000 ( US Dollars ten thousands) or its equivalent and/or the aggregate value of
foreign currency notes brought in by such person at any one time does not exceed USD 5,000 ( US Dollars five
thousands) or its equivalent.
INTEREST ON IMPORT BILLS
(i) AD bank may allow payment of interest on usance bills or overdue interest for a period of less than three years
from the date of shipment at the prescribed rates. The current all-in-cost ceilings are as under:
24
Maturity period up to one year: All-in-cost ceilings 50 basis points over 6 months LIBOR for the respective
currency of credit
or applicable benchmark.
Maturity period more than one year but less than three years: All-in-cost ceilings 125 basis points over 6 months
LIBOR for the respective currency of credit or applicable benchmark.
(ii) In case of pre-payment of usance import bills, remittances may be made only after reducing the proportionate
interest for the unexpired portion of usance at the rate at which interest has been claimed or LIBOR of the
currency in which the goods have been invoiced, whichever is applicable. Where interest is not separately claimed
or indicated, remittances may be allowed after deducting the proportionate interest for the unexpired portion of
usance bills at the prevailing LIBOR of the currency of invoice.
• TRADE CREDITS FOR IMPORTS INTO INDIA: RBI has decided to revise the all-in-cost ceiling for Trade Credits as
under:
For the respective currency of credit or applicable benchmark •
The all-in-cost ceilings include arranger fee, upfront fee, management fee, handling / processing charges, out of
pocket and legal expenses, if any.
The change in the all-in-cost ceiling will come into force immediately. The enhancement in all-in-cost ceiling is
applicable upto March 31, 2012 and subject to review thereafter. All other aspects of Trade Credit policy remain
unchanged.
EVIDENCE OF IMPORT- MANDATORY AUDIT IN f3ANKS A. Physical Imports
In case of all imports, where value of foreign exchange remitted/paid for imports into India exceeds USD 100,000
or its equivalent, it is obligatory on the part of the ADs through whom the remittance was made, to ensure that
the importer submits:
The Exchange Control copy of the Bill of Entry for home consumption, or
The Exchange Control copy of the Bill of Entry for warehousing, in case of 100% Export Oriented Units. Or
Customs Assessment Certificate or Postal Appraisal Form, as declared to the Customs Authorities, where import
has been made by post, as evidence that the goods for which.the payment was made have actually been
imported into India. imports are made in non-physical form, i.e., software or data through internet/data
channels.and drawings and designs through e-mail/fax, a certificate from a C.A. that the same has been received
by the importer, may be obtained. In respect of imports on DA basis, AD banks should insist on production of
evidence of import at the time of effecting remittance of import bill. However, if importers fail to produce
documentary evidence due to genuine reasons, AD banks may allow reasonable time, not exceeding three months
from the date of remittance, to submit the evidence of import. AD banks should issue containing all relevant
particulars relating to the import transactions to importers.Internal inspectors or auditors (including external
auditors appointed by AD banks) should carry out verification of the documents evidencing import.Documents
evidencing import into India should be preserved by AD banks for a period of one year from the date of its
verification. However, in respect of cases which are under investigation by investigating agencies, the documents
may be destroyed only after obtaining clearance from the investigating agency concerned.AD banks may accept
either Exchange Control copy of Bill of Entry for home consumption or a certificate from the Chief Executive
Officer (CEO) or auditor of the company that the goods for which remittance was made have actually been
imported into India provided:The amount of foreign exchange remitted is less than USD 1,000,000 (USD one
million) or its equivalent,
The importer is a company listed on a stock exchange in India and with a net worth is not less than Rs.100
croresThe importer is a public sector company or an undertaking of the Government of India or its departments.
Importer is an autonomous bodies institutes of Science / Indian Institute of Technology) audited by the
Comptroller and Auditor General of India (CAG).case an importerdoes not furnish any documentary evidence of
import, as required under paragraphs A.10.1 & 2 above, within 3 months from the date of remittance involving
foreign exchange exceeding USD100, 000, the AD bank should rigorously follow-up for the next 3 months,
including issuing registered letters to the importer.
BEF STATEMENT (Half yearly Statement to RBI)
BEF is the statement showing the details of remittances effected towards import in respect of which documentary
evidence has not .been received despite reminders. The statement should be submitted in duplicate, to the
Regional Office of Reserve Bank under whose jurisdiction the AD branch is functioning. Details of transactions
where the amount of remittance exceeds USD 100,000 or its equivalent should only be included in the statement.
The statement should include details of all remittances, exceeding USD 100,000 from India or payments from
abroad in connection with imports, including advance payments, delayed payments, etc. irrespective of the source
of funding (i.e. EEFC accounts / foreign currency accounts maintained in India and abroad, payments out of
external commercial borrowings; foreign investments in the shares of importers etc.)Statement should be
submitted within 15 days from the close of the half-year to which it relates.
CRYSTALLIZATION OF IMPORT BILLS
As per FEDAI guidelines, all foreign currency import bills drawn Letters of credit, in the event of non-retirement
are to be crystallized into Rupee liability on the 10th day after the date of receipt of documents at the LC opening
branch of the bank, in case of demand bills and on due date in case of Usance bills, at Bills Selling Rate /
contracted rate as the case may be. In case the 10th day or the due date falls on a holiday or Saturday, the
importer's liability shall be crystallized into Rupee liability on the next working day.
EXTERNOL CONMERCIAL BORROWINGS (ECBs)
At present, Indian companies are allowed to access funds from abroad in the following methods:
a) EXTERNAL COMMERCIAL BORROWINGS (ECB): ECB refer to commercial loans in the form of bank loans,
buyers' credit, suppliers' credit, securitized instruments (e.g. floating rate notes & fixed rate bonds, non-
convertible, optionally convertible or partially convertible preference shares) availed of from non-resident lenders
with a minimum average maturity of 3 years.
b) FOREIGN CURRENCY CONVERTIBLE BONDS (FCCBS): FCCBs mean a bond issued by an Indian company
expressed in foreign currency, and the principal and interest in respect of which is payable in foreign currency.
25
c) PREFERENCE SHARES: Preference shares (i.e. non-convertible, optionally convertible or partially convertible)
and should conform to the ECB policy, Since these instruments would be denominated in Rupees, the rupee
interest rate will be based on
the swap equivalent of LIBOR plus the spread as permissible for ECBs of corresponding maturity. .
d) FOREIGN CURRENCY EXCHANGEABLE BOND (FCEB): FCEB means a bond expressed in foreign currency, the
principal and interest in respect of which is payable in foreign currency, issued by. an Issuing Company and
subscribed to by a person who is a resident outside India, in foreign currency and exchangeable into equity share
of another company, to be called the
Offered Co, in any manner, either wlolly, or partly or on the basis of any equity related warrants attached to debt
instruments.ECB CAN BE ACCESSED UNDER TWO ROUTES:
i) Automatic Route ii) Approval Route
A) AUTOMATIC ROUTE : i) Eligible Borrowers
a) Corporates, including those in the hotel, hospital, software sectors (registered under the Companies Act, 1956)
and Infrastructure Finance Companies (IFCs) except financial intermediaries, such as banks, financial institutions
(Fls), Housing Finance Companies (HFCs) and Non-Banking Financial Companies (NBFCs) are eligible to raise ECB.
Individuals, Trusts and Non-Profit making organizations are not eligible to raise ECB.Units in Special Economic
Zones (SEZ) are allowed to raise ECB for their own requirement. However, they cannot transfer or on-lend ECB
funds to sister concerns or any unit in the Domestic Tariff Area.Non-Government Organizations (NGOs) engaged
in micro finance activities registered as societies, trusts and co-operatives and engaged in micro finance should
have a satisfactory borrowing relationship for at least 3 years with a scheduled commercial bank authorized to
deal in foreign exchange in India and would require a certificate of due diligence on 'fit and proper' status.
d) Micro Finance Institutions (MFIs) engaged in micro finance activities are eligible to-avail of ECBs.
ii) Recognized Lenders: Borrowers can raise ECB from internationally recognized sources, such as: a)
International banks, b) International capital markets, c) Export credit agencies, d) Suppliers of
equipment,e) Multilateral financial institutions (such as IFC, ADB, CDC, etc.) / regional financial institutions and
Government owned development financial institutions, f) Foreign collaborators and g) Foreign equity holders
(other than erstwhile OCB's)
,iii) Amount and Maturity : a) The maximum amount of ECB which can be raised by a corporate other than those
in the hotel, hospital and software sectors is USD 750 million (mn) or its equivalent during a financial year.
b) Corporates in the services sector viz. hotels, hospitals and software sector are allowed to avail of ECB up to
USD 200 million or its equivalent in a financial year for meeting foreign currency and / or Rupee capital
expenditure for permissible end-uses. The proceeds of the ECBs should not be used for acquisition of land.
c) ECB up to USD 20 mn or its equivalent in a financial year with minimum average maturity of three years.
d) ECB above USD 20 mn or equivalent and up to USD 750 mn or its equivalent with a minimum average
maturity of 5 years.
e) NGOs engaged in Micro finance activities and Micro Finance Institutions (MFIs) can raise ECB up to USD 10
million or its equivalent during a financial year. At the time of drawdown, the forex exposure of the borrower has
to be fully hedged.
f) ECB up to USD 20 million or equivalent can have call/put option provided the minimum average maturity of
three years is complied with before exercising call/put option.
All eligible borrowers can avail of ECBs designated in INR from 'foreign equity holders'. NGOs engaged in micro
finance activities can avail of ECBs designated in INR, from overseas organizations.
iv) All-in-cost ceilings
All-in -cost includes rate of interest, other fees and expenses in foreign currency except commitment fee, pre-
payment fee, andfees payable in Indian Rupees. The payment of withholding tax in Indian Rupees is excluded for
calculating the all-in-cost. The following ail-in-cost ceilings for ECB are are applicable upto March 31, 2012 and
subject to review thereafter:
Average Maturity Period All-in-cost Ceilings over 6 month LIBOR*
Three years and up to five years 350 basis points
More than five years . 500 basis points
* for the respective currency of borrowing or applicable benchmark
In the case of fixed rate loans, the swap cost plus margin should be the equivalent of the floating rate plus the
applicable margin
v) End-use ECB can be raised for investment such as import of capital goods, new projects, modernization /
expansion of existing production units in real sector - industrial sector including small and medium enterprises
(SME), infrastructure sector and specified service sectors, namely, hotel, hospital, software in India.
Infrastructure sector is defined as (i) power, (ii) telecommunication, (iii) railways, (iv) roads including bridges, (v)
sea port and airport, (vi) industrial parks, (vii) urban infrastructure (water supply, sanitation and sewage
projects), (viii) mining, exploration and refining and (ix) cold storage or cold room facility, including for farm level
pre-cooling for preservation or storage of agricultural and allied produce, marine products and meat.
Overseas Direct Investment in Joint Ventures (JV)/ Wholly Owned Subsidiaries (WOS) subject to the existing
guidelines on Indian Direct Investment in JV/ WOS abroad.
Utilization of ECB proceeds is permitted for first stage acquisition of shares in the disinvestment process and also
in the mandatory second stage offer to the public under the Government's disinvestment programme of P$U
shares. Interest During Construction (IDC) for Indian companies which are in the infrastructure sector, where
Infrastructure" is defined .as per the extant ECB guidelines, subject to IDC being capitalized and forming part of
the project cost.
For lending to self-help groups or for micro-credit or for bonafide micro finance activity including capacity building
by NGOs engaged in micro finance activities.

26
Payment for Spectrum Allocation, and Infrastructure Finance Companies (IFCs) i.e. Non Banking Financial
Companies (NBFCs) categorized as IFS s by the Reserve Bank, are permitted to avail of ECBs, including the
outstanding ECBs, up to 50 per cent of their owned funds, for on-lending to the infrastructure sector as defined
under the ECB policy, subject to the compliance with the norms prescribed and hedging of the currency risk in
full.
vi) End-uses not permitted : For on-lending or investment in capital market or acquiring a company in India by a
corporate investment in Special Purpose Vehicles (SPVs), Money Market Mutual Funds (MMMFs), etc., are also
considered as investment in capital markets). For real estate sector, For working capital, general corporate
purpose and repayment of existing Rupee loans.
vii) Guarantees: Issuance of guarantee, standby letter of credit, letter of undertaking or letter of comfort by
banks, Financial Institutions and Non-Banking Financial Companies (NBFCs) from India relating to ECB is not
permitted.
viii) Security: The choice of security to be provided to the lender/supplier is left to the borrower. AD Category - I
banks have been delegated powers to convey 'no objection' under the Foreign Exchange Management Act (FEMA),
1999 for creation of charge on immovable assets, financial securities and issue of corporate or personal
guarantees in favour of overseas lender /
security trustee, to secure the ECB to be raised by the borrower. -
ix) Parking of ECB proceeds: Borrowers are permitted to either keep ECB proceeds abroad or to remit these funds
io India, pending utilization for permissible end-uses. The proceeds of the ECB raised abroad meant for Rupee
expenditure in India, such as, local sourcing of capital goods, on-lending to Self-Help Groups or for micro credit,
payment for spectrum allocation, etc. .should be repatriated immediately for credit to the borrowers' Rupee
accounts with AD Category I banks in India. In other words, ECB proceeds meant only for foreign currency
expenditure can be retained abroad pending utilization. The rupee funds, however, will not be permitted to be
used for investment in capital markets, real estate or for inter-corporate lending.
ECB proceeds parked overseas can be invested in the following liquid assets:
Deposits or Certificate of Deposit or other products offered by banks rated not less than AA (-) by Standard and
Poor / Fitch IBCA or Aa3 by Moody's
Treasury bills and other monetary instruments of one year maturity having minimum rating as indicated above,
and
Deposits with overseas branches / subsidiaries of Indian banks abroad.
The funds should be invested in such a way that the investments can be liquidated as and when funds are
required by the borrower in India.
x) Prepayment: Prepayment of ECB up to USD 500 million may be allowed by AD banks without prior approval of
Reserve Bank subject to compliance with the stipulated minimum average maturity period as applicable to the
loan.
xi) Refinancing of an existing ECB: The existing ECB may be refinanced by raising a fresh ECB subject to the
condition that the fresh ECB is raised at a lower all-in-cost and the outstanding maturity of the original ECB is
maintained.
xii) Debt Servicing: The designated AD bank has the general permission to make remittances of installments of
priricipal, interest and other charges in conformity with the ECB guidelines.
APPROVAL ROUTE i) Eligible Borrowers The following types of proposals for ECB are covered under the Approval
Route:
On lending by the EXIM Bank for specific purposes will be considered on a case by case basis.
Banks and financial institutions which had participated in the textile or steel sector restructuring package as
approved by the Government are also permitted to the extent of their investment in the package and assessment
by the Reserve Bank based on prudential norms. Any ECB availed for this purpose so far will be deducted from
their entitlement.
ECB with minimum average maturity of 5 years by Non-Banking Financial Companies (NBFCs) from multilateral
financial institutions, reputable regional financial institutions, official export credit agencies and international
banks to finance import of infrastructure equipment for leasing to infrastructure projects.
Infrastructure Finance Companies (IFCs) i.e. Non-Banking Financial Companies (NBFCs), categorized as IFCs, by
the Reserve Bank, are permitted to avail of ECBs, including the outstanding ECBs, beyond 50 per cent of their
owned funds, for on-lending to the infrastructure sector.
Foreign Currency Convertible Bonds (FCCBs) by Housing Finance Companies satisfying the following minimum
criteria: (i) The minimum net worth of the financial intermediary during the previous three years shall not be less
than Rs. 500 crore, (ii) A listing on the BSE or NSE, (iii) Minimum size of FCCB is USD 100 million and (iv) The
applicant should submit the purpose / plan of utilization of funds.
Special Purpose Vehicles, or any other entity notified by the Reserve Bank. Multi-State Co-operative Societies
engaged in manufacturing activity.
SEZ developers can avail of ECBs for providing infrastructure facilities within SEZ. Eligible borrowers under the
automatic route other than corporates in the services sector viz. hotel, hospital and software can avail of ECB
beyond USD 750 or equivalent per financial year Corporates in the services sector viz. hotels, hospitals and
software sector can avail of ECB beyond USD 200 million or equivalent per financial year.Service sector units,
other than those in hotels, hospitals and software, subject to the condition that the loan is obtained from foreign
equity holders. This would facilitate borrowing by training institutions, R &D, miscellaneous service Co's etc.ECB
from indirect equity holders provided the indirect equity holding by the lender in the Indian company is at least
51%. ECB from a group company provided both the Borrower and the foreign lender are subsidiaries of the same
parent. Corporates which have violated the extant EC 3 policy and are under investigation by the Reserve Bank
and / or Directorate of Enforcement are allowed to avail of ECB ody under the approval route.
Recognized Lenders .•

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Borrowers can raise ECB from internationally recognized sources, such as international banks, international capital
markets, multilateral financial institutions (such as IFC, ADB, CDC, etc.), export credit agencies, suppliers' of
equipment, foreign collaborators and foreign equity holders (other than erstwhile OCBs).
The total outstanding stock of ECBs (including the proposed ECBs) from a foreign equity lender should not exceed
seven times the equity holding, either directly or indirectly of the lender.
Amount and Maturity:
Eligible borrowers under the automatic route other than corporates in the services sector viz. hotel, hospital and
software can avail of ECB beyond USD 750 or equivalent per financial year.
Corporates in the services sector viz. hotels, hospitals and software sector are allowed to avail of ECB beyond
USD 200 million or its equivalent in a financial year for meeting foreign currency and/ or Rupee capital
expenditure for permissible end-uses. The proceeds of the ECBs should not be used for acquisition of land.
Indian companies which are in the infrastructure sector, as defined under the extant ECB guidelines, can avail of
ECBs in Renminbi (RMB), subject to an annual cap of USD one billion pending further review.
iv) All-in-cost ceilings: All-in-cost includes rate of interest, other fees and expenses in foreign currency except
commitment fee, pre-payment fee, and fees payable in Indian Rupees. The payment of withholding tax in Indian
Rupees is excluded for calculating the all-in-cost.
The all-in-cost ceilings for ECB are reviewed from time to time. The following ceilings are applicable upto March
31, 2012 and subject to review thereafter:
Average Maturity Period All-in-cost Ceilings over 6 month LIBOR*

Three years and up to five years 350 basis points
More than five years 500 basis points
* for the respective currency of borrowing or applicable benchmark
End-Use
ECB can be raised only for investment (such as import of capital goods), implementation of new projects,
modernization / expansion of existing production units] in real sector - industrial sector including SME and
infrastructure sector in India. Overseas Direct Investment in Joint Ventures (JV)NVholly Owned Subsidiaries
(NOS).
Interest During Construction (IDC) for Indian companies which are in the infrastructure sector subject to IDC
being capitalized and forming part of the project cost.
The payment by eligible borrowers in the Telecom sector, for spectrum allocation may, initially, be met out of
Rupee resources by the successful bidders, to be refinanced with a long-term ECB.
Repayment of Rupee loans availed from domestic banking system.
vi) Bridge Finance: Indian companies which are in the infrastructure sector, are permitted to import capital goods
by availing of short term credit (including buyers' / suppliers' credit) in the nature of 'bridge finance', under the
approval route; subject to the following conditions:-
The bridge finance shall be replaced with a long term ECB;
The long term ECB shall comply with all the extant ECB norms; and
Prior approval shall be sought from the Reserve Bank for replacing the bridge finance with a long term ECB.
End-uses not permitted For on-lending or investment in capital market or acquiring a company except
Infrastructure Finance Companies (IFCs), banks and financial institutions.
For real estate; and for working capita and general corporate purpose
vii) Guarantee: Issuance of guarantee, standby letter of credit, letter of undertaking or letter of comfort by banks,
financial institutions and NBFCs relating to ECB is not normally permitted.
viii) Security: The choice of security to be provided to the lender / supplier is left to the borrower.
ix) Parking of ECB Proceeds: Borrowers are permitted to either keep ECB proceeds abroad or to remit these fund;
to India, pending utilization for permissible end-uses. The proceeds of the ECB raised abroad meant for Rupee
expenditure in India, such as, local sourcing of capital goods, on-lending to Self-Help Groups or for micro credit,
payment for spectrum allocation, etc. should be repatriated immediately for credit to their Rupee accounts with
AD Category I banks in India. ECB proceeds parked overseas can be invested in the following liquid assets
Deposits or Certificate of Deposit or other products offered by banks rated not less than AA (-) by Standard and
Poor/ Fitch IBCA or Aa3 by Moody's;Treasury bills and other monetary instruments of one year maturity having
minimum rating as indicated above andDeposits with overseas branches / subsidiaries of Indian banks abroad.
The funds should be invested in such a way that the investments can be liquidated as anc when funds are
required by the borrower in India.
x) Prepayment
Prepayment of ECB up to USD 500 million may be allowed by the AD bank without prior approval of the Reserve
Bank subject to compliance with the stipulated minimum average maturity period as applicable the loan. Pre-
payment of ECB for amounts exceeding USD 500 million would be considered by the Reserve Bank under the
Approval Route.
xi) Refinancing of an existing ECB: Existing ECB may be refinanced by raising a fresh ECB subject to the condition
that the fresh ECB is raised at a lower all-in-cost and the outstanding maturity of the original ECB is maintained.
CAPITAL ACCOUNT - LIBERALISATION
The Reserve Bank of India, in consultation with the Government of India has decided to introduce the following
liberalization measures w.r.t. capital account transactions with immediate effect:
a)To allow Indian companies in manufacturing and infrastructure sector and having foreign exchange earnings to
avail of external commercial borrowing (ECB) for repayment of outstanding Rupee loans towards capital
expenditure and/or fresh Rupee capital expenditure under the approval route. The overall ceiling for such ECBs
would be USD 10 billion.

28
b)Theexisting limit for investment by Securities and Exchange Board of India (SEBI) registered foreign
institutional investors (Flls) in Government securities (G-Secs) has been enhanced by a further amount of USD 5
billion. This would take the overall limit for Fl I investment in G-Secs from USD 15 billion to USD 20 billion.
c) In order to broad base the non-resident investor base for G-Secs, RBI has decided to allow long term investors
like Sovereign Wealth Funds (SWFs), multilateral agencies, endowment funds, insurance funds, pension funds and
foreign central banks to be registered with SEBI, to also invest in G-Secs for the entire limit of USD 20 billion. The
sub-limit of USD 10 billion (existing USD 5 billion with residual maturity. of 5 years and additional limit of USD 5
billion) would have the residual maturity of Three years.
d)The terms and conditions for the scheme for Fll investment in infrastructure debt and the scheme for non-
resident investment in Infrastructure Development Funds (IDFs) have been further rationalized in terms of lock-in
period and residual maturity.
e)Further, Qualified Foreign Investors (QFIs) can now invest in those mutual fund (MF) schemes that hold at least
25 per cent of their assets (either in debt or in equity or both) in infrastructure sector under the current USD 3
billion sub-limit for investment in mutual funds related to infrastructure.
ECB — REPAYMENT OF RUPEE LOANS
On a review, of ECB norms for Infrastructure and Power sector, RBI has decided as follows:
a)To allow Indian companies to avail of ECBs for repayment of Rupee loans availed of from the domestic banking
system and / or for fresh Rupee capital expenditure, under the approval route., subject to them satisfying the
following conditions:
The overall ceiling for such ECBs as given above shall be USD 10 billion. The maximum permissible ECB that can
be availed of by an individual company will be limited to 50% of the average annual export earnings realized
during the past three financial years.
FOREIGN INVESTMENT IN INDIA: On a review, RBI has decided as under:
GOVERNMENT SECURITIES
i) The limit of USD 15 billion for Fl I investment in Government securities stands enhanced with immediate effect
by USD 5 billion to USD 20 billion. It has also been decided to rationalize the conditions governing the
investments under this scheme by making the residual maturity of the instrument at the time of first purchase by
Flls and SEBI registered eligible non-resident investors in IDFs and foreign Central Banks to be at least three
years for a sub-limit of USD 10 billion. Accordingly, the existing and new sub limits ndattendant n it ns are
summarized as follows:
EXISTING POSITION NEW POSITION REMARKS
Sub limit Conditions Sub limit Conditions
USD 10 billion No conditions USD 10 billion . No conditions, No change
USD 5 billion Residual maturity of at USD 10 bn (existing Residual maturity of the Increase in sub limit
least 5 years sub limit of USD 5 bn instrument at the time of and change in
plus the enhancement first conditions
of USD 5 bn) purchase by Flls to be at
least three years
TRADE CREDITS FOR IMPORTS INTO INDIA

'Trade Credits' (TC) refer to credits extended for imparts directly by the overseas supplier, bank and financial
institution for maturity of less than three years. Depending on the source of finance, such trade credits include
suppliers' credit or buyers' credit.
SUPPLIERS' CREDIT: Supplier's credit relates to credit for imports in to India extended by the overseas supplier.
BUYERS' CREDIT:Buyer’s credit refers to loans for payment of imports in to India arranged by the importer from a
bank or financial institution outside India foi maturity of less than three years.
Buyers' credit and suppliers' credit for three years and above come under the category of External Commercial
Borrowings (ECB), which are governed by ECB guidelines.
AMOUNT:
AD banks are permitted to approve trade credits for imports into India up to USD 20 million per import
transaction for imports permissible under the current Foreign Trade Policy of the DGFT with a maturity period up
to one year (from the date of shipment).
For import of capital goods (as classified by DGFT), trade credits up to USD 20 million per import transaction with
a maturity period of more than one year and less than three years can be allowed by AD Banks. No roll-
over/extension will be permitted beyond the permissible period.AD banks cannot approve trade credit exceeding
USD 20 million per import transaction and must advise the Importer to seek RBI approval. ALL-IN-COST CEILING:
200 Basis points over 6 months LIBOR for all maturities
GUARANTEES: AD banks are permitted to issue Letters of Credit /Guarantees/Letter of Undertaking /Letter of
Comfort, in favor of overseas supplier, Bank or Financial institution, up to USD 20 million per transaction for a
period up to one year for import of
all Non-capital goods permissible under Foreign Trade Policy (except gold) and up to three years for import of
capital goods, subject to prudential guidelines issued by Reserve Bank from time to time. The period of such
Letters of credit / guarantees / LoU / LoC has to be co-terminus with the period of credit, reckoned from the date
of shipment.
LETTERS OF_CREDIT
All Letters of Credit are governed by a set of rules known as Uniform Customs and Practices for Documentary
Credits (UCPDC) — Publication 600 (UCP — 600) evolved by the International Chamber of Commerce (ICC). UCP
600 has come in to effect from ls' July 2007.

29
DEFINITION: Letter of Credit is an undertaking given by the Issuing Bank on behalf of Importer in favor of the
Exporter, undertaking to make the payment on presentation of the documents, subject to the conditions that the
documents are as per the terms and conditions of LC.
ADVANTAGES OF LETTERS OF CREDIT: Under bill of exchange system, the exporter faces risk of repudiation of
contract or non-payment. To overcome this problem, a superior method of settlement has been devised namely
Letter of Credit, under which the issuing bank through LC assures the exporter that if the goods exported are as
per terms and conditions of contract with importer and produces evidence to that effect by way of submission of
documents in accordance to the terms of the LC, it would make the payment to the exporter without default.
MAIN PARTIES TO LC
Buyer or Importer on whose request the LC is opened.

Applicant or Opener
Opening Bank The LC Issuing or Opening Bank, which opens the LC on behalf of buyer / importer.
Beneficiary The party in whose favour LC is opened i.e. Supplier of goods or Exporter.
Advising Bank The bank Authorised by the opening bank, which on receipt of LC, forward the same
to the Beneficiary. Advising bank is liable for ensuring the genuineness of LC by
verifying the specimen signature of Issuing Bank.
Confirming Bank Bank authorized by the Issuing Bank to confirm the LC. By confirmation, it means
that the Confirming Bank adds its guarantee and undertakes to negotiate and to pay
the documents subject to the condition that the documents are as per the terms and
conditions of LC.
The Bank, which negotiates the documents. It may be Confirming Bank or any other
Negotiating Bank Bank.
Types of Letters of Credit :Revocable Credit : Such a Credit can be revoked / modified or amended without
consent of beneficiary. If the negotiating bank makes a payment to the seller prior to receiving notice of
cancellation or amendment, the issuing bank must honour the liability.
Irrevocable Credit : Such a Credit cannot be cancelled I modified or amended without consent of beneficiary. In
the absence of any indication whether an UC is revocable or irrevocable, it shall be deemed to be irrevocable. As
per UCPDC 600, banks will issue only irrevocable LC
Confirmed Credit: An irrevocable credit which carries confirmation of the advising bank is called confirmed credit.
Article 8 of UCPDC, 600 says that a confirmation of irrevocable credit by another bank (the 'Confirming Bankl
upon the authorisation or request of the Issuing Bank constitutes a definite undertaking of the confirming Bank, in
addition to that of the Issuing Bank, provided that the stipulated documents are presented to the Confirming Bank
or any other Nominated Bank and that the terms and conditions of the Credit are complied with.
Transferable Credit: Under a transferable UC the beneficiary requests for credit being made available in whole or
in part to one or more other beneficiaries. Under Article 38 of UCPDC, 600 a credit is transferable only if it
designated as 'Transferable' by the issuing bank. Unless otherwise stated in the Credit, a transferable Credit can
be transferred once only. Other features of a transferable credit are:
(a) Transferable credit can't be transferred at the request of the Second Beneficiary to any subsequent Third
Beneficiary. However a retransfer to the First Beneficiary is allowed.
(b) Fraction of a transferable Credit (not exceeding in the aggregate of the amount of the credit) can be
transferred separately, provided partial shipments/drawings are not prohibited and the aggregate of such
transfers will be considered as constituting only one transfer of credit. The first Beneficiary has the right to
substitute his own invoice (s) (and Draft(s)) for those of the Second Beneficiary(ies), for amounts not in excess of
the original amount stipulated in the Credit and for the original unit prices if stipulated in the Credit, and upon
such substitution of invoice(s) (and Draft(s)) the First Beneficiary can draw under the Credit For the difference, if
any, between his invoice(s) and the Second Beneficiary(ies)ls invoice(s)
Revolving Credit: In such an L/C the amount of drawing is reinstated and made available to the beneficiary again
after negotiation of documents drawn under LC. There will be restriction regarding number of times LC can
revolve or maximum value upto which documents can be negotiated or both.
Back to Back Credit: It is an UC which is issued on the strength of original UC. Beneficiary of original UC is
applicant of Back to Back credit. Normally, an exporter uses his export UC as a cover for UC in favour of local
suppliers.
Red Clause LC: This LC has a clause permitting the correspondent bank in the exporter's country to grant advance
to beneficiary at issuing bank's risk and responsibility. These advances are adjusted from proceeds of the bills
negotiated.
Green Clause LC: This type of L/C is an extension of Red Clause L/C. Besides pre-shipment credit, Green Clause
L/C entails finance for storing of goods in a warehouse. Both Red clause and Green clause LC are called
anticipatory credits.
Restricted LC: A letter of credit in which negotiation is restricted to a particular bank.
Stand by LC: A LC issued in lieu of Bank Guarantee. It is similar to performance bond or guarantee, but issued in
the form of LC. The beneficiary can submit his Claim by means of a draft accompanied by the requisite
documentary evidence of non-performance, as stipulated in the credit.
11.DA,LCs are those, where the payment is to be made on the maturity date in terms of the credit. The
documents of title to goods are delivered to applicant merely on acceptance of docurrients drawn under LC.
DP LCs are those where the payment is made against documents on presentation.' -
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13.With or without recourse LCs: Where the beneficiary holds himself liable to the holder of the bill if
dishonoured, is considered to be with-recourse. Where he does not hold himself liable, the credit is said to be
without-recourse.
Instalment Credit: It is a letter of credit for the full value of goods but requires shipments of specific quantities of
goods within nominated period and allows for part-shipment. In case any instalment of shipment is missed, credit
will not be available for that and subsequent insalment unless of LC permits the same.
Merchant Exporter will prefer transferable or back to back credit whereas manufacturer exporter will prefer Red
clause or Green clause LC. All exporters prefer Irrevocable LC
UNIFORM CUSTOMS & PRACTICE:FOR DOCUMENTARY CREDITS : (UCP - 600)

International Chamber of Commerce, Paris have now finalized the 2007 revision of UCP (ICC Publication No 600)
which came into force from 1st July 2007. With due approval of Reserve bank of India, the authorized dealers in
India are I now be subscribing to UCP- 600 with effect from 1st July, 2007. This includes and revises the clauses
of UCPDC 500 as well as the 12 clauses of E-UCP. It also addresses Standby Letters of Credit and therefore is a
comprehensive document. It has to be clearly mentioned in the Letter of Credit that it is subject to UCPDC by
inserting a clause generally worded as follows:
"Except as otherwise expressly stated this Documentary Credit is subject to The Uniform Customs and Practice for
Documentary Credits 2007 revision, International Chamber of Commerce Publication No.600."
Main features of UCP - 600 are contained in articles as follows, Article 1 : Applicability
UCP 600 applies only when referred to
"they are binding on all parties thereto unless expressly modified or excluded by the credit" UCP 600 can still be
used for Standby
Article 2 : Definitions- Contains "definitions" - A new concept for the UCP. r'revious UCP revisions did contain
common trade words / phrases but did not expressly define the terms.
Article 3 : Interpretations- "Interpretations" were collected and put into this single article.
Major change, i.e. that all credits are irrevocable even if there is no indication to that effect. Revocable LC's are
no longer discussed. Word "between" has been added to shipment period (includes dates mentioned) Added
"from" and "after" to define maturity dates (excludes the date mentioned)
Please notice that the word "from" is defined differently 1) for SHIPMENT (includes date mentioned) and 2) for
Maturity (excludes the date mentioned). Article 5: Documents vs Goods, Services, Performance- It is now
ensuring that banks are limited to only dealing with documents. Banks do not become responsible for the goods,
services 8./or performances to which any document relates.
Article 6: Availability, Expiry date and Place of presentation - Availability, expiry date and place for presentation
.Credits must not be made available against drafts drawn on the applicant. "Freely negotiable" no longer used.
Now credit is "available with any bank". Expiration date for Negotiation or Honour will be deemed to be an
expiration date for "PRESENTATION".
Article 13: Bank to Bank Reimbursement Arrangements - Now defines that the ICC rules for bank-to-bank
reimbursements, URR 525, must be stated in the LC, for them to apply. Otherwise, default reimbursement rules
are those stated in Article 13. ,Reimbursing Bank charges now for the Issuing Bank unless otherwise stated.
New Article 14: How long is too long : A nominated bank acting on its nomination, a confirming bank, if any and
the issuing bank shall each have a maximum of five banking days following the day of the presentation to
determine if a presentation is complying. The period is not curtailed or otherwise affected by the occurrence on or
after the date of presentation of any expiry date or last day for presentation.
A presentation that includes one or more original transport documents subject to Articles 19, 20, 21, 22, 23 and
24 or 25 must be made by or on behalf of the beneficiary not later than 21 calendar days after the date of
shipment as described in these rules, but in any event, not later than the expiry date of the Credit.
Article 16: Discrepant Documents, Waiver and Notice- Contains refusal message wording and respective delivery
options (contains parts of former Article 14).There is no longer a need to reference: "payment under reserve".
Article 29: Extension of Expiry date or last day of Presentation- Deals with extension of presentation periods and
expiry date when such dates fall on a day on which the bank to which presentation is to be made is closed.
Former Article 44 of UCP 500.This does not effect the latest date for shipment.
If the expiry date of a credit or the last day for presentation falls on a day when the bank to which presentation is
to be made is closed for reasons other than those referred to in Article 36, the expiry date or the last day for
presentation, as the case may be, will be extended tc the first following banking day.
If presentation is made on the first following banking day, nominated bank must provide the issuing bank /
confirming bank with a statement on its covering schedule that the presentation was made within the time limits
extended in accordance with sub-Article 29 (a).
Article 36 - Force Majeure-This article deals with disclaimer on "force majeure" and is consistent with former
Article 17 of UCP 500. Now added "acts of terrorism".
Banks are to insert clauses regarding the method of reimbursing the negotiating banks. This issue is between the
two banks (i.e. Issuing bank & Negotiating banks). However, to bring uniformity and infuse confidence,
International Chamber of Commerce has brought out their Publication number 525 called —Uniform rules for
Bank-bank reimbursements or UR-525.
STANDBY LETTER OF CREDIT (GUARANTEES) : Another popular instrument for international trade is a
Standby letter of credit. It is very similar in nature to a bank guarantee. Standby Letters of Credit differ from the
traditional letters of credit in a very fundamental manner. In a normal or traditional L/C, the beneficiary gets
payment upon performing his part of the contract as per the terms of the credit and providing evidence thereof as
stipulated. In a Standby Letter of credit, the beneficiary is eligible for payment from the L/C issuing bank if the
applicant fails to pay or perform his part of the obligation. Thus, the Standby Letter of Credit is actually a back-
up system. In a Standby UC-the following parties/steps are involved: (1) Applicant, (2) The issuing Bank
(3) Advising Branch / Bank (4) Beneficiary
31
The issuing bank agrees to pay the L/C value to the beneficiary before the expiry of the Credit upon a: D.
Demand by the beneficiary along with, Documents that evidence that the beneficiary has fulfilled his obligation,
&Document evidencing the applicant's non-performanceIf the Beneficiary is not comfortable with the Issuing bank
being a bank in the applicant's country, he can insist on the L/C being confirmed by a loCal bank just as in
traditional L/Cs. Authorised dealers can issue stand by LCs, either under International Standby Practices (ISP-98),
ISP-98 or UCP-600, as agreed upon mutually by the parties concerned.
Usage of Standby LC by Authorised Dealers: Banks can establish stand by LCs for the following transactions:
I) As a document of promise in respect of "non-performance" situation especially as a substitution to guarantees
which A.D.s are permitted to issue under FEMA, 1999, such as a guarantee in respect of any debt, obligatithi or
other liability incurred by: An exporter On account of exports into India.Owed to a person resident in India by a
person resident outside India for a bona fide trade transaction, duly covered by a counter guarantee of a bank of
international repute resident abroad.Exporters may also opt to receive stand by LC in respect of exports from
India. Commercial Standby LC for Import of Goods
A D Banks can issue standby LCs towards import of goods into India subject to the following safeguards:
The facility of commercial standby should be extended on a selective basis and to the following categories of
importers only: Independent power producers / importers of crude oil and petroleum products.
Export / Trading Houses, Star Trading House / Super Star Trading Houses / 100% EOUs. Public Sector Units /
Public Limited Companiei with good trade record.
Satisfactory credit report on the overseas supplier should be obtained by the issuing bank, prior to issue of
standby LC. Invocation by the beneficiary should be supported by proper evidence.
The applicant of a commercial stand by L/C (Indian importer) should undertake to provide "evidence of imports as
provided under FEMA in all cases of payments made under the Standby L/C covering imports in to India. (Bill of
Entry and so on).A Ds should follow up evidence of import in all cases of payments under such stand by L/Cs.
Implications of some of the Articles of ISP-98
Before issuing stand by LC, the bank as the opener / applicant must understand the implications of the clauses of
the ISP-98.A few articles which merit special mention are as follows:
Article 1.02: ISP -98 Rule supplements the applicable law to the extent not prohibited by that law. Hence, if there
is any provision in the rules which conflict with Indian law, such provision would not be applicable.
Article 1.09: Business Day — Business day means a day on which the place of business at which the relevant act
is to be performed is regularly open, and banking day means a day on which the relevant bank is regularly open
at the place at which the relevant act is to be performed. Therefore, while issuing the Stand by UC, care needs to
be taken to ensure that the terms are used after properly understanding of the same.
Article 3.13: Expiration Date on Non Business Day.
Article 3.14: Closure on a Business Day and authorisation of another reasonable place for presentation. This
provides for automatic extension to the day after 30 calendar days after the place of presentation re-opens for
business if in the event that on the last business day for presentation, the place of business is closed for any
reason unless the Standby otherwise provides. Thus, the openers have to be careful. It also provides for
authorizing an alternate reasonable place for presentation subject to conditions.
Article 5.01: Timely Notice of Dishonor — The article provides for timely notice of dishonour as per the provisions
contained therein.
Articles 10.0 and 10.02: Relates to syndication / participation under the standby LC may be taken note of by the
banks issuing such standbys under syndication / consortium loan arrangements among authorized dealers.
INCOTERMS - 2000(INTERMIRMAL COMMERCIAL TERMS)
With a view to minimize different interpretations and to facilitate international trade quotes and transactions in a
transparent (avoiding inclusion of hidden costs and risks), International Chamber of Commerce evolved a set of
commercial terms in 1936 called as 'International commercial terms or INCOTERMS. Over the years amendments
have taken place such as in 1953, 1967, 1976 etc. The latest version is that of 2000.This version defines 13
contract terms and also provides a set of rules broadly in line with current trade practices. Usage of INCOTERMS
is optional. It is therefore necessary that the contracting parties indicate their concurrence by specifically
mentioning that the contract is to be governed by INCOTERMS 2000. Given below are the most used INCOTERMS
(out of total 13).
ABBREVIATION CONTRACT TERMS EXPLANATION

FOB* Free on Board The seller delivers when the goods pass the railings of the
(named port of shipment) ship at the named port of shipment. The buyer will bear the
costs and risks thereafter.
CFR* Cost & freight
(named port of destination) The seller delivers when the goods pass the railing of the
ship in the port of shipment. However, the seller has to pay
the freight charges up to place of destination. The risk of
damage or loss subsequent to loading is on the buyer.
CIF* Cost, insurance & freight The seller delivers when the goods pass the ship's rails in
(named port of destination) the named port of shipment. However the seller must pay
the freight charges. He also has to procure a marine
insurance policy against the buyer's risk (which begins once
the goods are delivered at the port of shipment).
IMPORTANT FOREX RETURNS
Name Period Objective
R- Return Fortnightly on 15th and last day, Transactions in various currencies. Consolidated bank wide return only.
within 7 days
32
XOS HY - Jun a Dec within 15 days Outstanding export bills > 6 months
BEF HY - Jun & Dec within 15 days Imports in respect of which documentary proof has not been • submitted by the
importer.
EBW HY - Jun & Dec within 15 days Export Bills written off
NRD- CSR Monthly Non-resident deposits comprehensive single return on NR/FCNR deposits and their
STAT-5 Monthly transactions
Statement ofinFCNR
a month
deposits (total inflow, outflow and outstanding deposits under
(only soft FCNR accounts)
STAT-8 Monthly STAT-B Statement showing inflow/outflow of deposits under non-resident (external)
(only soft rupee (NRE) accounts scheme
copy
2012) and NRO accounts scheme for the specified month
BAL Fortnightly Foreign currency balances of Authorized Dealers and rupee balances of non-resident
ECB-2 Monthly banks
External Commercial Borrowings
GPB Daily Gaps, Positions, and Balances (GPB) : Gaps of foreign currency, net open
exchange positions and cash balances
SEW Form When exports of goods or software in physical form are made, otherwise than by post and Custom Office has EDI
facility.
EDF ( Earlier PP Form ) When exports are made to any country by post parcel.
VP/COD form When exports are made by post parcel under arrangements to realise proceeds through postal channels on value
payable or cash delivery basis.
SOFTEX Form In case of export of computer software in non-physically form.
EDF (Export Declaration When exports are made otherwise than by post & custom house is not Computerised ( ie EDI facility is not available
form )-Earlier GR form ) Prepare in Duplicate Submitted to Commissioner of Custom
NEW FOREIGN TRADE POLICY : The Central Government declares the Foreign Trade Policy (FTP) every five
years, under Foreign Trade (Development & Regulation) Act, 1992, to set the vision and direction for the foreign
trade in India. The present policy was notified on 27th August, 2009 for a period of five years, from 27th August
2Q09 to 315' March, 2014. The policy is declared by the Ministry of Commerce and Industry and is monitored by
the Department of Commerce. It is reviewed at annual intervals: First review of the FTP was done on 23`d August
this year.
OBJECTIVES
Short Term: To arrest and reverse the declining trend of exports and to provide additional support especially to
those sectors which have been hit badly by recession in the developed world.
Long Term: To double India's share in global trade by 2020.
TARGETS : An annual export growth of 15% with an annual export target of US$ 200 billion by March 2011.In the
remaining three years of this Foreign Trade Policy i.e. upto 2014, the country should be able to come back on the
high export growth path of around 25% per annum.By 2014, to double India's exports of goods and services.
FIRST ANNUAL REVIEW : Going by the basic theme of the policy, the first review relied heavily on the pace of
global economic recovery, though overall theme seemed to be continuity as most of the incentives announced
were largely extensions of the existing schemes. The Govt. used the platform of annual review to extend the
ambit of Export Promotion Schemes to include some of the laggards such as textiles and engineering and the
'aamadmi' focused ones such as handicrafts, handlooms and leather. In several cases, such as the Duty
Entitlement Passbook (DEPB), a scheme particularly popular with the exporters for availing duty draw back, the
validity period was extended by another year, up to 30th June, 2011; although the scheme is incompatible with
World Trade Organization norms. ANNUAL SUPPLEMENT-2012-13 : Faced with uncertain global environment,
government has announced annual supplement (2012-13) to the Foreign Trade Policy (FTP) 2009-14. One of the
key objectives of the FTP has been to give a thrust to a technology upgrade of exports to enhance global
competitiveness of the products.
TARGET: The annual supplement has set a target of achieving 20% growth in exports this fiscal to almost $360
billion over $303.7 billion last year.
HIGHLIGHTS : 1) 2% Interest Subvention Scheme: Continuation and Expansion:
The export credit 2% Interest Subvention Scheme was available only to Handlooms, Handicrafts, Carpets and
SMEs till 3181 March 2012. Now this would be continued til! 31" March 2013. The subvention scheme has now
been extended to labour intensive sectors, namely, Toys, Sports Goods, Processed Agricultural Products and
Ready-Made Garments.
Technological Upgradation / EPCG Scheme: ,EPCG 0% duty scheme for continued technological up-gradation of
export sectors extended till March 2013.
Support for Export of products from North Eastern Region: To promote manufacturing activity and employment in
the North Eastern Region of the country, export obligation under the EPCG Scheme has been fixed at 25% of the
normal export obligation. Support For Export of Green Technology Products: To promote exports of 16 identified
green technology products, export obligation for manufacturing of these products, under the EPCG Scheme, has
been reduced to 75% of the normal export obligation.
Support for Infrastructure for Agriculture Sector: Status holders exporting products under ITC (HS) are provided
Duty Credit Scrip equivalent to 10% of FOB value of agricultural products so exported. Now these scrips are
eligible for import of 14 specified equipment for setting up of Pack-houses.
Incentives for promoting Investment in Labor Intensive Sectors: The Status Holders Incentive Scrip (SHIS) up to
10% of its value, allowed to be utilized to import components and spares of capital goods imported earlier.
Encouragement for Manufacturing Sector in Domestic Market: Scrips under different schemes of Chapter 3 of
Foreign Trade Policy have been permitted to be utilized for payment of Excise Duty for domestic procurement so
33
as to encourage manufacturing, value addition and employment. This will be an important measure for import
substitution and will help in saving of foreign exchange in addition to creating additional employment.
Use of Delivery against Acceptance terms not to be encouraged for export of Carpets I Handicrafts: Export of
Handicraft items and export of Hand-Made Woollen Carpets including other floor coverings are not allowed on the
basis of Delivery against Acceptance (DA) terms, unless they are covered by Bank Guarantee or ECGC guarantee.
Towns of Export Excellence: Three new towns are being declared as Towns of Export Excellence (TEE). These are
Ahmedabad (Textiles), Kolhapur (Textiles), and Saharanpur (Handicrafts).
Miscellaneous: Market linked focus product scheme extended till March 2013 for Apparel export to USA and EU.
Ahmedabad, Kolhapur, and Saharanpur designated as new towns of Export Excellence.
Government to come out with new guidelines to promote SEZs.Thirteen shows abroad to promote Brand
India.SWOT ANALYSIS OF FOREIGN TRADE:
STRENGTH: Our exports are growing at a double digit rates. Industry and services are alsc growing at competitive
level.
WEAKNESS: Global recovery is uneven and not strong enough to sustain good growth.
OPPORTUNITY: Export of goods and services need to be doubled by 2014.
THREAT: The developed countries may adopt protectionist policies adversely affecting our export prospects.
BRAND INDIA: The Government seeks to promote Brand India through six or more 'Made in India' shows to be
organized across the world every year.
A new rationalized scheme of categorization of status holders as Star Export Houses has been introduced as
under:
CATEGORY PERFORMANCE PERIOD
Export House 20 3 years
Star Export House 100 3 years
Trading House 500 3 years
Star Trading House 2500 3 years
Premier Trading Hopse 7500* 3 years.
In view of the global slow down, the performance criterion for Premiere Trading Houses was reduced from
Rs10,000 crore to Rs.7500 in the Annual supplement announced during February 2009.
FULLER COWL ( MONT CONVERTIBILITY )
Capital Account Convertibility (CAC) implies freedom to convert local financial assets into foreign financial assets
and vice versa, at market determined rates of exchange. It is associated with changes of ownership in foreign /
domestic financial assets liabilities and embodies the creation and liquidationof claims on, or by, the rest of the
world. CAC can be, and is, coexistent with restrictions other than on external payments. To revisit the subject and
arrive at a roadmap towards fuller Capital Account Convertibility based on current realities, a Committee to set
out the framework for Fuller Capital Account Convertibility (FCAC) was set up by RBI. The committee was chaired
by Shri. S.S.Tarapore, erstwhile Deputy Governor of RBI. Shri Tarapore had headed an earlier committee on CAC
in 1997, which had put out a road map for full convertibility.The Committee on FCAC has submitted its report to
RBI on 31st July 2006. They have recommended a Road map for Fuller convertibility within a broad frame work of
Five years in three phases, 2006-07 (Phase I), 2007-08 and 2008-09 (Phase II) and 2009-10 and 2010-11 (Phase
III) .
EXPORT CREDIT GUARANTEE CORPORATION OF INDIA LIMITED
STANDARD POLICY: Standard Policy is a whole turn over policy which has been formulated by the ECGS .,with a
motive to provide Insurance Cover to Export Shipments on going or continuing basis. The maximum period of the
credit, as has been fixedby RBI, is 180 days on DA, DP or on Open Sale terms. Standard Policy is of two sub types
namely: a) Comprehensive Risks Standard Policy for Exporters having anticipated Export Turn Over above Rs 50
lakhs in the year, b) Small Exporters' Policy for Exporters having anticipated export turnover of less than 50 lakhs
during the year. The year is reckoned of 2 months from the issue of policy.
Comprehensive Risks Standard Policy: Main features of the Comprehensive Risks Standard Policy are as listed
below: The policy is issued to exporters with future or existing exports over. Rupees 50 lakhs.It covers shipment
with maturity period of 180 days. Policy covers political, as well as commercial risks listed already Shipments to
various Govt. departments of foreign countries are covered for only political risks.
Small Exporter's policy These Policies are designed for exporters who have an anticipated export turnover of
Rs.50 lakh during next 12 months. Minimum premium to be charged is less than the Standard policy, which is
notified by the corporation from time to time.
The Policy is issued for a period of 12 months It covers, Political and Commercial Risks both. All overdue
payments are to be reported after 30 days from due date. Claims up to 95% of the defaulted amount are settled.
SPECIFIC POLICIES: Contracts for export of capital goods turn key basis projects, construction projects are
generally carried on contract to contract basis rather than on ongoing basis. The payment period involved is also
generally long term or medium term credit. Such type of Export Projects is covered under Specific Policy issued
by the corporation for carrying out single project as per contract. Such types of projects require approval from
EXIM Bank, as the payment is on Deferred Payment Terms. Therefore, insurance cover is issued by corporation
only after the projects have been cleared by EXIM Bank or Special Working Group appointed by RBI.
BUYER'S CREDIT AND LINE OF CREDIT POLICY: Corporation provides this type of policy to foreign buyers where
imports have been financed by Indian Banks, or they have been getting finance facility from their banks under
line of credit facility given by Indian Banks. In this way, ECGC actually safeguards financial interests of Indian
Banks who have financed the foreign buyers. Such policies are issued on buyer to buyer basis and not on
continuing basis.
SERVICE POLICIES: These policies are issued for performance of technical and professional service contracts in
foreign countries. Four types of Service Policies are issued. '
A)Specific Service Contract (Comprehensive Risks) Policy, b)Specific Service Contract (Political Risks) Policy

34
c) Whole Turn Over Service (Comprehensive Risks) Policy, d) Whole Turn Over Service (Political Risks) Policy
Risks Covered: Political and Comprehensive Risks as mentioned above are covered under these policies as well
CONSTRUCTION CONTRACT POLICY: These policies are exclusively for civil construction contracts undertaken
abroad. These policies are different from SpecificContract Policy on account of Payment terms.Under this
category, contractors receive payment as per progress of contract.The Contractors raise the bills in between the
contract depending upon the progress
GUARANTEES BEING ISSUED TO BANKS: In order to provide timely and need based pre-shipment or post-
shipment credit facilities to exporters, banks too need some assurance that there will not be any financial loss to
their institution in case of default on part of the importer. With the motive that banks may not deny financial
assistance to the exporters for want of repayment assurance, the ECGC has formulated a set of different types of
guarantees for suiting different needs of the exporters and protecting banks dues. A major part of the finance is
covered by way of these guarantees.
TYPES OF GUARANTEES: ECGC issues following '6 types of guarantees to the Bank,Packing Credit Guarantee: (a)
Normal, (b) Whole Turn Over, Export Production Finance Guarantee, Post Shipment Export Credit Guarantee
Export Finance Guarantee, Export Performance guarantee
Export Finance-Over Seas Lending Guarantee PACKING CREDIT GUARANTEE (NORMAL): All credit facilities given
to exports by the bank at Branch level are covered under Packing Credit Guarantee: Important Terms of Packing
Credit Guarantee: Guarantee is issued for a period of 12 months. Guarantee covers all the pre shipment advance
made by the banks at Branch level to the exporters within the approved limit of the bank The bank is to submit a
declaration in respect of all-pre shipment advances every month.
The bank is to pay a premium of 10 paisa per Rs.100 per month on the highest outstanding during the month
(subject to change).
All packing credit advance will be covered with maturity date up to 360 days from the date of advance. Separate
approval from ECGC is required for advance with maturity beyond 360 days.
ECGC will cover 66% of the loss by way of claim to the bank.ECGC will entertain the claim after a period of 4
months from the due date of the bill. h. All recoveries made from the exporters after payment of the claim to the
bank, will be shared between ECGC and Bank in the ratio of 3 :2 It is necessary that the bank should have
conducted the business with due care and without negligence as per rules and policies of RBI / Govt. of India.
PACKING CREDIT GUARANTEE (WHOLE TURN OVER): All types of packing credit advance given by the bank at all
India level are covered under the Whole Turn over Packing Credit. Guarantee. Bank will inform ECGG of all the
Packing Credit Advance made to exporters by all its branches in consolidated figures.ECGC will cover a 75 % of
the loss under the policy by way of claims.Bank will have to obtain separate guarantees for Bills-on Deferred
Payment Terms.
EXPORT PRODUCTION FINANCE GUARANTEE: All export pre shipment advance which constitutes FOB value, plus
Export Incentives are covered under this scheme.
Terms & conditions Full cost of production is covered under the guarantee. The guarantee is available both at
branch level and whole turnover guarantees at bank level. All Other terms, including premium rates.
POST SHIPMENT EXPORT CREDIT GUARANTEE : This Guarantee is issued by the Corporation to the banks for
amount outstanding against negotiation of export bills, export bills Purchased and export bills discounted (Other
than on deferred payment terms). The guarantee is issued at branch level funding and for whole turn over on all
India basis.Premium is payable monthly on the highest outstanding/last day balance as the case may be.
Prior approval of the ECGC is required for covering-shipments made to restricted countries. EXPORT FINANCE
GUARANTEE: This guarantee is for advances against export incentives.
EXPORT PERFORMANCE GUARANTEE: Big Importers and Foreign Governments require exporters to furnish
guarantees issued by Indian Banks that export projects or exports will be completed on time and in case of their
failure to do so, a certain percentage of amounts, usually up to 2% of the order, tender or higher, will be paid by
the guarantee issuing bank. Such types of guarantees are very common in Bid Bonds. These types of Counter
guarantees issued by banks are called Export Performance Guarantees and ECGC provide them a cover under this
policy.
EXPORT FINANCE (OVERSEAS LENDING) GUARANTEE : This type of guarantee covers Foreign Currency Finance to
Exporters by banks and for the projects to be carried outside India. Short Term Finance is provided a risk cover of
75% to 90% as agreed by the ECGC.All the Claims are settled in Indian rupees.
SPECIAL GUARANTEES / POLICIES : Transfer Guarantee: Such guarantees are issued to the banks against loss
arising out of their adding confirmation to foreign LC. The losses covered are as under Comprehensive Policy. Loss
under Political Risk is covered to an extent of 90% Losses to an extent of 75% is covered under commercial risks.
Premium is also charged as per Standard or Small Exporters Policy. Overseas Investment, Insurance: This policy
covers investments made by Indian Exporters in Foreign Countries. Such invectrnents are long term investments
involving Capital Projects, Joint Ventures or loans etc.
Exchange Risk Cover Policy: There is always an exchange fluctuation risk in payments involving long term civil
construction projects, turn key projects, supply of capital goods on deferred payment. The cover is available for
payment schedules in select currencies beyond 12 months and up to 15 years. Here, ECGC makes good the losses
for fluctuations between 2%to 35%. In other words, losses below 2% or beyond 35% due to fluctuations in the
reference rates are not covered.
Objective Type Questions

1. Foreign Exchange Management Act (FEMA) is administered by:
(a) RBI (b) Govt. of India (c) SEBI (d) Both (a) & (b) (d) All of these
2. A license to deaf in foreign exchange to authorized dealers is issued by:
(a) DGFT (b) FEDAI (c) RBI (d) EXIM Bank (e) both (a) & (c)
3. All foreign exchange transactions in India are governed by :
(a) Foreign Exchange Regulation Act, 1973 (b) Reserve Bank of India Act, 1934
35
(d) Foreign Exchange Management Act, 1999 (e) Banking Regulation Act,1949
4. Restricted money changers are the firms/ organizations authorized to undertake:
sale of foreign currency notes, coins and travellers' cheques to the public
purchase of foreign currency notes, coins and travellers' cheques from the public
issu6of letters of credit for their importer customers
both sale and purchase of foreign currency notes, coins, travellers' cheques to / from the public
either (a) or (b) above
5. Full fledged money changers are the firms/ organizations authorized to undertake:
sale of foreign currency notes, coins and travellers' cheques to the public
purchase of foreign currency notes, coins and travellers' cheques from the public
issue of letters of credit for their importer customers
(d) both sale and purchase of foreign currency notes, coins, travellers' cheques to / from the public
(e) either (a) or (b) above
6. Forward transaction in foreign exchange means a transaction:
that is to be settled on the same day
in which delivery of foreign exchange takes place on the second working day of the contract
in which delivery of foreign exchange takes place on the next working day of the contract
in which delivery of foreign exchange takes place beyond second working day of the contract
in which delivery of foreign exchange takes place after at least 90 days beyond the day of the contract
7. Forex transactions are classified according to date of deal and date of delivery. Which of the following is not correct regarding type of
exchange transaction?
cash: which is to be settled on the same day
spot: delivery of foreign exchange takes place on the second working day of the contract
TOM: delivery of foreign exchange takes place on the next working day of the contract
Forward: delivery of foreign exchange takes place beyond second working day of the contract
None of these
8. For the purpose of foreign exchange transactions, foreign banks maintain accounts with ADs in India in Indian rupees. In their
mutual communications, Ads in India refer to such accounts as accounts.
(a) Loro (b) FCNR (c) Vostro (d) Nostro (e) Escrow
9. Account of a bank in India with a foreign correspondent bank abroad in foreign currency is called:
(a) Loro (b) FCNR (c) Vostro (d) Nostro (e) Escrow
10. Which of the following is not correct regarding classification of correspondent accounts?
(a) Nostra Our account with you (b) Vostro: Your account with us
(c) Loro: Their account with them (d) None of these
11. Bank of India maintains Nostro account with Citibank in New York. Bank of Baroda also maintains Nostra :account with Citibank
New York. If Bank of India wants to transfer funds from its Nostro a/c to Nostro alc of BoB, then account of BoB is called as
(a) Nostro (b) Vostro (c) Loro (d) Kerb (e) None of these
EXCHANGE RATES
12. When Foreign currency is fixed and value of home currency is variable, it is called:
(a) Direct Rate (b) Indirect Rate (c) Cross Rate (d) Variable Rate (e) None of these
13. When home currency is fixed and value of foreign currency is variable, it is is called:
(a) Direct Rate (b) Indirect Rate (c) Cross Rate (d) Variable Rate (e) None of these
14. In1ndia, which type of rate is applied?
(a) Direct Rate (b) Indirect Rate (c) fixed rate (d) Variable Rate (e) None of these
In India, exchange rates are decided by whom?
(a) RBI (b) FEDAI (c) IBA (d) market forces (e) None of these
The quotation US $ 1 = Rs. 44.40 - Rs. 44.50 is:
(a) average rate (b) .indirect rate (c) direct rate (d) cross rate (e) none of these
When Nostra account of the bank is credited before the payment to the tenderer of foreign exchange, which of the following rates will
be applied?
(a) TT Buying Rate (b) Bills Buying Rate (c) IT Selling Rate (d) Bills Selling Rate
When Nostro account of the bank is credited later than the payment to the tenderer of foreign exchange, which of the
following rates will be applied?
(a) TT Buying Rate (b) Bills Buying Rate (c) TT Selling Rate (d) Bills Selling Rate
When there is outward remittance and handling of import bills is involved, which of the following rates will be applied?
(a) TT Buying Rate (b) Bills Buying Rate (c) TT Selling Rate (d) Bills Selling Rate
20. When there is sale of foreign exchange, but import bills are not handled, which rate will be applied?
(a) Clean Selling Rate (b) Cheque Selling Rate (c) TT Selling Rate (d) Bills Selling Rate
21. Why exchange rate for purchase or sale of foreign currency are most unfavourable?
(a) Holding cost of currency is high (b) Bank does not get any exchange commission
Bank runs the risk of counterfeit currency (d) Both (a) & (c) (e) All of these
22. The difference between buying and selling rate quoted by an Authorised Dealer is called:
(a) Dealer's Margin (b) Dealers spread (c) Dealer's commission (d) None of these
23. A customer wants to subscribe to a magazine published in Paris. The exchange rate for draft will be :
(a) TT buying (b) TT selling (c) Bills selling (d) Bills buying (e) none of these
24. Your non-resident customer presents a draft in foreign currency for which cover has already been provided in Nostro account. The rate of exchange to
be applied to the transaction will be
(a) TT buying (b) Bills selling (c) Bills buying (d) -TT selling (e) none of these
25. Your importer customer has to retire his import bill. The rate of exchange to be applied will be:
(a) Bills buying (b) TT selling (c) Bills selling (d) TT buying (e) none of these
26. You had negotiated an export bill of your customer in May,2009. This bill has been returned by the overseas buyer for some reasons and the AD has
to debit his customer's account with Indian rupees. The rate to be applied will be :
(a) Bills buying (b) TT selling (c) TT buying (d) Bills selling (e) none of these
27. On which of the following TT buying rate will not be applied?
(a) Payment of DO drawn on the paying bank (b) cancellation of outward TT, MT
(c) Conversion of proceeds of instruments sent for collection (d) purchase of foreign DO drawn abroad
28. On which of the following TT Selling rate will not be applied?
36
(a) crystallization of overdue export bills(b) crystallization of overdue import bills
(c) Issue of foreign OD/MT (d) cancellation of outward TT/MT (e) Both (b) & (d)
LETTER OF CREDIT
29. Letters of credit transactions subject to provisions of :
(a) exchange control manual of RBI (b) UCPDC, 600 (c) UCPDC,500
(d) Foreign Trade Policy, 2009 (e) INCOTERMS
30. Full form of UCPDC is:
Uniform Contract & Practices for Documentary Credit
Universal Customs & Practices for Documentary Credit
Uniform Customs & Practices for Documentary Credits
Universal Customs & Provisions for Documentary Credits
31. For letter of credit transactions in international trade, under UCPDC (ICC publication 600) branches of a bank in different countries are considered:
(a) another bank (b) units of the same bank (c) associate banks
(d) either (a)- or (b) as per choice of beneficiary (e) either (a) or (c) as per choice of negotiating bank
32. If a credit does not indicate whether it is revocable or irrevocable, as per UCPDC, 600, it will be treated as :
(a) irrevocable (b) revocable (c) either revocable or irrevocable as per choice of beneficiary
.(d) :either revocable or irrevocable as per choice of applicant of the credit
(e) either (a) or (b) as per mutual consent of beneficiary and advising bank
33. If a letter of credit and UCPDC have contradictory provisions which of the following statements will be ' true ' in this regard:
(a) Provisions of UCPDC will prevail over those of Credit
(b) Provisions of Credit will prevail over those of UCPDC
(c) Better of the provisions of UCPDC or Credit as applicable to beneficiary will prevail
(d) Better of the provisions of UCPDC or Credit as applicable to applicant of Credit will prevail
(e) It being a disputed matter the matter will have to be referred to ICC,Paris
34. Which of the following feature(s) do/does not apply to a 'Transferable Credit'?
Transferable L/C is one which is expressly written to be 'Transferable'.
Transferable L/C can be transferred only once but can be transferred to more than one parties.
In a 'Transferable Credit' the first beneficiary has the right to substitute his own invoice(s) and draft for those of the second beneficiary.
Transfer of such Credit by second beneficiary back to first beneficiary is not permitted
35. A 'Revolving Credit' means a letter of credit :
which is available for use in any country
covering many shipments up to a particular period of time or a particular amount or both
which can be easily transferred by the beneficiary to his suppliers
which allows the beneficiary packing credit in foreign currency
36. A 'Red Clause' LC is one in which :
the beneficiary can avail pre-shipment finance up to the amount specified in LC.
negotiation is restricted to a particular bank (c) all clauses are compulsorily printed in red
(d) there are certain restrictive clauses as to period of shipment I negotiation of bills etc
37. A 'Back to Back' letter of credit is :
one on the strength of which another bank's guarantee is obtained
a second set of fresh LC opened in favour of second beneficiary on the strength of original LC
one backed by the government guarantee
a set of two LCs printed on the back of each other (e) none of these
38. A 'Green Clause' letter of credit is an extension of:
(a) transferable credit (b) confirmed irrevocable credit (c) red clause credit
(d) revolving credit (e) all of the above
39. A 'Claused bill of lading' means bill of lading :
la) containing special clauses as required under letter of credit
with a clause that shipping company has a right to increase freight
giving the importer right to refuse payment of freight if goods are damaged on board
indicating defective condition / packing of goods (e) any one or more of the above
40. The expiry of a letter of credit is 15.07.2009. The last date of shipment mentioned in the LC is 30.06.2009. The shipment was actually made on 17.06.2009 and
documents were presented on 15.072009. Choose the best option out of the following as per provisions of UCPDC, 600.
(a) The documents should have been presented within 7 days from date of shipment
(b)- The documents can be accepted as they are presented within the validity of the letter of credit
The documents should have been presented within 15 days from date of shipment
The documents should have been presented within 21 days from date of shipment
none of the above
41. PNB received a letter of credit opened by a bank in Germany. It is not in a position to verify the apparent authenticity of UC. Which of the following is true with
reference to the L/C as per UCPDC,600 ?
PNB must advise the credit to the beneficiary without disclosing the facts
PNB may elect not to advise the credit and must so inform the issuing bank without delay
PNB may elect to advise the credit to the beneficiary without recourse
either (b) or (c) (e) either (a) or (b)
42. A letter of credit was issued on 1.8.2009. The bill of lading presented on 10.8.2009 under L/C was dated 25.07.2009. The UC is silent on this aspect AD
should :
(a) accept the bill of lading, if otherwise in order (b) not accept a document dated prior to date of L/C
(c) refer the matter to the applicant of L/C (d) refer the matter to issuing bank (e) none of these
43. A manufacturer exporter will prefer:
a) Transferable LC b) Irrevocable LC c) irrevocable Confirmed LC d) Revocable LC
44. As per UCPDC 600, the words "about" or "approximately" used in connection with the amount of the credit or the quantity or the unit price stated in the credit are to be
construed as allowing a tolerance not to exceed % more or less than the amount, the quantity or the unit price to which they refer.
(a) 10% (b) 5% (c) 1% (d) No variation is allowed
45. In a set of documents submitted under letter of credit the date of shipment is 30. 3.2009 whereas the insurance policy is dated 3.4.2009. In this case :
(a) we may accept the documents provided necessary cover has been provided in the policy effective from date of shipment
(b),e,we must refuse the documents as it is a discrepancy
the date of insurance policy must be changed to be prior to the date of shipment
either (b) or (c) (e) none of the above

37
46. The beneficiary of an irrevocable letter of credit which was advised by us requests us to add our Confirmation. Under the circumstances :
confirmation is added at the request of opening bank and will be done only as per the arrangement.
we may do so as confirmation is usual course of business only and there is no commitment of the bank which adds the confirmation.
we must add our confirmation as it was advised by us
we should decline it as no confirmation is necessary on the irrevocable letter of credit and only a revocable letter of credit needs confirmation.
we may do so only after obtaining indemnity from the issuing bank.
47. Our bank opened an irrevocable letter of credit and our correspondent bank abroad negotiated the bills under this LC and got the reimbursement When the documents
were presented to our importer customer, he refused to pay on the plea that goods were not as per the contract. In this case :
we will verify the goods and take them into our possession
we cannot recover the money from the negotiating bank because as per UCPDC we deal in documents and not in gbods and will proceed to recover the
amount from the importer.
we will request the correspondent bank to pay back the money.
either (a) or (b) (e) none of the above.
48. A letter of credit was opened by us stipulating for 'clean on board bill of lading'. While scrutinizing documents under the UC we find that the notation
'some packages torn' appears on the bill of lading. We should :
accept the bill of lading as it is as per terms of LIC
try to rectify the irregularity with the shipping agent
wait until the ship arrives and verify the goods
immediately on receipt of documents, inform the negotiating bank by telex that documents are discrepant and they are held at the risk and responsibility
of the negotiating bank
either (b) or (c)
49. A letter of credit is opened in US dollars. The insurance document can be in :
(a) US dollars only if not otherwise stipulated in the Credit. (b) in any freely convertible currency
(c) in Indian rupees only (d) in US dollars only (e) either (b) or (c)
50. As per UCPDC 600, if there is no indication in the credit of the insurance coverage required, the amount of
insurance coverage must be at least value of the goods.
(a) 110% of CIF value (b)110% of FOB value (c)100% of FOB value (d) 100% of CIF value (e) None
51. An UC calls for commercial invoice not exceeding US $ 2,00,000. As per UCPDC, 600, the invoice can be for :
(a) US $ 2,00,000 (b) Upto US $ 2,20,000 (c) Upto US $ 2,10,000
(d) Upto $ 2,02,000 (e) none of the above.
52. Bank of Tokyo advised an UC to the beneficiary in India through BOB. It intends to advise an amendment through SBI. Under UCPDC :
(a), it is choice of issuing bank to select any bank for advising amendment.
(b) it has to advise amendment only through BOB
(c) it has to advise amendment through RBI only. (d) either (a) or (c ) (e) none of these.
53. If a credit contains conditions without stating document(s) to be presented in compliance therewith, what should the bank do?
(a) have to seek clarification from opening bank (b) disregard the conditions as not stated
obtain documents in their discretion which appear to satisfy these conditions.
(d) either (a) or (c) (e) none of the above
54. An UC was available for shipment by monthly instalments of ready made garments from India. The shipment for March,2009 was not effected within
the time available for that instalment. In this case, as per UCPDC:
beneficiary of LiC can ship two instalments together in Apri1,2009
the credit ceases to be available for that and subsequent insalment unless otherwise stipulated in the credit.
even earlier instalments will not be covered under LiC
either (a) or (c) (e) the matter be referred to RBI
55. Under UCPDC 600, what is maximum number of days allowed for examination of documents by issuing bank and negotiating bank?:
(a) 5 banking days each (b) 5 days each (c) 7 banking days in total (d) 7 banking days
56. As per Article 36 of UCPDC 600, (Force Majeure clause) a bank assumes no liability or responsibility for the consequences arising out of the interruption
of its business by Acts of God, riots, civil commotions, insurrections, wars, acts of terrorism, or by any strikes or lockouts or any other causes beyond its
control. Which of these items has been added in UCPDC 600?:
(a) acts of terrorism (b) wars (c) riots (d) Both (a) & (b) (e) None of these
57. If !about' or 'approximately' is not written with the quantity of goods, a tolerance of more or less than
the quantity of the goods is allowed, provided the credit does not state the quantity in terms of a stipulated number of packing units or individual items
and the total amount of the drawings does not exceed the amount of the credit.
(a).1 % (b) 5% (c)10% (d) Nil (e) None of these
58. If in a letter of credit, word about is written with the date for the submission of documents for negotiation, then up to which date documents can be
submitted for negotiation?
(a) 5 days before (b) 5 days after (c) 5 days before or 5 days after (d) None of these
59. As per UCPDC 600, if on a LC date of expiry is written as by the end of June, it means
(a) 21st to 30th June (b) 30Ih June (c) 215' June to 29th June if 30th June is holiday (d) None
60. Unless otherwise stated in Letter of Credit, banks will accept which type of bill of lading?
a) Charter party bill of lading b) Straight bill of lading c) Received for shipment bill of lading
d) On Board bill of lading (e) None of these
61. Under Letter of Credit part amount paid to beneficiary. While paying balance amount, Importer complains against quality of goods and request the
bank not to pay the amount for bills drawn under LC. What should be done by bank?:
Bank should not pay as it is a case of fraud
Bank should not pay as recovery will be difficult in such circumstances
Bank can suspend payment, seek clarification from exporter and make payment after being satisfied.
(d) Bank has to make payment as in LC transactions, banks deal in documents and not in goods.
62. In a letter of credit, it is written that documents can be negotiated on 30th June. In this case, the documents can be
negotiated up to which date?
(a) on 30m June only (b) between 25th June to 30th June (c) between 26th June to 30th June
th th
(d) between 25 June to 5 July (e) None of these
63. A letter of credit issued on the strength of another LC is called:
(a) Back to Back Credit (b) Transferable LC (c) Red Clause LC (d) Anticipatory LC
64. A Letter of credit that carries a provision (traditionally written or typed in red ink) which allows exporter to raise pre shipment credit
up to a fixed sum from the advising or paying-bank at the request of issuing bank is called:
(a) Back to Back Credit (b) Transferable LC (c) Red Clause LC (d) Anticipatory LC

38
NON RESIDENT ACCOUNTS
65. Who of the following can open a Non-Resident Account ?
(a) An Indian national working with a foreign shipping company with his base office in Hongkong
(b) An Indian who has gone abroad to pursue higher studies
(c) An Indian who has gone abroad for medical treatment (d) all of these (e) only (a) & (b)
66. Who is called as Resident as per FEMA 1999?:
A person who stayed in India for more than 182 days in the previous financial year.
A person who stayed in India for minimum 182 days in the previous financial year
A person who stayed in India for more than 182 days in the previous calendar year
A person who stayed in India for minimum 182 days in the previous calendar year
None of these
67. An NRE term deposit account can be opened for a minimum period of:
(a) 3 years (b) 5 years (c) 10 years (d) 6 months (e) 1 year
68. As per RBI guidelines FCNR (Bank) Account can be opened in:
three currencies, namely Pound sterling., US dollar & Euro
only two foreign currencies namely Pound sterling or US dollars
six currencies, namely Pound sterling., US dollar, Euro, Japanese Yen, Canadian dollar & Aus dollar
(d) any freely convertible currency
None of these
69. At present rate of interest on NRE term deposit for 5 years maturity as per RBI guidelines is:
(a) not exceeding 6% (b) not exceeding 250 basis points below BPLR of the bank
(c) not exceeding 250 basis points above LIBOR for USD for 3 years maturity
(d) not exceeding LIBOR for USD for 3 years maturity plus 275 basis points
(e) As per Bank discretion but not more than as applicable for domestic deposits.
70. At present rate of interest on NRE savings bank account as per RBI guidelines is:
4 per cent per annum
As applicable in domestic deposits
not exceeding 50 basis points above LIBOR for USD for 6 months maturity
not exceeding 50 basis points above LIBOR for USD for one year maturity
(e) As per Bank discretion but not more than as applicable for domestic deposits.
71. When an NRE FD is made for more than 5 years, interest rate will be:
(a) as applicable for 5 years (b) as applicable for 3 years
(c) Nil as NRE FD cannot be for more than 3 years. (d) 3 year or 5 year as per bank discretion
72. Minimum and maximum period for which FCNR (B) term deposits can be opened is year and ____ year.
a) 1, 5 (b) 1, 3 (c) 1, 7 (d) 3, 5 (e) none of these
73. Which type of account can be opened as NRE account?
(a) Saving (b) current (c) fixed deposit (d) Both (a) & (b) only (e) All of these
74. For converting NRE Deposit to FCNR Deposit which rate would be applicable?
a) FT Buying Rate b) TT Selling Rate c)Bill Buying Rate d) Bill Selling Rate
NRI is defined in which of the following Acts
a) RBI Act b) lncome Tax Act c)FEMA d)PML Act (e) None of these
A NR1 can remit up to US$ in a financial year from his NRO account on account of Sale proceeds of immovable property
provided it is held for at least years.
(a) 1 million, 10 years (b) 1 lakh, 5 year (c) 1 lakh, 5 year (d) 1 million, no restriction
In NRO A/c, Minimum period of term deposit is :
(a) 1 year (b) 6 months (c) 7 days (d) 15 days (e) None of these
Which type of account can be opened as NRO account?
(a) Saving (b)current (c) fixed deposit (d) Both (a) & (b) only (e) All of these
In which of the following type of deposit accounts, exchange risk is borne by bank? (a) NRO account (b) NRE account (c)
FCNR account (d) Both NRE & FCNR (e) None of these
If FCNR deposit is for more than 1 year, interest will be compounded at what interval?
(a) monthly (b) quarterly (c) half yearly (d) after every 180 days (e) None of these
81. In which type of accounts of NRI, joint account can be opened with resident?
(a) NRO account (b) NRE account (c) FCNR account (d) All of these (e) None of these
82. Which of the following type of accounts can be opened only as Fixed Deposit?
(a) NRO account (b) NRE account (c) FCNR account (d) Both NRE & FCNR (e) None of these
83. Maximum loans against NRE FCNR deposit that can be allowed by a bank is:
(a) Rs 20 lac (b) Rs 30 lac(c) Rs 50 lac (d) Rs 100 lac (e) None of these
84. What type of exchange rate is applied when foreign currency funds from FCNR(B) account are converted to NRE Saving
account:
(a) Bills Buying (b) TT Buying (c) TT Selling (d) Bills Selling (e) None of these
85. In a NRE account, which of the following cannot be done by Power of attorney holder?
(a) all local payments in rupees including payments for eligible investments & Remittance outside India of current income in India of the
non-resident individual account holder, net of applicable taxes to the account holder himself.
repatriate outside India funds in the account other than to the non-resident individual account holder
make payment by way of gift to a resident on behalf of the non-resident account holder & transfer funds from the account to
another NRO account
(d). Both (b) & (c) only (e) None of these
86. For which type of accounts, STAT 5, STATE returns are prepared respectively?
(a) NRE, FCNR (b) FCNR & NRE (C) NRE & NRO (d) FCNR & NRO
87. A FCNR(B) deposit has been made for one year. Interest compounding will be done at the interval of
(a) monthly (b) quarterly (c) half yearly (d) after 180 days (e) No compounding
88. FCNR-B, account cannot be opened in which of the following currency?
(a) US Dollar (b) Australian Dollar (c) Canadian Dollar (d) None of these (e) All of these
89. The balance alongwith interest is fully repatriable in which type of accounts?:
(a) NRO account (b) NRE account (c) FCNR account (d) Both NRE & FCNR (e) None of these
90. NRE account cannot be opened in which of the following currencies?
(a) Indian Rupees (b) USD (c) Euro (d) Both (b) & (c) (e) None of these
39
FOREIGN CURRENCY ACCOUNTS OF RESIDENTS
91. A Non-resident account holder returned to India for permanent settlement on 1.7.2009 after spending about 2 years abroad. His Non-
Resident (External) account can be converted into:
(a) Non-Resident (Ordinary) account (b) Resident account (c)Resident Foreign Currency account
(d) (b) or (c) as per his choice (e) (a) or (c) as per his choice
92. RFC account can be opened in which type of following accounts?
(a) Saving (b)current (c) fixed deposit (d) Both (a) & (b) only (e) Any of these
93. Who can open RFC account:
(a) NRI returning to India after staying abroad for a minimum period of 1 year.
(b) Any NRI who had opened NRE or FCNR(B) account with the bank.
(c) Any resident individual (d) All of these (e) None of these
94. My uncle gave me gift of USD 20000. In which type of following accounts it can be credited?
(a) RFC (b) RFC(Domestic) (c) EEFC (d) NRE (e) None of these
Exporters other than 100% Export Oriented Unit can deposit % of export proceeds to Exchange
Earners Foreign Currency account:
(a) 25% (b) 50% (c) 75% (d) 100% (e) None of these
What type of account can be opened under EEFC scheme?:
(a) Only fixed deposit (b) Only non interest bearing current account(c) Either (a) or (b)
(d) None of these as scheme has been discontinued w.e.f. 1.11.08
EXPORT CREDIT
97. Presently rate of interest on pre-shipment credit in forex (PCFC) up to 180 days is not exceeding:
(a) 350 basis points above LIBOR (b) 100 basis points above LIBOR
(c) 150 basis points above LIBOR (d) 50 points above LIBOR(e) 350 basis points below LIBOR
98. As per current guidelines of RBI, for loans sanctioned up to 30.6.2010, rate of interest on pre-shipment credit in rupees
up to 270 days should not exceed:
(a) Bank Rate plus 2.5% (b) BPLR plus 1.5% (c) BPLR minus 2.5%
(d) Bank Rate minus 2.5% (e) lower of (a) and (b)
99. As per the exchange control regulations, the payment for exports should in general be realized within a period of:
(a) 12 months from date of shipment (b) 360 days from date of packing of goods
(c) 180 days from the date of shipment (d) 270 days from date of shipment
(e) 180 days from the date of receipt of consignment by the buyer in foreign country
100. Which of the following is/are not true with regard to features of Gold Card Scheme for exporters:
(a) Only exporters whose accounts have been 'Standard' continuously for 3 years are eligible
(b) Gold Card holders will be given preference is granting packing credit in foreign currency (PCFC)
(c) Time norm for disposal of fresh applications for credit under the scheme will be 25 days
(d) Gold Card for exporters will be issued for a period of 5 years (e) none of these
101. Minimum and maximum amount up to which the Gold Credit card can be issued to exporter is Rs ___ lac and Rs___ lac.
(a) 100,1000 (b) 50, 500 (c) 100, 5000
(d) 20,200 (e) None of these as it is based on anticipated turnover.
102. As per the exchange control regulations, the payment for exports should in general be realized within a
period of :
(a) 9 months from date of shipment (b) 3 months from date of shipment
(c) 6 months from the date of shipment (d) 1 month from date of shipment
(e) 4S days form date of shipment
103. Units in a special economic zone are permitted to realise and repatriate to India the full export value of
goods or software within a period of from the date of shipment.
(a) 3 months (b) 6 months (c) 180 days (d) 12 months (e) none of these as there is no time limit
104. In respect of shipments made to Indian owned warehouses abroad established with permission of RBI,
export proceeds should be realized within :
(a) 6 months (b)3 months (c) 9 months (d)15 months (e) 150 days
105. RBI monitors overdue export bills-not realized within the stipulated time by calling for a half yearly
statement from ADs referred to as :
(a) BEF (b)XOS (c) GTE-1 (d) ST-9 (e) ENC
106. Packing credit advances mean :
advances granted to industrial units for packing of manufactured goods for sale in India
advances granted to eligible exporters for purchase/manufacturefprocessing/transporting/packing etc.
(c ) advances granted to importers to enable them to store and subsequently sell imported goods locally
(d) any one or more of the above (e) none of the above.
107. To be eligible for packing credit advances the customer:
(a) should not be in the caution list of RBI or specific approval list of ECGC
(b) must be holding importer/exporter code number allotted by DGFT
(c) should be recognised export house (d) all above (e) both (a) and (b)
108. Packing credit advances is normally allowed for:
(a) 90 days (b) 60 days (c) 360 days (d) 180 days (e) as per requirement of the exporter
109. 'Normal Transit Period ' in the context of export finance means:
(a) the number of days the documents take to reach destination
(b) the gap between period taken by the ship and the documents to reach destination
(c) the number of days taken by a ship to complete a voyage
(e) the number of days fixed by FEDA1 and is the average period normally involved from date of negotiation to credit to NOSTRO account.
(e) either (a) or (b)
110. For facilities granted up to 30.6.2010, rate of interest on post shipment credit in rupees upto 180 days in respect of usance bills is:
(a) 12% (b) 15% (c) not exceeding BPLR
(d) not exceeding BPLR minus 2.5% (e) not exceeding BPLR plus 1.5%
111. Refinance for export credit from RBI is available for how many days?
(a) 90 days (b) 180 days (c) 360 days (c1) 270 days (e) None of these
Refinance against eligible export finance is available from :
(a) RBI (b) IDBI (c) ECGC (d) Exim Bank (e) None of these
On PCFC refinance is available to the extent of % of outstanding PCFC.

40
(a) 15%(b) 50% (c) 25% (d) Nil (e) None of these
114. Which of the following is not correct with respect to Liberalised Remittances Scheme?
(a) 180 days (b) 90 days (c) 270 days (d) 360 days (e) None of these
115. Which of the following is not correct regarding Liberalised Remittance Scheme?
Amount can be remitted for capital as well as current account transactions
Maximum amount that can be remitted in a financial year restricted to USD 75000
Remittance for gift and donation will be within USD 75000 remitted under LRS
Bank can allow advance to a resident individual for making remittance under this scheme
None of these
116. For outward remittance for medical expenses, estimate from the doctor or hospital is required if the remittance is more than USD:
(a) 1 lac(b) 5 lac(c) 10 Lac (d) none of these as it is required in all cases
117. What is the maximum amount of inward remittance that can be done by a resident individual?
(a) USD 1 Lac (b) USD 5 lac (c) USD 10 Lac (d) None as there is no limit
118. How much amount can be released for remittance abroad for education on declaration basis and withal
estimate from educational institution?
(a) USD 1 Lac (b) USD 5 lac (c) USD 10 Lac (d) None as there is no limit
119. Which of the following is true?
If a bank has oversold position, Bank will gain if the rate of foreign currency rises.
If a bank has oversold position, Bank will gain if the rate of foreign currency declines
If a bank has oversold position, Bank will lose if the rate of foreign currency declines
If a bank has overbought position, Bank will gain if the rate of foreign currency declines
None of these
IMPORTS
120. ADs may allow advance remittance for import of goods without any ceiling. However, if the amount of
advance remittance exceeds USD50,00,000 or its equivalent it is mandatory to obtain
unconditional irrevocable stand by L/C of an international bank of repute situated outside India
guarantee from an international bank of repute situated outside India
guarantee of an AD in India, if such guarantee is issued against counter guarantee of an international bank of repute situated outside India
.:(d) any one of the above (e) either (a) or (b) only
121. BEF statement containing details of remittance exceeding USD1,00,000 where evidence of import is
not furnished within 6 months from date of remittance is submitted by ADs to RBI on:
(a) monthly basis by 10th of the following month
:(b) quarterly basis by 15th of the month following close of quarter
(c) half yearly basis for March/ September by 151h of succeeding month
(d) half yearly basis as of June/ December by 15th of succeeding month (e) none of these
122. Crystallisation of import bill under L/C means:
bill is scrutinised whether it is as per VC terms or not
it is ensured that currency of VC and insurance is the same or not
converting bill amount into Indian rupees and deciding customer's liability on due date in case of usance bill and on 10 th day from date of receipt in case of
demand bills.
none of the above as the concept is gone with the termination of PSCFC
123. Application for making payment towards imports into India has to be made to authorised dealers by
importers in :(a) ENC (b) R-3 (c) Form A-1 (d) Form A-4 (e) none of the above
124. Advance remittance for import of goods into India is to be allowed after obtaining guarantee from an
international bank of repute situated outside India or guarantee of an AD in India against counter-guarantee of an international bank when amount of
advance remittance exceeds:
(a) US $ 10,000 (b) US $ 25,000 (c) US $5,000 (d) US S 15,000 (e) US $ 50,00,000
125. How much- advance remittance is allowed for import of services without guarantee of a reputed
international bank? (a) USD 1 Lac (b) USD 5 lac (c) USD 10 Lac (d) None as there is no limit
MISCELLANEOUS
126. Which of the following types of Bill of Lading is not acceptable by a bank under LC?
(a) On Board (b) Clean (c) Charter Party (d) All of these (e) None of these
127.. Interest Subvention is available on rupee export credit at the rate of 2% for loan up to Rsbut
. interest rate after subvention should not be less than 7%.
(a) Rs 3 lac (b) Rs 5 lakh (c) Rs 10 lakh (d) Rs 100 lakh (e) None of these
Interest rate charged by RBI on export refinance to banks is at the rate of :
(a) Bank Rate (b) Repo Rate (c) Reverse Repo Rate (d) Base Rate (e) None of these
Export Refinance is provided by RBI at the rate of % of eligible outstanding export credit?
(a) 15% (b) 25% (c) 50% (d) 100% (e) None of these
R Return is submitted to RBI on which of the following dates of the month?
(a) 7th and 21st (b) 15th & last day (c) 101h, 20th and last day (d) None of these
Overdue import demand bills and usance bills are crystalised on which dates?
(a) 10th day & due date (b) 15th day and 30th day (6) 30th day and 60th day
(d) 101h day and 60th day (e) None of these
Which of the following is incorrect regarding export declaration forms?
GR form is used for declaration of exports other than by post where custom office not linked to EDI
Export Declaration form is not required to be submitted for exports up to USD 25000.
Softex form is used for declaration of export of software in physical or electronic form.
None of these (e) All of these
ANSWERS:
1 D 2 C 3 D 4 B 5 D 6 D 7 E 8 C 9 D 10 D 11 C 12 A
13 B 14 A 15 D 16 C 17 A 18 B 19 D 20 C 21 A 22 B 23 B 24 A
25 C 26 B 27 D 28 E 29 B 30 C 31 A 32 A 33 B 34 D 35 B 36 A
37 B 38 C 39 D 40 D 41 D 42 A 43 C 44 A 45 A 46 A 47 B 48 D
49 A 50 A 51 A 52 B 53 B 54 B 55 A 56 A 57 B 58 C 59 A 60 D
61 D 62 D 63 A 64 C 65 E 66 A 67 E 68 D 69 E 70 E 71 A 72 A
73 E 74 B 75 B 76 D 77 C 78 E 79 C 80 D 81 D 82 C 83 E 84 B

41
85 D 86 B 87 E 88 D 89 D 90 D 91 D 92 E 93 E 94 B 95 D 96 B
97 A 98 C 99 A 100 D 101 E 102 A 103 D 104 D 105 B 106 B 107 E 108 E
109 D 110 D 111 B 112 A 113 D 114 A 115 D 116 A 117 D 118 A 119 B 120 D
121 D 122 C 123 C 124 E 125 B 126 C 127 E 128 B 129 C 130 B 131 A 132 C
MODULE – B : RISK MANAGEMENT

RISKMANAGEMENT
The process of liberalization and globalization is gradually integrating the Indian economy with the rest of the
world. The presence of foreign bank with more sophisticated products and superior technology has intensified the
competition and has also put a severe pressure on the profitability. With the opening up of the economy, the
Indian banking system has become vulnerable to the spillover and contagion effects. The increasing competition
and survival compulsions have made Indian banks reorient their attitudes and approach towards risk
management.
DEFINITION: Risk is the potential loss an asset or a portfolio is likely to suffer due to variety of reasons. Risk is
inherent in all business but the risk exposure is much more in the financial activity. Banks are basically financial
intermediaries. They mobilize deposits from the surplus sector and channelize it in the investment sector through
lending. Bank assumes or restructures risk for its clients. As such the risk exposure of the banks is increased.
Banks are trustees of public money, and as such management of public money calls for sound and efficient Risk
Management techniques.Risk arises due to various reasons. It may be due to impact of past activity or
performance, instability of present orDroval J uncertainty of future. However, the word uncertainty is not to be
confused with the term risk. Uncertainty arises due to lack of information while risk has known probability.
Prudent banking lies in identifying, assessing and minimizing these risks. In a competitive market environment, a
banks rate of return will be greatly influenced by its risk management skills.
OBJECTIVES OF RISK MANAGEMENT:

The ultimate objective of Risk Management System is profit maximization and capital optimization i.e., capital
preservation and optimization. Broadly, the same can be summed up as follows:
Survival of the Organization.Efficiency in OperationsUninterrupted OperationsIdentifying and achieving acceptable
level of risk.Earning Stability.Continued and sustained Growth.
"Financial Risks' are uncertainties resulting in adverse variation of profitability or outright losses. Uncertainties
associated with risk elements impact the net cash flow of any business or investment. Under the impact of
uncertainties, variations in net cash flow take place. This could be favorable as well as unfavorable. The possible
unfavorable impact is the "Risk" of the business.
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 be low as compared to other opportunities available in the market.
RISK, CAPITAL AND RETURN
A business with large variation in net cash flow would be a business with higher risk. The profit potential and loss
possibilities would be higher in such businesses due to higher variability of net cash flow. Capital requirements
would be higher because of possibilities of higher losses. Similarly, a business with lower variation in net cash flow
would be a business with low risk. The profit potential as well as low possibilities would be lower in such
businesses due to lowvariability of net cash flow. Capital requirements would also be lower because of possibilities
of lower losses. This is the basic linkage between risk and capital.
Rs. In '000s
Cash flow Year 1 Year 2 Year 3 Year 4 Year 5 Total
from
Investment 1 6 6 6 6 6 30
Investment 2 3 9 5 -2 15 _ 30
If we ignore the time value of the money, both these investments yield Rs. 30,000 over five-year period or @12%
p.a. simple, assuming initial investment at Rs. 50,000. From return on investment point of view both are equal,
but intuitively, without going into the arithmetic, one is more likely to prefer investment 1. This is because of
steady stream of cash flow associated with it. Investment 2 would have a chance to become equally acceptable
provide return on it is higher than what it is now, say @ 14% p.a. simple. This 2% additional return is the risk
premium or costof risk. Higher the risk is higher would be this premium.It would be desirable to account for risks
as well. Returns net of risk would be the proper basis of comparinginvestments. In other words, risk in a business
or investment is netted against the return from it. This is called Risk Adjusted Return on Investment. This is the
key driver in managing a business seeking enhancement in risk adjusted return on capital (RAROC). Higher the
RAROC, higher may be the reward to investors / shareholders. From the risk management point of view banking
business lines are grouped under the following major heads:
RISK IN BANKING BUSINESS

Risk is inherent pan, of Bank's business. Effective Risk Management is critical to any Bank for achieving financial
soundness. In view of this, aligning Risk Management to Bank's organizational structure and business strategy
has become integral in banking business. Over a period of year, banks have taken various initiatives for
strengthening risk management practices. They have developed an integrated approach for management of risk
taking into account the business requirements / best international practices or as per the guidelines of the
national supervisor.
42
BUSINESS LINES
From the point of view of the risk management, banking business line may be broadly classified under three
heads:
a) Banking Book b) Trading Portfolio c) Off-balance sheet exposures
BANKING BOOK TRADING BOOK OFF-BALANCE SHEET ITEMS

The banking book The trading book includes Off-balance sheet exposures are
advances, deposits .& the assets that are contingent in nature.
borrowings, marketable i.e., they can Where banks
commercial and retail banking market. Trading credit lines, letters of credit etc.,
operations. All assets & have following face payment obligations
banking book have 1) They are normally not on some event such as failure to
characteristics: until maturity. Positions are payment obligations.
They are normally held liquidated in the market Off-balance sheet exposures may
maturity, and holding for a period. become fund-based exposure
Accrual system of accounting is 2) Mark to market system certain contingencies. Both,
applied is followed Difference contingencies given (where
The banking book is market price & book value provides benefit) and
exposed to liquidity taken to P & L account. receivable (where bank is
rate risk, default or credit risk Trading book is beneficiary) may form off-balance
operational risks. It is not exposed to market risk, exposure. Off-balance sheet
to Market risk as these items liquidity risk, and may have liquidity risk, interest
Ore not marked to market. default or rate risk, market risk, default or
credit risk credit risk and operational risk.
•
BANKING RISK : The major risk in banking business can be classified as follows:
LIQUIDITY RISK ,INTEREST RATE RISK, MARKET RISK, DEFAULT OR CREDIT RISK,OPERATIONAL RISK
LIQUIDITY RISK :
Liquidity Risk: Liquidity can be defined as the ability or the capacity to meet the contractual obligations (or the
demand) of the liability holders and the commitments to the loan/advances customers comfortably all the while
ensuring that the Statutory obligations such as CRR & SLR are met adequately without having to borrow unduly.
The variability of loan demand and variability of deposit determine a bank's liquidity needs. It is the Risk of
inability of a bank to meet its contractual obligations due to mismatch in inflows/outflows from assets and
liabilities.
Factors affecting Liquidity: A decline in earnings, deterioration of asset quality (NPA increase), Slow down of fresh
deposit accretion, major fraud, a down grading by rating agencies, new business demanding huge funds outlay /
Commitments, Acquisitions, New tax initiatives by Government, sudden withdrawal pressure due;to market
concerns (either specific to the Bank or to the industry / country). All these factors affect the liquidity of a bank.
Increasing Liquidity: Disposing liquid assets, increasing short term borrowings (call money, notice money, Repo
„,etc), increasing long term liabilities and capital are some of methods in which liquidity can be augmented.
Liquidity Risks Factors: Liquidity risk can arise due to either internal (institution specific) or external factors.
External Liquidity risks can be geographic, systemic or instrument specific.
Internal liquidity risk relates largely to perceptions of an institution in its various markets, local, regional, national
or international. Other categories of liquidity risk are:
INTEREST RATE RISK

Definition: Interest rate risk is the risk where changes in market interest rates might adversely affect a bank's
financial condition. It is the risk of getting locked in wrong pricing positions by wrong pricing. It exposes the
bank's financial assets to adverse movements in interest rates. Interest rate risk is now accepted as an inherent
risk in banking business.
CLASSIFICATION & SOURCES OF INTEREST RATE RISK
Interest rate risk is broadly classified into mismatch or gap risk, basis risk, netinterest position risk, embedded
option risk; yields curve risk price risk and reinvestment risk.
GAP OR MISMATCH RISK: A gap or mismatch risk arises from assets and liabilities with different principal
amounts, maturity dates or re-pricing dates in a given time period, thereby creating an exposure to changes in
the level of interest rate between assets and liabilities. The gap is thedifference between the value of assets and
liabilities on which the interest rates are reset during a given period.
BASIS RISK: The risk that the interest rate of assets aid liabilities can change in different magnitudes (Over a
given period of time) is called Basis risk.
NET INTEREST POSITION RISK: The bank's net interest position exposes it to an additional interest rate risk. If a
bank has more assets on which it earns interest than its liabilities on which it pays interest. Interest rate risk
arises when interest rate earned on assets changes while the cost Of-funding of the liabilities rerriiiiis the same.
Thus, the bank with a positive net interest position (higher assets) will experience a reduction in NII as interest
rate declines (on new assets or re-pricing the existing assets) and an expansion in Nil as interest rate rises. A
large positive net interest position accounts" for most of the profit generated by financial institutions that fund
their assets from equity rather than boritiWingS. In an increasing interest rate market, assets keep getting re-
priced at higher rates but liabilities are hardly prone to changes being long term equity mostly.
EMBEDDED OPTION RISK: Large changes in the level of market interest rates create another source of risk to
banks profit by repayment of loans and bonds (with put or call options) and/or premature withdrawal of deposits
before there stated matutity-ttgrerTFr cases where there is no penalty for prepayment of loans, the borrowers

43
have a natural tendency to pay-off their loans when a decline in interest rate occurs. In such cases, the bank will
receive only a lower Nil. Many banks stipulate a Pre-closure penalty to cover the embedded option risk.
REINVESTMENT RISK: Uncertainly with regard to interest rate at which assets and future cash flows can be
reinvested is called reinvestment risk. For example, in a rising interest scene, a bank has to keep paying higher
rate. of interest to the same depositors each time he renews
EFFECTS OF INTEREST RATE RISK
Changes in interest rates can have adverse effects both on a bank's earnings and its economic value. Therefore
effects of Interest rate risks can be assessed in three ways.
Earnings Perspective >'Economic Perspective
Embedded Losses
EARNINGS PERSPECTIVE: In the earning perspective, the focus is on the impact of changes in the interest rates
on actual or reported earnings. Variations in earnings represented by Net Interest Income is the focal point for
interest rate risk analysis as reduced earnings or outright losses (for example - where a bank is paying more
interest on its liabilities than it is earning on its assets because it is locked in to contractual positions) can harm
the financial stability. The losses can reduce the market confidence it enjoys. Banks have now moved into other
activities that generate fee-based and other non-interest income and a broader focus on overall net income,
incorporating boll'? interest and non-interest income and expenses, has become more common.
ECONOMIC VALUE PERSPECTIVE: Variation in market interest rates affects the economic value of a bank. The
sensitivity of a bank's economic value to movements in interest rates is relevant from an investor's point of view.
The economic value of a bank is the Present value of the bank's expectesiluture cash flows.
EconomOViltre—Orili Enterprise(Bank) = Present value of future cash flows on assets + Expected net cash flows
on off-balance sheet items - present value expected cash flows on liabilities. Economic value perspective of
measuring interest rate risk actually measures the sensitivity of the net worth of the bank to changes in interest
rates.
EMBEDDED LOSSES: The impact that past interest rates on future performance is called embedded risk.
Investments that are not marked to market may .alreadraiiiialifirribidded gains or losses due to pail rate
movements. These gains or losses may be reflected over time in the bank's earnings. For example, say a bank
has invested in its subsidiary and_ hold its shares at par value (Rs.10). The subsidiary's shares are trading in the
market at Rs2/- but the bank continues to show the shares at par value in its balance sheet as the shares are not
marked to market. There is an embedded loss in the balance sheet which can affect the bank in a future date.
Note: Due to diligent accounting principles, bank balance sheets have become fairly transparent. Most of the
holdings are marked to market these days.
CREDIT RISK
Credit Risk arises out of several situations-in the banking field. Some of the important areas are:
Lending activities of the banks: Where there is a default
Non-fund based commitments such as Letters of credit / Letters of Guarantee issued when devolved •
Treasury activities: When the Counter-party fails to honor the commitment (settlement etc), when investments in
Fixed income securities of Corporates fail.
Other financial activities involving a Counter-party.
Credit Risk has two components: Default Risk and Credit Spread Risk.
DEFAULT RISK: Default risk is nothing but potential failure of the counter-party (borrower) to make promised
repayments. This default can occur in Loan repayment or interest repayment (on loans & corporate bonds etc).
CREDIT SPREAD RISK OR DQWNGRADE RISK: Capital market portfolios are marked to market. In view of this
they have an additional risk called Credit Spread risk. For example, in a corporate bond, which gives semi-annual
interest, there is no default and half yearly interest obligations are being met. Yet, this is not a risk free
investment as still risk due to worsening in credit quality exists. If the company is having problems and may
default in future (not done so; so far), the credit Rating agencies announce that they have downgraded the rating
of the Company. Immediately, the market resets and the corporate bond issued by the Company already trading
in the market will see an adverse price movement. This results in the possible widening of the credit-spread. This
is credit-spread risk. Normally this spread is firm specific.
PORTFOLIO RISK: Normally fund managers both in Banks and in other agencies have to deal with "Portfolio
risks": These are the risks which can bring down a whole portfolio. For example- Fund managers are to take
positions or quote based on Country or sovereign ratings. Let us say a fund manager has taken position in bonds
issued by several emerging Economy nations. Then, "Standard & Poor" or "Moody's" or any international rating
agency makes a negative revision of the emerging markets. Immediately international markets react to changes
in the Ratings of a Sovereign and all the assets generated out of the emerging markets will suffer deterioration
irrespective of whether some of the instruments trading in the market belong to the very best Companies in those
Countries. Such risks associated with the entire portfolio as a whole are termed portfolio risk.
Portfolio Risk has two Components.
Systematic or Intrinsic Risk
Concentration Risk
Systematic or Intrinsic Risk: Portfolio risk as discussed above can be reduced due to diversification. In other
words, the banks & the Fund managers should4 not focus only on one type of assets but have a portfolio which is
diversified equitably across geographies, Sectors; borrowers, markets and so on. This ensures that the portfolio
44
risk is reduced to a minimum level. This minimum level corresponds to the risks in the economy in which it is
operating. This intrinsic risk which is closely knit with the economy of the country where the bank or the Fund is
situated will never go away. Such a risk is called systematic or intrinsic risk. If economy as a whole does not
perform well, all portfolios will be affected.
Concentration Risk: If the portfolio is not diversified Concentration risk occurs. Concentration risks can arise out
of focusing on large borrowers, borrowing groups, instruments, Sectors, markets etc. In India, RBI has stipulated
prudential limits Or Individual and Group loan exposures to minimize Concentration risks.
Counter Party Risk: Counter - party risk arises from non-performance from counter party either by his refusal /
inability to perform. The counter party risk is normally financial risk associated with trading rather than standard
credit risk.
Country Risk: 'Country Risk' is also a type of credit risk where non-performance by a borrower or counter party
arises because of restrictions imposed by a sovereign. Country Risk may be defined As the risk to operating cash
,flows, or to In value of investment, resulting from operating in a particular country. At the macrolevel country
Risk iricTidei–Coth sovereign FriCiicicurrency risk. The Banks need to look at all the dimensions of country before
reaching a conclusion on whether or not to do business with a country.P81 has advised that banks should
formulate appropriate, well documented and clearly defined. 'Country Risk Management' (CRM) policies which
should focus on the issues of identifying, measuring, monitoring and .controlling country exposure risks. Banks
should design contingency plans and Clear exit strategies, which would be activated at times of crisis.
CREDIT DERIVATIVES
A credit derivative refers to any one of "various instruments and techniques designed to separate and then
transfer the credit risk" of the underlying loan. It is a securitized derivative whereby the credit risk is transferred
to an entity other than the lender_
Where credit protection is bought and sold between bilateral counterparties, this is known as an unfunded credit
derivative. the ore sanative is entered into by a financial institution or a special and
payments under the credit denvative are funded using securitization techniques, such that a debt obligation is
issued by the financial institution-to support to-these obligations, this is known as a funded credit lieriVative.
Credifdenvabves are fUndamenallydiVidedintiawo categories:
Funded credit derivatives and
Unfunded credit derivatives.
A credit rating evaluates the credit worthiness of a debtor, especially a business or a government. It is an
evaluation made by a credit rating agency of the debtor's ability to pay back the-debt and the likelihood default.
Credit ratings are determined by credit ratings ageliBR7rhe credit rating represents the credit rating agency's
evaluation of -qualitative and quantitative information for a-company or government; including non-public
information obtained by the credit rating agencies analysts.
CRISIL Limited
Fitch Ratings India Private Ltd.
ICRA Limited
Credit Analysis & Research Ltd. (CARE)
Brickwork Ratings India Private Limited
SME Rating Agency of India Ltd. (SMERA)
COUNTRY RISK-RBI GUIDELINES

Exposure: Banks are required to formulate the CRM policy for dealing with the country risk problems only in
respect of that country, where a bank's net funded exposure is 1 per cent or more of its total assets.
Application of KYC: The CRM policy should stipulate rigorous application of the 'Know Your Customer' (KYC)
principle In international activities which should not be compromised by availability of collateral or shortening of
maturities. Country risk element should be explicitly recognized while assessing the counter-party risk.
Funded & Non Funded Exposures: Banks should consider both funded and non-funded exposures from their
domestic as well as foreign branches while identifying, measuring, monitoring and controlling country risks.
Indirect Country Risk: Banks should take into account indirect country risk. For example, exposures to a domestic
commercial borrower with a large economic dependence on a certain country may be considered as subject to
indirect country risk, which may be reckoned at 50 % of the exposure.
Ratings: Banks should use a variety of internal and external sources as a means to measure country risk.
However, the rating accorded by a bank to any country should not be better than the rating of that country by an
international
rating agency. Till the time banks move over to internal rating systems, banks may use the seven category
classification followed by Export Credit Guarantee Corporation of India Ltd. (ES.G. for the purpose of classification
and making provisions for country risk exposures. ..
Exposure Limits: B nk Boards may set country exposure limits in relation to the bank's regulatory capital..(Tier I
+
tierII) with sub-limits,'1 con d necessary, for products, branches, maturity etc. In respect of foreign ha-rig:T-1e
regulatory capital would be the capital (Tier I + Tier ID held in their Indian books.
MARKET RISK
Risk of adverse deviations due to marking to.market value of Investment portfolio is called Market risk. Banks are
exposed to market risks just as all other investors. Their trading books are particularly exposed to Market risks.
Normally a bank's Proprietary trading book (where the bank trades on its own account) consists of investments in
45
securities such as, Debt Securities (T bills, bonds etc), Equity, Foreign Exchange (held in Nostro accounts or
invested abroad), and Commodities (Gold, Silver, Platinum).
COUNTER PARTY RISK: Counterparty or Credit risk can arise out of two situations: Default of the issuer of the
Security orDue to the rate migration of the instrument on hand. Debt instruments in the market are normally
rated instruments. If the rating agency lowers the rating on the CP, the spread over the risk free return increases
and Price decreases as Price is an inverse function of yield.
SETTLEMENT RISK (11ERSTATT RISK): Let us say that a bank buys some treasury bills from Bank B. What if after
receiving the amounts, Bank B fails to deliver the treasury bills? This risk of the Counter-party failing to deliver is
known as Settlement risk or Herstatt Risk. The failure may or may not be intentionatilis risk is also called Herstatt
Risk due an incident which took place earlier which actually compelled the G-8 countries to come together to
form Basel norms. A German bank called Herstatt Bank was put under liquidation by the authorities after it had
entered in to transactions with various American banks, received the dollars but had not yet delivered due to the
time-zone differences. In case of Stock & Commodity markets, respective exchanges such as BSE, NSE and NCX,
MCDX take the role of the counter-party and mitigate this risk. But in other cases, especially the OTC items, the
risk continues to exist. RBI has taken the initiative to make Real Time Gross settlement possible in our country to
obviate settlement risk. .As the monetary authorities want to ensure that the settlement problems between two
banks or parties should not start a chain reaction and become endemic (System risk), they normally take care
regarding Settlement issues. This is a risk may lead to systematic risk and therefore monetary authorities usually
take steps to put in place a risk free settlement system to obviate the risk. In India Reserve Bank of India has put
in place 'Real Time Settlement System' for the purpose.
MARKET RISK MEASUREMENT: Market risk measurements rely heavily on quantitative methods. Some of them
are as follows:
SENSITIVITY: Captures the deviations in the market price of an investment or asset due to variations of a unit of
one another parameter
BASIS POINT VALUE (BPV): BPV is the change in value due to 1 basis point (0.01%) change in market yield. This
is used as a measure of risk. In other words let us say a bond with face value Rs100 with coupon rate of 10%
with a 10 year term is trading at say Rs.102.50.The market discount rate is say 9%. Assume that the market rate
goes up by 0.01% to 9.01%.The bond price quickly changes to say Rs. 102.10. BPV= 102.50-102.10=0.40 The
higher the basis point value, the higher is the risk associated with this instrument. BPV changes with remaining
maturity. It will decline with time and on the day of maturity it will be zero.
DURATION: McCauley's Duration was first proposed by Frederick McCauley in 1938 as means of describing a
bond's price sensitivity to yields change with a single number. This is equivalent to time, on average, that the
holder of the bond must wait to receive the present value of
the cash flows. In other words this represents cash flow 'Centre of Gravity' or fulcrum'. Let us take a Bond with
the following features
This bond trading at 10% YTM has a Macaulay's duration of 5.97 years. This means at the point of 5.97 years,
receiving the balance cash flows (Rs 90 per year x 5 balance installments of interest + face value of
Rs1000=Rs1450) is equivalent to receiving the amount in a bullet repayment.
Maculae's Duration Formula D= EtT x Wt
Where D = Duration (Maculae's), T=No of periods to maturity.
Period= No of terms where interest is due CFt (1+0'
Wt =
Bond Price
Further, Duration or Modified duration is McCauley's duration discounted by 1 period yield to maturity. The longer
the duration of a security, the greater will be the price sensitivity to yield changes & higher is the risk associated
with the bond. Bond price changes can be estimated using modified duration as follows:
Approx. % change in price = modified duration x yield change
DOWNSIDE POTENTIAL: Downside risk is the most comprehensive measure of risk as it integrates sensitivity and
volatility with the adverse effect of uncertainty. This is the measure that is most relied upon by banking and
financial service industry as also the regulators.
VALUE AT RISK (VaR): A fair measure of what can be the maximum loss can be ascertained by the concept of
VaR. Here W3 attempt to create a more useful answer and arrive at Value at Risk which would tell us that we can
lose a maximum of Rs X) the VaR) over the next week (time horizon) and may expect that with 99% confidence
(i.e., it would be so 99 Wes out of 100).
VALUE AT RISK is defined as the predicted worst-case loss at a specific confidence level over a certain period of
time assuming 'Norma! Trading Conditions'
VaR measures the potential loss I e market value under normal circumstances of a portfolio. It is not a measure
1.1.7iffei- abnormal market conditions
In Economic Value perspective-the focus is on the potential loss of Capital funds invested. A portfolio or security
with 1 day VaR of Rs 1 crore with 99% confidence interval means that there is only one chance in 100 (or 2.5
days per year based on 250 working days in a year) that daily loss will be more than 1 crore under normal trading
conditions. Conversely, there is 1% chance that the daily loss may exceed Rs 1 crore under normal trading
conditions in a given time frame of 100 days.
Yield Vs. Price Volatility: Yield volatility is degree of variance in yield. It increases as yields fall and is not affected
by time & duration. Price volatility is degree of variance in price. This is unaffected by yield and substantially
affected by time and duration.
Price Volatility .= (Yield volatility x BPV x Yield) / Price
There are three main approaches to calculating value-at-risk:
Correlation method, also known as the variance/covariance matrix method
Historical simulation
Monte Carlo simulation

46
In all the methods three basic parameters — holding period (balance time to maturity/ first Call), confidence
interval and the historical time horizon over which prices are tabulated or observed.
CORRELATION METHOD: Here the change in the value of the position is calculated by combining the sensitivity of
each component to price changes in the underlying asset(s), with a variance/covariance matrix of the various
components' volatilities and correlation. It is a deterministic approach.
HISTORICAL SIMULATION METHOD: This calculates the change in the value of a position using the actual
historical movements of the underlying assets starting from the current value of the asset. It is critical that the
length of the period chosen is neither too long nor too short as either of them can distort the observation.
MONTE CARLO SIMULATION METHOD: Here the change in the value of a portfolio is measured using a sample of
randomly generated price scenarios.
Limitations of VaR: VaR is not worst-case scenario. It does not measure losses under any particular market
conditions. VaR by itself — is not sufficient for risk measurement. Measures to get over the limitation include back
testing and model calibration and Scenario analysis and stress testing.
Estimating Volatility: VaR uses past data to compute volatility. Volatility is estimated by several methods.
Arithmetic moving average from historical time series data.
Exponential moving average method.
As already explained, the User has to determine the length of the past data he/she wishes to consider. Each
treasury (in the Bank) may have its own views on this aspect. Volatility also does not capture unexpected events
or "event risk". Therefore VaR can not be the only measure (of Risk). It should be used in combination with
"Stress tests" to take care of event risks. Stress test takes into account the worst-case scenario.
VOLATILITY: The volatility is a measure of the stability or instability of any random variable. It is a statistical
measure of dispersion around the average of any random variable (under study). These variables can be
earnings, losses or Value erosions etc.
Volatility is the standard deviation of the values of a chosen variable. Standard deviation is the square root of the
variance of the random variable.
HISTORICAL VOLATILITY: If we need the Volatility of a given Company's share prices, we need to observe itsOf
behavior for say) previous six months or previous one year. The computation can be on "daily", "weekly" or
"monthly" basis. The frequency of observation (or noting the day-end stock price) has to be changed as per
requirement. It Possible to convert daily volatility in to or monthly volatility using 'Square root of time rule'. The
equation is given below:
TABLE SNOWING THE MOVEMENTS IN THE STOCK PRICE OF XYZ BANK :

OBSERVED OVER A TIME PERIOD OF 18 DAYS
Why is Volatility Estimated?

Volatility gives us the range in which the prices (or any other variable) are likely to move and helps us to
understand how much the stock or bond price may go up and what can be the downward movement.
Downside Potential: Downside Potential is another measure which is used to assess risk. While volatility gives us
both up-swings and down-swings, Downside potential measures only the negative potential or the adverse
potential (of loss). Downside Risk or the potential of value erosion / loss can have two dimensions.
What can be the maximum downside?
How often can this occur?
To illustrate, if it is possible to estimate that a bond is likely to lose 1% in value during market fluctuations, it is
also possible to estimate how often this can occur. Market fluctuates continuously and hence it is important to
note this frequency and build the bank's exit (from a security) plans accordingly. Estimating probabilities requires
prior modeling of the probability distribution of potential losses." Worst-case scenarios" are used to quantity
extreme losses but have these have low probability of occurrence. 'Downside risk' is the most comprehensive and
widely used measure of risk as it integrates sensitivity and volatility with the adverse effect of uncertainty.
RISK PRICING
Risk Pricing of a Product: To understand this, first let us understand Pricing. Let us say a borrower approaches the
bank for a big term loan. How does the bank arrive at the interest rate? The bank takes in the following factors
into consideration:
What is the cost that the bank has to pay on the funds (Cost of Capital) that will be used to issue this loan?
What are the transaction / operation costs incurred? (Operating expenses such as salaries, stationery etc).
What is the Capital charge to be made on this asset?
These are the basic costs that a bank would incur on any transaction. Over and above these, a bank has to
analyze the costs associated with the risk involved in the transaction or the probability of loss. This becomes the
fourth parameter in arriving at the cost of the transaction. The process of pricing a product which takes the risk
factor in to account apart from all other normal cost factors is called "Risk Pricing". It is now recognized that
arriving at the costs involved in a transaction is one of the most important activities of bank. This has to be done
accurately as the banks have to aim at making a profit on every transaction. If the basic costing is goes amiss,
the Pricing of the Product will be wrong and the bank can end up taking particular business at a loss.
What is the concept of probability of Loss? Every banking transaction has certain risks associated with it. Risk
means that there is a possible loss that is associated with that transaction. This possibility of risk is measured
mathematically and Probability of loss arrived at and factored in to the Pricing:•Risk pricing is arriving at the price
of a product after factoring the probability of loss associated with the transaction in addition to other normal
costs.
RISK MITIGATION: The term Risk Mitigation" refers to the process of minimizing the risks or containing the risks.
There are many tools available in the financial markets for Risk mitigation. For example, a large Indian software
service Company recently announced on a business news channel recently that they have entered in to Forward
47
contracts with-their bankers for 100% their next three quarters earnings. They have, therefore no concern about
the movement of the rupee against the dollar. Balance invoicing will be in Euro/Jap Yens Hence risk diversification
is also achieved. The point to be noted here is while getting in to Forwards Contracts helps them to avoid risk, it
also caps the profits. To illustrate:
Let us say that the Company expects cash inflows of USD 10, 00,000 per quarter. They have contracted to sell
these dollars (bank will purchase) at forward rates as follows
January - USD 250,000 @Rs 44.25/USD February - USD 250,000 @Rs.44.35/USD
March - USD 250,000 @Rs 44.45/USD Current market rates Rs 44.20 / USD
Having covered 100% of their exposure, Company can now be confident that they are insulated from the
exchange risk. There can be three scenarios in this quarter.
Average Rupee rate per USD < Average rupees Company 's profits are protected & the Company
earned as per the three forward contracts therefore has benefited from the Forward cover
Average Rupee rate per USD = Average rupees No loss / no profit situation
earned as per the three forward contracts
Average Rupee rate per USD > Average rupees Company has lost the opportunity of earning higher i.e.
earned as per the three forward contracts Forward cover has actually capped the profits
Banks deal in various financial instruments and also have diverse asset portfolios. The risk mitigation techniques
vary according to the nature of the assets / investments. Some examples are:
•
RISK MITIGATION TECHNIQUES
Primary and Collateral securities, Cash margins, Third party
CREDIT RISK guarantees, ECGC / CGFT covers, Insurance, Credit derivatives
INTEREST RATE RISK - Gap or Mismatch management, Interest rate swaps, Forward rate
FOREIGN EXCHANGE RISKS agreements,
Limits, Forex Futures
derivatives such as Forwards contracts, Futures /
Options / Swaps and so on
MARKET RISKS (FOR INVESTMENTS Equity futures I options
IN EQUITY) _
Additional issues in Risk Mitigation'Techrilaues: While risk mitigation reduces the risk considerably, it also caps
the potential profits. (See example of the Software Company) some Risk mitigation techniques involve a counter
party & therefore carry Counter-party risk. However, in exchange traded instruments used for hedging such as
options and futures, the Stock exchanges are taking up the role of the counter-party, thus reducing or eliminating
the counter-party risk.
Market Risk Monitoring and Control: Risk monitoring and control calls for implementation of risk and business
policies simultaneously. It consists of setting market risk limits or controlling market risk, based on
economicmeasures of risk while ensuring best risk adjusted return. Organizational set Up, Training systems,
setting up ofLimits at all levels of functionaries (staff), Proper Reward/Punishment systems are important for
managing Mark risk. Of these, the following is very important.
Setting up of Limits at all levels of functionaries (staff)
Limits and triggers: The Risk policy committee should allocate market risk limits.
Sensitivity and value at risk limits.
Stop losses mandatory for all Mark to market risk taking activities.
Exposure limits should ensure unduly large exposures are no taken for any one type of asset
The Portfolio designer should avoid infrequently traded instruments
When new securities enter the market, with either fixed or implied Lock-in conditions, they tend to create one-
sided markets. They do not have liquidity. They should be avoided till the market deepens if possible. Risk
Mitigation in Market Risks
Risk Mitigation Strategies: A diversified portfolio will disperse or spread the risk. However, each of the assets.in
the portfolio has their own volatility measures. The portfolio should be built in a balanced way.
Sensitivity Measures a portfolio has bonds X with BPV of 500, we can add another bond Y with BPV of 220 such
that the portfolio's weighted average of BPV (500+220) = 770/2=385. We can this way manage to have a
portfolio with the desired level of BPV. Similar strategies can be applied for all other measures also.
Correlation Measures: Here the theory of Correlation is used. If we can identify two financial instruments that
have negative correlation then their prices would in exactly opposite direction. The extent of the movement can
be estimated. In this case price volatility of the portfolio will be reduced.
Strategies using Market Instruments: Options are normally used for hedging Market risk purposes. An Option
gives us the right to Buy (or Sell) at an agreed upon rate (Strike rate) without the obligation that we must
necessarily do so. If a traders take a long positions in cash or future markets and enter in to put option (sell
Option) at a particular rate, he has the right to exercise the option and will do so only if the market turns adverse
to him.
OPERATIONAL RISK
The risk of loss resulting from inadequate or failed internal processes, people and-systems, or from external
events is called - Operational Risk. Operational risk has a bearing on the very capital of the bank. Recognizing
this, Basel II has stipulated a Capital charge on the operation risk now when the Basel II accord is adopted
Three types (mutually OPERATIONAL RISK — CLASSIFICATION

independent) three types, the classifications were suggested as for Operational risk. of the based"
Third consultative classification. follows However, adopting
paper of Basel Committee has

48
1.Cause based People oriented Process Process oriented Technology oriented External
causes oriented causes causes causes
causes (Operational
(Transaction control based)
Negligence, Business volume Inadequate Poor technology & Natural
Key man loss, fluctuation, segregation of telecom disasters,
Incompetence, organizational duties, lack connectivity, operational
insufficient complexity, of obsolete failures of a
training, product Supervision, applications, third party,
integrity issues complexity inadequate lack of deteriorated
2. Effect Legal liability procedures.
• Regulatory compliance automation,
and taxation penalties social or
based Loss or damage to assets • Restitution
fb• Loss Fraud
3. Event based Internal of recourse • Write-downs
(recommended External Fraud
by Basel — Employment practices and workplace safety
Third Clients, product and buSiness practices
consultative Damage to physical assets
paper) Business disruption and system failures
to him.
OPERATIONAL RISK
Three types (mutually OPERATIONAL RISK — CLASSIFICATION of the

independent) three types, the classifications were suggested for Operational based"
Third consultative as follows risk. However,
1.Cause based People paper
Processof Basel Committee
Process has Technology External
oriented oriented oriented oriented causes
causes causes causes causes
Negligence, Business Inadequate Poor technology & Natural
Key man loss, volume segregation of telecom disasters,
Incompetence, fluctuation, duties, connectivity, operational
insufficient organizational lack of obsolete failures of a
training, complexity, Supervision, applications, third party,
integrity issues product inadequate lack of deteriorated
complexity procedures. automation, social or
information system political
2. Effect Legal liability • Regulatory compliance and taxation penalties
fb• Loss of recourse • Write-downs

49
3. Event based Internal Fraud
(recommende External Fraud
d by Basel — Employment practices and workplace safety
Third Clients, product and business practices
Execution, delivery and process management
to him.
OPERATIONAL RISK
Three types (mutually OPERATIONAL RISK — CLASSIFICATION

independent) three types, the classifications were suggested as for Operational risk. of the based"
Third consultative classification.follows However, adopting
1.Cause based People oriented paper
Processof Basel Committee
Process has Technology oriented External
causes oriented oriented causes causes causes
causes (Operational
Negligence, Business volume Inadequate Poor technology & Natural
Key man loss, fluctuation, segregation of telecom disasters,
Incompetence, organizational duties, lack connectivity, operational
insufficient complexity, of obsolete failures of a
training, product Supervision, applications, third party,
integrity issues complexity inadequate lack of deteriorated
procedures. automation, social or
information system political
2. Effect Legal liability • Regulatory compliance and taxation penalties
3. Event based fb• Loss Fraud
Internal of recourse • Write-downs
(recommended External Fraud
by Basel — Employment practices and workplace safety
Third Clients, product and business practices
Execution, delivery and process management
RISK in BANKING INDUSTRY

Bankers have traditionally been managing the various risks in their business through collateralizing' their
exposures in various ways (property / financialsecurity / third party guarantee/insurances and so on).
The inadequacy of existing measures was felt after a notorious incident named as "Herstatt incid8ht".
The "Herstatt" incident led Central Bankers from major countries to formulating and ensuring, minimum standards
for participants in International financial markets.
50
HERSTATT INCIDENT:
In 1974, an incident took place which shook the complacent bankers in to action which finally led to international
best practices in risk identification and management. Bank has Herstatt was a small bank in Cologne, Germany
active in the foreign exchange market.On 261h June 1974, Herstatt Bank was suddenly closed at the end of the
business day in Germany by its banking supervisor. This was at 10.30 a.m. at New York time. Prior to the
announcement of closure, several counterparties had entered in to contracts with Herstatt and gifted it Deutsche
(German) marks in exchange for US dollars to be delivered to the debit of its account with a Correspondent bank
in New York. Once the news of the closure was out, Herstatt's New York correspondent stopped all out going
dollar payments from its account.
CONSEQUENCES OFHERSTATT INCIDENT
The action of the Central bank in Germany left all the counterparties exposed to "Settlement" and "Liquidity" risks
up to the amount of deliveries made by them. Other parties to lose were Banks that had deposits with Herstatt
and those who had entered in to Forward contracts with the collapsed bank. This incident brought the settlement
risk that is inherent in transactions with the legs in different time zones. This incident led to an awareness that it
is needed to ensure that all parties in financial transactions, especially cross border transactions, working in
different time zones under different central bankers need certain basic standards to make the markets safe places
for all counter parties.
Thus began the process of identifying major risks and minimum standards for international market participants
G-10 COUNTRIES RESPONDED TO HERSTATT INCIDENT BY FORMING BASEL COMMITTEE:
In response to the Herstatt incident, Group Ten (G10) central banks began working towards common supervisory
issues including the issue of the "Foreign exchange settlement risk" (also called Herstatt risk). A committee
named as "The Basel Committee" was established in 1974. The Basel Committee as well as its four main working
groups meet regularly tour times a year.
With its current expanded membership, the Committee is now comprised of representatives from 27 countries
including India. THE BASEL COMMITTEE ON BANKING SUPERVISION (BCBS)
The Basel Committee (BCBS) does not possess any formal supranational supervisory authority, and its
conclusions do not, have legal force. However, it reports to the Central bank Governors or Heads of Supervisory
authorities of G-10 countries and seeks their endorsement for its major initiatives. BCBS formulates broad
supervisory standards / guidelines and recommends best practice in the expectation that individual national
authorities will take steps to implement them. Each national supervisor is expected to make arrangements that
are best suited to its own national systems leading to convergence towards common approaches and common
standards
An important objective of the Committee's work is to close gaps in international supervisory coverage in pursuit of
two basic principles: that no foreign banking establishment should escape supervision; and that supervision
should be adequate. To achieve this, the Committee has issued a long series of documents since 1975. •
BASEL CAPITAL ACCORDS: Two important Basel accords called as Basel-I and Basel-II accords have emerged
over the past two decades.
BASEL-I ACCORD:
101- The Basel Committee introduced a capital measurement system commonly referred to as the Basel Capital
Accord. The 1988 system provided for the implementation of a Credit risk measurement framework with a
IlIvisissonivespikistangiactkif89ffibreirlilet992.
1996eithtf-fistakillwes-ffiedifieditiffrititIctelff84,904814,816iteckteAdarketittk
Thus the Basel-I accord addressed two major risks faced by banks- the esedit.tWapoilOwMgrkaNsk.
BASEL-II ACCORD 8 THE THREE PILLARS
In 2004, BCBS issued another comprehensive framework that seeks to arrive at significantly more risi sensitive
approaches to capital requirements.
" as a source of threat and included this risk for calculating the "risk
weightage assets" for which a minimum capital is prescribed.
The new capital framework consisting ,Pillar-01: _ irrim capital requirements,Pillar-02:Supervisory review process
Pillar-03: Market discipline,
OBJECTIVES OF BASEL ACCORDS: Basel II objectives, which are central to sustained economic development in
long run include: Promotion of safety and soundness in the financial system by stronger risk management
practices in banks. Designing approaches for credit and operational risk tnat are based on increasing risk
sensitivity and allow banks to select an approach that is most appropriate to the stage of development of bank's
operation.The ultimate objective of Basel accords is to encourage the International players in the financial sector
(namely Banks) to converge towards a minimum standard both in Capital adequacy and processes ,such that
there i3 adequate confidence built up This is especially applicable to cross border transactions (international
transactions)
THREE TIERED CAPITAL FUNDS: A minimum standard for Capital adequacy is the most important objective of the
Basel accords. Here, the concern is about the quality of the capital also. The Basel Capital Accord 1988 classifies
capital under three tiers. Tier I Capital &Tier II Capital are as follows:
TIER I CAPITAL TIER II CAPITAL TIER III CAPITAL (not

allowed by RBI in India)
• Permanent • Undisclosed Reserves. • As per BCBS each

Shareholders' national
Equity. 0 Revaluation Reserves authority (Example-
RBI in

51
• Perpetual Non- General provisions / general ...- India) at its
cumulative4/• loan-loss -'- discretion may
Preference shares. reserves. . employ a third tier of
Hybrid Debt Capital (Tier -III), consisting of
• Disclosed Reserves • short-
instruments (an term subordinated
• Innovative Capital instrument with mix of equity debt
'iris- e' for --a
pin mg
instruments. capital proportion of the
and debt characteristics ), and capital
• Subordinated Term Debt. requirements for market
risks.
RBI GUIDELINES MIGRATING TO NEW CAPITAL ADEQUACY FRAMEWORK (BASEL - II STANDARDS)

The Base! committee had bestowed discretion to each Country's supervisor to make detailed arrangements and
give a time frame within which the Banks in that country should migrate to the new Basel-II standards. The
Committee has prescribed the "minimum" standard of at impitei-adectuae4 ungeOl• "first OW and left it tc each
country to prescribe more stringent norms where felt necessary.
RBI has prescribed required minimum 6iiiiMilimmuleeipssifilist-41,1.RBI issued Prudential Guidelines on Capital
Adequacy and Market Discipline — Implementation of the New Capital Adequacy Framework (NCAF) which gave
detailed guidelines and directed follows.
TIME FRAME TO COMMERCIAL BANKS IN INDIA TO MIGRATE TO NCAF
Foreign banks operating in India and Indian banks having operational presence outside India were directed to
migrate to NCAF with effect from March 31, 2008.
'It other commercial banks (except Local Area Banks & Regional Rural Banks) were encouraged to migrate to the
Revised Framework not later than March 31, 2009.
Thus all eligible banks in India are.now-Basel-fl compliant
PILLAR I - MINIMUM CAPITAL REQUIREMENTS
Basic approach of capital adequacy framework is that a bank should have sufficient capital to provide a stable
resource to absorb any losses arising from the three main risks in its business. Under this pillar, banks have to
ensure that they have a CRAR of at least 8% (minimum standards) after taking in to account all the three major
risks.
PROCESS OF ARRIVING AT CRAR
CAR: Capital adequacy is the ratio of capital funds available in the Bank to the assets (Loans plus investments)
acquired and reflected in the Balance sheets.
CRAR: Capital to Risk weighted as16.EisffiFfatio of Capital funds available to the Risk weighted assets (loans and
investments) acquired by the Bank and reflected in the Balance sheet.
Risk Weights: Risk weights are the perceptions of risk inherent in any types of claims the Banks have on
counterparties (in their loans and investments).For example, a loan given against security of commercial real
estate is riskier than a small loan given against gold jewelry. Both these assets need not attract the same amount
of mandatory capital. At the same time, Basel-II takes in to account not only the Credit Risk but also Market and
Operational risks. Detailed guidelines are given by RBI as to how the assets should be risk weighted taking all the
three risks in to consideration
CAPITAL CHARGE FOR CREDIT RISK
AS per Pillar-I of Basel-II standards, the assets of a Bank are risk weighted taking all the three major risks in to
consideration. The ratio of capital to such risk weighted assets should be a minimum of 9%. Let us now take up
the process of risk weighting a Bank's assets for Credit Risk.
The Basel II has recommended two approaches arriving at Capital charge for Credit risk purposes. These are:'
Standardized Approach
Internal Rating based Approaches
As per RBI's current regulation, Banks have to use the first approach i.e. Standardized approach. However, RBI
has already framed a time frame for Banks to move on to advanced approaches as follows:
Internal Ratings-Based (IRB) Banks should RBI approval
Approaches for Credit Risk apply to RBI by would be given
(Foundation - asAPPROACH
STANDARDIZED well as Advanced April 1, 2012OF CAPITAL
FOR CALCULATION before
CHARGE FOR CREDIT RISK STEP-01 :
CLASSIFICATION OF ASSETS
RBI has given various classes of claims and directed as to how these assets are to be risk weighted.
Broadly, the Risk weights are either provided directly by RBI or based on the ratings by external agencies.
In the latter case, RBI provides Ratings Versus Risk weight tables after mapping ratings by different agencies in
to standardized ratings
RISK WEIGHTS PROVIDED BY RBI
1 Claims on Domestic Sovereigns-Central Government fri%
Claims on Domestic Sovereigns-State Government 0%
c Claims • guaranteed b Central Government 0%
Claims guaranteed by State Government 20%
Claims on RBI, DICGC and CGTMSE 0%
I. Claims on ECGC 20%
Cash balances on the Balance sheet 0%
2 Claims on BIS, IMF & Multilateral Banks (ADB, World Bank .etc.) 20%
3 Claims on Foreign banks incorporated in India and foreign bank branches in India with 20%
• CAR above 9%. (Depending on the Capital adequacy of the Bank, nature of the
instrument etc, If the capital ade • uac is above 9% and it is not an investment, the RW
is 20%
52
4 Claims secured by Commercial Real Estate (includes SEZ) '4 100%
5 Claims included in the Regulatory Retail Portfolios
Education Loans 75%
Loans up to Rs.1 Lakh against Gold and Silver ornaments 50%
All others included in Re ulatory retail 75% ,
6 Claims on Specified • Venture capital Funds 150%
Categories Consumer Credit (& Credit card exposures) 125%
Capital Market exposures 100% ,
NBFC-ND-SI 100%
7 Other Assets Loans and advances to staff fully covered by superannuation 20%
benefits and/or mortgage of flat/ house
Other Loans to staff 75%
CCP- Clearing Corporation of India 20%
Other CCPs Based on
Ratings
8 NPA (unsecured If the specific provisions are less than 20% If the specific 150%
portion, net of specific provisions are at least 20% If the specific provision is at least 100%
provisions) 50% 50%
9 Claims based on Residential mortgage (Housing loans)

LOAN TO VALUE RATIO (LTV): Percentage with total outstanding in the account (viz. "principal
+accrued interest + other charges pertain to the loan" without any netting) in the numerator and the
realizable value of the residential property mortgaged to the bank in the denominator. Loans /
exposures to intermediaries for on-lending not included claims secured by residential property but will
be treated as claims on corporates or claims included in the regulatory retail portfolio as the case may
LTV Amount of Loan Risk weight 25% if
reconstructed
LTV Ratio = or < 75% Up to Rs.30 lac 50% 75%
LTV Ratio = or < 75% Above Rs.30 lakh but less than Rs. 75 75% 100%
LTV Ratio > 75% lac amount < Rs. 75 lac
Loan 100% 125%
Irrespective of LTV Loan amount Rs. 75 lac and above 125% 150%
RISK WEIGHTS BASED ON RATING
10 Claims on Foreign Sovereigns
11 Claims on Public Sector Entities
12._ Claims on other Foreign Banks
13 Claims on Primary Dealers -
14 Claims on Corporates
15 Securitization Exposures
16 NBFCs categorized as Infrastructure Finance Companies
RISK WEIGHTS FOR OFF BALANCE SHEET EXPOSURES WILL BE BASED ON CREDIT
CONVERSION FACTORS & RBI GUIDELINES
Off-Balance Sheet (Non-funded) Items: The credit risk exposure has to be first calculated by multiplying the face
amount of each of the off-balance sheet items by the prescribed credit conversion factor and then multiplied by
the relevant weights laid down.
While calculating the aggregate of funded and non-funded exposure of a borrower for the purpose of assignment
of risk weight, banks may 'net-off against the total outstanding exposure of the borrower Advances collateralized
by cash margins or deposits,Credit balances in current or other a/cs which are not earmarked for specific
purposes and free front any lienIn respect of any assets where provisions for depreciation or. for bad debts have
been madeClaims received from DICGC/ ECGC and kept in a separate account pending adjustment, and
Subsidies received against advances in respect of Govt. sponsored schemes and kept in a separate account.
SCOPE OF APPLICATION OF EXTERNAL RATINGS
Banks should use the chosen credit rating agencies and their ratings consistently for each type of claim, for both
risk weighting and risk management purposes.
Banks must disclose the names of the credit rating agencies that they use for the risk weighting of their assets,
To be eligible for risk weighting purposes, the rating should be in force and confirmed from the monthly bulletin of
theconcerned rating agency.
The rating agency should have reviewed the rating at least once during the previous 15 months.
For other .assets which have a contractual maturity of more than one year, long term ratings accorded by the
chosen credit rating agencies would be relevant.
Cash 'credit exposures should be reckoned as long term exposures and accordingly the long term ratings
accorded by the chosen credit rating agencies will be relevant.
Similarly, Banks may use long-term ratings of a counterparty as a proxy for an unrated short-term exposure on
the same counterparty.
Mapping Process: A mapping of the credit ratings awarded by the chosen domestic credit rating agencies has
been furnished by RBI that should be used by banks in assigning risk weights.
Risk weight mapping of Long term Ratings of the chosen domestic rating agencies
Illustration: ABC Bank has obtained ratings from CRISIL for its corporate clients (standard assets). When the
bank completes the assignment of risk weights, the chart shows the total risk weighted assets under the
corporate segment as follows.
53
SI Name of the Supervisory Rating given Risk Asset 0/s Risk
no Customer category(Based on by the rating weight to as on 31 weighted
Sector classification) agency - be given March in Asset
CRISIL Rs. lakh Rs .lakh
ABC Ltd Corporate AAA 20% 150 30
XYZ Ltd ... Corporate M 30% 120 40
Ram Ltd Corporate A 50% 200, 100
Shyam Ltd Corporate BBB 100% 300 300
DEF Ltd Corporate Unrated 100% 420 420
Ujala Electronic Corporate BB- 150% 500 750
ltd
Total 1690 1640
Part-B: Corporate assets-Short term exposures (less than one year)
Rating A agencies Risk weights
PR 1+ P 1+ F 1+ (Ind) A1+ 20%
PR 1 P1 F1 (Ind) A1 30%
PR 2 P2 F2 (Ind) A2 50%
PR 3 P3 F3 (Ind) A3 100%
PR 4 & 5 P4&5 F 4 & 5 (Ind) A4&5 150%
Unrated Unrated Unrated (Ind) Unrated 100%*
Unrated Corporates
2008-09: Fresh sanctions or renewals in excess of Rs.50 crore - 150%.
2009- April onwards: Fresh sanctions or renewals and unrated restructured advances for the year under watch if
in excess of Rs. 10 crore- 150%.
The threshold will be with reference to the aggregate exposure on a single counterparty
Restructured/rephrased advances for the first year under watch-125% irrespective of the rating. If unrated, the
above stipulations apply (100% up to and inclusive Rs.10 crore and 150% if above Rs.10 crore from 01-04-09
onwards).
CLAIMS INCLUDED IN THE REGULATORY RETAIL PORTFOLIOS
All Claims included in Retail regulatory portfolio attract 75% risk weight
For a claim (asset) to be classified as Retail Regulatory portfolio —four criteria should be met (include both fund-
based and non-fund based)
1 Orientation criterion (ii) Product criterion (iii) Granularity criterion (iv) Low value of individual
exposures
1) ORIENTATION CRITERION 2) PRODUCT CRITERION
• The exposure (both FB & NFB) - The exposure (both FB and NFB) in
individual person or persons or to Revolving credits and lines of credit
• Person means any legal person overdrafts),
•
capable of entering into contracts Term loans and leases (e.g.
limited companiei, public- • Small business facilities and
• lithited—abiiiiiinies,–co- operative
Small' business is one where the commitments. .,
total average annual turnover is
less than Rs. 50 crore. (Average
of the last 3 years for existing
entities; STANDARDIZED
SIMPLIFIED projected APPROACH (SSAI
To assist banks and national supervisors, Basel committee has provided a simplified approach .The salient points
of the simplified approach are as below:
For sovereign exposures rating, Export Credit Agency ratings are used Risk weight for Corporates is a fiat 100%,
since ratings are not used.Reduced risk weights of 75% and 35% for retail and housing portfolio would be
available.Off balance sheet items will have credit conversion factors.
INTERNAL RATING BASED (IRB) APPROACHES
There are...two options available viz. •
(1) FOUNDATION APPROACH - • • • (2) ADVANCED APPROACH.
In the IRB approaches, the bank's internal assessment of key risk parameters serves as a primary input to capital
computation. The salient features of IRB appro.ach are as under:
Capital charge computation is dependent on the following parameters:
PD Probability of default
LGD - Loss given at default
ED or EAD - Exposure at default
54
Effective Maturity
IRB approach computes the capital requirement of each exposure directly .Banks need to categories banking book
exposure into broad classes of assets with different risk characteristics. The classes of assets are:
(a) Corporate (b) Sovereigns (c) Banks (d) Retail (e) Equity.
Within Corporates and retail, there are sub-clauses which are separately identified. Risk weighted assets are
derived from the capital charge computation. Banks must use the risk weight functions provided by Basel —
11.IRB approach does not allow banks to determine all the above elements. These two approaches to IRB, differ
only in the aspect of who provided the in-puts. For example, in the Foundation Approach, EAD is provided by the
Supervisor and in advanced IRB, EAD is provided by the bank.
RISK COMPONENT FOUNDATION IRB ADVANCED IRB

Input Provided by Input provided by
Probability Default (PD) Bank Bank
Loss given default (LGD) Supervisor Bank
Exposure-at Default (EAD) Supervisor • Bank ...
Effective Maturity Bank or supervisor Bank
Risk weight Function provided by Committee Function provided by Committee
Data requirements Historical data for five years to Historical data
estimate Probability default(PD) LGD-7 years EAD-7 years ,PD -7
years
Internal Ratings-Based Banks should apply to RBI by RBI approval would be given
(IRB) April 1, 2012_ before March 31, 2014
Approaches for Credit
Risk
CREDIT RISK MITIGATION

ELIGIBLE FINANCIAL COLLATERAL: The following collateral instruments are eligible for recognition in the
comprehensive approach of Credit Risk Mitigation:
i) Cash (as well as certificates of deposit or comparable instruments, including fixed deposit receipts, issued by
the lending bank) on deposit with the bank which is incurring the counterparty exposure.
ii) Gold: Gold would include both bullion and jewelry. However, the value of the collateralized jewelry should be
arrived at after notionally converting these to 99.99 purity.
iii) Securities issued by Central and State Governments
iv) Kisan Vikas Patra and National Savings Certificates provided no lock-in period is operational and if they can be
encashed within the holding period.
v) Life insurance policies with a declared surrender value of an insurance company which is regulated by an
insurance sector regulator.
vi) Debt securities rated by a chosen Credit Rating Agency in respect of which the banks should be sufficiently
confident about the market liquidity where these are either: Attracting 100 per cent or lesser risk weight i.e.,
rated at least BBB(-) when issued by public sector entities and other entities (including banks and Primary
Dealers); or Attracting 100 per cent or lesser risk weight i.e., rated at least PR3 / P3/F3/A3 for short-term debt
instruments.
vii) Debt securities not rated by a chosen Credit Rating Agency in respect of which the banks should be
sufficiently confident about the market liquidity where these are
Issued by a bank; and Listed on a recognized exchange; andClassified as senior debt; andAll rated issues of the
same seniority by the issuing bank are rated at least BBB(-) or PR3/P3/F3/A3 by a chosen Credit Rating Agency;
andThe bank holding the securities as collateral has no information to suggest that the issue justifies a rating
below BBB (-) or PR3/P3/F3/A3 (as applicable) and;
Banks should be sufficiently confident about the market liquidity of the security.
viii) Units of Mutual Funds regulated by the securities regulator of the jurisdiction of the bank's operation mutual
funds where:
A price for the units is publicly quoted daily i.e., where the daily NAV is available in public domain; and
Mutual fund is limited to investing in the instruments listed in this paragraph.
CALCULATION OF CAPITAL REQUIREMENT
For a collateralized transaction, the exposure amount after risk mitigation is calculated as follows:
E* = max {0, [E x (1 + H.) - C x (1 - H.- H*4])
where:
E* = the exposure value after risk mitigation
E = current value of the exposure for which the collateral qualifies as a risk mitigant
He = haircut appropriate to the exposure
C = the current value of the collateral received
= haircut appropriate to the collateral
Hfx = haircut appropriate for currency mismatch between the collateral and exposure
The exposure amount after risk mitigation (i.e., E*) will be multiplied by the risk weight of the counterparty to
obtain
the risk-weighted asset amount for the collateralized transaction.
Holding period will be the time normally required by the bank to realize the value of the collateral.
Haircuts
In principle, banks have two ways of calculating the haircuts:
Standard supervisory haircuts, using parameters set by the Basel Committee, and

55
Own-estimate haircuts, using banks' own internal estimates of market price volatility. Banks in India shall use
only the standard supervisory haircuts for both the exposure as well as the collateral.
CAPITAL CHARGE FOR MARKET RISKS
Changes in market prices affect financial conditions. Values of financial instruments and other assets may fall due
to changes in market parameters. Basel — I accord after the modification in 1996 addressed the issues of
allocation of capital for market risk but not operational risk. There is a general perception that the operational
risks are on the rising path. The failure of the old institution such as Barings Bank (due to Derivative trades by
one Nick Lesson) was largely attributed to operational risk. Similarly, Societegeneral, second biggest bank in
France has reported a huge loss, running in multi billion US Dollars due to the Derivative positions taken by a
trader named Jerome Kenreil. Hence Basel-II prescribe*: Capital charge for Operational risk also.
CAPITAL CHARGE FOR MARKET RISK: The following assets of a bank require Capital charge for market Risks.
Trading Book Positions which are Interest related: These items are sensitive to the market interest rates: Their
market values fluctuate with the market interest rates. For example, if a .bank is holding a 10 year bond with
coupon rate of 10% and the market rate for such instruments is 8%, the price at which the market is willing to
buy this bond will be higher than when the general market rate is say 12%.
Equities in Trading Book: These are sensitive to market movements. They are sensitive both general market
conditions & to specific issues related to the particular stock.
Foreign exchange open positions (inclusive of Bullion positions*)
These occur both in Trading and Banking books.
*Since 1997-98, a few Indian banks are authorized to import and deal with Bullion, Silver & platinum. The import
is from Switzerland or Dubai mostly. The invoices are denominated in USD. The sale of gold is both on wholesale
& retail basis. In the Indian scenario, the trading book comprises:
Securities under 'held for trading' (HFT) category
Securities under 'Available for sale' (AFS) category
Open gold positions
Open Forex positions
Trading positions in derivatives
Derivatives for hedging trading positions.
As per RBI guidelines, banks are required to calculate counter party credit risk charge for OTC derivatives.
CAPITAL CHARGE ON MARKET RISK
The minimum capital requirement is further divided in to components as follows:
1.General Market Risk Charge
Capital requirements for General market risk are meant to capture the risk of loss arising variations in market
interest
The capital charge is the sum of four components:
The net position in the trading book.
A small portion of the matched position in each time band (vertical disallowance).
A larger portion of the matched position across different time-bands (horizontal disallowance).
A net charge for positions in options.
As discussed before The Basel Committee has suggested two methodologies for computation of capital charge for
market risks.
a. Standardized method > Maturity method
Duration Method*
b. Internal risk management model method
In India, RBI has prescribed 'duration' method to arrive at the capital charge for market risk. Thus, banks will be
required to measure the general market risk charge by calculating price sensitivity (modified duration) of each
position separately. Measurement of capital charge for equities in the trading book.
2. Specific Charge for each Category of assets
Thus we have to work out the above two charges for each of the three categories of assets and then aggregate.
CAPITAL CHARGE ON MARKET RISK
CATEGORY General market Risk' Specific Charge Total Market

Capital Charge (Category based) Charge
1) Trading book A B
positions To be arrived using -* As per RBI 1) A+B
which are interest related. Standardised-Duration guidelines given in •
Method Table 1 below
. Net position
Horizontal disallowance
Vertical disallowance
2) Equities in trading 9% computed on the 9% computed on 2) A+B
book Bank's gross equity the
positions Bank's gross
equity
3) Foreign 9% 3) B
exchange open The open
positions (inclusive of NA position
Bullion positions*) would be the limit
These occurbath in. or
TOTAL CAPITAL CHARGE - 1+2+3

56
CAPITAL CHARGE FOR OPERATIONAL RISK
Operational risk is defined as the risk of loss resulting from inadequate or failed internal processes, people and
systems or from external events. This definition includes legal risk, but excludes strategic and reputation risk.
Basel II accord provides three methods for calculating operational risk capital charges.
(I) The Basic Indicator Approach ( BIA ),(II) The Standardized Approach & (III) The Advance Management
Approach ( AMA)
BASIC INDICATOR APPROACH (BIA)
Under BIA regime, a bank must hold capital for operational risk equal to the average over the previous three
years of a fixed percentage (denoted by alpha) of positive annual gross income is negative or alpha) of positive
annual gross income. If annual gross income is negative or zero, it should be excluded while calculating the
average. The charge may be expressed as follows: K = E (G11 .....3x a ) / 3
Where K - Capital Charge under BIA, GI - Gross Income (annual), where positive, over the previous three
years.a15%, this is set by Basel II accord. (a-alpha).
DEFINITION OF GROSS INCOME : A Gross income is defined as” Net Interest Income Plus Net Non Interest
Income “.It is intended that this measure should: 1.be gross of any provisions (e.g. for unpaid interest) and
write-offs made during the year; 2.be gross of operating expenses, including fees paid to outsourcing service
providers, in addition to fees paid for services that are outsourced, fees received by banks that provide
outsourcing services is included in the definition of gross income; 3.exclude reversal during the year in respect of
provisions and write off during the previous years, 4.exclude income recognized from the disposal of items of
movable and immovable property; 5.Exclude realized profits / losses from the sale of securities in the "held to
maturity" category; 6.exclude income from legal settlements in favor of the bank; 7.exclude other extraordinary
or irregular items of income and expenditure and 8.exclude income derived from Insurance activities.
2. The above definition is summarized in the following equation: Gross Income = Net Profit (+) Provisions &
contingencies (+) Operating expenses (Schedule 16 of Balance Sheet) (-) items 3 to 8i in the para above
Illustration-ABC Bank -Basic Indicator Method for calculating Capital charge for Operational risk.
Year 31-03-200731-03-200831-03-2009
Gross Income 1000.00 1400.00 1600.00
(Amount in Crore) ,
Capital Charge fpr Operational Risk using Basic indicator method

This is to be calculated using Basic indicator method
K (BIA) = GI (Annual Gross income of Previous three years)* alpha i.e. 15%
= 1500+ 1400+ 1600 = 1500 x 15% = 225 Crores
THE STANDARDIZED APPROACH (TSA) FOR MEASURING CAPITAL CHARGE : OPERATIONAL RISK
In the Standardized Approach, bank's activities are divided into eight business lines: corporate finance, trading
and sales, retail banking, commercial banking,' payment and settlement, agency services, asset management,
and brokerage. Within each business line, gross income is a broad indicator that serves as a proxy for the scale of
business operations and thus the likely scale of operational risk exposure. The capital charge for each business
line is calculated by multiplying gross income by a factor (denoted beta) assigned to that business lines.
Total Capital charge = Sum of (Gross Income x Beta). In TSA gross income is measured for each business line,
Gross income of eight business lines should be equal to the gross income of the institution
Beta = a fixed percentage set by the Committees, relating the level of required capital to the level of the gross
income for each of the 8 business lines.
BUSINESS LINES BETA FACTORS (13) Method of Arriving at Capital charge using TSA (The
I. Standardized approach)
S. No Business activity Beta factor The total capital charge is the three-year average of the
131 Retail Banking 12% simple summation of the regulatory capital charges across
(32 Retail Erokerage 12% each of the business lines in each year.
The year at the end of which the capital is being calculated
13 3 Asset management 12% will also be one of the three years.
13 4 Commercial Banking 15% In any given year, negative capital charges (from negative
gross income) in any business line may offset positive
85 Agency Service 15% capital charges in other business lines without
f3 6 Corporate Finance 18% limit.
87 Trading 18% However, where the aggregate capital charge across all
business lines within a given year is negative, then the input
S8 Payment & Se ttlement 18 %
to the numerator for that year will be zero.
activities
The total capital charge will be expressed as:
KTSA = (I years 1-3 maz[Z(G11-8 X (31-8),0]}/3
Where, KTSA = the capital charge under TSA
GI1-8 = annual gross income in a given year, for each of the
eight business lines.
13 1-8 = afxed percentage, set by the Basel Committee,
XYZ- ILLUSTRATION OF CAPITAL CHARGE FOR OPERATIONAL RISK-STANDARDIZED METHOD
Amount in Rs. Beta . Year-02 Year-03
' Crore factor Year

57
S. Business 12% Gross Capital Gross Capital Gross Capital
No activity Income in charge Income in charge Income in charge
Rs. Crore Operational Rs. Crore Operational Rs. Crore Operational
risk — risk risk
1 Retail Banking 12% 100 12 80 . 9.6 180 21.6
2 Retail 12% 200 24 240 28.8 150 18
3 Asset 15% 100 12 120 18 160 24
management ,
4 Commercial 15% Banking 15 140 21 120 18
100
5 Agency Service 15% 200 30 300 45 320 48
6 Corporate 18% 2000 300 2400 432 2500 450
Finance 900 162
7 Trading 18% 1000 180 800 144
8 Payment & 18% 300 54 400 72 500 90
Settlement
activities' •
Total 4000 627 4480 _ 770.4 4830 831.6
Capital charge as per Approach = KTSA = (I years 1-3 max(f(G11-8 X 131-8),0)/3
The Standardized KTSA=
627 + 770.40 + 831.60 /3 = 743
crorescrores
THE ALTERNATIVE STANDARDISED APPROACH (ASA)
CALCULATING CAPITAL CHARGE FOR OPERATIONAL RISK : The ASA is a special variant of TSA. A bank can
use the ASA provided the bank is able to satisfy RBI that this alternative approach provides an improved basis for
risk management. Once a bank has been allowed to use the ASA, it will not be allowed to revert to use of TSA
without the permission of RBI. Under the ASA, the operational risk capital charge / methodology is the same as
for TSA except for two business lines — Retail Banking and Commercial Banking. For these business lines, loans
and advances — multiplied by a fixed factor 'm' — replaces gross income as the exposure indicator. The betas for
retail and commercial banking are unchanged from TSA. For instance, the ASA operational risk capital charge for
retail banking can be expressed as: KRB = B x (m x LArB),Where KRB = the capital charge for the retail banking
business line B7 = the beta for the retail banking business line LArB = total outstanding retail loans and advances
(non-risk weighted and gross of provisions), averaged over the past 12 quarters; and m = the fixed factor 0.035.
Overall capital charge under ASA will be calculated as under:
KASA = years 1-3 max[E(GI14 x (i1-6),0]) / 3 + ((37 x m x LArB) + (88 x m x LAcB), Where
LArB = total outstanding retail loans and advances (non-risk weighted and gross of provisions), averaged over the
past 12 quarters; and LAcB = total outstanding commercial banking loans and advances (non-risk weighted and
gross of provisions), averaged over the past 12 quarters; and m = 0.035 (for both -retail and commercial
banking).
For the purposes of the ASA, total loans and advances in the retail banking business line consists of the total
drawn amounts in the following credit portfolios: retail, SMEs treated as retail, and purchased retail receivables.
For commercial banking, total loans and advances consists of the drawn amounts in the following credit portfolios:
corporate, sovereign, bank, specialized lending, SMEs treated as corporate and purchased corporate receivables.
The book value of securities held for the purpose of interest income such as in HTM and AFS should also be
included. Under the ASA, banks may aggregate retail and commercial banking (if they wish to) using a beta of
15%. Similarly, those banks that are unable to disaggregate their gross income into the other six business lines
can aggregate the total gross income for these six business lines using a beta of 18%.As under TSA, the total
capital charge for the ASA is calculated as the simple summation of the regulatory capital charges across each of
the eight business lines.
ADVANCED MANAGEMENT APPROACHES (AMA)
Under AMA, internal operational risk measurement system is used. Internal measurement system is required to
be vetted by the supervisor (RBI in India). The regulatory capital requirement will equal the risk measure
generated by the bank's internal operational risk measurement system, using the quantitative and qualitative
criteria for the AMA. The criteria are summarized below.
QUALITATIVE STANDARDS
1 A Bank must have an independent operational risk management function. Operationai risk management system
must be closely integrated into day-to-day risk management processes.
There must be regular reporting of operational risk exposures and loss experiences. Operational risk management
system should be well documented.
Internal / external auditors must perform regular reviews of operational risk management processes and
measurement system.
The validation of operational risk management system should be done by external auditors and / or supervisors.
QUANTITATIVE STANDARDS: Basel Committee has chosen not to prescribe a specific approach as many options
are available and are continuously being improved upon. However, a Bank must demonstrate that its operation
risk measures fulfill soundness standards comparable to that of internal rating based approach. The quantitative
standards prescribed by the Committee are given below:
Internal operational risk measurement system should be consistent.

The Bank should calculate Regulatory capital and the sum of Expected Loss (EL) & Unexpected Loss (UL).
The measurement system must be sufficiently granular (detailed) to capture major events of operational risk.
The systems for determining correlations must be sound and the bank must validate the correlation assumptions
58
INTEGRATED RISK MANAGEMENT
Integrated risk management is the process of managing all risks that are there in a given business in a
simultaneous and integrated way. A macro view should be taken and all the risks such as liquidity risk, interest
rate risk, 'Market risk, credit risk and operational risk sho071 be assessed and addressed in the context of each
other.
The sum total of all risk impacts is a critical factor for all organizations. Integrated Risk management therefore is
a coordinated approach to all the risks in a comprehensive manner. Its objective is to minimize the aggregate risk
to tolerable limits..
INTEGRATED RISK MANAGEMENT - CHALLENGES :Real-Time Concern:
Identifying & Measuring of Risk, is critical to managing risks. Measuring and monitoring helps to maintain market
discipline. MIS or data for integrated risk should be on tap where possible
The markets where the banks take exposure move so very fast that unless the data is almost simultaneous and
real-time, nothing much can be achieved. Evolution of the real-time business environment (markets) giving rise
to risks on a continuous basis especially the Foreign exchange markets
Regulatory requirements make it compulsory to generate some of this data however; the primary objective of
Integrated Risk management is to meet the business challenges such as: Quick obsolesce of technology.
CULTURAL ISSUES
Most institutions are yet to migrate fully to integrated and inter-connected networks. Stand alone technology
makes it difficult to share information, which is critical to integrated risk management. Inaccurate data works on
a "Junk in, junk out" basis this deteriorates or reduces the quality of information and therefore the quality of the
decisions.
INTEGRATED RISK MANAGEMENT - APPROACH :Organization Structure: Chief Risk Officer & team, which
reports directly to Board of directors.
Process : Across the organization, standardization of the process of identifying, assessing, controlling risk.
System : Information systems should be integrated with management systems to ensure availability of
information and analytical tools
INTEGRATED RISK LIMITS: A well-defined limit structure (discretionary powers) articulating various financial
and other powers, which translate in to risk taking activities, should be put in place.
INTEGRATED RISK REPORTING:
A comprehensive reporting system, which aggregates all' the risks outstanding across the branches (enterprise -
wide) should be prepared.
The format should be in such a way that the users (Risk management committee and the Board) should have an
immediate, real time, overall view to be able to give quality decisions.
In an integrated risk management framework, the top management should have a holistic view of all risks.
For Example, credit risk reports like outstanding counter party limits should include all outstanding limits across
treasury and credit departments.
RISK BASED SUPERVISION (RBS) OF BANKS

The international banking scene has in recent years witnessed strong trends towards globalization and
consolidation of the financial system. Stability of the financial system has become the central challenge to bank
regulators and supervisors throughout the world. The Indian banking scene too has witnessed progressive
deregulation, introduction of prudential and exposure norms and an emulation of international supervisory best
practices. The supervisory processes have also been evolved and have acquired a certain level of sophistication
with the adoption of the CAMELS approach to supervisory risk assessments and rating.
OBJECTIVES OF RBS: The objective of RBS is to:
To optimize utilization of supervisory resources and Minimize the impact of crisis situation in the financial system.
The RBS process essentially involves continuous monitoring and evaluation of the risk profiles of the supervised
institutions in relation to their business strategy and exposures. This assessment will be facilitated by the
construction of a Risk matrix for each institution.
MAJOR ELEMENTS OF RBS APPROACH
a) Risk Profiling of Banks. e) Monitor able Action Plan (MAP)

b) Supervisory Cycle and supervisory f) Supervisory organization
Inspection Process. g) Enforcement process and incentive
Review, evaluate and follow-up. framework
Risk Profiling of Banks
The risk profiling of the bank is done by document, which would contain various kinds of financial and non-
financial riski faced by a banking institution.
Risk profiling of banks is designed for assessing Business risks and Control risks. "
Business risks have been classified into eight categories namely capital, credit, market, earnings, liquidity,
business strategy and environment, operational and group risks.
Control risks have been classified into four categories, namely internal control, organization, management and compliance
risk. Overall risk of Banks will be assessed as low, moderate fair or high. Banks with low risks will have longer supervisory
cycle and less supervisory intervention.
Key Components of the Risk Profile Document: CAMELS rating with trends Narrative description of key risk features
captured under each CAMELS component,Summary of key business risks including volatility of trends in key business risk
factors,Monitor able action plan and bank's progress to date, Strength, Weaknesses, Opportunities, Threats (SWOT)
analysis and Sensitivity analysis

59
Supervisory Cycle:
The supervisory process would commence with the preparation of the Bank Risk profile (based on data furnished by banks
to the DBS of RBI, besides data from other sources). The supervision cycle will vary according to risk profile of each bank,
the principle being the higher the risk the shorter will be the cycle.
Supervisory Programme:
The supervisory programme would be tailored to individual banks and would focus on the highest risk areas as well as
specify the need for further investigation in identified problem areas. The supervisory programme would also identify
the package of supervisory tools to be deployed from a range consisting of:
Greater off-site surveillance • Targeted on-site inspection • Structured meetings with banks
Commissioned external audits • Specific supervisory directions
New policy notices (i.e. new policy directions to banks emanating from individual bank level concerns, which are
relevant for the industry).
Inspection Process
The risk assessment process would highlight both the strengths and vulnerabilities of an institution and would provide a
foundation from which to determine the procedures to be conducted during the inspection.
The inspection would target identified high-risk areas from the supervisory perspective and would focus on the
effectiveness of mechanism in capturing, measuring, monitoring and controlling various risks.
Review, Evaluation and Follow-up

An evaluation will be undertaken to ensure that the supervisory programme has been effective in improving the risk profile of
the bank concerned.The risk profile document of the bank will accordingly be updated in the light of new information.
Monitor able Action Plans (MAPs)

A Monitarable Action Plan (MAP) is devised to ensure that banks take corrective action in time to remedy or
mitigate any significant risks that have been identified during the supervisory process.
RBI uses MAPs to set out the requirements as identified during the on-site & off-site supervisory process. MAPs are
effective in a number of ways. MAPSthey-include directions to Banks on actions to be taken. The remedial actions that
would be outlined would be tied explicitly to the areas of high risks identified in the Risk profiling /Supervisory process and
lead to improvements in the systems and controls environment at the Bank.
Key individuals at the bank would have to be made accountable for each of the action points. If actions and timetable set
out in the MAP are not met, RBI would consider issuing further directions to the defaulting banks and even impose
sanctions and penalties.
The mandatory and discretionary actions as enshrined in the Prompt Corrective Action (PCA) framework would be a part of
the Supervisory enforcement action. The enforcement function would be carried out through an independent Enforcement
Cell to be set up at the BSD to ensure consistency of treatment, maintain objectivity and neutrality of enforcement action.
Role of External Auditors in Banking Supervision :The use of specialist third parties, such as, external auditors can be of
significant aid to the bank supervisors. In some countries, external auditors are required to perform an early warning
function and inform supervisors without delay of information material to the supervisor.The Basel consultative paper 'Internal audit in
Banks & the relationship of the Supervisory authorities with Internal and External auditors' discusses the comrepoality of focus & concern
of External auditors & Bank supervisors.The supervisory process instead of duplicating the efforts of the external / internal auditors
should seek to leverage off (use) their work / reports. LFAR format *Being used in part realization of this goal
MODULE – C : TREASURY MANAGEMENT

TREASURY MANAGEMENT
Treasuries have a critical role in managing the various risks that the banking businesses face. There is however a
risk that treasury operations themselves bring. Termed as "Treasury risk", this risk focuses on the operational
risks that arise out of treasury functioning. Treasury risk management is critical because the nature of activity is
such that though income is generated out of market opportunities, market risk is present in every single
transaction. The risk of losing capital is very high unlike in the area of Credit (where capital adequacy norms
ensure the limiting of exposures) as the treasury business gears itself on the high advantage facility that banks
enjoy. The capital requirement for treasury operations is low because only margins have to be deposited but the
risk of losing the capital is very high in comparison.The size of the transactions is also a cause for concern. The
minimum lots in certain currencies are a quarter million. Though all these are factored in to the Limits policies,
Staff policies, Overnight limits policies, the risks remain a concern.
TREASURY DECISIONS CURRENCY MANAGEMENT INTEGRATED TREASURY
Funds Management (short & long term) Export earnings I import outgo to be Seamless integration of the
carefully matched /synchronized. treasury functions involving Money
markets,
Cash Management Exchange rate fluctuations To be Security markets and Foreign exchang
watched and managed .
Credit Management (repayment of Interest rate fluctuations watched &
interest and installments) foreign currency holdings managed
Forex Management (exchange rate Country risk to be monitored
management, interest rate and
fluctuation measured
management)

60
Risk Management (ALM, interest rate,
credit, risk. country risk)
Managing other. Concurrent risks
TREASURY - ORGANIZATIONAL CONTROL (INDICATIVE) : Treasuries have three important divisions called
Front Office, Middle Office and Back office. Their roles are discussed in detail elsewhere. The work flow and
division is constructed to ensure that there is a cross verification of every single transaction. Once the dealer in
the front office completes a deal, the slip is handed over to the back office. The back office staff settles the
liadebiT-CyblterVelifyirirnr151T5iltriiithififirriarabritrolS-. It -obtains independent confirmation of each debt from
the Counterparty. It also verifies that the rates / prices-in the deal slips conform to the market ai the time ortherr
dial. Reuter/ Bldaffiberg screens are used for verification.The back office is responsible for compliance with risk
limits imposed by the management and REiLras well as for accuracy_ and objectivity of the transaction details:
Middle office, maintains the overall risk of Treasury portfolio and monitors the liquidity and interest rate risks
closely, in line with Asset Liability- Management'(ALM) guidelines. In quite a few banks,the ALM support group is
a part of middle office, or works closely with the middle office.
ORGANIZATION OF TREASURY (INDICATIVE) :

DIVISION FUNCTIONS
FRONT OFFICE Headed by a Chief dealer with several dealers focusing on and dealing in different markets,
or THE DEALING Securities, Clients, Currencies depending on the size & needs of the Bank. Dealers are to
ROOM function
Exposurewithin set
Limits: limitscaps are put in place to
These
Internal Controls:
protect the
bank from credit risk, which, in Treasury, may be of a) Deal sizeb) Open position c) Stop-
defaulters and counter party. loss.
MIDDLE OFFICE Exclusively engaged in providing information to top Is responsible independent market
management. monitoring, measurement, analysis risk Middle Office should
BACK OFFICE Verifies and confirms all the deals put through by the front office. The critics: issue of
settlement as per the deal
* terms and Nostro account issues rest with this section.
RISK CONTROL THROUGH DISCRETIONARY POWERS / EXPOSURE LIMITS
Exposure limits ensure, that the dealers while taking ;positions do not take more than a predetermined level of
exposure against .given Party. The idea is to limit the counter-party risk. Exposure limits are put in place against
other banks and countries and Corporates, etc. Delivery vs. Payment option exists in government securities as the
banks have both the securities account (SGL) and funding account with RBI, so that debit and credit can take
place simultaneously. In other deals, Settlement risk continues to exist now (except where RTGS is used). In
foreign exchange transactions, the gap between Rupee and FC settlement is unavoidable when the FC settlement
takes place in a different time zone (e.g. USD in New York). The counterparty risk is bankruptcy, or inability of
the counterparty for whatever reason to complete their end of transaction. Banks impose limits and review them
periodically to ensure that the Counter party and settlement risks' are understood and controlled.
INTERNAL — CONTROL: Internal controls are positions limits and stop loss limits. Limits are allocated to the
dealers who trade in foreign exchange and securities. TRADING LIMITS ARE OF THREE KINDS:
1) Limits on deal size 2) Limits on open-potitions, and 3) Stop-loss limits.
NOTE ON STOP LOSS LIMITS
The limit is a protection against potential losses on the deal. Stou-loss limits represent the ultimate way of
controlling trading operations.
When the market moves adversely, the open positions will result in loss. Whenever such a situation arises, the
human tendency would be to wait until the market turns around, such that the position can be closed with a
profit. The stop loss limits prevent the dealer from waiting indefinitely and limit the losses to a level, which is
acceptable to the management. If the stop loss limit is USD 10:000, the dealer must close his position (i.e. sell or
buy at a loss) when the adverse movement reaches a loss level of USD 1000. Normally, stop losses are keyed in
to the systems soon as the dealer takes a position such that when the levels are breached, the computers will
square off the positions automatically. The stop-loss limits are prescribed per deal, per day, per month as also an
aggregate loss limit per year. Back office monitors all these limits meticulously.
RISK CONTROL THROUGH USE OF DERIVATIVES
A derivative is a financial product, which hat been derived from another financial product or commodity.
Derivatives are financial contracts which derive their value off a spot price time-series, which is called the
"underlying".
For example, wheat farmers may wish to contract to sell their harvest at a future date to eliminate the risk of a
change in prices by that date. The transaction would take place through a forward or futures market. This market
is the "derivative market", and the prices on this market would be driven by the spot market price of wheat which
is the "underlying".
The derivatives do not have independent existence without underlying product and market. The underlying assets
could be a stock index, a foreign currency, a commodity or an individual stock. The primitive and simplest form of
derivatives is the forward contract (also known as the forefather of the derivatives).
The most common examples of derivative instruments that are used for Treasury risk control are Future /
Forwards, options and swaps. A separate chapter on derivatives is given later in greater detail:
TREASURY & TRANSFER PRICING
In the banking context, Transfer pricing is a mechanism of price at which resources are allocated within an
organization across its various business units. (In banks, business units are branches, Extension counters,
departments raising and using resource etc.). Banks used terms such as Central office interest or Head Office
interest for this process earlier. Branches are paid / charged (either notionally r or actually) at a rate known as
61
"Transfer Price" for the funds raised by them or used by them (depending on whether it is a "Deposit oriented" or
a "Sourcing branch" or an "Advances oriented" or" Using" branch). In most of the banks, it is the treasury which
determines this rate periodically and administers the same.
TREASURY & ASSETS LIABILITY MANAGEMENT
Bank branches routinely accept deposits and extend loans without having the macro view of where r these
transactions are fitting in the balance sheet of the bank. A branch may very happily accept a Rs100 crore deposit
for 6 months. The responsibility of deploying these funds in a manner profitable to the bank rests with fund
managers in the treasury department. Similarly, if a branch clinches a proposal to be a part of the Rs.1800 crores
loan that a big corporate is availing it is the treasury managers who have to worry about sources. It is reiterated
that the above examples are simplistic and are created to sensitize the reader to the macro-view. Banks have
other checks and balances to ensure that they do not get in to any major positions without going in to aspects of
sources and uses before the deals are made. Thus treasury has a big role in ALM management. They are a link
between the sources and uses. They monitor the various risks.They take trading positions to reduce the
mismatches as discussed above and support the ALM.
TREASURY & SLR : In most banks, funds department, planning department and treasury are integrated to
various extents to manage the SLR regulations. Most of the SLR approved securities come in the trading book.
Thus, altering the positions (buying or selling) based on the ia-puts by the MIS from planning department is the
responsibility of treasury. The figures from across the branch network for the relevant Fridays are of course
dynamic.The required trades have to be put to ensure SLR compliance.SLR approved securities are risk free
instruments and carry lesser yields. So, the bank would endeavor not to lock up more funds than necessary in
such a portfolio. All these aspects are taken by the treasury and the dealers in the front office are given mandated
to buy or sell accordingly.
TREASURY & CREDIT PRICING : Modern day treasuries have to deal with sophisticated customers who want to
avail their requirements through foreign currency loans or commercial paper rather than plain vanilla credit in
rupee terms. Most banks have also introduced options of Fixed or floating interest rates. In these cases, the
benchmarks to be watched and the spread rates to be quoted accordingly. Banks have teams / sophisticated
system’s to arrive at the pricing of all these products. Treasury is apart of all such sensitive activities. When a
bank subscribes to the Commercial paper raised by Corporates, once the issue is over, the product ur the asset
comes in to the trading books managed by the treasury. Here, apart from the usual market risks, Counterparty
risks also exist. The market movements of such products should be monitored and decisions regarding booking
profits or stopping losses is to be taken.
CLASSIFICATION OF TREASURY INVESTMENTS
Treasury investments are categorized into government securities, other approved securities, shares, debentures
and bonds, commercial papers, and mutual funds. In line with international best practices, the investments are
classified in to the following categories: Held to Maturity: The securities contracted basically on account of long
term investment relationships or for steady income and statutory obligations are classified under Held-To-Maturity
(HTM) category.
Held for Trading: The investments made to earn profits from the short-term price movements. These Securities
are sold in 90 days (defeasance period).
Available for Sale: The securities, which do not fall under the above two categories, are classified as Available-
for-Sale. Shifting of securities from HFT to AFS is normally permitted only under exceptional circumstances such
as tight liquidity conditions, extreme volatility or exceptional market conditions and only with the approval of
Board of Directors / ALCO / Investment Committee. These assets in the Trading Book are held for generating
profit on differential interests/yields. Ideally, the securities held in the Trading Book are marked-to-market on a
daily basis.
Marking to Market: Securities under HFT & AFS must be marked-to-market periodically as per bank / RBI
guidelines.
Investment Fluctuation Reserve: Maintained to guard against any possible reversal of interest rate environment
on unexpected developments. It is prudent to transfer maximum amount of gains realized to sale of securities to
the IFR. Banks can build IFR up to 10 % of the portfolio under HFT and AFS with the approval of the Board of
Directors.
TREASURY FUNCTIONS - FUNDING AND REGULATORY ASPECTS
The treasury has the important function of managing the funds that flow through the bank in terms of the
statutory requirements and banking regulations. In India, the two most important functions are maintaining the
Cash Reserve ratio and the Statutory Liquidity Ratio. RBI prescribes CRR and SLR from time to time. The current
CRR is 6% and SLR is 24%
These rates are subject to change. Please visit CTDI website www.corporatetraininginstitute.com for latest rates.
.. PARTICULARS CASH RESERVE RATIO (CRR) STATUTORY LIQUIDITY RATIO (SLR)

1 Concept A quantitative tool of Monetary policy to SLR is a quantitative tool of Monetary policy to
and Objectives regulate money supply in the economy. regulate the money supply irithe economy by
RBI varies the CRR & regulates controlling funds available with commercial
the lendable funds of the commercial banks for lending activities.
banks.
2 Provision Section 42( 1 ) of Reserve Bank Act —1934 Section 24 (2-A) or BR Act - 1949.
3 Limits Minimum-Maximum not prescribed Minimum Nil- and maximum 40%
4 Current rates 4..00% 22 %

62
5 Applicable on Net Demand and Time Liabilities (NDTL) in Total Demand & Time Liabilities in India as on
India on fortnight basis Last Fridays of second Preceding fortnight
6 _ How maintained RBI To be kept in approved Securities within India.
7 Type of In cash only In Cash, Gold or Unencumbered approved

Investment securities defined u/s 5(a) & 25 (a) of BR Act.
,
8 Requirements . Fortnightly Basis: Saturday to following Friday Last Friday of second preceding fortnight.
- 14 days. Daily Basis: Minimum _
balance up to 70% of the total CRR
requirement on all days of the fortnight.
9 Interest No Interest on CRR balances now by RBI Return depends upon the investment made
10 Penalties 3% PA above bank rate on the day of 3% PA above bank rate on the day of shortfall
\ shortfall, increased to a rate of 5% PA above and increased to a rate of 5% PA above the bank
the bank rate 'for succeeding days of default. rate for next succeeding working day and
In cases of default in maintenance of CRR on collected for the actual days of default.
average basis during a fortnight, penal
interest will be recovered as envisaged in sub-
section (3) of Section 42 of Reserve Bank of
India Act, 1934.
CALCULATION OF DTL / NDTL

Liabilities not included for DTL/NDTL computation Exempted Categories (CRR)
Paid up capital, reserves, credit balance in the P&L A/C, Liabilities to banking system in India as
refinance from RBI, Exim Bank, NABARD, etc. computed underClause (d) of the
Amount of provision for excess income tax, Amount from DICGC Explanation to section 42(1) of the RBI Act, 1934.
pending adjustments / ECGC, insurance company on ad-hoc Credit balances in ACU (US$) Accounts.
settlement of claims, Court Receiver. Demand and Time Liabilities in respect of their
Liabilities under Bankers Acceptance Facility Offshore Banking Units (OBU). _
DRDA subsidy of Rs.10,000/- kept in Subsidy Reserve Fund account
in the name of Self Help Groups, Subsidy released by
NABARD underInvestment Subsidy Scheme for
Construction/Renovation /Expansion of Rural Godowns,
Net unrealized gain/loss arising from derivatives transaction under
trading portfolio.
Income flows received in advance such as annual fees and other
charges which are not refundable.
Bill rediscounted by a bank with eligible financial institutions as
approved by RBI.
Provision not being a specific liability arising from contracting
additional liability and created from profit and loss account.
Inter-bank term deposits / term borrowing liabilities of Original
maturities of 15 days & above and up to one year. This concession is
not available for maintenance of SLR
Inter-bank assets of term deposits and term lending of original
maturity of 15 days and above and up to one year. This concession is
not available for maintenance of SLR.
Income flows received in advance such as annual fees and other
charges which are not refundable.
RBI - LIQUIDITY ADJUSTMENT FACILITY :

 Treasuries participate in the LAF to manage the liquidity and funding requirements.
LAF is a mechanism used by RBI to inject or absorb liquidity from domestic markets Repo/Reverse Repo under
LAF are operated by RBI for "overnight" or short term periods such as up to seven days as decided by RBI from
time to time.RBI announces a calendar for conduct of these transactions well in advance The Scheme Operates as
under:
Reverse Repo auctions (for absorption of liquidity) and Repo auctions (for injection of liquidity).The above
instruments are conducted on a daily basis.
Minimum Bid Size: Minimum Rs.5 crore and in multiples of Rs. 5 crore thereafter.
Rate of Interest: Both the reverse repo and repo operations will be conducted by RBI at a fixed rate. The reverse
repo rate will be fixed by the Reserve Bank from time to time. The repo rate will continue to be linked to the
reverse repo rate through a spread as mark up over the reverse repo rate.
MECHANICS OF LAF OPERATIONS
LAF is conducted through bids which are submitted electronically in the Negotiated Dealing System (NDS).
The Reverse Repo / Repo will be conducted as "Hold- in- Custody" transaction, where the RBI will act as a
custodian for the participants and hold the securities on their behalf in the Reverse Repo / Repo Constituents SGL

63
Accounts. On acceptance of bid in respect of Reverse Repos, the tenderer's RRC SGL Account will be credited with
the
required quantum of securities and Current Account will be debited for the Reverse repo amount. The transaction
will be reversed in the second leg. In the case of Repos, on acceptance of bid, the tenderer's RC SGL Account will
be debited with the required quantum of securities and Current Account will be credited with the Repo amount.
The transactions will be reversed in the second leg. Pricing of all securities including Treasury Bills will be at face
value for Reverse Repo / Repo operations Since the securities available in RC SGL Account are meant only for
availing liquidity from Reserve Bank, the system will automatically transfer the securities once the allotment is
complete.
Eligible Securities: Reverse Repos and Repos will be undertaken in all SLR-eligible transferable Government of
India dated Securities / Treasury Bills.
Margin Requirement: A margin will be uniformly applied in respect of the above eligible securities. The amount of
securities offered or tendered on acceptance of a bid for Rs.l'JOwill be Rs.105 in terms of face value.
Settlement of Transactions: The settlement of transactions in the auction will take place on the same day. As the
second leg of all LAF transactions are automatically generated at the 'begin of day', participants must ensure
sufficient balance in their current account in case of reversal of Repo.
Periodicity of LAF: Currently RBI conducts daily Repo transactions with a second Repo only on reporting Fridays
RBI gives out the calendar for conduct of the Reverse repo periodically.
Rates: RBI announces the Repo / Reverse rates periodically. Current rates are Repo-6.25% and Reverse rep-
5.25%. The difference between these two rates is referred to as the "Repo corridor". Under normal market
conditions, Call rates move within the Repo corridor.
MAIN TYPES OF MARKETS
CAPITAL MARKET FOREIGN EXCHANGE MARKET MONEY MARKET
Capital Market: Market Foreign Exchange Markets are global, 24 The Money market
financial assets for X7 markets in which Banks, is a
with long or Financial place for deploying and
indefinite maturity. Market Institutions, Central Banks and merchants trading in money ,and short
Can be classified as: market participate. Speculators are an integral term highly liquid
Corporate securities as : part of FX markets (just as in equity financial
Govt. or Gilt securities markets) Apart from Foreign currencies, assets that are close
(Central, State, quasi derivative instruments such as Futures substitutes for money.
Primary Market: New issues
and Options etc. are traded in FX markets. Treasury Bills (c)Commercial
Secondary Market: Consists of S/E
Some of these derivatives are traded on paper
& OTC exchanges governed by
the stock exchanges also. In India, (d) Certificate of Deposit
SEBI.
Foreign currency futures in USD-INR were (e)Call Money / Notice
Capital
> Market
Equity Instruments:
/ Preference shares launched initially and now Euro-INR, GBP- Money
Company Fixed Deposits INR and Jap Yen- INR are also permitted
3,. Debentures / Warrants In India,only Authorized Persons
/ (as defined in FEMA) are allowed to
Floating rate bonds deal in FX. The public can deal with APs
3- IDRS / ADRS / GDRS for all their FX needs. Dealing rooms in
ie Mutual fund units each Bank, will quote rates, consolidate
the FX received and manage positions as
per the respective Bank's Board approved
policies.
IMPORTANT CAPITAL MARKET RATIOS

Return on Equity Net Profit after Tax — I Return on Equity can be compared with the opportunity
(ROE) Pref. Dividend / equity cost of capital
PBIT — Tax 1 Avg. Total ROA enables the investor to compare his return on Vis
Return on Asset Assets . assets
(ROA)
Earning per share Profit after Tax / No. of Measures the profitability of the investment.Used
(EPS) outstanding shares for
Share - price -/ Earning- comparison with similar
Price Earning (PE) A market indicator whichinvestments.
is used for measuring valuations.
ratio per share
Dividend Yield Dividend per share / Dividend yield indicates the returns total the equity
Share price investors by way of dividend
Book value per Total equity / No of 0/S
Share shares
Treasury products in Money Market : These may be in the form of: (a) Inter-bank money market such as Call
money, Notice money and Term money, where investment are as per the ceiling imposed by RBI.
Call Money : This is lending or borrowing for one day i.e. overnight. Call money transactions reflect the liquidity
availability on any particular day. Call money rate is indicated by Mumbai Inter-bank Offered Rate (MIBOR).
Notice money Investment of funds for a period of more than one day but up to 14 days.

64
Term money : Investment of funds for a period of 15 days or above up to I year. Prudential Limits fixed by RBI
for inter-bank money market :
(1) Borrowing : On a fortnightly average basis, borrowing outstanding should not exceed 100 per cent of capital
funds (i.e., sum of Tier I and Tier II capital) of latest audited balance sheet. However, banks are allowed to
borrow a maximum of 125 per cent of their capital funds on any day, during a fortnight.
(2) Lending: On a fortnightly average basis, lending outstanding should not exceed 25 per cent of their capital
funds; however, banks are allowed to lend a maximum of 50 per cent of their capital funds on any day, during a
fortnight.
(b) Investments in Securities such as treasury bills, commercial paper, certificate of deposit, repo.
Treasury bills : These are issued by Govt. through RBI for maturity of 91 days, 182 days and 364 days, for pre-
determined amount. The interest is allowed by way of discount which is called implicit yield. The prices are
determined by way of Auction by RBI where the banks or primary dealers participate. In:estment ie Treasury Bills
by the Treasury of a bank, is an opportunity to park surplus funds in zero-risk securities that yield low income
(but more than call money lending) and is liquid (as these can be sold) in secondary market.
T-Bills are held in electronic form in a SGL account (or constituent SGL account) maintained by banks with RBI.
The payment of T-bills is received through Clearing Corpn. Of India.
Commercial paper: CP is an unsecured usance promissory note (i.e. negotiable instrument) issued by rated
companies or financial institution to raise short term money with a maturity period of 7 days to one year. It can
be issued for a minimum amount of Rs.5 lac, in Demat form only, at a discount to face value. For a company to
issue CP, it should have credit rating of A3 by CRISIL or equivalent from any other agency. Issuing of CP is
regulated by RBI guidelines and market practices prescribed by Fixed income and Money Market and Derivatives
Association of India (FIMMDA).
Certificate of deposit: CD is an unsecured usance promissory note (i.e. negotiable instrument unlike a fixed
deposit) issued by Banks and financial institutions to raise short term sources with a maturity of 7 days to one
year. The minimum amount is Rs.1 lac. It is issued at a discount to face value, in demat form only. Treasury can
make investment in CD and earn return better than T-Bills or call money operations. Being negotiable instrument,
it also offers liquidity. Since it is issued by a bank or FI, it carries relatively lower risk.
Repo : It refers to sale of a security (normally a Govt. security) with a commitment to repurchase of the same
security at a later date. Whenever a bank is in need of short term funds, it can enter into a repo transaction with
other bank or RBI. The difference in the sale price and re-purchase price is similar to interest on cash advance,
The effective rate on repo is marginally lower than the corresponding money market rate, as the lending bank has
security in hand, till the loan is repaid. In the books of a bank, the transaction appears like a sale and purchase
transactions.
Treasury of the respective bank can use the Repo transaction both for investment purpose and for the purpose of
raising short term funds. RBI makes use of Repo extensively as an instrument to control liquidity in the inter-bank
market. In case of short term liquidity problem, the banks also make use of repo under Liquidity Adjustment
Facility. Whenever RBI wants to absorb liquidity from the inter-bank market, it resorts to purchase of govt.
securities i.e. a Repo transaction. On the other hand to inject liquidity it makes use of Reverse Repo transaction
and resorts to sale of govt. securities. The rate at which these transactions are undertaken is called Repo Rate
and Reverse Repo Rate which keeps on changes. However, RBI maintains some spread in these rates.
Bills rediscounting : Bills discounting provides an investment opportunity to the Treasury. These bills are of short
term nature with maturity, generally, of 3-6 months which are already discounted by other banks. The
rediscounting is done at near market prevailing rates. The borrowing bank is able to maintain liquidity by getting
these bills rediscounted. It also is in a position to reduce its capital requirement for capital adequacy purpose, as
these bills are removed from credit portfolio and are added to the inter-bank liability.
Treasury products in Securities Market : Securities market offers an excellent opportunity for bank Treasury
to invest surplus funds in (a) govt. securities and (b) corporate securities.
Govt. Securities: Major portion of investment in Govt. securities takes the form of investment for SLR purpose
(SLR is fixed by RBI without any minimum but subject to Maximum of 40% as per provision of Section 24 of RBI
Act).
Govt. securities are issued (in the form of Bonds) by Public Debt Office of RBI on behalf of Govt. of India or State
governments. The securities are sold through auctions conducted by RBI. Interest paid is called coupon rate.
During these auctions, RBI reaches the cut-off price, based on the bids received from banks or PDs.

65
Govt. securities are actively traded in the secondary market. Hence, the market price of these securities keeps on
changing depending upon demand and also the current interest rates prevailing in the market.
RBI issues bonds with a maturity period ranging from I to 30 years, with step-up coupon rates or coupon rates
linked to inflation index or floating rate coupons.
Corporate Securities — Debt paper: These securities referred to as non-SLR' investment, include the debenture
and long term bonds issued by companies and financial institutions. Tier-2 bonds such as Redeemable Cumulative
Bonds issued by banks also fall in this category.
yield on such securities is higher than the Govt. securities. Most of these securities are issued in Demat form.
Companies issue these securities after getting them rated from rating agencies. When these securities are issued
in international market, the rating is obtained from international rating agencies.
Corporate Securities — Debentures & bonds : These debt instruments are issued by companies as secured
instruments by creating charge on their assets including floating charge or at times without any charge also
(called unsecured debentures).
Conventionally, in India, the debentures are issued by companies and bonds by Public Sector Undertakings. PSUs
may issue these bonds with or without govt. guarantee.
Debentures are governed by provisions of Companies Act and transferable by registration only. Bonds are
negotiable instruments. Companies issues unsecured debentures and bonds have to comply with Companies
Acceptance of Deposits Rules 1975.
Both may be issued with dilferent structures such as (a) structured obligations, with put / call option (b)
convertibility options (c) zero coupon bonds (d) floating rate bonds (e) deep discount bonds. These can be issued
with redemption options in instalments (called period bonds).
The issuer of these securities appoints a Trustee where the bonds or debentures are secured. Such trustee
functions in a fiduciary capacity to protect the interest of debenture / bond holders. The role of Trustee is
governed by SEBI guidelines.
Corporate Securities — Convertible bonds : These bonds are a mix of debt and equity. In this arrangement, the
bond holders are given an opportunity to convert the debt into equity on a pre-fixed date or during a fixed period.
The advantage of such instrument is that the company has no debt repayment obligation and gets additional
equity on conversion.
Banks can make investment in the corporate securities within the overall Capital Market Exposure ceiling
prescribed by RBI, (Direct exposure 20% of net worth of previous year of a bank and aggregate exposure 40% -
as on Mar of previous year).
Derivative Products : A derivative is a financial contract that derives its value from another financial
product/commodity (say spot rate) which is called underlying (that may be a stock, stock index, a foreign
currency, a commodity). Forward contract in foreign exchange transaction, is a simple form of a denyative.
RBI guidelines : Forward contracts were the only available derivative product available in Indian market, till
early 1990. Cross currency products were also allowed for hedging purpose, where rupee payments were not
involved. Interest rate swaps and forward rate agreements were permitted by RBI in 1998. In its April 2007, RBI
has allowed the following derivative products:
Permissible derivative instruments.At present, the following types of derivative instruments are permitted, subject
to certain conditions: Rupee interest rate derivatives -
Interest rate derivatives — Interest Rate Swap (IRS), Forward Rate Agreement (FRA), and Interest Rate
Future (IRF).
Foreign Currency derivatives — Foreign Currency Forward, Currency Swap and Currency Option. A Forward
Rate Agreement is a financial contract between two parties to exchange interest payments for a ' notional
principal' amount on settlement date, for a specified period from start date to maturity date. Accordingly, on the
settlement date, cash payments based on contract (fixed) and the settlement rate, are made by the parties to
one another. The settlement rate is the agreed bench-mark/ reference rate prevailing on the settlement date.
Interest Rate Swap (IRS) : An Interest Rate Swap is a financial contract between two parties exchanging or
swapping a stream of interest payments for a 'notional principal' amount on multiple occasions during a specified
period. Such contracts generally involve exchange of a ' fixed to floating' or floating to floating' rates of interest.
Accordingly, on each payment date - that occurs during the swap period - cash payments based on fixed/ floating
and floating rates, are made by the parties to one another.
Interest Rate Futures (IRF)

66
Interest Rate Future is a standardized, exchange-traded contract with an actual or notional interest-bearing
instrument(s) as the underlying asset.
Foreign Currency derivatives -
Foreign Exchange Forward
A foreign exchange forward is an over-the-counter contract under which a purchaser agrees to buy from the
seller, and the seller agrees to sell to the purchaser, a specified amount of a specified currency on a specified date
in the future - beyond the spot settlement date - at a known price denominated in another currency (known as
the forward price) that is specified at the time the contract is entered into.
Currency Swaps
A currency swap is an interest rate swap where the two legs to the swap are denominated in different currencies.
Additionally the parties may agree to exchange the two currencies normally at the prevailing spot exchange rate
with an agreement to reverse the exchange of currencies, at the same spot exchange rate, at a fixed date in the
future, generally at the maturity of the swap.
Currency Options
A currency option is a contract where the purchaser of the option has the right but not the obligation to either
purchase (call option) or sell (put option) and the seller (or writer) of the option agrees to sell (call option) or
purchase (put option) an agreed amount of a specified currency at a price agreed in advance and denominated in
another currency (known as the strike price) on a specified date (European option) or by an agreed date
(American option) in the future.
Interest Rate Caps and Floors
An interest rate cap is an interest rate option in which payments are made when the reference rate exceeds the
strike rate. Analogously, an interest rate floor is an interest rate option in which payments are made when the
reference rate falls below the strike rate.
TREASURY RISK MANAGEMENT : Risk Management is a critical function of the Treasury. As discussed before,
Risk Management functions are in-built in the organizational structure of the Treasury. Deal and Dealer limits,
Bifurcation of the Dealing room in to three sections are tools and methods of Risk Management. These however,
focus on the Operational or human part of the Risk Management. Dealers however take positions in derivative
markets to hedge the risks that a Treasury faces in the normal course of business. The Treasury also sells some
of these products to the customers (exporters/importers/NRIs etc) for covering their risks. Once a customer gets
in these positions, the exchange or Interest risk is passed on to the Treasury (Bank) which in turn has to hedge
the risk in the market.
FOREIGN EXCHANGE DERIVATIVES'
The primary purpose of the derivative instruments is not to borrow or lend funds but to transfer price risks
associated with fluctuation in asset values. The derivatives provide three important economic functions viz.
a) Risk Management. b) Price Discovery c) Transactional Efficiency.
TYPES OF DERIVATIVES : The commonly used derivatives are as follows:
a) Forward contracts b) Futures c) Options d) Swaps
FORWARD CONTRACTS : Authorized dealers (Banks) have been permitted Under FEMA to enter in to Forward
contracts for sale or purchase of Foreign Currency with their customers who are exposed to foreign currency risks
arising out of their normal transactions which are permitted under current regulations. The mechanism of Forward
Contract is very simple. On being approached by a customer for a forward cover, the AD would satisfy himself
that there exists a genuine exposure and quote a rate. For example, if an Importer who is required to pay an
inward bill maturing after one month may approach his banker for a forward cover. This is because the importer is
either risk averse or feels that the rupee / dollar rate would move against him in the intervening month. The bank
would then quote a forward rate. If the customer is satisfied with the quotation, he would sign the contract which
would bind him to the rate and the date. Contract documents are signed and charges if any are collected. If the
customer fails to perform his part of the contract, the contract is cancelled and Swap charges are recovered'
where necessary. Similar contracts can be entered in to different customers based on'their requirements.In other
words-subject to RBI / FEDAI guidelines, banks enter in to contracts to sell or buy specified amount of foreign
currency on specified future dates.Forward Contracts are either Forward purchase contracts or Forward Sale
contracts depending on the nature of the transaction. Exporters, NRIs, EEFC holders and so on would enter in to
Forward purchase contracts. Importers, Constituents who have to make payments under foreign currency loans
and so on would enter in to Forward sale contracts. It is again emphasized that the word purchase and Sale are
used from the point of view of the Bank and not the customer. Forward Contracts in India are governed by RBI
guidelines and FEDAI rules. RBI has permitted all entities having Exchange risk exposures permission to enter in
to Forward contracts subject to rules and limits.
FUTURE CONTRACTS:
A future contract is defined as a commitment to buy or sell at a specified future settlement date and a designated
amount of commodity or a financial asset. It is a legally binding contract by two parties to make / take delivery of
commodity at certain point of time in the future.

67
MAIN FEATURES OF FUTURES CURRENCY FUTURE CONTRACTS
FUTURES CONTRACTS MARKETS IN
1)Futures are traded on High level Only Resident Indians may
Security Exchanges. counter trading purchase or sell
2)Futures contracts Physical currency futures to hedge an
have standard contract exchange rare. exposure to foreign exchange
terms. Very high rate risk or otherwise. (In other
3)Futures exchanges degree words, NRIs and FlIs etc. cannot
are of leverage participate in Currency Futures
associated with clearing as trading).
houses. margin 1.Recognized stock
4)Futures' trading based exchanges offer currency
requires margin trading futures contracts in the currency
payments and daily takes pairs of USDINR, Euro-INR, JPY-
settlement. place. INR and GBP-INR.
5)Futures positions can Low default 2.The size of each contract should
be exited easily levels be in units of
DIFFERENCE BETWEEN FUTURES & FORWARD CONTRACTS :Futures and forwards contracts are very similar
to each other in terms of contractual obligations. However there are certain distinguishing features which are as
follows:
FUTURES FORWARD CONTRACTS
Traded on organized stock exchanges. Over the Counter products.
Issued in standard forms and, do not have Offer flexibility and are custom made.
flexibility regarding quantity or quality( of Indian banks entering in to forward contracts
commodity to be delivered) have to follow RBI guidelines.
Regulated by SEBI, RBI and other agencies.
CONCEPT OF OPTIONS
right but not the
An option is a contract conveying
obligation a certain future to buy or sell a specified financial
the instrument at a fixed price
date.
before or at
THE OPTIONS BUYER THE OPTION SELLER EXERCISE PRICE OR STRIKE PRICE
The option buyer is also Also called option Writer, he The price at which the option buyer
called as Holder/Owner. The deals in Options. The Writer will has the contractual rights to buy or
option sell an Option (whether it is a sell the
buyer pays a premium Buy option or a Sell option
and as per the currency is called the-exercise price
purchases the option counterparty's requirements) for or strike price.
which a fee called Premium. He has
confers a right to buy or sell to perform his
the currency (as the case commitment only if the
may be) at an agreed price Holder chooses to
in exchange for another exercise the
currency at a future date. option.
TYPES OF OPTIONS
CLASSIFICATION BASED ON UNDERLYING CLASSIFICATION BASED ON TIME OF
TRANSACTION EXECUTION
Call Option: The owner / buyer has the right to American option: Option holder can exercise the
purchase and the writer / seller has obligation to option any time during the option term.
the specified quantity of the sell specified European Option: Option holder can exercise
underlying at a prior to the option price the option only at the end of the Option period.
expiry date. right to sell In India,earlier only European Options
Put Option: The owner or buyer has and to buy were
the the Option writer / seller has specified price permitted. However, RBI has since
'obligation quantity of the prior to the permitted
underlying at a specified options American options also.
expiry date.
1) American Call Option: Option to buy and can be 2) American put option; Option to sell and can
exercised any time during the option term be exercised any time during the option term
3) European Call option : Option to buy and can 4/ European Put option: Option to sell and can
be exercised only at the end of the option period be exercised only at the end of'the option
period
IN-THE-MONEY OPTION AT-THE-MONEY OPTION OUT-OF-THE-MONEY OPTION

68
An in-the-money (IIM) option An at-the-money (ATM) An out of-the-money (OTM)
is an option is an option that option is
option that would lead to a positive would lead to an option that wouldlead
cash flow to the holder if it were zero cash flow if it to a
exercised were negative cash flow it was
immediately. A call option exercised immediately. exercised
on the An immediately. A call
currency(say USD) is :aid to be in- option on the currency (say option on the
the- USD) is at-the-money when currency (say USD) is said to be
money when the current the current value of out-of-the-money when the
SWAP & COVER DEALS: Swap literally means exchange of commodities. In banking, Swap in a foreign exchange
market refers to simultaneous sale and purchase of currencies.
CURRENCY SWAPS: Exchange of predetermined streams of payments in different currencies on pre-determined
dates, at pre-determined exchange rates. Here there are two simultaneous deals for the same amount as follows
One at the spot and other for future date or
Both for future dates.
In other words in Swap Deals, there are two different transaction I maturity dates for the same amount. Some
examples are as follows:
A transaction where bank buys 1 lakh USD spot (against rupees) and sells1 lakh USD one month forward.
A transaction where bank sells 1 lakh USD spot and buys 1 lakh USD one month forward.
A transaction where bank buys 1 lakh USD one month forward and sells 2 months forward.
A transaction where bank sells 1 lakh USD one month forward and buys 2 months forward.WHY SWAP DEALS?
19. Banks have to meet. obligations arising out of merchant transactions with customers such as Forward
contracts and normal Sale / Purchases where there is a time lag. They also have to manage their Foreign
Currency holdings (FCNR balances). They may go for swap operations for short-term interest arbitrage. Under
such operations, they buy one currency from a plakhe where interest is low and sell at some other market to buy
another currency where interest is high. They also cover their cross currency future maturity deals by swap
operations. The most compelling reason for entering in to Swap transaction is avoidance of exchange risk on their
open positions. The Swap deals are made for future coverings. Therefore, it is the future points or margins that
affect the swap rates.
MECHANISM OF SWAP: Every swap operation has two legs / aspects. a) Buying b) Selling
The difference between the buying rates and selling rates for the swap operation is known as swap differential.
One point that should be kept in mind that the bank undertakes a Swap Deal only on gain. On the other hand,
while covering its position by outright sale or purchase, there could be a loss. Banks cover the mismatch between
the buying and selling operation by swap deals.
INTEREST RATE SWAPS
Here an exchange of different streams of interest structures occurs. There would be no exchange of principle
amounts under interest rate swap, and only the interest streams would be exchanged. Interest rate swaps are
further classified as Coupon swaps, where, fixed interest rate are swapped with floating interest rates and Index
or Basis swaps, where floating rates based on one benchmark is exchanged with floating rates based on another
benchmark. Cross currency interest rate swap is a combination of currency swap and an interest rate swap, where
streams of currencies as also interest rate structures are swapped:
EXCHANGE TRADED INTEREST RATE DERIVATIVES: Interest rate risk the world over is managed through the
process of hedging with derivatives. Instruments like futures and options are tools through which investors can
manage volatility better and provide insurance to investors against interest rate fluctuations. Following
recommendations of Working. Group on Rupee Derivatives (Chairman Sh. Jaspal Bindra), SEBI has decided to
introduce anonymous order driven trading system for trading in IRDs on Stock Exchange, Mumbai (BSE) and
National Stock Exchange (NSE), for following products: Ten-year long bond futures, Futures on notional T-Bills
with a maturity of 91 days. Options on notional long bond and notional Treasury Bills (T-Bills).
PARTICIPANTS WHO CAN UNDERTAKE THE TRANSACTIONS: With a view to enabling regulated entities to
manage their exposure to interest rate risks, RBI has decided to allow Scheduled Commercial Banks, Primary
Dealers (PDs) and specified All India Financial Institutions (A1F1s) to deal in IRDs in a phased manner.
TYPE OF INSTRUMENTS: In this first phase, the above participants can transact only in interest rate futures on
national bonds and T-Bills for the limited purpose of hedging the risk in their underlying investment portfolio.
Allowing transactions in a wider range of products, as also market making, will be considered in the next stage
based on the experience gained.

69
MODULE – D : BALANCE SHEET MANAGEMENT
ASSET LIABILITY MANAGEMENT
What is ALM? - ALM is the management of Assets and Liabilities in the balance sheet in such a way that the
net
earning from interest is maximized and Liquidity Risk and Interest Rate risks are minimized, It is mandatory
now for banks since April 01, 1999. RBI has issued guidelines on ALM to banks.
Definition of ALM: Asset Liability Management (ALM) is the act of planning, acquiring and directing the flow of
funds through an organisations. The ultimate objective of this process is to generate adequate / stable
earnings and to steadily build an organization's equity over time, while taking reasonable and measured
business risks. Objectives of ALM: The objectives of ALM is two fold: ensuring profitability am.' ensuring
liquidity. Mismatches in
Assets / Liabilities lead to banks incurring a cost for meeting their contractual obligations. This willaffed their
profitability. ALM strives to minimize the adverse impact. Asset Liability Committee: A top management
committee to oversee implementation of ALM, to be headed by CMD or ED or CEO.
MEASURING EFFECTIVENESS OF ALM: The parameters that are impacted due to Asset Liability Mismatches
and are used as a measure of the effectiveness and efficiency of ALM in are:
a) Net Interest Income (NII) b) Net Interest Margin (NIM) c) Economic Equity Ratio
a) Net Interest Income (NII): The impact of volatility on the short-term profit is measured by Net Interest
Income.
— Interest Expenses
Net Interest Margin (NIM): Net Interest Margin is defined as net interest income divided by average total
assets.
Net Interest Margin (NIM) = Net Interest Income / Average total Assets Net Interest Margin can be viewed as
the 'Spread' on earning assets.
Economic Equity Ratio: The ratio of the shareholdersfunds to the total assets measures the shifts in the ratio
of owned funds to total funds. This fact assesses the sustenance capacity of the bank.
SIGNIFICANCE OF ASSET LIABILITY MANAGEMENT: A financial institution may have sufficient assets to
satisfy its liabilities. However, if there is a mismatch like for example if 60% of the liabilities mature within 1
year but only 5% of the assets mature within the same period, the institution may become temporarily
insolvent due to a severe liquidity crisis. Alternatively, it may have to fund itself at Market costs which will
impact the profitability (NIM). Some of the reasons for growing significance of Asset Liability Management
are:
1) Volatility 2) Product Innovation 3) Regulatory Environment
4) Management awareness of significance of ALM
ALM METHODOLOGY: Indian banks were issued guidelines from RBI for ALM in 1999. There is no change to
those guidelines. Even though RBI subsequently issued draft amendments to these guidelines once in April
2006 and again in July 2007, they remain draft guidelines only. As per RBI guidelines, banks have to adopt
the Flow Approach and construct Maturity Ladders for identifying gaps for Liquidity management and Interest
rate risk management. These guidelines are discussed in detail under the chapters devoted to the respective
Risks.
Benefits of ALM: Enables bank managements to take informed business decisions, manage their liquidity and
Interest rate structures better leading to improved profitability.

Conclusion: Asset Liability Management is the continuous process of acquiring / deploying funds in a planned
manner such that the organization is not only liquid and able to meet the demand of the investors but also
generates steady and adequate margins all the time. ALM departments are functional in all banks under the
guidance of ALCO. ALCO has powers to mix and match of assets and liabilities and can recommend winding-
up activities, which do not fit business / ALM strategy. ALM demonstrates to the market that the bank is safe
SIGNIFICANCE OF ALM FOR BANKS IN INDIA : Earlier in India, RBI administered interest rates. Pricing
products was not an important exercise. In today's deregulated environment, pricing is a critical function.
Competition amongst Banks is forcing them to quote very fine rates leading to very narrow spreads.
Liquidity is another critical area. Now, no bank .can afford to have mismatched Assets and Liabilities, which would
result in their having to borrow at market costs to satisfy their obligations leading to reduced Net interest income.
Reduction in Net interest income will affect the Net interest margin.ALM is therefore is essential for the
management of the Net Interest Margin (NIM), and is implemented through managing the Assets and Liability
portfolios of the bank.The primary goal therefore is the control of net interest margins on an on-going basis
through ALM.
70
CURRENCY RISK MANAGEMENT
Managing Currency Risk is one more dimension of Asset- Liability Management.
Mismatched currency position besides exposing the balance sheet to movements in exchange rate also exposes it
to country risk and settlement risk. The simplest way is to avoid mismatches. Banks have been given the
discretion to set up overnight limits linked to maintenance of Capital to Risk-Weighted Assets Ratio (CRAR) of 8%
(9% in India) of open position limit. Presently, the banks are also free to set gap limits with RBI's approval but
are required to adopt Value at Risk (VaR) approach to measure the risk associated with forward exposures. Thus,
the open position limits together with the gap limits form the risk management approach to Forex operations.
Scope of ALM functions can be defined as: Liquidity Risk Management, Management of Market Risk, Funding in
Capital Planning,Trading Risk Management
RBI - GUIDELINES ON ALM

RBI has given broad guidelines in respect of interest rate and liquidity risks
management which form part of the Asset-Liability Management (ALM) function.
The ALM process must systems in banks, rest
on three pillars:
I-Pillar: ALM Information Systems II Pillar: ALM Organization III Pillar: ALM Process
Management Information Systems Structure and responsibilities. Risk parameters
Informationavailability, accuracy, Level of top management involvement. Risk identification
adequacy and expediency ALM has Asset Liability Committee (ALCO): A Risk measurement
to be supported by clearly top Risk management
specifying the management committee to oversee Risk policies &
risk policies and tolerance implementation of ALM, to be headed by tolerance levels.
limits. CMD or
Information is the key to ED or CEO only ALCO is responsible for
the ALM balance sheet planning from risk-
process. Hence, over a period of rettirn
time and avith the help of perspective, strategic management of
computers, banks should put in interest
place an adequate MIS system. rate and liquidity risks.
ALM departments are functional in all banks
The guidelines given in this RBI note mainly address Liquidity and Interest Rate risks which are
COMPONENTS OF A BANK'S BALANCE SHEET

To study assets and Liability Management in banks, it is essential to understand the balance sheet of the bank
first. Like the balance sheet of• any firm, the bank's balance sheet also comprises of sources and uses of funds.
SOURCES = Liabilities + Net worth USES = Assets (Loans + Investments + Other Assets)
LIABILITIES ASSETS
Capital Cash & Balances with RBI.
Reserves & Surplus: Statutory reserves, Capital Balances with Banks, Money lent at Call & Short
reserves, Notice.
Share premium,
Deposits: revenue
Demand, time, & other
call, reserves,
notice balance
deposits etc) in P & L a/c. Investments: Government Securities,
shares /
Borrowings: Refinance and Borrowings from RBI & Exim bank Advances (Loans, Cash Credit, Bills purchased /
and other such bodies. discounted etc.)
Other Liabilities & Provisions: Bills payable, DD / TT / BC, Inter- Fixed Assets: Immoveable property, Furniture,
branch adjustments, Interest accrued, IT provisions, Interest Fixture.
tax, TDS etc.
Contingent liabilities: LC, LG, Claims against the bank not Other Assets: Inter-office adjustments, Tax paid in
acknowledged etc. Advance, Stationery, Stamps, Non-banking assets.
BANK'S PROFIT AND LOSS ACCOUNT
A Bank's profit and loss account has following components:
Income: Interest income + Other income, and
Expenses: Interest expended + Operating expenses + Provisions + Contingencies.
INCOME EXPENSES
INTEREST INCOME —
• Income on investments. Interest on deposits.
• Commission, exchange and ,Interest on RBI / Inter-bank
brokerage. borrowings.
• Interest / discount on advances / . OPERATING EXPENSES
• bills.
Income on Investments. Payments to and provisions for
• employees.
Interest on balances with RBI and Rent, Taxes, Printing and
• Interbank funds.
Miscellaneous income. stationery. on bank's property.
Depreciation
OTHER INCOME Auditors' fees and expenses.
• Commission, Exchange & Postage, Insurance, Rent, taxes and
Brokerage. lighting.
71
• Profit on sale of Investments, Advertisement and publicity.
• exchange transaction.
Income earned by way of Director's fees allowance and
dividends.
• Profit on revaluation of expenses.
Law Charges.
• Investments.
Income earned from subsidiaries Repairs and Maintenance.
etc.
Misc. Income Other expenditure.
BANKING REGULATION & THE BASEL —II & III

„Bankers have traditionally been managing the various risks in their business through collateralizing their
exposures in various ways (property / financial security / third party guarantee/insurances and so on).
The inadequacy of existing measures was felt after a notorious incident named as "Herstatt incident". The
"Herstatt" incident led Central Bankers from major countries to formulating and ensuring minimum standards for
participants in International financial markets.
HERSTATT INCIDENT: In 1974, an incident took place which shook the complacent bankers in to action which
finally led to international best practices in risk identification and management. Bank has Herstatt was a small
bank in Cologne, Germany active in the foreign exchange market. On 26th •June 1974, Herstatt Bank was
suddenly closed at the end of the business day in Germany by its banking supervisor. This was at 10.30 a.m. at
New York time.Prior to the announcement of closure, several counterparties had entered in to contracts with
Herstatt and given it Deutsche (German) marks in exchange for US dollars to be delivered to the debit of its
account with a Correspondent bank in New York.Once the news of the closure was out, Herstatt's New York
correspondent stopped all out going dollar payments from its account.
CONSEQUENCES OF HERSTATT INCIDENT
The action of the Central bank in Germany left all the counterparties exposed to "Settlement" and "Liquidity" risks
up to the amount of deliveries made by them.
Other parties to lose were Banks that had deposits with Herstatt and those who had entered in to Forward
contracts with the collapsed bank. This incident highlighted the Settlement Risk and Systemic Risk.
Systemic risk refers to the failure of one big bank, leading to failure of large number of smaller banks, eroding the
confidence of people in the banking system.. It creates a 'ripple effect' threatening the stability of financial
system.
G-10 COUNTRIES RESPONDED TO HERSTATT INCIDENT BY FORMING BASEL COMMITTEE:
In response to the Herstatt incident, Group Ten (G10) central banks began working towards common supervisory
issues including the issue of the "Foreign exchange settlement risk" (also called Herstatt risk). A committee
named as "The Basel Committee" was established in 1974.
The Basel Committee as well as its four main working groups meet regularly four times a year.
With its current expanded membership, the Committee is now comprised of representatives from 27 countries
including India. THE BASEL COMMITTEE ON BANKING SUPERVISION (BCBS)
The Basel Committee (BCBS) does not possess any formal supranational supervisory authority, and its
conclusions do not, have legal force. However, it reports to the Central bank Governors or Heads of Supervisory
authorities of G-10 countries and seeks their endorsement for its major initiatives.
BCBS formulates broad supervisory standards / guidelines and recommends best practice in the expectation that
individual national authorities will take steps to implement them.
Each national supervisor is expected to make arrangements that are best suited to its own national systems
leading to convergence towards common approaches and common standards
An important objective of the Committee's work is to close gaps in international supervisory coverage in pursuit of
two basic principles: that no foreign banking establishment should escape supervision; and that supervision
should be adequate. To achieve this, the Committee has issued a long series of documents since 1975.
BASEL CAPITAL ACCORDS: Two important Basel accords called as Basel-I and Basel-II accords have emerged
over the past two decades.
BASEL-1 ACCORD: 1988- The Basel Committee introduced a capital measurement system commonly referred to
as the Basel Capital Accord. The 1988 system provided for the implementation of a Credit risk measurement
framework with a minimum capital standard of 8% by end-1992.
1998- Basel-I accord was modified to include the issues related to Market Risk.Thus the Basel-I accord addressed
two major risks faced by banks- the Credit risk and the Market risk.
BASEL-II ACCORD & THE THREE PILLARS :
In 2004, BCBS issued another comprehensive framework that seeks to arrive at significantly more risk sensitive
approaches to capital requirements .Essentially it identified "operational Risk" as a source of threat and included
this risk for calculating the "risk weighted assets" for which a minimum capital is prescribed.Thus, the Basel-II
accord captured three, of the five major risks in banking which are the Credit, Market and operational risks henew
Capital Framework consisted of Three Pillars:
Pillar -01: Minimum capital requirements Pillar-02: Supervisory review process
Pillar-03: Market discipline
OBJECTIVES OF BASEL ACCORDS: Basel II objectives, which are central to sustained economic development in
long run include:Promotion of safety and soundness in the financial system by stronger risk management
practices in banks.Designing approaches for credit and operational risk that are based on increasing risk
sensitivity and allow banks to select an approach that is most appropriate to the stage of development of bank's
operation.The ultimate objective of Basel accords is to encourage the International players in the financial sector
(namely Banks) to converge towards a minimum standard both in Capital adequacy and processes ,such that
there is adequate confidence built up This is especially applicable to cross border transactions (international
transactions)

72
PROCESS OF ARRIVING AT CRAR
CAR: Capital adequacy is the ratio of capital funds available in the Bank to the assets (Loans plus investments)
acquired and reflected in the Balance sheets.
CRAR: Capital to Risk weighted assets is the ratio of Capital funds available to the Risk weighted assets (loans
and investments) acquired by the Bank and reflected in the Balance sheet.
Risk Weights: Risk weights are the perceptions of risk inherent in any types of claims the Banks have on
counterparties (in their loans and investments). For example, a loan given against security of commercial real
estate is riskier than a small loan given against gold jewelry. Both these assets need not attract the same amount
of mandatory capital. At the same time, Basel-II takes in to account not only the Credit Risk but also Market and
Operational risks. Detailed guidelines are given by RBI as to how the assets should be risk weighted taking all the
three risks in to consideration
THREE TIERED CAPITAL FUNDS: A minimum standard for Capital adequacy is the most important objective of the
Basel accords. Here, the concern is about the quality of the capital also. The Basel Capital Accord 1988 classifies
capital under three tiers. Tier I Capital &Tier II Capital are as follows:
TIER I CAPITAL TIER II CAPITAL . TIER III CAPITAL (not

allowed by RBI in India)
• Permanent • Undisclosed Reserves. As per BCBS each national

Equity. • Revaluation Reserves (Example-RBI in
• Perpetual Non- • General provisions / general discretion may employ a
Preference shares. • Hybrid Debt Capital capital (Tier -III),
• Disclosed Reserves with mix of equity term debt for the sole
• Innovative Capital characteristics ), and purpose of meeting a
• Subordinated Term Debt. the capital requirements
for market risks.
CAPITAL ADEQUACY RATIO / CAR/CRAR

The objective is to strengthen the capital base of banks with reference to their risk weighted assets, expressed
as a ratio as under. Capital Fund / Risk Weighted Assets x 100
Minimum CAR as per Basel II 08 %
recommendations
Minimum CAR in India as per RBI
09%
guidelines
Out of this 6% should be Tier I by 31.3.2010, if already not so. Tier II cannot be more than 50% of the total
capital as per Basel I.
Tier I Tier II
paid-up capital
statutory reserves
other disclosed free reserves Un-disclosed reserves and cumulative
capital reserves representing surplus arising perpetual
out of preference shares:
sale proceeds of assets. Revaluation Reserves (at a discount of 55
Investment Fluctuation Reserve. percent While determining their value for
Innovative Perpetual Debt Instruments inclusion in Tier II
Perpetual Non-Cumulative Preference capital)
shares. General Provisions and Loss Reserves upto a
(PNCPS) maximum of 1.25% of weighted risk assets:
Both not to be more than 40% of Tier I (IPDI Hybrid debt capital Instruments (say bonds):
alone Subordinated debt (long term unsecured
max 15%). There is no maturity period. loans:
There is call Debt capital instruments min maturity 15
option after 10 years. years
Minus Redeemable cumulative preference shares.
equity investments in subsidiaries, Redeemable non-cumulative preference
intangible assets, and shares.
losses in the current period and those Perpetual cumulative preference shares.
brought
forward from previous periods
Risk weighted assets — Fund Based

Risk weighted assets mean fund based assets such as cash, loans, investments and other assets. Degrees of
credit risk expressed as percentage weights have been assigned by RBI to each such assets.
Risk Weights for Important Assets

Cash, balance with RBI, 0%
Balances with other banks with CRAR of 9% & above 20%
Secured loans to Staff Members 20%
Other loans to staff members 75%
Housing Loan if LTV.ratio more than 75% 100%
Housing loan if LTV Ratio is up to 75%
Loan up to Rs.30 lac to individual secured by Mortgage 50%
Loan more than Rs.30 lac to individual secured by Mortgage 75%
73
All Housing Loan of Rs 75 lakh and above 125%
Forex and gold open position 100%

Exposure to Central/State Govt 0%
Central Govt guaranteed advance 0%
State Govt guaranteed advances 20%
Loans to PStis (not guaranteed by Govt) 100%
Claims on unrated corporates 100%
Exposure to DICGC/CGFT. 0%
Exposure to ECGC 20%
Loans against FOR, LIC policy, NSCs with margin 0%
Education loan (under Basel I — 100%) But under Basel-II 75%
Loans against gold/silver jewellery up to Rs.1 lac 50%
Consumer credit / credit cards/Personal Loan 125%
Exposure to capital market 125%
Commercial real estate . 100%
Commercial Real Estate — Residential Housing (CRE-RH) 75%
Venture Capital invstmt as part of Capital market exposure 150%
Loans to non-deposit taking NBFCs for on-lending 100%
Retail Loan & Loan to SME (Retail Loan means limits up to Rs 5 crore and sale in 75%
FY less than Rs 50 crore)
NPA if specific provision is less than 20% 150 %
If specific provision is 20% and above but less than 50% 100%
If specific provision is 50% and above• 150%
Bills purchased under LC issued by another bank 20%
BASEL II: Three Pillars

1st Pillar: Minimum Capital Standard (to be complied with by bank)
2nd Pillar: Supervisory Review (to be carried by RBI based on ICAAP &SREP)
3rd Pillar: Market Discipline.
Approaches for risk calculation

Standard Approach*, Internal rating Based approach (comprise
Credit Risk
foundation approach & advance approach)
Market Risk Standard Approach* (comprising maturity method & duration
method), Internal risk based approach
Operational Basic Indicator Approach*, Standard Approach, Advance
Risk Measurement Approach
*Immediate implementation. Other approaches to be implemented later on.
Introduction of Advanced Approaches of Basel II Framework in India — Time Schedule

As part of Basel II, Banks have migrated to the Standardised Approach for credit risk, Basic indicator Approach for
operational risk and the Standardised Duration Approach for market risk. RBI has now laid down a timeframe for
implementation of the advanced approaches in India as given below.
S. Approach Earliest' date of Likely date of
No. making approval by the
application to the RBI RBI
Internal Models Approach (IMA) for Market April 1, 2010 March 31,
Risk 2011
The Standardised Approach (TSA) for April 1, 2010 September 30,
Operational 2010
Risk
Advanced Measurement Approach (AMA) April 1, 2012 March 31,
for Operational Risk 2014
'Internal Ratings-Based (IRB) Approaches April 1, 2012 March 31,

for Credit Risk Foundation- as well as 2014
Advanced IRB)
BASEL III
The Basel Committee on Banking Supervision (BCBS) has issued comprehensive reform packages entitled "Basel
III: A global regulatory framework for more resilient banks and banking systems" and "Basel III: International
framework for liquidity risk measurement, standard and monitoring" in December 2010. A summary of Basel III
capital requirements is given below:
Improving the Quality, Consistency and Transparency of the Capital Base: Presently, a bank's capital comprises
Tier 1 and Tier 2 capital with a restriction that Tier 2 capital cannot be more than 100% of Tier 1 capital. Within
Tier 1 capital, innovative instruments are limited to 15% of Tier 1 capital. Further, Perpetual Non-Cumulative
Preference Shares along with Innovative Ter 1 instruments should not exceed 40% of total Tier 1. capital at any
point of lime. Within Tier 2 capital, subordinated debt is limited to a maximum of 50% of Tier 1 capital. However,
under Basel III, with a view to improving the quality of capital, the Tier 1 capital will predominantly consist of
Common Equity. At present, the regulatory adjustments (i.e. deductions and prudential filters) to capital vary
across jurisdictions. These adjustments are currently generally applied to total Tier 1 capital or to a combination
of Tier 1 and Tier 2 capital. They are not generally applied to the Common Equity component of Ter 1 capital.

74
Most of the adjustments under Basel III will be made from Common Equity. The important modifications include
the following:
(I) deduction from capital in respect of shortfall in provisions to expected losses under Internal Ratings Based
(IRB) approach for computing capital for credit risk should be made from Common Equity component of Tier 1
capital;
cumulative unrealized gains or losses due to change in own credit risk on fair valued financial liabilities, if
recognized, should be filtered out from Common Equity;
shortfall in defined benefit pension fund should be deducted from Common Equity;
certain regulatory adjustments which are currently required to be deducted 50% from Tier 1 and 50% from Tier 2
capital, instead will receive 1250% risk weight; and
limited recognition will be granted in regard to minority interest in banking subsidiaries and investments in capital
of certain other financial entities.
The transparency. of capital base will be improved, with all elements of capital required to be disclosed along with
a detailed reconciliation to the published accounts.
Enhancing Risk Coverage: At present, the counterparty credit risk in the trading book covers only the risk of
default of the counterparty. The reform package includes an additional capital charge for Credit Value Adjustment
(CVA) risk which captures risk of mark-to-market losses due to deterioration in the credit worthiness of a
counterparty. The risk of interconnectedness among larger financial firms (defined as having total assets greater
than or equal to $100 billion) will be better captured through a prescription of 25% adjustment to the asset value
correlation (AVC) under IRB approaches to credit risk. In addition, the guidelines on counterparty credit risk
management with regard to collateral, margin period of risk and central counterparties and counterparty credit
risk management requirements have been strengthened.
Enhancing the Total Capital Requirement and Phase-in Period: The minimum Common Equity, Tier 1 and Total
Capital requirement will be phased in between Jan 1, 2013 and Jan 1, 2015 as indicated below:
April 1, Jan 1, Jan 1,
2013 2014 2015
Min Common Equity 3.50% 4.00% 4.50%
Min Tier I 4.50% 5.50% 6.00%
Min Total Capital 8.00% 8.00% 8.00%
Capital Conservation Buffer: The capital conservation buffer (CCB) is designed to ensure that banks build up
capital buffers during normal times (i.e. outside periods of stress) which can be drawn down as fosses are
incurred during a stressed period. The requirement is based on simple capital conservation rules designed to
avoid breaches of minimum capital requirements. Therefore; in addition to the minimum total of 8% as indicated
above, banks will be required to hold a capital conservation buffer of 2.5% of RWAs in the form of Common
Equity to withstand future periods of stress bringing the total Common Equity requirement of 7% of RWAs and
total capital to RWAs to 10.5%. The capital conservation buffer in the form of Common Equity will be phased-in
over a period of four years in a uniform manner of 0.625% per year, commencing from January 1, 2016.
Countercyclical Capital Buffer: further, a counter cyclical buffer within a range of 0 - 2.5% of Common Equity or
other fully loss absorbing capital will be implemented according to national circumstances. The purpose of counter
cyclical capital buffer is to achieve the broader macro-prudential goal of protecting the banking sector from
periods of excess aggregate credit growth. For any given country, this buffer will only be in effect when there is
excess credit growth that results in a system-wide build up of risk. The countercyclical capital buffer, when in
effect, would be introduced as an extension of the capital conservation buffer range.
Supplementing the Risk-based Capital Requirement with a Leverage Ratio: One of the underlying features of the
crisis was the build-up of excessive on and off-balance sheet leverage in the banking system. Subsequently, the
banking sector was forced to reduce its leverage in a manner that not only amplified downward pressure on asset
prices, but also exacerbated the positive feedback loop between losses, declines in bank capital and contraction in
credit availability. Therefore, under Basel III, a simple, transparent, non-risk based regulatory leverage ratio has
been introduced. Thus, the capital requirements will be supplemented by a non-risk based leverage ratio which is
proposed to be calibrated with a Tier 1 leverage ratio of 3% (the Basel Committee will further explore
to track a leverage ratio using total capital and tangible common equity). G-99-A The ratio will be captured with
all assets and off balance'sheet (OBS) items at their credit conversion factors and derivatives with Basel II netting
rules and a simple measure of potential future exposure (using Current Exposure Method under Basel II
framework).
Guidelines on Implementation of Basel III Capital Regulations in India: RBI has rescheduled the start date of
implementation of Basel HI capital regulations to April 1, 2013 from January 1, 2013. In view of the shift in the
start date of Basel III implementation, all instructions applicable as on January 1, 2013, except those relating to
Credit Valuation Adjustment (CVA) risk capital charge for OTC derivatives, would become effective from April 1,
2013 with banks disclosing Basel III capital ratios from the quarter ending June 30, 2013. As the introduction of
mandatory forex forward guaranteed settlement through a central counterparty has been deferred pending
resolution of certain issues such as exposure norms, etc., the CVA risk capital charges would become effective as
on January 1, 2014. The other transitional arrangements would remain unchanged and Basel III will be fully
implemented as on March 31, 2018.
BANKING SUPERVISION & CAMLES RATING CRITERIA
Banking supervision is carried by RBI on on-site basis (as per Sec 35 of B R Act) and off-site supervision (through
DSB returns). Based on that, rating of bank is carried by RBI an CAMELS criteria The rating arameters for Indian
Banks and Foreign Banks are given below:
Indian Foreign Banks
C Capital adequacy ratio C Capital adequacy
A Asset quality A Asset quality
M Management Effectiveness C Compliance
75
E Earning (Le. profitability) S System and
L Liquidity (asset-liability
S System and controls
STRUCTURE OF CAPITAL FUND
Banks are required to maintain a minimum CRAR of 9 % on an ongoing basis. As per RBI's
final guidelines on Basel —II, Banks have to maintain the higher of the following two as
their minimum capital
Minimum Regulatory Capital prescribed - 9%(presently), or
A floor percentage of the capital required for Credit Risk plus Market risk which will be
progressively reduced. Out of minimum capital of 9% prescribed, Banks are encouraged to
maintain Tier-1 of at least 6%
TIER I
Paid-up capital (ordinary shares), Statutory reserves, and other Disclosed free reserves, if
any.
Innovative Perpetual Debt Instruments (IPDI) eligible for inclusion as Tier I capital (up to
15% of Tier-1).
Perpetual non-cumulative Preference shares eligible for inclusion as Tier I capital - subject
to laws in force from time to time; (PNCPS together with Innovative PDI can not exceed
40% of Tier-1.Excess if any can be taken under Tier-2)
Capital reserves representing surplus arising out of sale proceeds of assets. Minus: Equity
Investment in Subsidiaries & Intangible assets.
BASEL - II STANDARDS
The Basel committee had bestowed discretion to each Country's supervisor to make detailed arrangements and
give a time frame within which the Banks in that country should migrate to the new Basel-II standards.
The Committee has prescribed the "minimum" standard of 8% capital adequacy under the first pillar and left it to
each country to prescribe more stringent norms where felt necessary.
RBI has prescribed 9% as required minimum CRAR under Basel pillar -01.
RBI issued Prudential Guidelines on Capital Adequacy and Market Discipline -Implementation of the New Capital
Adequacy Framework (NCAF) which gave detailed guidelines and directed as follows
TIME FRAME TO COMMERCIAL BANKS IN INDIA TO MIGRATE TO NCAF
Foreign banks operating in India and Indian banks having operational presence outside India were directed to
migrate to NCAF with effect from March 31, 2008.
All other commercial banks (except Local Area Banks & Regional Rural Banks) were encouraged to migrate to
the Revised Framework not later than March 31, 2009.Thus all eligible banks in India are now Basel-II compliant
BASEL - II : THIRD PILLAR - MARKET DISCIPLINE
The III Pillar, Market Disciple has been recommended to complement the minimum capital requirements under
Pillar 1 and the supervisory Review Process under Pillar II.
BCBS has developed a set of disclosure requirements which will allow market participants to assess key pieces of
information on the scope of application, capital, risk exposures, risk assessment processes and hence the capital
adequacy of the institution.
The Committee believes that such disclosures have particular relevance under the New Accord, where reliance on
internal methodologies gives banks more discretion in assessing capital requirements.
DISCLOSURES SET OUT IN PILLAR 3
The disclosures set out in Pillar 3 should be made on a semi-annual basis, subject to some exceptions.
Qualitative disclosures that provide a general summary of a bank's risk management objectives and policies,
reporting system and definitions may be published on an annual basis. These disclosures will facilitate market
participants to access key information. Market discipline can contribute to a safe and sound banking environment.
If information on risk exposure or other items is prone to rapid change, then banks should also disclose
information on a quarterly basis. Tier I, total capital adequacy ratios, and their components must be disclosed on
a quarterly basis.A bank may not disclose proprietary and confidential information such as customer information,
methodologies, parameters etc. But it must state the information it has not disclosed and also state reasons for
the non-disclosure. However, it must disclose more general information about the subject matter. Efforts to see
that Pillar 3 disclosure framework does not conflict with the requirements under accounting standards are made
Material provided under Pillar 3 framework must be consistent with the audited statements & disclosures. Banks
are encouraged to provide all information at one place.
Banks should have a formal disclosure policy approved by the Board of directors. The policy should state the
bank's approach to determining what disclosures it will make and the internal controls over the disclosure
process. Pillar 3 prescribes qualitative and quantitative disclosure sunder the following 13 areas:
AREAS OF DISCLOSURE : Scope of application
Capital structure, Capital adequacy
Credit risk — general disclosures
Credit Risk — disclosures for portfolios, under standardized approach.
Credit Risk — disclosures for portfolios, under IRB approaches.
Credit Risk mitigation — Disclosures for standardized & IRB approach
Securitization — disclosures for standardized & IRB approaches.
Market Risk — disclosures under standardized approach. (111) Market Risk — disclosures under internal models
approach. (1) Operational Risk

76
(1 ) Equities — disclosures for banking book positions. (1 ) Interest Rate Risk in the Banking book.
ASSET CLASSIFICATION & PROVISIONING NORMS

NPA GUIDELINES
TERM LOANS: Interest and / or installment remain overdue for a period of more than 90 days.
CC / OVERDRAFT: Account remains 'out of order' for a period of more than 90 days.
BILLS ACCOUNT: BP or BD remains overdue / unpaid for a period of more than 90 days.
AGRICULTURE: Short Duration Crop (Crop season up to one year): If the installment or interest overdue for two
crop seasons. Long Duration Crop (Crop season longer than one year): if the instalment or interest overdue for
one crop seasons.
NPA ON ACCOUNT OF EROSION IN THE VALUE OF SECURITY:
IS If RVS is less than 50%, the a/c to be shifted directly to Doubtful category. 111 If RVS is less than 10 % of the
0/S, the a/c to classified as loss asset.
ASSETS CLASSIFICATION
GROUP DEFINITION
STANDARD Accounts which are in order
SUB Accounts which have been classified as NPAs not exceeding 12
STANDARD for a period
DOUBTFUL Sub standard accounts, which have a period exceeding months
remained NPAs for
LOSS Accounts which have become unrealizable, where losses have been identified by the
ASSETS
bank / internal / external auditor / RBI Inspectors.
SMA Special mentioned assets: RBI has instructed banks to identify a/cs which are overdue/out
of order but not NPA & maintain a special watch.
CATEGORY PROVISION REQUIREMENTS -

STANDARD Direct Agril & SME All other loans & Commercial'Real Teaser Rate — Housing
ASSETS sectors Advances Estate Loan
0.25% . 0.40% 1% 2%
SUB- Secured Sub-standard Unsecured Sub-standard : Where the value of security is not more
STANDARD than 10% right from the beginning i.e. ab-initio
ASSETS
15% of outstanding 25% of outstanding dues
dues
DOUBTFUL DI D2 D3
ASSETS First 12 months Next 24 months Over 36 months
RVS Shortfall in RVS Shortfall in Security 100% Uniformly
Security
25% 100% 40% 100%
LOSS The entire assets should be written off. If permitted to remain in the books for any reason,
ASSETS 100% of the outstanding should be provided for.
Standard Assets provisions are covered under Tier II capital under the head Other liabilities & provisions
(Schedule 5)
As per the Income recognition norms, interest is recognized on realization / cash system basis.
State Govt. guaranteed advances — 90 days norms w.e.f. -31-3-2006 Central Govt. guaranteed advances when
govt. repudiates its guarantee. Accounts with Stock Statement overdue for 3 months : Out of Order
Accounts in which Renewal / reviewed overdue for 6 months :NPA Classification of accounts is borrower-wise and
not account-wise. In case of consortium advances, each bank to classify the account on the basis of its own
record of recovery. Accounts which have rescheduled / restructured should be upgraded after 12 months from the
due date of first installment.-The provisioning on Teaser Rate Housing Loan to be reduced to .40% after one year
from the date nn which the rates are reset at higher rates if the account remains standards.
LIQUIDITY MANAGEMENT
MEASURING AND MANAGING LIQUIDITY RISK :Developing a structure for managing liquidity risk.
Setting tolerance level and limit for liquidity risk. Measuring and managing liquidity risk. Sound liquidity risk
management involves:
A) DEVELOPING A STRUCTURE
Sold strategy overseen by the Board / Senior management effectively. Sound processes for measuring,
monitoring and controlling liquidity risk. Specific Policies on various aspects such as: Composition of assets and
liabilities, Approach to managing liquidity in different currencies/locations.
Maintaining cumulative gaps_
The Board should monitor the performance and review the liquidity risk profile of the bank periodically.
Treatment of Foreign Currencies:
77
In case of banks with an international presence, treatment of assets and liabilities in multiple currencies adds
complexity to liquidity management. The bank may not be well known to the account holders in those foreign
(currency) markets. The account holders may not be able to distinguish rumors from facts about the banks. This
means, jf market develops any concerns especially about 04e-bank's domestic operating environment (like a
rumor about political instability in India), they may panic and withdrawal of their funds causing heavy outflows all
of a sudden. The bank may not always be able to mobilize liquidity (domestically} to meet foreign currency
funding requirements. Therefore any bank conducting buOness in multiple currencies should have clear guidelines
as to Management structures and design clear strategy in each currency.
B) SETTING TOLERANCE LEVEL AND LIMIT FOR LIQUIDITY RISK: Bank management should set limits on the
mismatch to ensure liquidity.
C) MEASURING AND MANAGING LIQUIDITY RISK:
Measuring & managing funding requirement can be done through two approaches as follows:
STOCK APPROACH & FLOW APPROACH
(Note: In India, Banks have to follow the Flow approach as per RBI guidelines)
FLOW APPROACH OR THE GAP METHOD OF MEASURING MANAGING LIQUIDITY
This is the method to be followed by Indian banks as per RBI guidelines. The framework for assessing and
managing Bank liquidity through flow-approach has three major dimensions: Measuring and managing net
funding requirements. Managing Market access, and Contingency planning.
Flow approach is the basic approach being followed by Indian banks as per RBI guidelines. A maturity ladder is
constructed and all the assets and liabilities are placed in the respective time bucket's based on their residual
maturity. This gives a clear picture of the Inflows and outflows. Thereafter a structural liquidity gap report is
prepared and the net funding requirement is calculated.
RBI GUIDELINES ON CONSTRUCTION OF STRUCTURAL MATURITY LADDER
The Statement of Structural Liquidity has to be prepared by placing all cash inflows and outflows in the maturity
ladder according to the expected timing of cash flows. It has to be prepared over a time horizon of 90 days. •
Though prepared daily, it should be submitted to RBI on fortnightly basis on the first and third Wednesday of each
month.
The mismatches (negative gap) during the first four buckets should not exceed 5%,10%.15% & 20% of the cash
outflows in each time bucket respectively (see table).
A maturing liability will be a cash outflow while a maturing asset will be a cash inflow. The rupee inflows and
outflows on account of Forex operations should be taken in to account.
In order to enable the banks to monitor their short-term liquidity on a dynamic basis over a time horizon
spanning from 1 to 90 days, banks are permitted to estimate their short-term liquidity profiles based on business
projections for planning purpose.
MATURITY PROFILE – TIME BUCKETS FOR LIQUIDITY (RBI GUIDELINES)
A. OUTFLOWS •
HEADS OF ACCOUNTS —
Capital, Reserves & Surplus Over 5 years bucket.
Demand Deposits (Current Savings and Current Deposits to be classified into volatile and core portions.
and Savings Bank Deposits). 10% of SB and 15% of Current deposits may be treated as volatile and
the Bank's judgment of the behavior of its SB portfolio). The core portion
may
Banksbecan
placed
also in over 1-
classify 3 years
them bucket.
in the appropriate buckets based on behavioral
maturity instead of contractual maturity, subject to the approval of the Board
Term Deposits. / ALCO.
Respective maturity buckets or buckets based on Contractual or behavioral
maturity. However, wholesale deposits should be shown under respective
4.Certificate of Deposits, Bonds, maturity buckets only.
Subordinated Debts. Respective maturity buckets. Where call/put options are built into the issue
structure of any instrument/s, the call/put date/s should be reckoned as the
5. Other Liabilities & Provisions
Bills Payable The core component, which could reasonably be estimated based on past
data and behavioral pattern, may be shown under over 1-3 years time
bucket. The
Inter-office Adjustment The net credit balance may be shown in 1-14 days bucket.
Provisions other than for loan Respective buckets depending on the purpose.
loss & depreciation in -
investments.
Other Liabilities. ,
Respective maturity buckets. Itemsnot representing cash payables (i.e.
income received in advance, etc.) maybeplaced in over 5 years bucket.
6. Export Refinance Respective maturity buckets of underlying assets.
B. INFLOWS
1. Cash 1-14 days bucket.
2. Balances with RBI Excess balance over required CRR/SLR under 1-14 days bucket. Statutory
Balances to be distributed corresponding to the maturity profile of DTL with a
3. Balances with other Banks time-lag of 14 days.
Current Account Non-withdraw able (minimum) balances over 1-3 years bucket. Remaining
balances under 1-14 days bucket.
Money at Call and Short Respective maturity buckets.
Notice, Term Deposits & other
placements.
78
4. Investments (Net of
provisions)
(i) Approved securities. Respective maturity buckets excluding the amount required to be reinvested
to maintain SLR corresponding to the DTL profile in various time buckets.
(ii) Corporate debentures / (ii) Respective maturity buckets. Investments classified as NPAs should be
bonds, PSU bonds, CDs, CPs, shown under over 3-5 years bucket (Sub-standard) or over 5 years bucket
Redeemable Preference shares, (Doubtful).
(iii) Shares/Units of (iii) Over 5 years bucket.
Mutual
(iv) Investments in (iv) Over 5 years bucket.
Subsidiaries/Joint Ventures.
(v) Securities in the (v) 1-14 days, 15-28 days and 29-90 days according to defeasance periods.
Trading
Book
5. Advances (Performing)
(i) Bills Purchased and (i) Respective maturity buckets.
Discounted (including bills
under DUPN)
(ii) Cash Credit / Behavioral/ seasonal pattern of the core and volatile portion should be
Overdraft identified. While the volatile portion could be shown in the near-term
(including TOD) / Demand Loan maturity
component of Working Capital. buckets, the core portion may be shown under over 1-3 years bucket.
Term Loans (iii) Interim cash flows may be shown under respective maturity buckets.
6. NPAs (Net of provisions, interest suspense and claims received from ECGC/DICGC )
(i) Sub-standard (i) Over 3-5 years bucket.
(ii) Doubtful and Loss (ii) Over 5 years bucket.
7. Fixed Assets Over 5 years bucket
8. Other Assets
(i) Inter-office Adjustment Net debit balance in 1-14 day. Intangible assets and assets not representing
cash receivables in over 5 yr bucket.
(ii) Leased Assets Interim cash flows may be shown under respective maturity buckets.
C. Contingent Liabilities / Lines of Credit committed / available and other Inflows I Outflows.
1.(i) Lines of Credit to/ from 1-14 days bucket.
Institutions
(ii) Unavailed portion of Cash Based on behavioral/ seasonal pattern of potential availments in relevant
Credit/ OD / Demand maturity buckets up to 12 months.
loan
component
Export of W/C limits
Refinance (iii) 1-14 days bucket.
Unavaiied (inflows)
Letters of Credit / Historical trend analysis to be conducted on devolvement and the amounts
Guarantees (outflow) arrived at distributed in various time buckets. The assets created out of
devolvement may be shown under respective maturity buckets based on
Repo / Bills Rediscounted / probable
Respectiverecovery dates.
maturity buckets.
Swaps INR / USD, maturing
Forex forward contracts
etc. (outflow / inflow)
Interest payable / receivable Respective maturity buckets.

(outflow / inflow) —
Accrued
interest
OTHER RBIwhich are appearing in
GUIDELINES
Liability on a/c short fall in CRR balance on reporting Fridays, wage settlement, capital expenditure, etc. and
any other contingency may be shown under respective maturity buckets.
All overdue liabilities may be placed in the 1-14 days bucket.
o Interest / installments from overdue advances/ investments, overdue for less than one month to be placed
in over 3-6 months, bucket.
Interest and installments due (before classification as NPAs) in over 6-12 months bucket without the grace
period of one month if the earlier receivables remain uncollected.
MATURITY' LADDER : AN EXAMPLE
Maturity Ladder based on Contractual Maturities
DAY — I Amount Amount Gap RBI Remarks

CASH CASH OUTFLOWS (Excess I Tolerance
INFLOWS Shortfall) limits
Maturing Assets 100 Maturing liabilities 25 Negative Gap Gap is
Volatile SB (10%) 10 o positive
Volatile CA (15%) 15
79
Interest Receivable 20 Contractual maturities 10 should or net
Asset Sales 50 Interest Payable 30 cumulative
Draw downs on 10 Other Deposit Runoffs 10 mismatch.
Commercial Lines Draw downs on Lending - more than 5%
Commitment of Total
outflows.
TOTAL 180 TOTAL 100 +80 RBI Compliant
DAY - 2.7 CASH OUTFLOWS
CASH INFLOWS
Maturing Assets 100 Maturing Liabilities 70 Negative Gap Negative Gap is
Interest Receivable 25 Contractual maturities 40 should not outflow RBI
Asset Sales 55 Interest Payable 40 be compliant
Draw downs on 10 Other Deposit Runoffs 50 more than 10%
Commercial Lines Draw downs on Lending - of Total
Commitment outflows.
TOTAL 190 TOTAL 200 (-)10 _
DAY - 8-14 CASH OUTFLOWS 5% of the Total
CASH INFLOWS
Maturing Assets 160 Maturing Liabilities with 90 Negative Gap Negative Gap
Interest Receivable 50 Contractual maturities 130 should not is
Asset Sales 60 Interest Payable 40 be outflow
Draw downs on 30 Other Deposit Runoffs 140 more than 15% Here the Bank has
Commercial Lines Draw downs on Lending - of Total tolerance limits
Commitment outflows
25% of
TOTAL 300 TOTAL 400 (-) 100 the
DAY —15-28 CASH OUTFLOWS
CASH INFLOWS
Maturing Assets 160 Maturing Liabilities with 130 Negative Gap Gap is positive RBI
Interest Receivable 80 Contractual maturities 60 should not compliant
Asset Sales 90 Interest Payable 80 be
Draw downs on 40 Other Deposit 80 more than 20%
Commercial Lines of Total
Draw downs on Lending -
outflows
Commitment
•
TOTAL 370 TOTAL 350 +20
FUNDING EXERCISE :Some banks borrow in call markets and some lend. An efficient funds manager will lend in
call markets if his calculations show that excess liquidity is available and can be deployed. He will borrow in
various markets and for various maturities if there is a short fall. Typically, if a bank finds substantial funding
gaps in distant periods, it will endeavor to fill these gaps by incensing the maturity of transactions to off-set the
gap,For example, if there is a significant funding requirement 30 days hence but there is excess position now, the
fund manger will invest in an asset maturing on the required day or one day prior to that depending on the bank's
policy of floats.
Financing of Gap to maintain RBI Norms: •
In case the negative gap exceeds the prudential limit of 5%,10%,15% & 20% of outflows in the first four buckets,
the bank may show by way of a foot note as to how it proposes to finance the gap to bring the mismatch within
the prescribed limits. The Gap can be financed from market borrowings (call I term), Bills Rediscounting, Repo
and deployment of foreign currency resources after conversion into rupees ( un-swapped foreign currency funds ).
However, prudent Bankers would avoid borrowing in the markets' by managing their ALM better. Any borrowing
will lead to Interest expense' reducing the Net Interest Income (MI). Any reduction in MI will lead to a lower 'Net
interest. Margin" or MM. This is how, -hitt-and NIM become indicators of whether the Bank is having an efficient
ALM system or not.
CONSTRUCTING ALTERNATIVE SCENARIOS TO ASSESS LIQUIDITY POSITIONS
Once the maturity ladder is constructed, Banks should study the net funding requirements cider three alternate
scenarios such as:
GENERAL (NORMAL) MARKET CONDITIONS: Liquidity positions on a normal business day
BANK SPECIFIC CRISIS: Liquidity positions if there is a Bank specific crisis (some adverse news specific to that
Bank normally triggers a run on the deposits by the public and hesitation on the part of the peer Banks to lend to
the bank which is experiencing the crisis)
GENERAL MARKET CRISIS: Assessing the liquidity positions if there is an Industry / market crisis. Such a situation
did occur in India in the latter part of the financial year 2008-09. Indian Banks tided over this crisis mainly
because•of the quick and decisive action of RB! (reduction in CRR, SLR, Repo rate etc to induce liquidity).
The framework for assessing and managing bank liquiditv_presented here has three major dimensions:
Measuring and managing net funding requirements as discussed above
Managing Market Access: Through understanding of how funds can be arranged internally (inter-branch transfers)
or externally (borrowing arrangements with other Banks), building strong relationships with funds providers. (SBI
for example lends to most other Banks under some arrangement or the other), and developing markets for asset
sales or exploring arrangements under which a bank can borrow against its assets.
Contingency Planning: Spelling out procedures to ensure that information flows remain timely and uninterrupted,
and provide senior management with the precise information it needs on asset and liability behavior, in order to
80
make quick decisions. Contingency plans should also include procedures for making up cash flow shortfalls in
emergency situations (for example, the assets that can be liquidated to generate funds should be pre-decided
father than during the emergency).
Distinction between Market access and Contingency planning: Market access is the plan for normal business
activities while as Contingency plans are used when normal funding is insufficient and are meant for more serious
situations such as a 'Bank specific crisis" or 'General market crisis'.
Given below is a hypothetically constructed 'Alternate scenario' for ABC Bank. It takes in to account, three
possible situations and assesses the outcomes that can occur. Based on the results, fund managers can keep their
plans to ensure liquidity ready.
ABC BANK - MATURITY LADDER UNDER ALTERNATIVE SCENARIOS
CASH INFLOWS 1). Normal Business 2). ABC Bank (Institution) 3). General Market
, Conditions SpecificCrisis Crisis
Maturing Assets 200 200 180
Interest Receivable 40 40 20
Asset Sales 100 120 0
Draw downs 20 0 10
Total 360 360 210
CASH OUTFLOWS
Maturing Assets 100 100 100
Interest Payable 20 20 20
Deposit Runoffs 60 200 120
Draw downs on lending 100 120 150
Commitments
Total 280 440 390
Liquidity Excess 1 +80 4
-(80) -(180)
(Shortfall)
Note: We can note that Bank which would have a comfortable liquidity position of + 80 crore on a normal
ABC negative position of (-) 80 crore in a Bank specific crisis and a crisis situation of (-)
180 to the whole market. After making such assessments, Fund managers keep
business day went in to a their plans ready.
crore when the crisis
spread
Market access and
Contingency PERSPECTIVE: In the earning perspective, the focus is on the impact of changes in the interest
EARNINGS
rates on actual or reported earnings. Variations in earnings represented by Net Interest Income is the focal point
for interest rate risk analysis as reduced earnings or outright losses (for example - where a bank is paying more
interest on its liabilities than it is earning on its assets because it is locked in to contractual positions) can harm
the financial stability. The losses can reduce the market confidence it enjoys. Banks have now moved into other
activities that generate fee-based and other non-interest income and a broader focus on overall net income,
incorporating both interest and non-interest income and expenses, has become more common.
ECONOMIC VALUE PERSPECTIVE: Variation in market interest rates affects the economic value of a bank. The
sensitivity of a bank's economic value to movements in interest rates is relevant from an investor's point of view.
The economic value of a bank is the Present value of the bank's expected future cash flows.
EMBEDDED LOSSES: The impact that past interest rates on future performance is called embedded risk.
Investments that are not marked to market may already contain embedded gains or losses due to past rate
movements. These gains or losses may be reflected over time in the bank's earnings. For example, say a bank
has invested in its subsidiary and hold its shares at par value (Rs.10). The subsidiary's shares are trading in the
market at Rs2/- but the bank continues to show the shares at par value in its balance sheet as the shares are not
marked to market. There is an embedded loss in the balance sheet which can affect the bank in a future date.
Note: Due to diligent accounting principles, bank balance sheets have become fairly transparent. Most of the
holdings are marked to market these days.
MEASUREMENT OF INTEREST RATE RISK
Measuring the interest rate risk is the first step towards managing this risk. Measurement systems should: Assess
interest rate risk associated with a bank's assets, liabilities, and OBS positions;Utilize generally accepted financial
concepts and risk measurement techniques; andHave well-documented assumptions and parameters.Techniques
are available for measuring the interest rate risk exposure of both earnings and economic value. They range from
simple calculations to static simulations and highly sophisticated dynamic modeling techniques.
INTEREST RATE RISK MEASUREMENT TECHNIQUES usual methods followed in measuring the interest rate
risk are : EARNINGS PERSPECTIVE: Gap Analysis, simulation techniques and Internal Models based on VaR
ECONOMIC PERSPECTIVE: Gap analysis combined with Duration gap analysis, Simulation techniques and Internal
Models based on VaR.
RE-PRICING SCHEDULES: This is a simple exercise of assigning or distributing interest sensitive assets,
liabilities and off-balance sheet items to different time-bands according to Residual maturity. Assets and liabilities
lacking definitive maturity dates such as savings accounts are assigned to re-pricing time bands according to the
judgment and past experience of the bank (Behavioral maturity).
GAP ANALYSIS: Maturity / re-pricing schedules are used here to generate simple indicators of the interest rate
risk sensitivity of both earnings and economic value to changing interest rates. When this approach is used to
assess the interest rate risk of current earnings, it is referred to as gap analysis. Gap analysis was one of the
earliest tools used to measure a bank's interest rate risk exposure, and continues to be widely used by banks.

81
To evaluate earnings exposure, interest rate-sensitive liabilities in each time band are subtracted from the
corresponding interest rate-sensitive assets to produce a re-pricing 'gap' for that time band.
This gap can be multiplied by an assumed change in interest rates to yield - an approximation of the change in
the Net interest income that would result from such an interest rate movement.
This approximation in the possible change of the interest rate used in the analysis can be arrived at on the basis
of a variety of factors, including historical experience, simulation of potential future interest rate movements, and
the judgment of the bank management.
A negative, or liability-sensitive gap occurs when liabilities exceed assets (including OBS positions) in a given time
band. This means that an increase in market rates could cause a .decline in net interest income. That is liabilities
will incur higher cost.A positive or asset-sensitive gap occurs when assets exceed liabilities. This means that a
decrease in market interest rates could cause a decline in net interest income.
Short Comings of Gap Analysis
Gap analysis assumes that there are no variations in the characteristics of different positions within a time band
and that all positions within a given time band will mature / re-price simultaneously. This simplification has
significant impact on the estimates as the degree of aggregation within a time band increases.
Gap analysis ignores' differences in spreads between interest rates that could arises. as the level of market
interest rates changes (basis risk)
It does not take into account any changes in the timing to payments that might occur as a result of changes in
the interest rate environment. Thus, it fails to account for differences in the sensitivity or income that may arise
from option-related positions.Finally, most gap analyses fail to capture variability in non-interest revenue and
expenses, a potentially important source of risk to current income.
3. DURATION METHOD: Duration is a measure of the percentage change in the economic value of a position
that will occur given a small change in the level of interest rates.
A maturity /re-pricing schedule is used to evaluate the effects of changing interest rates on a bank's economic
value by applying sensitivity weights to each time band. Typically, such weights are based on estimates of the
duration of the assets and liabilities that fall into each time band. This method focuses on two important factors:
Balance life of the asset or liability and Impact of any change in interest rates on the economic value of the asset.
4. SIMULATION APPROACHES: The Simulations techniques involve detailed assessments of the potential
effects of changes in interest rates on earnings and economic value by simulating the future path of interest rates
and their impact on cash flows.
Simulation approaches involve a more detailed breakdown of various categories of on-and off-balance-sheet
positions, and incorporates specific assumptions about the interest and principal payments and non-interest
income and expenses arising from each type of position. In addition, simulation techniques can incorporate more
varied and refined changes in the interest rate environment, ranging from changes in the slope and shape of the
yield curve to interest rate scenarios derived from Monte Carlo simulations. Simulations techniques could be static
or dynamic
Static Simulations: In static simulations, the cash flows arising solely from the bank's current on/off balance
sheet positions are assessed. For assessing the exposures of earnings, simulations estimating the cash flows and
resulting earnings streams over a specific period are conducted based on one or more assumed interest rate
scenarios.
Dynamic Simulation: In dynamic simulation approach, the simulation builds in detailed assumptions about the
future course of interest rates and the expected changes in a bank's business activity over that time. For
instance, the simulation involves assumptions about a bank's strategy for changing administered interest rates
(on savings deposits, for example), behavior of the bank's customer (e.g. withdrawals from Current and savings
deposits), and/or about the future stream of business (new loans or other transactions) that the bank may have
Additional Issues: One of the most difficult tasks when measuring interest rate risk is how to deal with those
positions where behavioral maturity differs from contractual maturity or where there is no stated contractual
maturity. For example, how can an assessment be made as to how many depositors would close their accounts
prematurely when the interest rate on deposits increases in this bank or the markets?
Similarly, in a falling interest rate regime, many loan parties may want to close their loans in this bank and
borrow fresh at lower rates in some other bank. This is called 'Behavioral maturity'. Contracted maturity of course
is the agreed upon due date as the name suggests. The question being raised is how to assess this behavior and
quantify it for the purpose of analysis. Thus measuring embedded options-is a complex issue and banks normally
go by historic behavioral data and also information gathered from branches on the trend and customer
psychology.
GUIDELINES FOR CONSTRUCTING STATEMENT OF INTEREST RATE SENSITIVITY An 'asset or liability is
normally classified as rate sensitive if: Within the time interval under consideration, there is a cash flow;
The interest rate resets / re-prices contractually during the interval;
RBI changes the interest rates (i.e. interest rates on Savings Bank Deposits, DRI advances, Export credit,
Refinance, CRR balance, etc.) in cases where interest rates are administered ; and
It is contractually pre-payable or withdrawal before the stated maturities.
The Gap Report should be generated by grouping rate sensitive liabilities, assets and off-balance sheet positions
into time buckets according to residual maturity or next re-pricing period, whichever is earlier.
Banks have to identify gaps in the following buckets for Interest rate risk
1 1-28 days 5 Over 1 year and up to 3 years
, ..
2 29 days and up to 3 months 6 Over 3 years and up to 5 years
3 Over 3 months and up to 6 months 7 Over 5 years
4 Over 6 months and up to 1 year 8 Non-sensitive

82
GAP ANALYSIS : The Gap is the difference between Rate Sensitive Assets (RSA) and Rate Sensitive Liabilities
(RSL) for each time bucket. A 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 from declining interest rates by a negative Gap (RSL
> RSA).The Gap can, therefore, be used as a measure of interest rate sensitivity. Each bank should set prudential
limits on individual Gaps with the approval of the Board / Management Committee. The prudential limits should
have a bearing on the Total Assets, Earning Assets or Equity. The banks may work out Earnings at Risk (EaR) or
Net Interest Margin (NIM) based on their views on interest rate movements and fix a prudent level with the
approval of the Board / Management Committee.
STRATEGIES FOR CONTROLLING INTEREST RATE RISK
First step is to analyze and identify the assets/liabilities which are interest rate sensitive. Studying maturity
pattern is one method.
Banks normally rely on historical behavior of the various types of assets and liabilities.
Having identified the rate sensitive items, the bank should focus on controlling the gap between Rate Sensitive
Assets and rate Sensitive Liabilities.
Most banks endeavor to match the assets and liabilities maturities as closely as possible in order to reduce the
gap to zero and insulate the NII from the volatility of interest rate.
The basic strategy of the banks is focused on bridging the gap position.
The Balance sheet strategies to reduce the assets and liabilities sensitivity to interest rate dynamics of the
markets are:
REDUCTION OF ASSET SENSITIVITY REDUCTION OF LIABILITY

Increase short-term borrowings SENSITIVITY
• Increase short-term lending
Increase long-term lending • Increase long-term deposits
Extend investment portfolio • Reduce investment portfolio
Increase floating rate deposits • Increase floating rate lending's
Increase fixed rate lending
Sell floating rate loans
The other options available to the bank formanaging interest rate risk are:
Match long-term assets preferably with non-interest bearing liabilities. Match reprice able assets with a similar re-
price able liabilities; the term re-price able automatically denotes items which come up for renewing.Use Forward
Rate Agreements, Swaps, Options and Financial Futures to construct synthetic securities and thus hedge against
exposure to interest rate risk; and
Maturity mismatch is deepened by increase in non-performing Assets (NPAs) and loan re-negotiations. Banks
should have sound policies for monitoring assets and avoid slippages. It must be remembered that NPAs are non-
interest earning assets funded out of volatile interest expending liabilities.
PROFIT PLANNING
Profit planning in a bank essentially involves balance sheet management covering credit, investment and non-
fund based income. Banks' income arises from three sources viz. interest income, fee based income and treasury
income. Interest income is derived from lending as well as investments in securities, bonds etc. Banks are
required to have a proper blending of investment in government securities and credit portfolios to maximize the
profits for a given level of risk appetite. Thus, you would observe that risk would increase for lending to lower
rated customers resulting in an increased need for capital and also !ending portfolio to earn the best possible
returns for a given capital level.
Effect of NPA: Banks have to take into account the effect of NPA on the interest income and thereby on the
profitability. NPAs have two fold effects, reduction in income and need for additional capital. Hence, return on
capital or profitability gets further deteriorated.
Fee based Income: The second major source of income for banks is from fee based activities. The traditional
activities such as demand drafts, remittances safe custody, guarantees, letters of credits, bills etc. continue to be
prevalent. The last and most important component of income is treasury income, which is derived by trading in
securities, foreign exchange, equities, bullion, commodities and derivatives. This is largely a speculative activity,
which banks undertake with stringent internal Controls and checks in place. If a hank is not adequately
capitalized, such losses can cause serious problems for it. In the 90s, Barings Bank, a very old British Bank,
collapsed due to very large losses on the Exchange.
Controlling the Expenses: On the expenses side, there are two major expenses viz. interest expenses and
operating expenses. There are three major parts of the deposit portfolio. Current Deposits which are interest free,
Savings Deposits — which get a regulated interest rate of 3.5% in our country and term (short & long) Deposits

83
— for which interest rates are deregulated in India. Thus, 'a bank has to find ways and means to improve the
share of low cost deposits such as Current and Savings Bank. This helps them to lower interest costs.
The second factor of expenditure is operating costs which consist of staff costs and other costs. Banks try to
improve productivity and also link up some of the staff costs and other costs. Banks try to improve productivity
and also link up some of the staff costs to productivity by providing incentive based packages.
IMPORTANT TERMINOLOGY
Asset: An asset is anything of value that is owned by a person or business.
Available for Sale: The securities available for sale are those securities where the intention of the bank is neither
to trade nor to hold till maturity. These securities are valued at the fair value which is determined by reference to
the best available source of current market quotations or other data relative to current value
Balance Sheet: A balance sheet is a financial statement of the assets and liabilities of a trading concern, recorded
at a particular point in time.
Banking Book: The banking book comprises assets and liabilities, which are contracted basically on account of
relationship or for steady income and statutory obligations and are generally held till maturity.
Basel Capital Accord: The Basel Capital Accord is an Agreement concluded among country representatives in 1988
to develop standardized risk-based capital requirements for banks across countries. The Accord was replaced with
a new capital adequacy framework (Basel II), published in June 2004. Basel II is based on three mutually
reinforcing pillars that allow banks and supervisors to evaluate properly the various risks that banks face. These
three pillars are: minimum capital requirements, which seek to refine the present measurement framework
supervisory review of an institution's capital adequacy and internal assessment process; market discipline through
effective disclosure to encourage safe and sound banking practices
Basel Committee on Banking Supervision: The Basel Committee is a committee of bank supervisors consisting of
members from each of the G10 countries. The Committee is a forum for discussion on the handling of specific
supervisory problems. It coordinates the sharing of supervisory responsibilities among national authorities in
respect of banks' foreign establishments with the aim of ensuring effective supervision of banks' activities
worldwide.
Basic Indicator Approach: An operational risk measurement technique permitted under Basel II, The approach
sets a charge for operational risk as a fixed percentage ("alpha factor") of a single indicator. The indicator serves
as a proxy for the bank's risk exposure.
Basis Risk: The risk that the interest rate of different assets, liabilities and off-balance sheet items may change in
different magnitude is termed as basis risk.
Capital: Capital refers to the funds (e.g., money, loans, equity) which are available to carry on a business, make
an investment, and generate future revenue. Capital also refers to physical assets which can be used to generate
future returns.
Capital Adequacy: A measure of the adequacy of an entity's capital resources in relation to its current liabilities
and also in relation to the risks associated with its assets. An appropriate level of capital adequacy ensures that
the entity has sufficient capital to support its activities and that its net worth is sufficient to absorb adverse
changes in the value of its assets without becoming insolvent. For example, under BIS (Bank for International
Settlements) rules, banks are required to maintain a certain level of capital against their risk-adjusted assets.
Capital Reserves: That portion of a company's profits not paid out as dividends to shareholders. They are also
known as un distributable reserves.
Convertible Bond: A bond giving the investor the option to convert the bond into equity at a fixed conversion price
or as per a pre-determined pricing formula.
Core Capital: Tier 1 capital is generally referred to as Core Capital.
Credit Risk: Risk that a party to a contractual agreement or transaction will be unable to meet their obligations or
will default on commitments. Credit risk can be associated with almost any transaction or instrument such as
swaps, repos, CDs, foreign exchange transactions, etc. Specific types of credit risk include sovereign risk, country
risk, legal or force majeure risk, marginal risk and settlement risk.
Derivative: A derivative instrument derives much of its value from an underlying product. Examples of derivatives
include futures, options, forwards and swaps. For example, a forward contract can be derived from the spot
currency market and the spot markets for borrowing and lending. In the past, derivative instruments tended to be
restricted only to those products which could be derived from spot markets. However, today the term seems to be
used for any product that can be derived from any other.
Deferred Tax Assets: Unabsorbed depreciation and carry forward of losses which can be set-off against future
taxable income which is considered as timing differences result in deferred tax assets. The deferred Tax Assets
are accounted as per the Accounting Standard 22. Deferred Tax Assets have an effect of decreasing future income
tax payments, which indicates that they are prepaid income taxes and meet definition of assets. Whereas
deferred tax liabilities have an effect of increasing future year's income tax payments, which indicates that they
are accrued income taxes and meet definition of liabilities
Debentures: Bonds issued by a company bearing a fixed rate of interest usually payable half yearly on specific
dates and principal amount repayable on a particular date on redemption of the debentures.
Duration: Duration (Macaulay duration) measures the price volatility of fixed income securities. It is often used in
the comparison of the interest rate risk between securities with different coupons and different maturities. It is
the weighted average of the present value of all the cash flows associated with a fixed income security. It is
expressed in years. The duration of a fixed income security is always shorter than its term to maturity, except in
the case of zero coupon securities where they are the same.
Economic Capital Model (ECM): Economic capital is the target amount of capital, which optimizes the return for a
Bank's stakeholders for a desired level of risk. A model, that generates the Economic Capital target , is known as-
Economic Capital Model (refer ICAAP table for context) .

84
Foreign Institutional Investor: An institution established or incorporated outside India which proposes to make
investment in India insecurities; provided that a domestic asset management company or domestic portfolio
manager who manages funds raised or collected or brought from outside India for investment in India on behalf
of a sub-account, shall be deemed to be a Foreign Institutional Investor.
Forward Contract: A forward contract is an agreement between two parties to buy or sell an agreed amount of a
commodity or financial instrument at an agreed price, for delivery on an agreed future date. In contrast to a
futures contract, a forward contract is not transferable or exchange tradable, its terms are not standardized and
no margin is exchanged. The buyer of the forward contract is said to be long the contract and the seller is said to
be short the contract.
General Provisions and Loss Reserves: Such reserves, if they are not attributable to the actual diminution in value
or identifiable potential loss in any specific asset and are available to meet unexpected losses, can be included in
Tier II capital.
General Risk: Risk that relates to overall market conditions while specific risk is risk that relates to the issuer of a
particular security.
Hedging: Taking action to eliminate or reduce exposure to risk.
Held for Trading: Securities where the intention is to trade by taking advantage of short-term price / interest rate
movements.
Horizontal Disallowance: A disallowance of offsets to required capital used the BIS Method for assessing market
risk for regulatory capital. In order to calculate the capital required for interest rate risk of a trading portfolio, the
BIS Method allows offsets of long and short positions. Yet interest rate risk of instruments at different horizontal
points of the yield curve are not perfectly correlated. Hence, the BIS Method requires that a portion of these
offsets be disallowed.
Hybrid Debt Capital Instruments: In this category, fall a number of capital instruments, which combine certain
characteristics of equity and certain characteristics of debt. Each has a particular feature, which can be considered
to affect its quality as capital. Where these instruments have close similarities to equity, in particular when they
are able to support losses on an ongoing basis without triggering liquidation, they may be included in Tier II
capital.
Interest Rate Risk: Risk that the financial value of assets or liabilities (or inflows/outflows) will be altered because
of fluctuations in interest rates. For example, the risk that future investment may have to be made at lower rates
and future borrowings at higher rates.
Long Position: A long position refers to a position where gains arise from a rise in the value of the underlying.
Market Risk: Risk of loss arising from movements in market prices or rates away from the rates or prices set out
in a transaction or agreement.
Modified Duration: The modified duration or volatility of an interest bearing security and represents the
percentage change in a securities' price for a 100 basis points change in yield.
Mortgage-Backed Security: A bond-type security in which the collateral is provided by a pool of mortgages.
Income from the underlying mortgages is used to meet interest and principal repayments.
Mutual Fund: Mutual Fund is a mechanism for pooling the resources by issuing units to the investors and investing
funds in securities in accordance with objectives as disclosed in offer document. A fund established in the form of
a trust to raise monies through the sale of units to the public or a section of the public under one or more
schemes for investing in securities, including money market instruments.
Net Interest Margin: Net interest margin is the net interest income divided by average interest earning assets
Net NPA: Net NPA = Gross NPA — (Balance in Interest Suspense account + DICGC/ECGC claims received and held
pending adjustment + Part payment received and kept in suspense account + Total provisions held)
Nostro Accounts: Foreign currency settlement accounts that a bank maintains with its overseas correspondent
banks. These accounts are assets of the domestic bank.
Off-Balance Sheet exposures: Off-Balance Sheet exposures refer to the business activities of a bank that
generally do not involve booking assets (loans) and taking deposits. Off-balance sheet activities normally
generate fees, but produce liabilities or assets that are deferred or contingent and thus, do not appear on the
institution's balance sheet until or unless they become actual assets or liabilities.
Open position: It is the net difference between the amounts payable and amounts receivable in a particular
instrument or commodity. It results from the existence of a net long or net short 'position in the particular
instrument or commodity.
Option: An option is a contract which grants the buyer the right, but not the obligation, to buy (call option) or sell
(put option) an asset, commodity, currency or financial instrument at an agreed rate (exercise price) on or before
an agreed date (expiry or settlement date). The buyer pays the seller an amount called the premium in exchange
for this right. This premium is the price of the option.
Risk: The possibility of an outcome not occurring as expected. It can be measured- and is not the same as
uncertainty, which is not measurable. In financial terms, risk refers to the possibility of financial loss. It can be
classified as credit risk, market risk and operational risk.
Risk Asset Ratio: A bank's risk asset ratio is the ratio of a bank's risk assets to its capital funds. Risk assets
include assets other than highly rated government and government agency obligations and cash, for example,
corporate bonds and loans. The capital funds include capital and undistributed reserves. The lower the risk asset
ratio the better the bank's 'capital cushion'.
Risk Weights: Basel II sets out a risk-weighting schedule for measuring the credit risk of obligors. The risk
weights are linked to ratings given to sovereigns, Fls and corporations by external credit rating agencies.

85
Securitization: The process whereby similar debt Instruments /assets are pooled together and repackaged into
marketable securities which can be sold to investors. The process of loan securitization is used by banks to move
their assets off the balance sheet in order to improve their capital asset ratios.
Short Position: A short position refers to a position where gains arise from a decline in the value of the
underlying. It also refers to the sale of a security in which the seller does not have a long position.
Specific Risk: Within the framework of the BIS proposals on market risk, specific risk refers to the risk associated
with a specific security, issuer or company, as opposed to the risk associated with a market or market sector
(general risk).
Subordinated Debt: Refers to the status of the debt. In the event of the bankruptcy or liquidation of the debtor.
subordinated debt only has a secondary claim on repayments, after other debt has been repaid.
Tier One (or Tier I) Capital: A term used to refer to one of the components of regulatory capital. It consists mainly
of share capital and disclosed reserves (minus goodwill, if any). Tier I items are deemed to be of the highest
quality because they are fully available to cover losses. The other categories of capital defined in Basel II are Tier
II (or supplementary) capital and Tier III (or additional supplementary) capital.
Tier Two (or Tier II) Capital: Refers to one of components of regulatory capital. Also known as supplementary
capital, it consists of certain reserves and certain types of subordinated debt. Tier II items qualify as regulatory
capital to the extent that they can be used to absorb losses arising from bank's activities. Tier ll's capital loss
Absorption capacity is lower than that of-Tier I capital.
Trading Book: A trading book or portfolio* refers to the book of financial instruments held for the purpose of
short-term trading, as opposed to securities that would be held as a long-term investment. The trading book
refers to the assets that are held primarily for generating profit on short-term differences in prices / yields. The
price risk is the prime concern of banks in trading book.
Underwrite: Generally, to underwrite means to assume a risk for a fee. Its two most common contexts are:
Securities: a dealer or investment bank agrees to purchase a new issue of securities from the issuer and
distribute these securities to investors.
The underwriter may be one person or part of an underwriting syndicate. Thus the issuer faces no risk of being
left with unsold securities.„
Insurance: a person or company agrees to provide financial compensation against the risk of fire, theft, death,
disability, etc., for a fee called a premium.
Undisclosed Reserves: These reserves often serve as a cushion against unexpected losses, but they are less
permanent in nature and cannot be considered as 'Core Capital'.
Revaluation Reserves: arise from revaluation of assets that are undervalued on the bank's books, typically bank
premises and marketable securities. The extent to which the revaluation reserves can be relied upon as a cushion
for unexpected losses depends mainly upon the level of certainty that can be placed on estimates of the market
values of the relevant assets, the subsequent deterioration in values under difficult market conditions or in a
forced sale, potential for actual liquidation at those values, tax consequences of revaluation, etc.
Value At Risk (VAR): It is a method for calculating and controlling exposure to market risk. VAR is a single
number (currency amount) which estimates the maximum expected loss of a portfolio over a given time horizon
(the holding period) and at a given confidence level.
Venture Capital Fund: A fund with the purpose of investing in start-up businesses that is perceived to have
excellent growth prospects but does not have access to capital markets.
Vertical Disallowance: In the BIS Method for determining regulatory capital necessary to cushion market risk, a
reversal of the offsets of a general risk charge of a long position by a short position in two or more securities in
the same time band in the yield curve where the securities have differing credit risks.

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QUESTIONS BANK ( RECALLED QUESTIONS )
& PRACTICE TEST
MEMORY BASED RECALLED QUESTIONS

BANK FINANCE MANAGEMENT JUNE 2014
01 The latest proposal of the Basel Committee on Banking Supervision (BCBS) for the new Basel Accord (Basel II)
introduces the Advanced Internal Rating Approach for credit risk. Under this, banks will input their own __a) EAD
b) LGD c) EAD & LGD d) None
02 The difference between rates for buying and selling of foreign currency (Bid and Offer rates) is known as____a)
Surplus b) Profit c) Gain d) Spread
03 From 6.8.2005, which of the players listed below discontinued from participating in lending in Call Money Market b y
Reserve Bank of India?a)Primary Dealers b)Scheduled Co-operative Banks c)All India Financial Institutions / Mutual
Funds / Insurance Companies d)None of the above
04 Commercial Papers can be issued ___:a)As a Stand-alone facility b)Against Working Capital entitlement c)As a stand
alone facility with a standby assistance / Credit backstop facility from Banks/FIs d)Either (a) or (c)
05 Which of the foll owing investment carries more credit ris k? :a)Investment in Treasury Bills b)Investment in
Commercial Paper with A1 Rating c)Investment in ‘BBB’ rated 3 year Corporate Bonds d)All the above carry equal
credit risk
06 A trader buys a call option at an exercise price of 45 and premium of 2. Under what conditions will he make a profit?
a)Spot price < 43 b)43 < spot price < 45 c)45 < spot price < 47 d)spot price > 47
07 Basel-II accord rests on three pillars. The second pillar of the accord is ____a) Market Discipline b) Risk Management
c)Supervisory review process d)Operational risk management
0 8 A s p e r B a s e l I I , R i s k w e i g h t e d a s s e t s f o r Operational risk are worked out as :a)Capital for operational risk x 9
b)Capital for operational risk x 12.5 c)Capital for operation risk x 8.33 d)Capital for operational risk x 8
09 Basel-II accord prescribes that housing loan portfolio be given risk weight of____ a) 100% b) 75% c)
35% d) 150%
10 Under Simplified Standardised Approach (SSA), risk weight for corporates is prescribed as____
a) 150% b) 100% c) 50% d) 20%
11 Basic Indicator Approach (BIA) is one of the methods for computation of capital charge for: a)Interest rate risk
b) Market risk c) Operational risk d) Credit risk
12 Capital charge for Credit risk under Internal Rating based (IRB) approach is a function of Probabilit y of default
(PD), Loss given default (LGD), Exposure at default (ED) and :a)Risk weights as prescribed b) Maturity c) Provisions
already set aside d) Yield
13 For Substandard Secured Assets (code 21), the provision required is ____ of the outstanding amount.:a) 15%
b) 20% c)10% of the realizable value of security (RVS) d)None of these
14 For standard assets, the provision required is ____ of the outstanding amount. :a) 0.10% b) 0.2 0% c) 0.40 % d )
0.25%
15 The hi ghest beta factor (in percentage) is as si gned to di fferent business lines for op eration al risk u nder
standardis ed approach is :a ) 1 0 % b ) 2 0 % c ) 1 8 % d ) 1 5 %
16 Provisioning requirement for an advance facility under Doubtful-I category, denoted by code 31, is ____a)20% of
Realisable Value of Security (RVS) b)25% of RVS + 100% of shortfall in security c)40% of RVS + 100% of shortfall
in security d)20% of outstanding loan amount
17 Provisioning requirement for an advance facility under Doubtful-III category, denoted by code 33, is ____:a)Same as
loss asset b)50% of RVS + 100% of shortfall in security c)100% of outstanding amount d)none of the above
18 Market discipline under Basel-II framework refers to____:a)Disclosure requirements b)Rates quoted in the market
c)Market risk d)Disclosure of confidential information
1 9 A s s e t - l i a b i l i t y m a n a g e m e n t i s c o n c e r n e d with :a)Quality of the assets b)Recovery of non-performing assets
c)Operational risk d)None of these
20 A coupon Swap is defined as --- :a)Forex swap, where one currency is traded for another b)Interest rate swap, where
underlying benchmark interest rates are exchanged c)Interest rate swap, where fixed rate is exchanged with floating rate
d)None of these
21 FCNR Deposit is --- :a) Futures contract b) Options contract c) Swap d) None of these
22 Interest rate s ensitivit y gap statem ent is prepared b y classifying the ass ets and
liabilities based on their -- :a) Maturity dates b) Repricing dates c)Maturity date or repricing date whichever is later d)None
of these. 23 Find the odd man out.:a) Futures b) Value at Risk
(VAR) c) Options ------- d) Swaps
24 ALM system is built on three pillars, which are: a)Capital adequacy, supervisory review, and market discipline
b)Information system, organization and process c)ALCO, maturity ladder and duration d)All of the above
25 Change in interest rates will affect____:a) Net interest income b) Other income c) Staff expenses d) All of these
26 The risk for the option seller is____:a)Limited to the Premium amount b)Limited to the amount of option contract
c)Limited to a certain percentage of the option contract d)None of these 27 Currency futures are
forward contracts____:a)With standard size b)With standard maturity date c)Traded on the exchange d)All of the above
28 Savings bank deposits are placed in bucket. :a)Non sensitive b) 3-6 months c) Over 5 years d) None of these

87
2 9 B o r r o w i n g f r o m R e s e r v e B a n k o f In d i a a r e placed in bucket.: a) Upto one month b) 6 months or 1 yearc ) 1 m o n t h
t o 3 m o n t hs d) n on e o f t he s e 30 Sub-standard NPAs are placed in
____bucket.:a) Over 5 years b) 3-5 years c) Non-sensitive d) None of these
31 Capital and reserves are placed in ____bucket.:a) Over 5 years b)Upto one month c) Residual maturity d) Non sensitive
3 2 T h e t e r m “ e c o n o m i c v a l u e P e r s p e c t i v e ” indicates :a)Impact of interest rate changes on earnings b)Present value of
expected cash flows taking into account change in interest rates c)Instruments that are not marked to market d)None of
the above
3 3 B a n k ’ s o w n t r a d i n g p o s i t i o n s a r e c a l l e d as______:a) Overnight Positions b) Daylight Positions c) P r o p r i e t a r y
P o s i t i o n s d ) A l l t h es e 34 Basel Accord of 1988
recommended____:a)Minimum capital standards for the banks b)Classification of assets into various time buckets
c)Classification of assets based on counterparty risk d)All the above
35 Value at Risk (VAR) concept can be describedas________:a)Downside risk potential b)Measure of volatility c)Measure
of sensitivity d)All the above 36 Find the odd man out:a)Liquidity
risk b) Sovereign risk c) Int eres t r at e ri s k d) For ei gn ex chan ge ri s k
37 Find the odd man out:a) Standardised method b)Basic Indicator Approach c)Supervisory Review Process d)Internal
Rating Based Approach 38 Loans which are NPA for over
48 months arecategorized under ___:a)Doubtful-III category b)Doubtful-II category c)Sub-standard category d)None of the
above
3 9 C a p i t a l A d e q u a c y R a t i o u n d e r B a s e l I I i s computed on the basis of _____:a)Risk weighted assets for credit risk
b)Capital for market risk c)Capital for operational risk d)All the above
40 Supervisory Review under Basel-II framework refers to _____:a)Operational risk b) Market risk c) Credit risk d) None of
these 41 Find the odd man out.:a)Fee based
income b)Owned funds c)Staff expenses d) Treasury Income
42 Which of the following is not a function of integrated Treasury Department: a)Pricing of Products b)Facilitation of
Payment and Settlement of the bank c)Issuance of Foreign currency denominated Traveler’s cheques d)Assisting the bank
management in ALM.
43 By ‘Emerging Market Countries’ we mean____:a)Countries attracting BPO business b)Fast Developing economies
c)Countries which became independent after splitting of erstwhile USSR d)OECD countries.
44 The differences between Forward and Futurescontracts are _____:a)In futures contracts, the contract terms are highly
standardized unlike Forward contracts. b)Trades in Futures contracts require to be marked to market daily unlike
forward contracts c)Futures contract obligations are guaranteed by respective clearing houses unlike forward contracts
d)Both (a) & (b) only e) All of these
45 Promissory notes issued by Central Government to meet its short term
requirements are called --- :a) Certificate of Deposits b) Commercial Papers c) Capital In dex ed Bonds d) Treasur y Bills
1 C 11 C 21 B 31 D 41 B
2 D 12 B 22 C 32 B 42 C
3 C 13 A 23 B 33 C 43 B
4 D 14 C 24 B 34 A 44 E
5 C 15 C 25 A 35 A 45 D
6 D 16 B 26 D 36 B 46
7 C 17 C 27 D 37 C 47
8 B 18 A 28 B 38 A 48
9 C 19 A 29 A 39 D 49
10 B 20 C 30 B 40 D 50
BANK FINANCE MANAGEMENT DEC 2013

1) Net interest income (NII) is calculated using the following formula:
a) Interest income – Total expensesb) Total income – Interest expenses
c) Interest income – Interest expensesd) Total income – Total expenses
2) N.I.M. calculated using the following formula:
a) NII /Average total liabilitiesb) NII /Average Total Assets
c) Total Interest Income /Average Total Assets
d) Total Interest Income /Average Total Liability
3) Economic Equity Ratio is used to assess sustenance capacity of the bank. It is calculated using the formula:
a) Net Interest Income / Shareholder Funds
b) Total Income / Shareholder Funds
c) Shareholder Funds / Total of Assets & Liabilities
d) Shareholder Funds / Total Assets
4) The items in a Bank’s trading book are subject to ________:
a) Concentration Risk b) Funding Risk
c) Market Risk d) Credit Risk
5) In banking, contractual or relationship obligations means:
a) New loan demands b) Existing loan commitments
c) Withdrawal of deposits by customers d) All the above.
6) European Option can be exercised on :
a) Any day at the option of the buyer on or before the expiry of the option.
b) On the expiry of the option. c) Discretion of the bank.
d) Any day at the option of the buyer but at spot rate.
7) Risk of having to compensate for non-receipt of expected cash flows by a bank is called:
88
a) Call risk b) Funding risk c) Time riskd) Credit risk
8) 'Time risk' in the context of liquidity risk of an institution is caused due to:
a) Systematic risk b) Swaps and options
c) Loss of confidence d) Temporary problems in recovery
9) Crystallisation of contingent liabilities in a bank is called:
a) Call risk b) Funding risk c) Time risk d) Credit risk
10) If the volatility per annum is 25% and the number of trading days per annum is 252, find the volatility per day.
a) 1.58% b) 1.60% c) 158% d) 15.8%
11) RBI has put in place real time gross settlement system (RTGS) to mitigate the following risk:
a) Market risk b) Settlement risk c) Operational riskd) Strategic risk
12) A bank is having Rs.500 Crore liabilities @ 7% of one year maturity to fund Rs 500 Cr assets @ 9% with 2 year maturity. The bank is exposed to:
a) Gap Risk b) Basis Risk
c) Price Risk d) Yield Curve Risk
13) Interest rate risk is a type of:
a) Credit risk b) Market riskc) Operational risk d) All the above
14) If Regulatory Authority of the country feels that the Capital held by a bank is not sufficient, it could require the bank to _______:
a) Reduce it’s Risk b) Increase it’s Capital
c) Both of these d) Either of these
15) When a bank sanctions a loan to a large borrower, which of the following risks it may not face ______:
a) Liquidity b) Market c) Credit d) Operation
16) The sensitivity of an investment's return to market movement is
called _______:
a) Alpha b) Beta c) Haircut d) Any of the above
17) If two investments offer the same expected return, most investors
would prefer the one with variance.
a) Lower b) Higher c) Depends on rating d) Past track record
18) ABC bank suffers loss due to adverse market movement of a security. The security was held beyond the defeasance period. What is the type of
the risk that the bank has suffered?
a) Market Risk b) Operational Risk
c) Market Liquidation Risk d) Credit Risk
19) 8% IDBI infrastructure Bond with face value of Rs.100 and 10-year term to maturity is trading at Rs 120. The current yield on this bond is
_____ :
a) 10% b) 9.9% c) 6.7% d) 8%
20) XYZ company has declared a dividend of Rs.1 per share. The face value of the share is Rs.10 and the current market price is Rs.25. The
dividend yield will be :
a) 10% b) 40% c) 10% d) 4%
21) If RBI announces an increase in Reverse repo rate to 7%, it means the rate at which Banks can park funds with RBI has gone up to 7%. What
effect can this have on the Bond markets?
a) Bond prices may go up. b) Bond prices may go down
c) There will be no effect on the prices in Bond markets
d) The effect depends on how often the RBI would conduct the auction
22) A major limitation of the VaR is that:
a) It requires long term historical data b) It is a tedious process
c) It assumes extreme conditions d) It assumes normal market conditions
23) ________ is a transaction where financial securities are issued against the cash flow generated from a pool of assets.
a) Securitization b) Credit Default Swaps
c) Credit Linked Notes d) Total Return Swaps
24) Mr. Warren Buffet a well-known capital market investor once remarked that if any one holding a large number of shares of any company, try to
sell the shares in the market, the price of that security will start falling immediately resulting in the Seller getting lesser and lesser for each
subsequent share that he would sell. This type of Risk is
called ___ risk:
a) Price b) Operational c) Asset Liquidation d) Market liquidity
25) Recently, most of the Govts and Central Bankers went in to a major drive to support their major Banks and prevent their failures. This is
because they wanted to avoid the contagion effect & ‘Systemic Risk’ which is the risk due to:
a) Failure of a bank, which is not adhering to regulations
b) Failure of two banks simultaneously due to bankruptcy of one bank.
c) Where a group of banks fail due to contagion effect
d) Failure of entire banking system
26) As per RBI guidelines, placement of volatile portion and core portion of Savings and Current deposit may be done as:
a) 10% of SB and 15% of CA may be treated as volatile and placed in 1 - 14 days time bucket and core portion be placed in 1-3 year bucket.
b) 15% of SB and 20% of CA may be treated as volatile and placed in 1 -14 days time bucket and core portion be placed in 3-5 year bucket.
c) 10% of SB and 25% of CA may be treated as volatile and placed in 1 to 14 days time bucket and core portion be placed in 1-3 year bucket.
d) 15% of SB and 25% of CA may be treated as volatile and placed in 15 to 28 days time bucket and core portion be placed in 1-3 year bucket.
e) Discretion of the Bank.
27) Premature closing of a deposit will result in interest rate risk of type________ risk: a) Basis b) Yield curve c) Embedded Option
d) Mismatch
28) Daily volatility of a stock is 1%. What is its 9 days volatility? : a) 3% b) 9% c) 1% d) 4%
29) As per RBI guidelines on Asset Liability Management, the net cumulative negative mismatches during the day 1, 2-7, 8-14 and 15-28 days
buckets if exceed the prudential limits may be financed from market by: a) Market borrowings ( call / term) b) Bills discounting, c) Repo d)
All above.
30) As per RBI guidelines on placement of Assets and Liabilities in to various buckets for understanding and managing Interest rate risks. Capital,
Reserves and Surplus are to be treated as:
a) Non interest rate sensitive b) Interest Rate Sensitive, Depends on the source of the capital, Only 50% should be treated as not sensitive to interest rates.
31 to 34) Miss. Shruthi Jayaram was a student of St. Stephen’s college in New Delhi. She had opened an account with the extension counter of
Syndicate Bank operating in her College premises. She later went to Singapore to study in National University of Singapore on scholarship. As per
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the requirements of college, she opened an account with Indian Overseas Bank, Singapore. Being a thrifty person, she saved USD 3000 out of her
scholarship and sent it to her mother who deposited it in Indian Overseas Bank; Bangalore in US dollars. Shruthi returned after two years in
Singapore and now works in New Delhi with the Union Finance Ministry:
31) What was Miss. Shruthi’s status when she was a student at NUS, Singapore? : a) Resident Indian, b) NRI c) PIO d) Student
32) What was the status of her Syndicate Bank account when she was at Singapore? : a) Resident-SB b) NRE-SB c) NRO-SB d)
RFC
33) What is the status of the account opened by her mother in IOB, New Delhi?
a) It was FCNR when Shruthi was in Singapore, now it is RFC(D),
b) It was FCNR when Shruthi was in Singapore, now it is RFC.
c) It was EEFC when Shruthi was in Singapore, now it is RFC
d) It is FCNR.
34) Shruthi will be shortly joining Columbia University in USA. She can get her Indian Overseas Bank account re-designated as ________:
a) FCNR (B)b) NRO c) RFC d) RFC(D)
35) Mr.Vipin is informed by his Dealing room that he should give them prior information to fund the Nostro account latest by Monday the 25th.
They would be buying the dollars through the Inter-Bank Spot markets and would like the information on hand latest by 2.00 PM. If that is the case,
which is the latest possible time for Mr.Vipin to contact the Dealing room for funding the Nostro account:
a) Saturday -the 23rd before 12.30 PM b) Friday –the 22nd before 2.00 PM
c) Thursday-the 21st before 2.00PM d) Monday-the 25th before 2.00 PM
36 to 45) Mr. Vipin, AGM of ABC Bank has arranged for a ‘Customer Awareness’ programme in his branch on 24th May. The meeting is
attended by customers from all categories such as Exporters, Importers, NRIs etc. A question answer session as follows takes place. Please mark
the answers that Mr. Vipin must give in correct response to the customers:
36) Mr. Amrit, CEO of one of the big four auditing firms is a VIP customer residing in Hyderabad. He wishes to know whether he can invest in a
residential property in the USA as house prices have become very attractive there now:
a) Yes, he can invest and buy the house
b) No, he cannot invest in a house abroad
c) c) Yes, he can buy a house abroad but the maximum remittance per financial year is USD 1,25,000 under LRS
d) Yes, he can buy a house abroad and the maximum remittance per financial year is USD 200,000 under LRS
37) Mr. Amrit is your valuable customer (not NRI / PIO), he wants to know the maximum amount he can send towards purchase of a flat in London:
a) He can remit USD 75,000 per financial year
b) He can remit USD 1,25,000 per financial year
c) He can not remit towards purchase of property
d) He can remit USD 200,000 per calendar year
38) Mr. Anand is a NRI living in Richmond, U.S.A. Currently he is on a visit home. He has saved money in dollars in FCNR deposits maturing in
three months time. He wishes to know whether he can book a Forward contract to receive the maturity proceeds in GBP. He also wants to know
whether the Bank can make a remittance in GBP on maturity date to a third party directly (to his son studying in London School of Economics) a)
No, he cannot book a Forward contract and has to receive the proceeds in
dollars only.
b) Yes, he can book a Cross currency forward contract such that the proceeds can be paid in GBP.
c) Bank can pay in GBP but to him only.
d) Bank can make a direct remittance to his son in GBP as third party remittances are now allowed.
e) Mr. Anand has to be informed of b & d
39) Mr. Mohandas from Omni exports wanted to know whether the interest subvention is applicable to his packing credit. His firm deals with
manufacture of pickles and has an original investment of Rs.4 crore in plant and machinery:
a) Yes, interest subvention of 2% applicable because it is food-processing industry.
b) No, interest subvention not applicable.
c) Yes, interest subvention of 3% is applicable because it is a SME unit.
d) Interest subvention scheme has been scrapped now.
40) Mr. Mohandas also wanted to know if he can give some credit (time to pay) to his buyers abroad. He has sent his export bill on collection basis
through the Bank. His unit is situated in the vicinity of the branch and not in SEZ:
a) Yes, the time limit for realization of export proceeds is 180 days
b) Yes, the time limit for realization of export proceeds is 12 months
c) Yes, the time limit for realization of export proceeds is 15 months
d) Yes, there is no time limit for realization of export proceeds now for all exporters
41) Ms.Leela is the wife of Mr.Ramadas, an NRI customer. She wants to know whether her husband can put a FCNR deposit of USD 10,00,000 for
six years and whether he can get a loan against the deposit if need arises:
a) The FCNR deposit can be accepted for a minimum of 12 months and maximum of 60 months as per RBI rules.
b) The FCNR can be accepted for six years and maximum 90% loan extended
c) There is no limit on the maximum loan against FCNR now.
d) Ms.Leela should be informed of both a & c
42) Mr. Mohandas wants to know what he has to do in the case of another consignment where the bill amount is USD 30,000 and payment is
promised after seven more months (already five months have lapsed):
a) He has to apply to RBI on form ETX
b) He has to apply to ABC Bank on form ETX seeking extension of time
h
c) The Bill would be reported in form XOS to RBI as on 30t June if it is outstanding for more than six months
d) The Bill would be included in XOS as it more than USD 25,000 (Bill amount is USD 30,000)
e) b, c and d are correct
43) Mr. Anand (NRI) wants the Branch Manager to explain all the Forward contract facilities available to NRIs:
a) The amount of dividend due to NRIs on shares held in an Indian company.
b) The balances held in FCNR or NRE account with the rupee as one of the legs.
c) Cross currency (not involving the rupee) forward contracts may also be booked to convert the balances in one foreign currency to another foreign currency

90
in which FCNR(B) deposits are permitted to be maintained.
d) The amount of investment made under the portfolio scheme in accordance with RBI / FEMA rules and provisions
e) All of the above are eligible for Forward contract
44) Mr. Arjun is supplying raw iron ore to a Singapore party on continuous basis. He wants to now export processed cashew nuts. He first imports
them from Russia as raw kernel, processes them and exports them to USA. His buyers want to establish a Letter of Credit in his favor. He wants to
include a clause in the LC that allows him to draw advance against the L/C to pay for the raw cashew imports. Mr. Vipin should advise him to get a
______ : a) Green clause L/C b) Back-to-Back L/C, c) Red clause L/C d) Restricted L/C
45) Mr. Arjun also wants to know the number of days that a Negotiating Bank may take to negotiate the L/C once he has submitted the
documents:
a) Payment would be made if the documents were in accordance with the L/C within five banking days.
b) Banks have five banking days time for inspecting/examination of the documents as per UCP 600.
c) This new rule about five banking days has replaced the earlier provision of 7 days that was available in UCPDC 500.
d) All of the above are correct statements
46) In an Option contract, where the buyer of a contract has the right but not the obligation to sell a currency at a predetermined price only at the
end of the contract period or on the maturity date is called : a) European Put option b) American Call option c) European Call option
_______________________ d) American Put option.
47) The risk of large outflows of funds from a bank due to unanticipated withdrawals is called: a) Settlement risk b) Call risk c) Funding risk
d) Solvency risk
48) As per RBI guidelines on ALM, current account deposits are interest rate: a) Non-sensitive b) Sensitive on resetting PLR
c) Assigned to 15-28 days bucket , d )Assigned to 29 days to 3 months time bucket
49) The Banking Book is not exposed to the following risk: a) Liquidity risk b) Interest rate risk c) Market risk d) Operational risk
50) C 2 B 3 D 4 C 5 D
The
6 B 7 C 8 D 9 A 10 A
11 B 12 A 13 B 14 C 15 B
16 B 17 A 18 B 19 C 20 C
21 B 22 D 23 A 24 C 25 D
26 A 27 C 28 A 29 D 30 A
31 B 32 C 33 A 34 A 35 C
36 C 37 B 38 E 39 C 40 B
41 D 42 E 43 E 44 C 45 D
46 A 47 C 48 A 49 C 50 C
BANK FINANCE MANAGEMENT JUNE 2013
1) Net Interest Margin (NIM) is used for the purpose of stabilizing asset liability management of banks, the other parameter is:
a) Economic Equity Ratiob) Capital Adequacy Ratio
c) Cash Reserve Ratiod) Statutory Liquidity Ratio
2) Investment made by a bank in its subsidiary is considered in the following category in its balance sheet:
a) Secured advances b) Other assets
c) Investments d) Unsecured advances
3) Following is the most important item on the asset side of a bank's balance sheet:
a) Fixed Assets b) Cash & balances with RBI
c) Investments d) Advances
4) Net interest income (NII) is calculated using the following formula:
a) Interest income — Total expenses
b) Total income — Interest expenses
c) Interest income — Interest expenses
d) Total income — Total expenses
5) N.I.M. calculated using the following formula:
a) NII /Average total liabilities
b) NII /Average Total Assets
c) Total Interest Income /Average Total Assets
d) Total Interest Income /Average Total Liability
6) Economic Equity Ratio is used to assess sustenance capacity of the bank. It is calculated using the formula:
a) Net Interest Income / Shareholder Funds
b) Total Income / Shareholder Funds
c) Shareholder Funds / Total of Assets & Liabilities
d) Shareholder Funds / Total Assets
7) In banking, contractual or relationship obligations means:
a) New loan demands b) Existing loan commitments
c) Withdrawal of deposits by customers
d) All the above.
8) Risk of having to compensate for non-receipt of expected cash flows by a bank is called:
a) Call riskb) Funding risk c) Time risk d) Credit risk
9) 'Time risk' in the context of liquidity risk of an institution is caused due to:
a) Systematic riskb) Swaps and options
c) Loss of confidence d) Temporary problems in recovery
10) Crystallisation of contingent liabilities in a bank is called:
a) Call risk b) Funding risk c) Time risk d) Credit risk
11) If the volatility per annum is 25% and the number of trading days per annum is 252, find the volatility per day.
a) 1.58% b) 1.60% c) 158% d) 15.8%
12) RBI has put in place real time gross settlement system (RTGS) to mitigate the following risk:
a) Market risk b) Settlement risk
c) Operational risk d) Strategic risk
13) A bank is having Rs.500 Crore liabilities @ 7% of one year maturity to fund Rs.500 Crore assets @ 9% with 2 year maturity. The
bank is exposed to:
a) Gap Risk b) Basis Risk c) Price Risk d) Yield Curve Risk
14) Interest rate risk is a type of:
a) Credit risk b) Market risk
c) Operational risk d) All the above
15) If Regulatory Authority of the country feels that the Capital held by a bank is not sufficient, it could require the bank to _______:
a) Reduce it's Risk b) Increase it's Capital
c) Both of these d) Either of these
16) When a bank sanctions a loan to a large borrower, which of the following risks it may not face _______:
a) Liquidity b) Market c) Credit d) Operation
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17) Which of the following statement is correct?
a) Forex markets are localized markets.
b) Forex markets are international markets only.
c) Forex markets are dynamic and round the clock markets.
d) Forex markets are used only for trade transactions.
18) If market quotes USD/INR as 63.61/63, at what rate can you buy USD at the given quote?
a) 63.61 b) 63.62 c) 63.63 d) 63.60
19) The sensitivity of an investment's return to market
movement is called ________:
a) Alpha b) Beta c) Haircut d) Any of the above
20) ABC bank suffers loss due to adverse market movement of a security. The security was held beyond the defeasance period. What
is the type of the risk that the bank has suffered?
a) Market Risk b) Operational Risk
c) Market Liquidation Risk d) Credit Risk
21) 8% IDBI infrastructure Bond with face value of Rs.100 and 10-year term to maturity is trading at Rs 120. The current yield on this
bond is _______:
a) 10% b) 9.9% c) 6.7% d) 8%
22) XYZ company has declared a dividend of Rs.1 per share. The face value of the share is Rs.10 and the current market
price is Rs.25. The dividend yield will be :
a) 10% b) 40% c) 10% d) 4%
23) If RBI announces an increase in Reverse repo rate to 7%, it means the rate at which Banks can park funds with RBI has gone up to
7%. What effect can this have on the Bond markets?
a) Bond prices may go upb) Bond prices may go down
c) There will be no effect on the prices in Bond markets
d) The effect depends on how often the RBI would conduct the auction
24) A major limitation of the VaR is that:
a) It requires long term historical data b) It is a tedious process
c) It assumes extreme conditions
d) It assumes normal market conditions
25) ___ is a transaction where financial securities are issued against the cash flow generated from a pool of assets.
a) Securitization b) Credit Default Swaps
c) Credit Linked Notesd) Total Return Swaps
26) Mr. Warren Buffet is a well-known capital market investor. He once remarked that if any one holding a large number of shares
of any company, try to sell the shares in the market, the price of that security will start falling immediately resulting in the Seller
getting lesser and lesser for each subsequent share that he would sell. This type of Risk is called:
a) Price Risk b) Operational risk
c) Asset Liquidation risk d) Market liquidity risk
27) Recently, most of the Governments and Central Bankers went in to a major drive to support their major Banks and prevent their
failures. This is because; they wanted to avoid the contagion effect and "Systemic Risk". Systemic risk is the risk due to:
a) Failure of a bank, which is not adhering to regulations
b) Failure of two banks simultaneously due to bankruptcy of one bank
c) Where a group of banks fail due to contagion effect
d) Failure of entire banking system
28) Premature closing of a deposit will result in interest rate
risk of type________ :
a) Basis Risk b) Yield curve Risk
c) Embedded Option Riskd) Mismatch Risk
29) Daily volatility of a stock is 1%. What is its 9 days volatility?
a) 3% b) 9% c) 1% d) 4%
30) As per RBI guidelines, placement of volatile portion and core portion of saving and current deposit may be done as:
a) 10% volatile portion in day 1 time bucket and 90% core portion in 1-3 year bucket.
b) 15% volatile portion in day 1 time bucket and 85% core portion in 1-3 year bucket.
c) Volatile portion in 2-7 days time bucket and core portion in 1 year time bucket.
d) Left to each Bank
31) As per RBI guidelines on Asset Liability Management, the net cumulative negative mismatches during the day 1, 2-7, 8-14 and 15-
28 days buckets if exceed the prudential limits may be financed from market by:
a) Market borrowings ( call / term) b) Bills discounting
c) Repo d) All above.
32) As per RBI guidelines on placement of Assets and Liabilities in to various buckets for understanding and managing Interest rate
risks, Capital, Reserves and Surplus are to be treated as:
a) Non interest rate sensitiveb) Interest Rate Sensitive
c) Depends on the source of the capital
d) Only 50% should be treated as not sensitive to interest rates
33) UCP 600 with 39 articles is operative with effect from:
a) 1-7-2007 b) 1-1-2007c) 1-6-2007 d) 1-1-2008
34) All credits are ______ in UCP 600
a) Revocable b) Irrevocable c) Clean
d) Either Revocable or irrevocable as mentioned in the text of LC
35) Exchange of Fluctuation Risk policy of ECGC :
a) Covers all exports payments up to six months period
b) Covers 100% exchange fluctuation of Indian exporters
c) Covers exchange fluctuation above 2% and up to 35% only
d) None of these
36) Balances in NRO accounts can be freely repatriated out of India for permissible transactions up to a maximum of:
a) Rs. 1 million b) USD 1 million
c) Rs. 10 million d) USD 10 million
37) What is the ceiling for availing foreign currency by payment in Rupees in cash, for purchase of foreign exchange for any purpose?
a) Rs. 1 lac b) Rs. 5 lacc) USD 2000 d) Rs. 50,000
38) YTM of a Bond is also known as ___:
a) Internal rate of returnb) Current yield
c) Net present value d) All of the above
39) Duration is a not function of ____:
a) Time to maturity b) Coupon rate
c) Coupon frequency d) Principal amount
40) Which among the following is not an OTC item?
a) IRS b) FRA
c) Currency option d) Stock option
41) A Bond with coupon rate 7.35% is trading in a market where the market yield is 8.5%. Such a bond would be
trading ________ :
a) At a discount b) At a premium
c) At par d) Depends on the market
42) Which amongst the following is not a Credit risk mitigant?
a) Collateral security b) ECGC policy
c) Surety d) None of the above
43) Which of the following statement/s is/are correct?
I) Forward Contracts are primarily Over the Counter contracts
II) Futures are also Forward Contracts but traded on an Exchange
a) (I) is correct b) (II) is correct
c) Both (I) and (II) are correctd) Neither (I) nor (II) is correct
44) "Derivative" means an instrument, to be settled____, whose value is derived from change in interest rate, exchange rate, credit
rating or index, price of securities (called "underlying") or a combination of them.
a) At a future date b) At a rate fixed now
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c) On a given date/period d) All of the above
45) Derivatives can also be classified as _______ &
_______ based on where they are exchanged between the concerned parties:
a) Over the Counter (OTC) & Exchange traded
b) Exchange traded & Market traded
c) Over the Counter & Across the Counter d) Indian & Foreign
46) Different types of Derivatives in the "Foreign Exchange" and "Commodity" markets are:
a) Forward contracts b) Future contractsc) Options
d) Swaps e) All of the above
47) All Forward contracts with Rupee as one of the currencies, booked to cover foreign exchange exposures falling due, ____, can be
freely cancelled and rebooked.
a) Within one yearb) Within one month
c) Within six months d) Within one week
48) As a part of further developing the Derivatives market in India and adding to the existing menu of foreign exchange hedging tools
available to the residents, ____contracts have been permitted to be traded in recognized stock exchanges. a) Foreign Currency Futures b)
Foreign Currency Options c) Forward Rate Agreements d) All of the above
49) The items in a Bank's trading book are subject to ____ Risk while as the items in the Bank's Banking book are not :
a) Concentration Risk b) Funding Risk
c) Market Risk d) Credit Risk
50) ________ was introduced in India in August 2009 to
help Banks and other interested and eligible parties to hedge the interest rate risk:
a) Currency Futures b) Interest rate swaps
c) Interest rate futures d) All of the above
51) The main disadvantage with Future contracts is :
a) Counterpart risk is highb) These are illiquid instruments
c) No perfect hedge is provided d) All of the above
52) VaR is defined as the predicted worst-case loss at a specific confidence level, and:
A) Over certain period of time
B) Under normal trading conditions
a) A only b) B onlyc) Both A & B d) Either A or B
53) The process of utilizing different interest rates between two economies, through raising funds in low cost economy and lending
in high cost economy is called: a) Arbitrage b) ALM c) Benchmarking d) Embedded option
54) In calculating the capital charge for credit risk, Credit Conversion Factor (CCF) is used for the purpose of:
a) Estimating the NPA levels
b) Estimating the disbursals out of the sanctioned limits
c) Estimating the off-balance sheet commitments likely to
materialize d) All the above
55) If a bank is not maintaining the minimum required level of capital, RBI can resort to:
a) Increase the monitoring of the bank
b) Restrict the dividend pay-out
c) Require the bank to raise capitald) All the above
56) In India, type of options are permitted now:
a) American b) European c) Asian d) A & B
57) In the `Economic value" perspective, the focus is on:
a) Impact of interest rate changes on earnings
b) Assessment of the present value of its expected cash flows
c.Instruments that are not marked to market d)All of the above
58) Mr.Vipin is informed by his Dealing room that he should give them prior information to fund the Nostro account latest by Monday
the 25th. They would be buying the dollars through the Inter-Bank Spot markets and would like the information on hand latest by 2.00
PM. If that is the case,
rd
which is the latest possible time for Mr.Vipin to contact the Dealing room for funding the Nostro account:
a) Saturday -the 23 before 12.30 PM
nd
b) Friday —the 22 before 2.00 PM
st
c) Thursday-the 21 before 2.00PM
th
d) Monday-the 25 before 2.00 PM
59) Ms.Leela is the wife of Mr.Ramadas, an NRI customer. She wants to know whether her husband can put a FCNR deposit of USD
10,00,000 for 6 (six) years and whether he can get a loan against the deposit if need arises:
a) The FCNR deposit can be accepted for a minimum of 12 months and maximum of 60 months as per RBI rules
b) The FCNR can be accepted for six years and maximum 90% loan extended
c) The maximum loan against FCNR and NRE term deposits is — no limit now.
d) Ms.Leela should be informed of both a & c
60) Mr. Arun exports processed cashew nuts. He first imports them from Russia as raw kernel, processes them and exports them to
USA. His buyers want to establish a Letter of Credit in his favor. He wants to include a clause in the LC that allows him to draw
some advance against the LC to pay for the raw cashew imports. Mr. Mihir should advise him to:
a) Get a Green clause LC b) Get a Back-to-Back LC
c) Get a Red clause LC d) Get a restricted LC
1 A 2 C 3 D 4 C 5 B 6 D 7 D 8 C
9 D 10 A 11 A 12 B 13 A 14 B 15 C 16 B
17 C 18 C 19 B 20 B 21 C 22 C 23 B 24 D
25 A 26 C 27 D 28 C 29 A 30 A 31 D 32 A
33 A 34 B 35 C 36 B 37 D 38 A 39 D 40 D
41 A 42 D 43 C 44 D 45 A 46 E 47 A 48 A
49 C 50 C 51 D 52 C 53 A 54 C 55 D 56 D
57 A 58 C 59 D 60 C
MISC. RECALLED QUESTIONS
1) According to which of the following concepts even the proprietor of the business is treated as a creditor of the business: a) Money
Measurement Concept b) Cost Concept
c) Dual Aspect Concept d) Entity Concept
2) Identify from the following statements, one statement which is not concerning to market analysis: a) Production possibilities and constraints b)
Consumer behavior, intentions, motivations,
attitudes, preferences and requirements cr Extent of competition and market share d) Suitability of production process
3) From the following sources of finance, find out the free source of finance :
a) Equity Capital b) Preference Capital c) Retained Earnings d) None of the above
4) From the following information, compute the operating cycle of LMP Ltd.-No of days the raw material remain in stock is 60 days, suppliers credit
available for 15 days, production time 15 days,
finished goods inventory period 15 days, realization from customers takes 25 days. The operating cycle therefore would be :
a) 115 days b) 100 days c) 75 days d) 85 days
5) If the fixed and variable cost at 50% production capacity is Rs.20000 and Rs.30000, respectively, the total cost at 70% capacity will be:
a) Rs.50000 b) Rs.62000 c) Rs.70000d) Rs.58000
6) Commercial paper is a short term usance promissory note with fixed maturity period, issued by : a) Corporates & primary dealers b) All
India financial Institutions
93
c) (a) and (b) above d) None of the above
7) VK Enterprises has given you the following information. The Re-order level 4000 units, minimum usage 300 units per week, minimum lead time 2
weeks and re-ordering quantity 2000 units.
The maximum stock level of VK Enterprises should be :
a) 1900 units b) 5400 units c) 2900 unitsd) 4000 units
8) Ws Rastogi Ltd. are selling designer furniture to top customers. There is no direct competition for their product. They are negotiating a big
order from one wealthy business magnate.
While giving the quotation they should follow --:a) Conversions cost pricing method b) market based pricing c) Marginal cost pricing
d) full cost pricing
9) Under cash budget system method, working capital is determined by:a)Ascertaining level of current assets b)Ascertaining level of current liabilities
c)Finding cash gap after taking in to account
projected cash inflows and outflows d) All of the above
10) IRR is calculated for one of the following purposes:a) Working capital finance b) Pre-shipment finance c) Project finance d) Post shipment
finance
11) Actual Sales minus Break Even Sales means: a) Profit on sales b) Margin of safety sales c) Loss on sales d) Sales at which no profit or no
loss is resulted
12) Conversion cost is calculated on the basis of following formula:a) Direct Material plus Direct Labour b) Direct Material plus total overheads c)
Direct Labour plus direct overheads
d) Direct Material plus Administrative Cost
13) Under which method, the cost s are classified under fixed and variable cost and only variable costs are charged to products while fixed cost
are written off to Profit and Loss Account
a) Standard costing b) Marginal Costing c) Absorption costing d) Job costing
14) The following statements are pertaining to Letter of Credit (LC). One of the statements is wrong. Choose the wrong statement
All letters of credit in India relating to the foreign trade are subject to provisions of 'Uniform Customer and Practice for Documentary Credit'.
a) The provisions of UCPDC have the status of law The parties to a LC bind themselves to UCPDC provisions by specifically agreeing to do.
b) The UCPDC provisions help to arrive at unambiguous interpretation of terms used in LC
15) Which of the following is not part of working capital management? A)Credit period to buyers b)Proportion of current assets to be financed by long term
debt c)Dividend payout d) Cash credit limit
16) In an operating cycle which of the following is not there a) Acquisition of raw material b) Acquisition of power c) Acquisition of consumables d)
Conversion of raw material into work-in-progress
17) A low current assets ratio implies one of the following a) Greater liquidity & lower risk b) Poor liquidity & higher risk c) Greater liquidity &
greater risk d) Poor liquidity & lower risk
18) Financing temporary current assets with short term finance and permanent current assets with long term finance refers to:a) Matching
approach b) Conservative approach
c) Casual approach d) Conservative approach
19) The formula for Economic Order Quantity (EOQ) (A=stoc.. usage, C = cost of ordering, H= cost for holding stock per unit)
.
a) N.I2AC/H b) J2ACH c) q2CH/A dl -30-17.2
20) If a buyer of goods gets a discount of 1.5% on a supply of Rs. 100. if the amount is paid within 10 days where the normal credit period is 50 days.
What is the annualized benefit to the
buyer if he pays within 10 days. a) 12.75% b) 13.69% c) 14.21% d) 13 65:i:
21) Which of the following is not a risk involved in carrying inventory a) Obsolescence of the product b) Physical deterioration in the goodsc)
Price fluctuation in the product d) Increase in the price of raw material
22) Factoring means: a) Another entity buys your debts b) Another entity buys your credits c) Another entity loans an amount to you d) None of
the above
Q. 23-26: CHI Ltd. manufacturers two products: Product G and Product H. The Variable cost of the manufacture is as follows:
Product Product
Direct Material 3 10
Direct Labour (Rs.6 per hour) 18 12
Variable Overhead 4 4
Product G sells for Rs.40 and Product H at Rs.30. During the month of January, the Company is having only 21000 of direct labour. The maximal
production capacity of Product G is 5000 units and
Product H is 10000 units From the above facts, answer the following:
23) The contribution from Product G and H together is:
a) Rs.32 b) Rs.19 c) Rs.27 d) Rs.40
24) The contribution per labour hour from Product H
a) Rs. 4 b) Rs. 2 c) Rs. 3 d) Rs. 5
25) The contribution per labour hour from Product G is
a) Rs.2 b) Rs.5 c) Rs.15 d) Rs.3
26) The company can maximize profit if it can choose one of the following combination: a)Product G- 3500 units and Product H -5250 units
b)Product G- 5000 units and Product H -3000 units
c)Product G- 4500 units and Product H -6000 units d)Product G- 4000 units and Product H -4500 units
Q. 27.28) A Company producing a single product sells it at Rs. 100 each. The marginal cost of production is Rs 60 each and fixed cost is Rs.40000. Answer the
following questions from this information:
27) The amount of sales to earn a profit of Rs.50000 a) Rs.225000 b) Rs.125000 c) Rs.500000 d) Rs.90000
28) The new break even sales if sales price is reduced by 10% a) Rs 100000 b) Rs .120000 c) Rs.90000 d) Rs.110000
Q. 29) Three Investment projects have the following net cash flows. Decide which of them should be accepted using the payback period
method.
YEAR PROJECT PROJECT PROJECT Project D
0 (10000) (15000) (20000) (30000)
1 5000 5000 10000 0
2 5004 5000 10000 0

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3 20000 5000 4000 100000
4 1000 10000 2000 120000
5 - 5000 - 60000
Project D b) Project A c) Project C d) Project B
Q. 30-31): The cash flow in respect of two projects is given below. The cost of capital is 12%, the discount factor of 12% is also given.
Year Proj Projec Discount Discount Factor @
ect t Factor @ 16%
0 (200) (300) 1 1
1 60 100 0.8929 0.8620
2 60 100 0.7972 0.7431
3 60 90 0.7118 0.6406
4 60 70 0.6355 0.5522
5 60 70 0.5674 0.4761
Answer the following question using the above information. 10) What is the NPV of Project A (in Rs.):a) 216.29 b) 16.29
c) 200 d) 182.24
31) What is the NPV of Project B (in Rs.):a) 260,28 b) 300 c)17.27 d) 71
32) What is the Profitability Index of Project A:a) 1.30 b) 1.08 c) 1 d) 0.91
33) What is the Profitability Index of Project B:a) 0.86 b) 1 c) 1.06 d) 1 23
34) What is IRR of Project A:a) 15.24% b) 14,24% c) 16.24% d) 14.50%
35) Net Interest income is:a) Interest earned on advances b) Interest earned on investments c)Total interest earned on advances and investment
d)Difference between interest earned and interest paid
36) Interest rate risk is a type of:a) Credit risk b) Market risk c) Operational risk d) All the above
37) In order to decrease reinvestment risk, banks try to match ---------------of their assets and liabilities:a) Maturities b) Interest rates
c) Duration_________________ d) Yield of maturity
38) Cash is treated as a item while placing in the Interest rate sensitivity chartibuckets as per RBI guidelines.:a) 3-6 months bucket b) Up to
one month bucket
c) Non-sensitive d) Over 3-5 year bucket
39) The June 1999 Basle Committee on Banking Supervision issued proposals for reform of its 1988 Capital Accord (the Basle II Proposals).
These proposals contained MAINLY.
I) Settlement risk management Ii) Capital requirements
111) Supervisory review IV) The handling of hedge funds
V) Contingency plans VI) Market discipline
(a) 1,111 and VI (b) II, IV and V (c) 1,IV and V (d)11,111andVI
Case Study — I
You are working as a Middle Level Executive with 'Modern Bank Ltd.,' The MIS Department has submitted the following Statistics from
which you are required to
estimate the likely Capital Funds required by the Bank as of March, 31st, 2007 taking into account the Basel II implementation compliance.
i) Risk-Weighted Assets for Credit Risk likely to be Rs 53,889.50 crores
ii) Capital Allocation for Markel Risk to be Rs.100/- crores
For Operational Risk following Data available. The bank is required to calculate Capital Charge for Operational Risk by Basic Indicator
Approach. (Amount in Crore)
Year 31-03-2008 34t13.21S 31-113-2.:
Gross Income 2600.00 WOO 341310.0.:
Note: Capital Adequacy prescription apprec&ileIntim Banks has to be
considered for calculation. Answer the following ire quInicets baser on above facts.
40) In the process of Assets & Liabilities Management, Price (Interest) matching is used to assess whether an institution is in a position to
benefit for raising interest rates through 'Positive Gape.
Positive Gap means:a) Assets > Liabilities b) Liabilities > Assets c) Either (a) or (b) d) None of the above
41) The Basel Committee has defined gross income as net interest income and plus net non-interest income and has allowed each relevant
national supervisor to define gross income
in accordance with the prevailing accounting practices. Accordingly the Reserve Bank of India in the draft guidelines issued on 11.03.2005 for
implementation of the new capital adequacy
framework has modified the Gross Income definition slightly. The Net Interest Income has been replaced by:a) Net Profit b) Operating
Profit c) No Changes made d) Interest Expended
42) Based on the Gross Income given above, the likely Capital Charge for Modern Bank Ltd., as on March 31, 2007 to cover Operational Risk
under Basic Indicator Approach shall be:
a) 375 crores (b) 540 crores (c) 450 crores(d) 360 crores
43) The Modern Bank Ltd., will require total Capital Funds for coveringCredit Risk. As on March31,2007 to comply Basel II norms of
Rs.____crores.:a) 5400 crore b) 4500 crores
c) 4800 crores d) 4311.16 crores
44) The Modern Bank Ltd., should have minimum of Rs. Crones asTier I capital at the rate of minimum of % respectively as per RBI
guidelines applicable to Indian Banks.:
a) 2250.450%b) 2700,4.50% c) 2400, 4.00%d) 2400,800%
45) Which of the followings constitute liabilities for the bank a) Paid-up Capital b) Reserves c) Deposits from Public d) All of these
46) What liquidity means in the context of a bank a) Capacity to meet cash demands b) Creation of confidence to depositors c) Capacity to
meet refinance obligations.................. d) All of these
47) Which of the following is correct for 'money at call & short notice' : a) It is a low earning asset b) Money is traded for a short period
c)Transactions are among Nationalised Banks only
d)Transactions are among Private Banks only
48) Which of the following is not a contingent liability of the bank a) LC issued b) LC Confirmed c) LC Devolved d) Standby LC
49) What is incorrect as regards ALM :_________:a)it is Management of NIM b)Basic focus on Demand Deposits growth c)Control of
interest income & expense d)Management of mix & volume of Assets &Liabilities
50) What does Net Interest Margin signify •a)Tool to measure impact of volatility on short term gains b)Net Interest Income divided by
Average Total Assets c)Spread on Earning Assets d) All of these
51) Which of the followings is incorrect a) Higher the risk higher the reward b) Higher the turnover higher the profits c) Higher the spread

95
higher the risk exposure
d) Higher the credit higher the interest income
52) Under ALM which of the following is not relevant for profit planning:a) Tax reduction b) Generating fee based income c) NPAs d) Capital
Adequacy
53) Interest Rate Risk can be classified into risk.a) Mismatchb) Basis c) Net Interest positiond) Any of these
54) A mismatch may result in a gain if a) If Interest rates move up b) If Interest rates move down c) Neither of the two d) Either of the
two
ANSWERS:
Q A Q A CI 0 /1 A QT
1 D 2 D 3 D 4 B 5 B 6 r
7 B 8 D 9 C 10 C 11 B 12 C
13 B 14 B 15 C 16 B 17 B 18 A
19 A 20 B 21 D 22 A 23 B 24 B
25 B 26 C 27 A 28 B 29 C 30 B
31 C 32 B 33 C 34 A 35 D 36 B
37 C 38 C 39 0 40 A 41 A 42 C
43 A 44 B 45 D 46 0 47 13 48 C
49 B 50 0 51 A 52 A 53 D 54 D
Practice makes a man
b) Raw material
MISC RECALLED QUESTIONS
1) RBI has put in place real time gross settlement system (RIGS) to mitigate the following risk:a) Market risk b) Settlement riskc)
Operational risk d) Strategic risk
2) In banking, contractual or relationship obligations means:a) New loan demands b) Existing loan commitments c)Withdrawal of
deposits by customers d)All the above.
3) European option can be exercised on any day at the option of the buyer on or before the expiry of the option.:a) Trueb) False
4) Risk of having to compensate for non-receipt of expected cash flows by a bank is called:a) Call risk b) Funding risk c) Time risk d)
Credit risk
5) 'Time risk' in the context of liquidity risk of an institution 4 caused due to:(a) Systematic risk b) Swaps and options c) Loss of confidence
d) Temporary problems in recovery
6) Crystallisation of contingent liabilities in a bank is called:a) Call risk b) Funding risk c) Time risk d) Credit risk
7) If the volatility per annum is 25% and the number of trading days per annum is 252, find the volatility per day.:
a) 1.58% b) 1.60% c) 158% d) 15.8%
8) Economic Equity Ratio is used to assess sustenance capacity of the bank. It is calculated using the formula:a)Net Interest Income /
Shareholder Funds b)Total Income / Shareholder Funds c)Shareholder Funds / Total of Assets & Liabilities d)Shareholder Funds / Total
Assets
9) Net Interest Income is:a)Interest earned on loans and advances only b)Interest earned on investments only c)Total interest earned on
advances and investment d)Difference between interest earned and interest paid
10) As per existing norms, Banks in India can borrow funds from the following: a) Reserve Bank of India b) Consolidated fund of Govt of
India c) Capital Market d) None of the above
11) Investment made by a bank in its subsidiary is considered in the following category in its balance sheet:a) Secured advances
b) Other assets c) Investments d) Unsecured advances
12) When a bank sanctions a loan to a large borrower, which of the following risks it may not face_____:a)Liquidity b) Market c) Credit
d) Operation
13) Net interest income (Nil) is calculated using the following formula: a)Interest income - Total expenses b)Total income - Interest
expenses c)Interest income - Interest expenses d)Total income - Total expenses
14) N.I.M. calculated using the following formula:a)NII /Average total liabilities b)NII /Average Total Assets c)Total Interest Income
/Average Total Assets d)Total Interest Income /Average Total Liability 15)A bank is having Rs
500 Crore liabilities @ 7% of one year maturity to fund Rs 500 Crore assets @ 9% with 2 year maturity. The bank is exposed to:a) Gap Risk b)
Basis Risk c) Price Risk d) Yield Curve Risk
16)Interest rate risk is a type of: a) Credit risk b) Market risk c) Operational risk d) All the above
17)If you as a customer sell a Forward Rate Agreement (FRA), you are protecting against a fall in interest rates:a) TRUE b) FALSE
18)Following is the most important item on the asset side of a bank's balance sheet:a) Fixed Assets b)Cash& balances with RBI c)
Investments d) Advances
19)Basel II Accord is based on three pillars viz (I) Credit risk (ii) Market risk (iii) Operational risk.:a)TRUE b) FALSE
20)If Regulatory Authority of the country feels that the Capital held by a bank is not sufficient, it could require the bank to :a)
Reduce its Risk b) Increase it's Capital c) Both of these d) Either of these
21)Advance in the form of pledge should not be granted in respect of :a) Stock-in-process b) Raw Material c)Finished Goods
22)In which of the following methods of capital budgeting annual returns of the future years are discounted to their
present value ________ :a) Pay back period b) Internal rate of return c) Present value method d) Both 'a' & 'c'
23)Bonds may be secured by_______ :a) Floating charge on assets b) Fixed charge on assets c) Without charge d) All of these
24)A firm has an opening of stock of Rs.70.000, Closing stock of Rs.90,000 and Cost of goods sold Rs.2,40,000. What the Inventory Turnover
Ratio?:a) 5 b) 4 c) 3 d) 2
Based on the following information, solve questions 25&26.
Credit Sales - Rs.3,00,000
Opening Balance of Accounts - Rs 40,00
Closing Balance of Accounts - Rs. 60,00
Credit Purchases - Rs.1,80,000
Opening Balance of Account - Rs. 20,00
Closing Balance of Accounts - Rs. 40,00
25)The Debtors' Turnover Ratio is:a) 6 b) 8 c) 10 d) 12
26)The Creditors' Turnover Ratio is:a) 8 b) 6 c) 4 d) 2
27)To solve a standard maximization problem using the simplex method, we take the following steps: which are jumbled. Mark
the correct order of steps.
96
Step 1: Determine which variable to bring into solution.
Step 2: Determine which variable to replace
Step 3: Formulate problem in terms of an objective function and
a set of constraints
Step 4: Update remaining Row values Compute new z
Step 5: Calculate new row values for entering variable and insert
into new tableau
Step 6: Set up initial Tableau with slack variables Step 7: If there
is no positive (c-z) value found, the solution is optimum. If there is a positive value, then iterate again (repeat earlier three steps).
Choose the correct sequence of steps.:a) 3,5,4,5,7,1,2 b) 3,6,2,1,5,4,7 c) 3,6,2,1,4,5,7d) 3,6,1,2,5,4,7 28) Which of the
following is not a motive for the companies to hold cash?:a) Transaction motive b) Precautionary motive c)Lack of proper synchronization
between cash inflows & outflows d) Capital investments 29) VaR means: a) Volume of Business at Risk b)
Value at Risk c) Volume on Risk d) Value as Risk 30) In an inflationary trend, the pricing of the bank
products:a) Decreasing trend b) Constant c) Increasing trend d) No relevance
31) Credit Risk Assessment of the borrowal units is for:a)Assessing the repayment capacity b)To fix the pricing of the product c)To
review the units performance d) None of the above 32) Pricing is equals
to_____:a) Cost of the product b) Break Even Point of the firm c) Function of Risk rating d) All of the above
33) The bond prices can be estimated using modified duration. The formula for calculating % change in price of a bond
is:a)Modified duration x yield change b)Yield change /modified duration c)Modified duration / Yield change d)Modified duration + Yield
change 34) If both the regression
coefficients are negative, thecorrelation coefficient would be__________:a) Positive b) Negative c) Zero d) None
35) The most frequently used average is________:a) Mode b) Median c) Mean d) Geometric Mean
ANSWERS
1 B 2 D 3 B 4 C 5 C
6 A 7 A 8 9 10 A
D D
11 C 12 B 13 C 14 B 15 A
16 B 17 B 18 D 19 B 20 C
21 A 22 D 23 D 24 C 25 A
26 B 27 D 28 D 29 B 30 C
31 B 32 C 33 A 34 ,B 35 C
MISC RECALLED QUESTIONS :
36)Which of the following is not a Derivative Instrument:a) Interest Rate Swap b) Currency Swap
c) Treasury Bill d) Options
37)Some times dealers resort to simultaneous purchasing and selling of different securities such that the composition of portfolio can be
changed without significant cost. Such deals are called ___:a) Arbitrage Deals b) Swap Deals c) Switch Deals d) Option Deals
38)ABC Bank has made an Investment in its subsidiary. This is considered in the following category in its balance sheet____:a) Secured
advances b) Otner assets c)Investments d) Unsecured advances
39)Liquidity is measured by grouping assets and liabilities based on their____:a)Pricing b) Risk weight c) Maturity. d) Amounts
40)______ not forming part of Assets of a Bank in its balance sheet:a)Reserves and surplus b)Investments c) Fixed assets d) Balance with RBI
41) Which of the following is notan Off-Balance sheet item:a)Letter of Guarantee issued b) Letter of Credit issued c) Demand Draft issued
d) Option forward contract issued
42) In the process of Assets & Liabilities Management, Price matching is used to assess whether an institution is in a position to benefit for
raising interest rates through "Positive Gap". Positive Gap means:
a) Assets > Liabilities b) Liabilities > Assets c) Either (a) or (b) d) None of the above
43) In an Option contract, where the buyer of a contract has the right but not the obligation to sell a currency at a predetermined price during
the contract period is called :a) American Put option b) American Call option c) European call option d) European put option
4.4) The risk of large outflows of funds from a banking institution due to unanticipated withdrawals or non-renewal of deposits is called:a)
Deposit risk b) Call risk c) Funding risk d) Money risk
45) The Off-Balance Sheet items are treated as items that give rise to:a) Currency Risk b) Credit Risk c) Contingency Risk d) Liquidity Risk
46) Net interest margin is also called the Spread on earning assets. It is measured by:a)Interest income/Interest expenses b)(Interest income
— Interest expenses) / 100 c)Interest income / Average total assets d)(Interest income—Interest expenses)IAverage total assets
47) Stock Approach and Flow Approach are used to measure and manage which aspect of bank:
a) Liquidity Riskb) Market Risk c) Operational Risk d) Strategic Risk
48) The translation exposure is also known as 'Notional' due to the following reasons:a) As there is no cash flows b) Since these are
related to one transaction c) Both (a) & (b) above d) Either (a) or (b) above
49) Objective of the liquidity management is to :a)Ensure profitability of banks b) Protect banks from reputation loss c) Create the maturity
ladder of assets and liabilities d) None of the above
50) The most common means of hedging transactions in foreign currency in Indian markets is:
a) Swaps b) Options c) Forward Contracts d) Money market instruments
51) When the costs/yields of liabilities/assets are linked to a floating rate and there is no simultaneous movement in interest rates, it leads to:a)
Real interest rate risk b) Basis risk c) Reinvestment risk d) Volatility risk
52) The effective interest rate on a Repo transaction should be:a)Higher than the corresponding money market rate b)Lower than the
corresponding money market rate c)Equal to the corresponding money market rate d) None of these
53) If a dollar-yen transaction takes place between Bank A and Bank B in Mumbai then:a)II will give nse to settlement risk for only bank A
b)It will give rise to settlement risk for both the banks A&B c)It will give nse to settlement risk for bank A or bank B d)It will not give nse to
settlement risk for either banks
54) Given the remaining maturity is the same, which among the following will have the longest duration?:a)Bonds with half yearly coupon
rates b)High Coupon Bond trading at premium c)Low Coupon Bond trading at discount d) Zero Coupon Bond
55) Monitoring and control of risks as per bank's approved policies and strategies is the responsibilities :a) Board of directors b) Senior
management c) Front line staff d) All of the above
56) Exchange rates of currencies depend on the following factors :a) Demand ; supply b) Inflation i interest rates c) Political environment dl
All of the above
57) Portfolio Risk is always less than the weighted average risk of all the individual items due to : a)Risk in all items is not simultaneous
b) Risk is not unidirectional cl Diversification effect d) All as above
58) The failure of a single bank generates a risk of failure for other banks also due to:a)There is no risk of failure to other banks b)Other banks
failure risk s independent of defaulting bank c)Ongoing commitments with the defaulting bank d) Other banks became strong due to decrease
in competition
59) Within Savings Bank how much is generally treated as volatile:a}5%b)3% c)10%
60) The right to buy is called a Tut Option' & the right to selldislc2alled a'Call Option' a) True b) False
61) RISK PRICE = Cost of Funds + Transactional Costs + Capital Charge + Loss Probability:a)Yes b) No
c) Depends upon Accounting Method d) Depends upon RBI Policy
62) Maximum risk weight for an NPA is to be at: a) As per Provisioning Norms b) 100% of Gross NPA
c) 100% of Net NPA d) 150%
ANSWERS
36 C 37 B 38 C 39 C 40 A
41 C 42 A 43 A 44 C 45 C
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46 D 47 A 48 A 49 A 50 C
51 B 52 B 53 B 54 D 55 B
56 D 57 D 58 C 59 C 60 B
61 A 62 0
1) Mr Gopal is in the CHILD state when he complains to his wife that the work pressure is killing him at office. He wants to be comforted by
the "nurturing parent" in his wife. She however informs him that she had seen him sitting freely and reading newspaper at 11.00 AM in his
office. Her ego state is that of an adult. The statement made by her is based on facts that she has seen. Mr. Gopal gets upset and starts shouting.
What kind of transaction is this?:a) Complimentary transaction b) Cross transaction
c) Unnecessary transaction d) None of the above
2) Attitude changed can be tried through: a) Influence of friends and peers b) Opinion leadersc) Co-opting the people in the decision
making process d) All the above
3) Arrange in the ascending order the following career roles: Sponsor, Colleague, Apprentice and Mentor: A)Mentor. Colleague, Apprentice,
Sponsor b)Colleague, Mentor, Sponsor. Apprentice C)Apprentice. Colleague, Mentor, Sponsor, d)Sponsor. Colleague, Mentor Apprentice
4) Mr. A, a senior citizen arrives in the Bank in a foul mood. He complains that it is very hot outside. The Manager points out that the heat is in
fact lesser this year in comparison with last year. Mr. A gets up and goes away irritated. How do you classify this transaction as per Eric Berne's
Theory of Life Positions? a) Mr A was in critical parent ego state b) Manager was in adult ego state
c) It was a crossed transaction d) All are correct
5) Edgar Schein gave another framework for career concepts. They are three dimensional concepts. They are called Radial, Circumferential
and_____ concepts.: a) Horizontal b) Vertical c) Linear dl Parallel
6) Mohan is a branch manager of ABC Bank is in scale I. He works in a branch that predominantly has only SB I Current accounts. Upon
attaining scale It, he is posted to another branch which has Advances, Foreign exchange along with SB and CD. His designation continues to be
as Manager only. This kind of movement is called: a) Functional b) Horizontal c) Spiral d) a & b
7) The concept of Career Path relates to of movements and deciding the for each stage.: a) Sequence, time period b) Number,
candidatesc) Decision, number d) Type, time period
8) Every person has his or her personal feelings, perceptions and motives which make them take a particular career path. These are called : a)
Career plans b) Career ambitions c) Career dreams d) Career anchors
9) In deciding a Career Path for the organization's employees the HR department has a__________major responsibility. They have to:
a)Define career stages in relation to the organizational levels b)Identify core jobs at each level c)Define and spell out criteria for each
successive level d)Placements in the next role el All of the above
10) Out of the following which is not the mutually reinforcing pillar as per Basel II revised framework: a) Minimum Capital Requirement b)
Supervisory Review Process c) Market Discipline d) Asset Classification
11) Consumer's surplus is highest in case of: a) Luxuries b) Necessities c) Comfcrts d) Conventional necessities. 12)
A fall in the price of a commodity whose demand curve is a rectangular hyperbola causes total expenditure on the commodity to: a) Remain
unchanged b) Increase c) Decrease d) Any of the above 13) Multiple uses
of a commodity will make the demand go up when:a) Price increases b) Price remains the same c) Price falls down d) None of the above
14)Gross National Product is greater than gross domestic product when: a)NFI (from abroad) > 0 b) NFI < 0 c) NFI z 0 d) NFf =1 15)
Devaluation means: a) Fall in Marginal utility of Money b) Fall in pnnting of currency c)Risk in black money d)Fall in the value of money in
terms of foreign currency
16) Inflation means: a) Increase in price b) Decrease in value of money.c) Boom d) a and b.
17) The goals of monetary policy do not include:a) Maximum output b) Full employment c) Price stability d) Maximum tax revenue
18) Which of the following is not a fiscal monopoly? : a) Printing of currency b) Minting of coins c) Electricity supply d) None of the above
19) Essential services owned and controlled by government is called: a) Public monopoly b) Public utility c) Public Sector d) All of the above
20) Spread is the difference between: a)Average Cost of Deposits and Yield on Advances b)The Confessional Rate offered by the
Commercial Banks to Corporates c)Interest + Exchange + Commission + discount d) All of the above
21) VaR means: a) Volume of business at Risk b) Value at Risk c) Volume on Risk d) Value as Risk
22) In an Inflationary trend, the pricing of the bank products are:
a) Decreasing trend b) Constant c) Increasing trend d) No relevance
23) Choose from the following a symptom which is not relating to "Over Trading".:a) Cash shortage b) Low inventory turnover ratio c) Low
current ratio d) High inventory turnover ratio
24) The Over valuation of the stock would result in:a) Better Quick Ratio. b) Beller Current Ratio c)l Decrease Acid Test Ratio d)
Improve the acid test ratio
25) If a Company revaluates it fixed assets, the Current ratio of the company will? : a) Will improve b) Will remain unaffected c) Will undergo
change d) None of these
26) For Foreign banks,lending is not mandatory under priority sector advances: a) Agriculture b) Exports c) Both d) Neither
27) Finance provided to the selected dealers of the identified corporate is known as: a) Supply chain financing b) Channel Financing c)
Securitization d) a and b
28) The Limitation period in respect of term loan is : a)3 years from the due date of each loan installment b)3 years from date of disbursement
c)12 years from sanction date d) 12 years from Disbursement date
29) As a part of the Fair Lending Practices Code, Banks and Fls advised to invariably furnish a along with a copy each of all the enclosures at
the time of disbursement.: a) Copy of the lOan agreement b) Copy of their own B/S c) Copy of their NPA Policy d) All of the above
30) Right of a Creditor to retain possession of goods till debts due to him are paid by his debtor is called : a) Pledge b) Lien c) Set off
d) Assignment
31) No Frills' delivery of banking services at an affordable cost to the vast section of disadvantaged and low income groups is called:a) Vanilla
Banking b) Financial Inclusion c) Financial Exclusion d) Social Service
32) A border patrol checkpoint that stops every passenger van is using:a) Simple random sampling b) Systemic sampling c) Stratified
sampling d) Complete enumeration
33) Basis point value (BPV) is one of the methods of measuring risk involved in dealing with bond markets. BPV method: a)Measures the
change in the asset value per 0.01% change in market yield b)Higher the BPV, lower the risk in the instrument c)Higher the BPV, higher the risk d)a
&b e) a & c
34) Value at risk (VaR) is arrived at using: a) Best-case scenario b) Worst-case scenario c) Assumes Nonal trading conditions d) b & c
35) Monte Carlo method is one of the three methods of calculating Value at Risk. This method: a)Calculates the change in the value of the
portfolio using randomly generated price scenarios b)The user of this model essentially uses his own views and experience to generate outcomes c)a & b
d)Uses actual historical movements (past data).
36) Back Testing is done (for evaluating risks in a bank's trading book) by: a)Comparing actual performance of the portfolio on continuous basis with
the VaR model being used b)Checking whether real or actual figures fall within the bands stipulated by their VaR models c)If the model performs
poorly (i.e. actual yields or valuations do not fall within the model's prescriptions), probing the causes thereof d)All of the above
37) Simple Sensitivity test, Scenario Analysis, Maximum loss, Extreme value theory are some of the techniques for stress testing of a trading book
portfolio. Scenario analysis means: a)Testing short-term impact of a particular market with factor. b)Shocks that may affect a number of market risk factors
simultaneously in an extreme event c)Identifying the most potentially damaging combination of market risk
factor moves.d) All of the above.
38) If a Treasury officer in a bank has purchased 1000 shares of Wipro at Rs. 4401- and writes in his report that VaR in the transaction is Rs. 33,360/- it
means that: a)Potential loss under normal market condition is Rs. 33,360l- b)Potential loss under extreme market condition is Rs. 33,360z- c)Potential loss if
the price falls daily by 1% is Rs. 33,3601- d)Potential profit in the transaction is Rs 33,3601-
39) Under normal market conditions in India, if a bank purchases equity on a Friday evening at closing hours, the defeasance period is number
98
of days.: a) 1 b) 2 c) 3 d) 4
40) In its credit portfolio, a bank can incur concentration risk. Concentration risk means: a)Excess exposure to individual borrower / group b)Excess
exposure to a single industry c)Excess exposure in the same geographical area d) All of the above.
41) The Reserve Bank of India has issued instructions and guidance notes to banks regarding credit rating of the borrower accounts. In the credit
rating models so envisaged, rating migration refers to: a)Migration of the borrowers from one bank to another b)Migration of borrowing accounts from one
rating to another. C)Both of the above d) None of the above
42) In credit risk models Altman's Z score of •:a)Uses 5 financial ratios using reported accounting information and equity values b)Forecasts the
probability of a company entering bankruptcy within the 12 month period c)Estimates volatility in the value of assets due to changes in the quality of these assets
d) a & b
43) In Credit Metrics developed by JP Morgan group, volatility is computed by: a) Tracking the probability that a borrower might migrate (from one
rating to another) b) Actuarial calculations of expected default rates c) Both a & bd) None of the above
44) A bank's credit rating system for its borrowal accounts should incorporate: a) Financial analysis b) industry management risks c) Projections
and sensitivity analysis d)l All of the above
45) Risk-return pricing is fundamental to risk pricing. It should have the following: a)Weak borrowers (high risk) should pay a higher price (interest
rate) b)Probability of default should be taken in to account c)Future business prospects should not influence the Pricing
d)a & b only
46) Quantitative ceiling on aggregate exposure in specified rating categories is one of the methods of: a)Minimising concentration risk exposure to
specific industry b)Maintaining the quality of the credit portfolio c)a & b d) None of the above
47) There is change in the demand for traditional loan products i.e., credit requirements now. This is due to : a)Increased disintermediation (more
companies accessing capital from primary / subsequent issues) b)Increased liquidity in the market (excess supply) c)a&bd)Individuals ! Corporates are
borrowing less
48) If an officer of a bank is to be designated as a Loan review officer: a)He should have passed Law b)He should have sound knowledge in credit appraisal
/ procedures / legal aspects of lending c)He should have worked in Regional office, Credit department d)He should be conversant with capital markets
49) In the context of Securitisation, 'A clean up call' means: a)An option that can be exercised calling in of the securitisation exposure before all the
underlying exposures have been paid b)Nullifying the securitisation portfolio and not entering in to new positions c)Both a & b d) None of the above
50) Credit Derivatives are : a)Off balance sheet items b)Transfer the credit risk to the investor without transferring the underlying
Assets c) Both a & b d) Are generally exchange traded
51) Basic Indicator Approach, Standardised Approach are two of the three methods of operational risk quantification. The third method is: a)
Scenario analysis b) Sensitivity analysis c) Advanced measurement approach d) Beta calculation method
52) A Time Series consists of data arranged : a)Timely b) Chronologically c) Haphazard d) None of these
53) National Income is based on: a) Total Production x prices b) Rent + wages + Interest + Profit c) Domestic Income NFI d) The sum of all factor
incomes e) All the above
54) The CDR Mechanism is designed to facilitate restructuring of advances of borrowers. It is an organizational framework institutionalized for
speedy disposal of restructuring proposals and is available to all borrowers engaged in any type of activity subject to:a)Credit facilities from more than
one bank / Fl b)The total outstanding (fund-based and non-fund based) exposure is Rs.10 crore or above c)Both of the above d) Either of the above
55) In a Consortium account financed by A, B and C, the account is NPA in the books of bank B and it is performing in bank A and C. The statusof
account with bank A and C would be : a) Standard b) NPA c) Special watch category d) Depends on each Bank's policy
56) CDR empowered group would approve the package within a time frame of , or at best within days of reference: a) 45. 90 b) 90,120 c)
90,180 d),180,270
57) The firm has Current Assets of Rs.100 lacs and Current Liabilities of Rs 50 lacs. The Quick Ratio is 1.50:1. What is the amount of inventories? :a) 20
lacs b) 25 lacs c) 30 lacs d) 35 !acs
58) Financial products, whose prices are derived from the price of an underlying currency, interest rate. stocks etc. are called: a) Swapsb) Option
c) Derivatives d) Securitisation e) Factoring
59) Revaluation reserves are a part of: a) Pad-up capital I Tier I capitalb) Supplementary capital / Tier II capital of Gross capital c)Core capital d)
None of these
60) In loan cases where repayment of the major or large part of a loan is stipulated in a single payment following payment of smaller instalment
is referred as: a) Balloon payment schedule b) Equated payment schedule c) Buffet payment schedule d) None of the above
61) The Open Market Operations (OMO) refer to the sale and purchase by the RBI of: a) Foreign exchange b) Gold c) Government securities
d) All of the above
62) The domestic Commercial Banks have a target of % for total priority sector measured as a percentage of ANBC or CE-OBE
whichever is higher. a) 32% b) 50% c], 40',
63) of Small Enterprises advances should go to the Micro Enterprises.: a) 60% b) 40% c)25%. D) 50%
64) Total Current assets of a company are Rs. 32 crore and the net working capital is Rs. 8 crore. The Current ratio is: a) 1:1 b) 1.25:1 c) 1 33:1
d) 1.501
65) A Non SSI industrial undertaking (earlier Sick Industrial Company) irrespective of type of incorporation, is considered as sick -if accumulated
losses as at the end of the latest financial year are its net worth (paid up Capital + Free reserves).:a) Equal to or exceeding b) 1.1 c)50% d)
750/0
66) Accumulated loss will be deducted from: a) Paid-up capital b) Surplus capital c) Tier i capital d) Tier 11 capital,
67) Category - II, CDR is meant for cases where the alts have been classified as in the books of creditors: a) Standard b)Substandard c)
Doubtful d) Loss
68) What is the minimum & maximum denomination amount for a Commercial Paper? : a) 5 lac, 5 lac b) 10 lac, 5 lac c) 10 lac, 10 lac d) 5 :ac,
10 lac e) None of above
69) A 'Pass Through Certificate' (PTC) can be of the following nature in Securitisation transactions: a) With recourse b)Without recourse c)
Without limitation d) a and b
70) RBI has reaffirmed that extending collateral free loans up to _________sanctioned to the units of MSE sector (both manufacturing and service
enterprises) as defined under MSMED Act, 2006 is mandatory: a) Rs 50.000 b)Rs 2.00.000 c)Rs.10.00,000 d) Rs.5.00,000
71) For issuing a Commercial Paper, a company should have credit rating: a) AAA b) P2 from CRISIL or equivalent c) P2 from any of rating
agencies d) Not required any more
72) Simultaneous Sale or Purchase of a share to take benefit of the price variation in two different markets: a) Swap b)Arbitrage c) Forward
trading d) Options
73) Current Ratio denotes: a) Profitability b) Solvency c) Liquidity d) None of these
74) The Exposure limits for banks as fixed by RBI is 15% for individuals and 40% for groups (% of capital funds). This exposure however can be
extended further by_________in case the same is for Infrastructure projects by Board of Directors.: a 5% in the case of Groups b)5% in case of
exposures to Single borrowers c)5% in both single borrower and Group exposures d)5% in the case of single borrower and 10% in the case of groups
75) For Group Exposure purpose, the Non-fund based limit sanctioned to a borrower are to be reckoned at % weightage:
a) 50 b) 100 0) 200 d) Not reckoned
76) Debt service coverage ratio (DSCR) shows: a)Excess of Current assets over Current liabilities b)Number of times the value of fixed assets covers
the amount of borrowed funds. c)Number of times the company's surplus generation cover the payment of interest and repayment of principal of long debt
d)Effective utilisation of assets
77) If a Central Government guaranteed account has become NPA, income from the account: a)Should not be recognized b)Income continues to be
recognized for 24 months c)Income can be recognized if the Government has not repudiated its guarantee d) c&d
78) In which of the following transactions a number of loans are put together and then distributed among Small Investors:
a) Securitization b) Factoring c) Venture capital d) Lease
79) The observation period for accounts reconstructed under CDR in normal circumstances before they can be classified as "standard"assets
based on satisfactory performance is :a)One year b) 18 months c) 24 months d) Varies depending on the sector
80) Foreign Banks have a target of __of ANBC or Credit Equivalent amount of Off-Balance Sheet Exposure, whichever is higher under total
Priority sector.:a) 40% b) 18% c) 32% d) 50%
81) As per RBI guidelines, banks have to make a provision of 100% relating to unreconciled entries, if the entries are pending beyond a period
of months:a) 2 b) 3 c) 6 d) 12
82) Credit Exposure to a single borrower for infrastructure borrowings under Exposure norms is _ % of banks Net worth.
a) Five b) Ten c) Fifteen d) Twenty
83) The Standard Asset provisioning requirements for exposures to increased to 1%. The provision for direct advances to Agri. & SME
remained at 0.25%. All other Standard Assets attract a provision of 0.40%: a) Commercial real estate b) Housing loans above Rs.30,00,000 c) Gold
loans above Rs.1,00,000 d) All of the above
84) Advance for Pisciculture is granted under segment: a) C & I b) SSi c) SBF d) Agriculture e) Personal
ANSWERS
1 B 2 0 3 C 4 D. 5 B
6 A 7 A 8 0 9 E 10 D
11 B 12 A 13 C! 14 A 15 D
99
16 D 17 D 18 C 19 D 20 A
21 B 22 C 23 B 24 B 25 B
26 A 27 0 28 A 29 A 30 B
31 B 32 0 33 E 34 D 35 C
36 0 37 B 38 A 39 C 40 0
41 B 42 D 43 A 44 D 45 D
46 B 47 C 48 B 49 A 50 C
51 C 52 B 53 E 54 C 55 A
56 C 57 B 58 C 59 B 60 A
61 D 62 D 63 A 64 C 65 A
66 C 67 C 68 A 69 D 70 D
71 B 72 B 73 C 74 D 75 B
76 C 77 A 78 A 79 A 80 C
81 C 82 D 83 A 84 D

1) "Derivative" is an instrument, to be settled, whose value is derived from change in interest rate, exchange rate, credit rating or index,
price of securities (called "underlying") or a combination of them.
a) At a future date b) At a predetermined rate fixed now c) On a given date/period d) All of the above
2) All Forward contracts with Rupee as one of the currencies, booked to cover foreign exchange exposures falling due, can be
freely cancelled and rebooked.a) Within one year b) Within one month
c) Within six months d) Within one week
3) As a part of further developing the Derivatives market in India and adding to the existing menu of foreign exchange hedging tools available
to the residents, contractshave been permitted to be traded in recognized stock exchanges.:a) Foreign Currency Futures b) Foreign
Currency Options c) Forward Rate Agreements d) All of the above
4) In India, type of options are permitted now:a) American b) European c) Asian d) a & b
5) Net Interest Margin (NIM) is used for the purpose of stabilizing asset liability management of banks, the other parameter is:a) Economic
Equity Ratio b) Capital Adequacy Ratio c) Cash Reserve Ratio d) Statutory Liquidity Ratio
6) Net Interest Income (NH) is:A)Interest earned on loans and advances only B)Interest earned on investments only c)Total interest earned on
advances and investment d)Difference between interest income & interest expenses
7) Economic Equity Ratio is used to assess sustenance capacity of the bank. it is calculated using the formula:
a) Net Interest Income / Shareholder Funds b)Total Income / Shareholder Funds c)Shareholder Funds / Total of Assets & Liabilities
d)Shareholder Funds / Total Assets
8) Crystallisation of Contingent liabilities in a bank is called:a) Call risk b) Funding risk c) Time riskd) Credit risk
9) RBI has put in place real time gross settlement system(RTGS) to mitigate the risk:a) Market b) Settlement c) Operational d)
Strategic
10) Basel ti Accord is based on three pillars viz (i) Credit risk (ii) Market risk (iii) Operational risk.a) TRUE b) FALSE
11) Some times dealers resort to simultaneous purchasing and selling of securities or exchange of cash flows such that the
composition of portfolio can be changed without significant cost. Such deals are called deals:a) Arbitrage b) Swap c) Soft
d) Option
12) The current basis point difference between Repo and Reverse Repo as announced by RBI is
a) 1% b) 1.25% c) 1.5% d) 2%
13)do not appear on the Assets side of a Bank'sbalance sheet:a) Reserves and surplus b) Investments
c) Fixed assetsd) Balance with RBI
14) VaR is defined as the predicted worst-case loss at a specific confidence level, and:a) Over certain period of time b) Under normal trading
conditionsa) a only b) b only c) Both a & b d) Either a or b
15) In calculating the capital charge for credit risk, Credit Conversion Factor (CCF) is used for the purpose of:a)Estimating the NPA levels
b)Estimating the disbursals out of the sanctioned limits c)Estimating the off-balance sheet commitments likely to materialize d) All the above
16) In the 'Economic value" perspective, the focus is on:a)Impact of interest rate changes on earnings b)Assessment of the present value of its
expected cash flows c)Instruments that are not marked to market d)All of the above
17) In the process of Assets & Liabilities Management, Price (Interest) matching is used to assess whether an institution is in a position to
benefit for raising interest rates through "Positive Gap". Positive Gap means:a) Assets > Liabilities b) Liabilities > Assets c) Either (a) or (b)
d) None of the above 18) In an Option contract, where the buyer of a contract has the right but not the
obligation to sell a currency at a predetermined price only at the end of the contract periodor on the maturity date is called:a) European
Put option b) American Call option c) European call option d) American put option 19) The risk of large outflows of funds from a bank due
to unanticipated withdrawals is called:a) Settlement riskb) Call risk c) Funding risk d) Solvency risk
20) As per RBI guidelines on ALM, current account deposits are interest rate:a) Non-sensitive b) Sensitive onresettingPLR c) Assigned to
15-28 days bucket d) Assigned to 29 days to 3 months time bucket 21) The Banking Book is not exposed to the following risk:a)
Liquidity risk b) Interest rate riskc) Market risk d) Operational risk
22) The market price of 10 year, 7% G-Sec, when yield of similar instruments rises to 8%:a) Increasesb) Decreases c) Doesn't changed)
Can't be said 23) The Trading Book is exposed to the risk:a) Liquidity
b) Interest ratec) Marketd) Operational
24) Translation losses are significant for banks as they affect the Bank's :a) Market value b) Interest income c) Both (a) & (b)
above d) All of the above
25) The maximum loan against NRE / FCNR Term deposit was Rs.20 lakh earlier. RBI has now increased it to:
a) Rs.25 lakh b) Rs. 1 core c) Rs.50 lakh d) No change
26) The phrase 3-6-3 meant__ a)Bankers went home each day at 3.00 PM b)Banks accepted deposits at short term for 3% c)Banks' long term
lending rate was 6% d)All of the above
27) Embedded option risk, Yield curve risk, and Price risk are risks associated with:a) Bond yields b) Treasury operations c) a & b d)
Interest rates
28) When an asset is sold before its maturity, it is subject to:a)Reinvest risk b)Yield curve risk c)Price risk
d)Embedded option risk
29) Mr. Ram Lai is investing Rs.1,5001- every year at the beginning of the year for the next 3 years at 10% p.a. What is the present
value of the amount which he will get at the end of 3 years:a) Rs. 4103/- b) Rs. 4580/- c) Rs 4965/- d) Rs. 5461/-
30) Margin of Safety means _______ :a) Sales at Break Even Point b) Sales at point of cash profits
c) Sales at achievement of Current Ratio of 1.3:1 d)Sales over BEP sales
31) The formula for doubling of the amount after specific period will be:a) 0.35+59/rate b) 0.35+69/rate
c) 0.36+56/rate d) 0.36+69/rate
32) The co-efficient of Correlation.a) Has no limits b) Can be less than one c) Can be more than one d) Varies between ± 1
33) Coupon rate means _______ :a)Market rate of return of a bond / Debenture b)The rate at which the bond would pay interest at stipulated
periods c)The total amount (Principal+ Interest) that a bond would pay d)Yield to maturity of the bond
34) Term Loan payable within 12 months is considered as:a) Long term sources b) Long term uses c) Short term sources d) Short term uses
35) Effective interest Rate will___________with increase in frequency of compounding:a) Increase b)Decrease c) Equalize quoted rate
d) Equalize nominal rate 36) What is Du Pont System :a)Rate
of Return based decisions b)Working Capital Management tool c)Debtors solvency analysis d)Cash Management tool
37) Internal rate of return ( IRR) indicates :a)The profit made by the unit b)Bench mark prices for material transfer,c)Discount rate at which
NPV of the project is zero d)Rate of rejection of project 38) In a Highly Geared Company :a)Only ordinary capital
is raised b)Only debentures are issued c)Major part of finance is raised by debentures d)Major part of finance is raised by equity capital
39) in a normal distribution the Mean, Mode and Median are related as:a) Mean > Median > Mode b) Mean > Mode > Median c) Mean =
Mode > Median d) Mean = Mode = Median 40) Low turnover of Stock ratio
reflects :a) Over- trading b) Solvency positionc) Good liquidity d) Over- investment in inventory
41) Over Capitalization is cured by :a)Increase in the rate of debenture interest b)Redemption of debentures c)issue of bonus shares
100
d) All the above 42) The sum of deviations of
individual observations is zero from:a) Mode b) Median c) Arithmetic Mean d) None
43) Suppose you receive annually Rs. 3,000 per year for 3 years, what is the present value of this stream of cash flows if the discount rate is
10%.: a) 7261 b) 7361 c) 7461 d) 7561
44) Higher Debtor's turnover ratio (in months) indicates:a) Less working capital b) More working capital
c) No effect on working capital d) None of the above
45) As a firm's cash conversion cycle increases, the firm:a)Becomes less profitable b)Increases its investment in working capital c)Reduces
its accounts payable period d)Incurs more shortage costs
46) A firm has an opening of stock of Rs.70,000, Closing stock of Rs.90,000 and Cost of goods sold Rs.2,40,000. What the Inventory Turnover
Ratio?a). 5 b) 4 c) 3 d) 2
47 & 48) Based on the following information, solve the following uestions:
Credit Sales - Rs.3,00,000
Opening Balance of Accounts - Rs.40,000
Receivable
Closing Balance of Accounts - Rs.60,000
Receivable
Credit Purchases - Rs.1,80,000
Opening Balance of Account - Rs.20,000
Payable
Closing Balance of Accounts - Rs.40,000
Payable
47) The Debtors' Turnover Ratio is:a) 6 b) 8 c) 10 d) 12
48) The Creditors' Turnover Ratio is:a) 8 b) 6 c) 4 d) 2
49) To solve a standard maximization problem using the simplex method, we take the following steps which are jumbled. Mark
the correct order of steps.
Step 1: Determine which variable to bring into solution.
Step 2: Determine which variable to replace
Step 3: Formulate problem in terms of an objective function and
a set of constraints
Step 4: Update remaining Row values. Compute new z
Step 5: Calculate new row values for entering variable and insert
into new tableau.
Step 6: Set up initial Tableau with slack variables
Step 7: If there is no positive (c-z) value found, the solution is
optimum. If there is a positive value, then iterate again (repeat
earlier three steps)
Choose the correct sequence of steps.:a) 3,5,4,5,7,1,2 b) 3,6,2,1,5,4,7 c) 3,6,2,1,4,5,7 d) 3,6,1,2,5,4,7 .
50) The bond prices can be estimated using modified duration. The formula for calculating % change in price of a bond is: a)Modified
duration x yield change b)Yield change /modified duration c)Modified duration / Yield change d)Modified duration + Yield change
51) If both the regression coefficients are negative, the correlation coefficient would be .a) Positiveb) Negative c) Zero d) None
52) The most frequently used average is: a) Mode b) Median c) Mean d) Geometric Mean
53) Advance in the form of pledge cannot be granted in respect of :a) Stock-in-process b) Raw material c) Finished goods d) Stores
54) Capital redemption reserve is created out of. :a) Sinking fund b) Share forfeiture account.c) Share premium account. d) General
reserve.
55) Bank overdraft account is a. :a) Personal Account b) Real Account c) Nominal Account d) No Account.
ANSWERS
Q A Q A Q Q A Q A Q A
1D 2 A A
3A 4 D5 A 6 D
7 0 8 A 9 B 10 B 11 B 12 A
13 A 14 C 15 C 16 A 17 A 18 A
19 C 20 A 21 C 22 B 23 C 24 A
25 B 26 D 27 D 28 C 29 A 30 D
31 B 32 D 33 B 34 C 35 A 36 B
37 C 38 C 39 D 40 D 41 B 42 C
43 C 44 B 45 B 46 C 47 A 48 B
49 0 50 A 51 B 52 C 53 A 54 A
55 A
Basel-3 questions
01 RBI implemented the Basel-D1 recommendations in India, w.e.f:a) 01.01.2013 b)31.03.2013 c)01.04.2013 d)30.09.2013
02Basel III capital regulations are based on 3 mutually reinforcing pillar. These pillars are (1) Pillar-1 minimum capital standards (2)
supervisory review of capital adequacy (3) risk management.: a)all the 3 are correct b)only 1 and 2 are correct c)only 1 and 3 are correct d)only 2
and 3 are correct 03Under Basel DI, the options available to compute capital for credit risk
are : a)standardized approach, risk management approach, advancj measurement approach. b)standardized approach, internal rating based
approach, advance measurement approach. c)standardized approach, foundation internal rating based approach, advance internal rating based
approach d)standardized approach, foundation internal rating based approach, advance measurement approach
04Under Basel 11I, the options available to compute capital for operational risk are : a)standardized approach, risk management approach,
advance measurement approach. b)basic indicator approach, standardized approach, advance measurement approach. c)standardized approach,
basic indicator approach, risk measurement approach.d)basic indicator approach, advance measurement approach, internal risk based approach.
05Under Basel III, the options available to compute capital for market risk are : a)standardized approach, risk management approach,
advance measurement approach. b)standardized approach, internal risk management approach,advance measurement approach.c)standardized
approach,maturity method,standardized method duration method, internal risk management approach d)standardized approach, internal risk
management approach, basic indicator approach.
06 In India, the banks are required to maintain a minimum. Pillar 1 capital to risk weighted assets ratio (or minimum total capital to risk
weighted assets ratio) of , as on :a)8%, 31st Mar each year b)9%, 31s` Mar each year c)8%, ongoing basis d)9%, ongoing basis
07 Which of the following statement regarding the Total regulatory capital under Basel III is correct: a)total regulatory capital is sum total of
Tier I capital and Tier 2 capital b)Tier I capital is called `going-concern' capital and Tier 2 capital is called 'gone-concern' capital. C)Tier I
capital comprises common equity Tier I and additional Tier L d)all the above
08 As per Basel In implementation in India, Common Equity Tier 1capital must be______ % of risk weighted assets on ongoing basis:
a)5.5% b)7%c)9%d)11%
09 As per Basel III implementation in India, minimum Tier 1 capital must be % of risk weighted assets on ongoing basis: a)5.5% b) 7% c)9%
d)11% 10 As per Basel In implementation in India, within the
minimum Tier 1 capital, the additional Tier I capital can be: a)min 5.5% of risk weighted assets b)max 5.5% of risk weighted assets c)min 1.5%
101
of risk weighted assets d)max 1.5% of risk weighted assets
11 As per Basel III implementation in India, within total capital of 9% of risk weighted assets, the Tier 2 capital can be: a)max equal to Tier I
capital b)min equal to Tier I capital c)max equal to 2% of risk weighted assets d)min equal to 2% of risk weighted assets
12)Which of the following statements is not correct regarding Basel In implementation in India: a)minimum common equity Tier I ratio should
be 5.5% of RWAs b) capital conservation buffer (CCB) consisting of common equity, should be 2.5% of RWAs c)maximum additional tier 1
capital should be 1.5% of RWAs d)minimum common equity Tier I ratio plus capital conservation buffer should be 7%
13) Which of the following statements is not correct regarding Basel
DT implementation in India: a)minimum Tier I capital ratio should be 8% b)Tier 2 capital should be max 2% c)minimum total capital ratio
should be 9% d)minimum total capital ratio plus capital conservation buffer should be 11.5%
14)As per Basel III, which of the following can be included in Additional Tier I capital (1) Perpetual Non-cumulative Preference shares — PNCPS
(2) stock surplus or share premium resulting from issue of Additional Tier I instruments (3) Debit capital instruments eligible to be included in
additional :a)Tier I. 1 to 3 all b)1 and 2 only c)1 and 3 only d)2 and 3 only
15)As per Basel DI, Tier 2 capital comprises which of the following (1) general provisions and loss reserves (2) debt capital instruments issued
by bank (3) preference share capital instruments with redeemable or cumulative feature (4) revaluation reserve (5) stock surplus i.e. share
premium resulting from issue of Tier 2 eligible instruments. : a)1 to 5 all b)1 to 4 only c)1, 4 and 5 only d)1, 2 and 3 only.
16) As per Basel III, general provisions and loss reserves are included in Tier-2 capital maximum to the extent of: a)1.25% of total risk
weighted assets under standardized approach and 0.6% of total risk weighted assets under IRB approach b)0.6% of total risk weighted assets
under standardized approach and 0.6% of total risk weighted assets under IRB approach c)0.6% of total risk weighted assets under
standardized approach and 1.25% of total risk weighted assets under IRB approach d)1.25% of total risk weighted assets under standardized
approach and 1.25% of total risk weighted assets under IRB approach
17)As per Basel III, the value of revaluation reserve is to be taken at____% discount to include in Tier 2 capital: a)60%b)55%c)50%d)45%
18)As per Basel III, adjustments / deductions are required to be made from Tier I and Tier 2 capital, relating to which of the following (1)
goodwill and other intangible assets (2) deferred tax assets (3) Investment in own shares (treasury stock) (4) investment in capital of banking,
financial or insurance entities : a)1 to 4 all b)1 and 2 only c)1 and 3 only d)1 only
19 As per Basel ILL the investment of a bank in the capital of a banking or financial or insurance entity is restricted to which of the following:
a)10% of capital funds (after deductions) of the investing bank b)5% of the investee bank's equity capital c)30% of paid up capital and reserves
of the bank or 30% of paid up capital of the company, whichever is lower. D)all the above
20)Under Basel Ell, the risk weight for capital charge for credit risk on the basis of standardized approach, does not match in respect of which
of the following: a)Fund and non-fund based claims on Central Govt. — 0% b)Fund and non-fund based Central Govt. guaranteed claims — 0%
c)Fund and non-fund based State Govt. guaranteed claims — 0% d)Fund and non-fund based claims on State Govt. — 0%
21)Under Basel 11I, the risk weight for capital charge for credit risk on the basis of standardized approach, does not match in respect of which
of the following: a)Claims on RBI or D1CGC — 0% b)Claims on Credit Guarantee Fund Trust for MSE — 0% c)Claims on Credit Risk
Guarantee Fund Trust for Low Income Housing — 0% d)Claims on ECG.C— 0%
22)Under Basel ILL the risk weight for capital charge for credit risk on the basis of standardized approach, does not match for claims on foreign
governments (based on rating of international rating agencies such as S & P, Fitch, Moody's Rating), in respect of which of the following:
a)AAA to AA rating — 0% b)BBB rating — 20% c)Below B rating — 150% d)unrated — 100%
23)Under Basel DI, the risk weight for capital charge for credit risk on the basis of standardized approach, does not match for claims on foreign
public sector enterprises (based on rating of S & P, Fitch, Moody's Rating), in respect of which of the following: AAA to AA :a)rating — 20%
b)A rating — 20% c)BBB to BB rating —100% d)unrated — 100%
24)Under Basel DI, what is the risk weight for capital charge for credit risk on the basis of standardized approach, for claims on Bank for
International Settlements, International Monetary Fund, Multilateral Development Banks: a)0% b)10% c)20% d)50%
25)Under Basel 111, the risk weight is % for capital charge for credit risk on the basis of standardized approach, for claims on banks
incorporated in India and foreign bank branches in India, where they meet the level of common equity Tier I capital and applicable CCB: a)0%
b)10% c)50% d)20%
26 Under Basel III, the risk weight for capital charge for credit risk on the basis of standardized approach, does not match for claims on foreign banks
(based on rating of international rating agencies such as S & P, Fitch, Moody's Rating), in respect of which of the following:a)AAA to AA rating — 20%
b)BBB rating — 50% c)Below B rating — 150% d)unrated—150%
27)Under Basel BI, the risk weight for capital charge for credit riskon the basis of standardized approach for long term loans, does not match for
claims on domestic corporates, AFC and NBFCIFC (based on rating of internal rating agencies such as CRISIL,CARE, ICRA etc.), in respect of
which of the following:a)AAA rating — 20% b)A rating— 50% c)BBB —100%d)unrated—150%
28) Under Basel III, the risk weight for capital charge for credit risk on the basis of standardized approach for short term loans, does not match for
claims on domestic corporates, AFC and NBFCIFC (based on rating of internal rating agencies such as CRISIL, CARE, ICRA etc.), in respect of which
of the following:a) A1+ - 20% b)A2 — 50% c)A3 — 75% d)A4 — 150%
29) Under Basel III, the risk weight is _% for capital charge for credit risk on the basis of standardized approach, for claims included in
regulatory retail portfolio: a ) 2 0 % b ) 5 0 % c ) 7 5 % d ) 1 0 0 %
30) Under Basel BI, which of the following is part of the regulatory retail portfolio (1) mortgage loans which qualify as claim secured by
residential property or commercial real estate (2) consumer credit or personal loans or credit card receivables (3) capital market exposure (4) venture
capital exposure.: a)1 and 3 only b)2 and 4 only c)1and 2 d) all of the above
31)Under Basel III, to consider a claim as part of regulatory retail portfolio, which of the following condition is stated correctly: (1) orientation
criteria i.e. the exposure to individual person or to small business, where total average annual turnover in small business is less than Rs.50 cr (2)
granularity criteria i.e. no aggregate exposure to one counterpart is more than 0.2% of overall regulatory retail portfolio (3) maximum retail
exposure to one counterpart does not exceed the threshold limit of Rs.1 cr. :a)1 to 3 all b)1 and 2 only c)1 and 3 only d)2 and 3 only
32)Under Basel DI, the risk weight for capital charge for credit risk on the basis of standardized approach for home loan up to Rs.20 lac where
loan to value (LTV) ratio is 90% is : a)20% b) 50% c)75% d) 100% 33)Under Basel HE, the risk
weight for capital charge for credit risk on the basis of standardized approach for home loan of above Rs,20 lac up to Rs.75 lac, where loan to
value (LTV) ratio is 80% is : a)20% b)50% c)75% d)100%
34)Under Basel III, the risk weight for capital charge for credit risk on the basis of standardized approach for home loan of above Rs.75 lac,
where loan to value (LTV) ratio is 75% is : a)20% b)50% c)75% d)100%
35)Under Basel DI, the risk weight is_________ for capital charge for credit risk on the basis of standardized approach for commercial real
estate — residential housing:a)20% b)50% c)75% d)100% 36)Under Basel DI, the risk weight is for capital charge
for credit risk on the basis of standardized approach for exposure to commercial real estate: a)20% b)50% c)75% d)100%
102
37)Out of the following, which are domestic credit rating agencies,approved by RBI for the purpose of credit rating to determine risk weight
for rated exposures (1) Brickwork (2) CARE (3) Fitch (4) CRISIL (5) Moody's (6) SMERA (7) Standard & Poor: a)1, 2, 4, 7 b)1, 2, 4, 6 c)1, 2, 3, 4
d)1, 2, 4, 5 38)As per Basel III, the exposure amount after credit risk mitigation is
calculated by using the following: a)= max {0, [E x (1 +HO+ C x (1 —1-1c-Hfx)ll b)= max {0, [E x (1 - He) — C x (1 —I-1,- Hfx)l) c)=max {0, [E x
(1 + He) —C x (1 —I-1,- Hfx)]) d)= max {0, [E x (1 + Ile) — C x (1 + I-lc- Ha )l} (E = current value of exposure, C = current value of collateral,
11, = haircut appropriate to collateral, He = Haircut appropriate to exposure, Hfx = Haircut appropriate to currency mismatch between collateral
and exposure) 39)As per Basel HI,
which of the following is part of operationalrisk :a)legal risk b)reputational risk c)strategic risk d)all the above
Answers
01 c 02 b 03 c 04 b 05 c
06 d 07 d 08 a 09 b 10 d
11 c 12 d 13 a 14 a 15 a
16 a 17 b 18 a 19 d 20 c
21 d 22 b 23 a 24 c 25 c
26 d 27 d 28 c 29 c 30 d
31 b 32 b 33 b 34 c 35 c
36 d 37 b 38 c 39 a
CASE STUDIES
Case study - 1 : Calculation of Capital Fund (Fund based)
Popular Bank is a leading bank in public sector and its balance sheet as on 31.03.2008 reveals the following inter-bank call money market
lending and refinance & loans to other banks:
1 Call money lending Rs.1100 cr which comprises: a)Rs.500 cr to a public sector bank having CRAR of 10%, b)Rs.300 cr to a private bank
having CRAR of 14%, c)Rs.200 cr to a scheduled bank having CRAR of 8%, d)Rs.50 cr to a non-scheduled bank with CRAR of 16%,e)Rs.50
cr to another non-scheduled bank with CRAR of 5.5%.
2. Loans and refinance to other banks as under: a)Rs.300 cr to a scheduled bank with CRAR of 5.5% b)Rs.200 cr to a non-scheduled bank
with CRAR of 15% c)Rs.100 cr to a non-scheduled bank with CRAR of 8.5%.
What will be amount of capital fund required for this purpose and what will be the minimum or maximum amount of Tier I and Tier II
capital. The RBI guidelines on the issue are as under:
RBI guidelines: The claims on banks incorporated in India and foreign bank branches in India, will be risk weighted as under:
(i) All claims on scheduled banks, which comply with the minimum CRAR (9% presently), will be risk weighted at 20%.
(ii) All claims on non scheduled banks which meet the minimum CRAR (9% presently), will be assigned a risk weight of 100%.
(iii) Claims on other scheduled and non scheduled banks will be assigned a risk weight as applicable to the bank's CRAR position as under:
a)CRAR of 6 to < 9 : For scheduled bank - 50% and for non-scheduled bank 150%
b)CRAR of 3 to < 6 : For scheduled bank - 100% and for nonscheduled bank 250%
c)CRAR of 0 to < 3 : For scheduled bank - 150% and for nonscheduled bank 350%
Negative CRAR: For scheduled bank or non-scheduled bank 625% Solution: Risk weight for Call money lending to other banks:
a) 500 cr x 20% = 100 cr b) 300 cr x 20 %= 60 cr c) 200 cr x 50% = 100 cr d) 50 cr x 100% = 50 cr
e) 50 cr x 250% = 125 cr
Total amount of risk weight for call money lending = 435 cr Risk weight for loan and refinance to other banks: a) 300 cr x 100% =
300 cr b) 200 cr x 100% = 200 cr c) 100 cr x 150%= 150 cr
Total amount of risk weight for loans/refinance = 650 cr Total amount risk weight assets = 435 + 650 cr = Rs.1085 cr. Total capital
fund requirement = 1085 x 9% = Rs.97.65 cr Tier I capital should be minimum 50% = Rs.48.825 cr Tier II capital can be maximum
50% = Rs.48.825 cr
Case study - 2 : Calculation of Capital Fund (Non-Fund based)
Universal Bank has allowed non-fund based credit facilities to its borrowers, the details of which are as under:
a) letters of credit for imports of goods and buying of domestic goods to various parties within the retail portfolio — Rs.1000 cr (out of this, to
AAA rated companies 20% and the balance for BBB rated).
b) standby letters of credit serving as financial guarantees for credit enhancements — Rs.500 cr (Entire amount is to A rated companies)
c) Standby letters of credit related to particular transactions — Rs.200 cr (out of this to AA rated is 50% and balance amount is for unrated
companies).
d) Performance bonds and bid bonds on behalf of their customers Rs.1000 cr (out of this 50% is to A rated and the balance for unrated
companies)
e) Financial guarantees — Rs.400 cr (on behalf of AA rated companies)
f) Letters of credit of other banks confirmed by Universal Bank for imports — Rs.100 cr
RBI guidelines on credit conversion factor (CCF) are as under:
1. Direct credit substitutes e.g. general guarantees of indebtedness(including standby L/Cs serving as financial guarantees for loans and
securities, credit enhancements, liquidity facilities for securitisation transactions), and acceptances (including endorsements with the
character of acceptance). (i.e., the risk of loss depends on the credit worthiness of the counterparty or the party against whom a potential
claim is acquired) : 100%
2. Certain transaction-related contingent items (e.g. performance bonds, bid bonds, warranties, indemnities, standby LC related to particular
transaction) : 50%
3. Short-term self-liquidating trade letters of credit arising from the movement of goods (e.g. documentary credits collateralised by the
underlying shipment) for both issuing bank and confirming bank : 20% The rules relating to risk weight for corporates based on rating provide
as under:
AAA rated — 20%, AA-30%, A-50%, BBB-100%, BB & Below-150%, unrated- 100%
103
Please calculate the total amount of risk weighted assets and the total capital fund requirement.
Solution: To calculate the risk weight and provide for capital, the non-fund based exposure will be first converted into the funded exposure by
applying the credit conversion factor.
Calculation of credit exposure using CCF:
a) Rs.1000 cr x 20% = 200 cr.
b) Rs.500 cr x 100% = 500 cr
c) Rs.200 cr x 50% = 100 cr
d) Rs.1000 cr x 50% = 500 cr
e) Rs.400 cr x 100% = 400 cr t) Rs.100 cr x 20% = 20 cr
Calculation of Risk weight on the above credit exposure:
a) Rs. 200 cr Out of this for 20% i.e. Rs.40 cr x 20% = 8 cr (20% is for AAA rated companies where risk weight is 20%)
Out of this for 80% i.e. Rs.160 cr x 100% = 160 cr (for this the risk weight is 100%)
b) Rs.500 cr x 50% = 250 cr (for A rated companies, the risk weight is 50%)
c) Rs.100 cr Out of this for 50% i.e. Rs.50 cr x 30% = 15 cr (risk weight is 30% for AA rated companies)
Out of this for 50% i.e. Rs.50 cr x 100 = 50 cr (risk weight is 100% for unrated companies)
d) Rs.500 cr Out of this for 50% i.e. Rs.250 cr x 50% = 125 cr (risk weight is 50% for A rated companies)
Out of this for 50% i.e. Rs.250 cr x 100% = 250 cr (risk weight is 100% for unrated companies)
e) Rs.400 cr x 30% = 120 cr (risk weight is 30% for AA ratedcompanies)
f) 20 cr x 20% = 4 cr (risk weight for confirming banks is 20%).
Total amount of risk weight assets from (a) to. (f)
8+ 160 + 250 + 15 + 50 + 125 + 250 + 120 4= 982
Minimum capital fund required for risk weighted assets of Rs.982 cr = 982 x 9% = Rs.88.38 cr
Case study - 3 : Effect of change of interest rates on net interest income

International Bank has the following repricing assets and liabilities:Call money— Rs.300 cr Cash credit loans — Rs.240 cr Cash in hand -
Rs.200 cr S a v i n g b a n k - R s . 3 0 0 c r F i x e d D e p o s i t s - R s . 3 0 0 c r C u r r e n t d e p o s i t s R s . 2 5 0 c r O n t h e b a s i s
of above information, answer the following questions:
01What is the adjusted gap in repricing assets and liabilities?: a)Rs.540 cr b)Rs.600 cr c)Rs.60 cr negative d)Rs.60 cr positive
02What is the change in net interest income, if interest falls by 2% points across the board i.e. for all assets and liabilities?:a) improves by
Rs.1.20 cr b)declines by Rs.1.20 cr c)changes by Rs.1 cr d) there is nochange
03)If the interest rates on assets and liabilities increase by 2%, what is the change in net interest income?:a)improves by Rs.1.20 cr b) declines
by Rs.1.20 cr c)changes by Rs.1 cr d) there is no change 04)If interest rate falls on call money by 1%, on Cash credit by 0.6%, on
saving bank by 0.2% and on FD by 1%, what is change in net interest income?:a)improves by Rs.0.72 cr b)declines by Rs.0.82 cr c)decline by
Rs.0.84 cr d)declines by Rs.0.96 cr 05)If interest rate increases
on call money by 0.5%, on Cash credit by 1%, on saving bank by 0.1% and on FD by 0.8%, what is change in net interest income?:a)declines
by Rs.1.05 cr b)improves by Rs.0.90 cr c)declines by Rs.1.25 cr d)improves by Rs.1.20 cr
Explanations: 01
Que-1: (SB + FD) — (Call money +CC) = (300 + 300) — (300 + 240) = Rs.60 cr (assets are less than liabilities — Hence negative gap). The
cash in hand and current account deposits are not subject to re-pricing as these are not interest bearing, hence these have been ignored.
Que-2: There is negative gap (interest bearing liabilities more) of Rs.60 cr [(300 + 300) — (300 + 240)], which means the interest cost declines
@2% on this negative gap, which leads to increase in NIL Hence it is Rs.60 cr x 2% = Rs.1.20 cr.
Que-3: There is negative gap of Rs.60 cr [(300 + 300) — (300 + 240)],3.00 cr) = 3.60 cr
Net fall in interest income = 4.44 cr — 3.60 cr = 0.84 cr.
Que-5: Increase in interest amount in case of assets = (Call — 300 x 0.5% = 1.50 cr) + (Cash credit — 240 x 1% =2.40) = Rs. 3.90 cr.
Increase in interest amount in case of liabilities (SB — 300 x 0.1 = 0.30 cr) + (300 x 0.8% = 2.40 cr) = 2.70 cr
Net improvement = 3.90 cr — 2.70 cr = 1.20 cr.
Case Study — 4 : Rating Migration in Borrowal Accounts •

You are provided the following information about the no. of loan accounts with different rating, in International Bank as on Mar 31, 2009
and Mar 31,2010.
Rating Mar Mar 31, 2010
31,
2009
AAA AA+ AA A+ A BBB C Default
AAA 100 70 16 4 4 2 2 2 -
AA+ 100 10 60 14 10 - 2 2 2
AA - - - - - - - - -
A+ - - - - - - - - -
A 200 - - - 20 160 12 4 4
BBB 400 - - - 20 - 240 60 80
C 60 - - - - - 10 40 10
Default -
Based on this information, answer the following questions.:

01What is the %age of AAA rated borrower that remained at the same rating level during the observation period?: a)70% b)65% c)60% d)55%
02What is the no. of AAA rated accounts as at the end of observation period: a) 100 b) 80 c)70 d)60
03What is the percentage of migration of borrowers from A and BBB category to default category: a)1%, 20% b)2%, 20% c)1%, 10% d)2%,
10%
04What is the percentage of migration of loan accounts from C rated to default category?: a)10% b)12.50% c)15.5% d)16.7%
05What is the total no. of borrower in the default category at the beginning and end of the observation period?: a)nil, 80 b)nil, 90 c)nil, 96
d)inadequate information to answer the question
06Calculate the percentage for migration of AA+ account to AA category.: a) 10% b)12% c)14% d)16%
07What is the percentage of BBB category accounts, that did not change their category during the observation period?: a)70% b)60%
c)50%d)40%
08What is the percentage of A category accounts that were upgraded to A+ category?: a)10% b)12.5% c)15%d)17.5%
104
Answers: 1-a 2-b 3-b 4-d 5-c 6-c 7-b 8-a
Explanations:
Que-1: Mar 2010 = 70 accounts. Mar 2009 = 100 account. Hence70/100x100 = 70%
Que-2: 70 + 10 = 80
Que-3: For A category = 4 / 200 x 100 = 2%. For BBB category = 80/ 400 x 100 = 20%
Que-4: 10 / 60 x 100 = 16.7%
Que-5: At beginning — nil At end = 2+4+80+10 = 96
Que-6: 14 / 100 X 100 = 14%
Que-7: 240 / 400 x 100 = 60%
Que-8: 20 / 100 x % = 10%
Case Study — 5 : Calculation of capital for market risk

International Bank has paid up capital of Rs.100 cr, free reserves of Rs.300 cr, provisions and contingencies reserves Rs.200 cr, revaluation
reserve of Rs.300 cr, Perpetual non-cumulative preference shares of Rs.400 cr, and subordinated debt of Rs.300 cr. The risk weighted assets
for credit and operational risk are Rs.10000 cr and for market risk Rs.4000 cr.
Based on the above information, answer the following questions?:
01What is the amount of Tier-1 capital?: a)900 cr b)800 cr c)750 cr d)610 cr
02Calculate the amount of Tier-2 capital?: a)900 cr b)800 cr c)750 cr d)610 cr
03Calculate the amount of capital fund.: a)895 cr b) 1255 cr c)1435 cr d)1675 cr
04What is the capital adequacy ratio of the bank?: a)9% b)9.65% c)10.05% d)10.07%
05What is amount of minimum capital to support credit and operational risk?:a)900 cr b)950 cr c)1000 cr d)1250 cr
06What is the amount of minimum Tier 1 and Tier 2 to support the credit and operational risk?: a)900 cr, 900cr b)600 cr, 900 cr c)450 cr, 450 cr
d)300 cr, 450 cr
07What is the amount of Tier-1 capital fund, to support market risk?: a)450 cr b)350 cr c)250 cr d) 185 cr
08What is the amount of Tier-2 capital fund, to support market risk?: a)450 cr b)350cr c)250 cr d) 160 cr
Answers: 1-b 2-d 3-c 4-d 5-a 6-c 7-b 8-d

Case Study — 7: Calculation of Risk Weighted Assets based on. Standard Approach for credit risk
The assets side of balance sheet of International Bank provides the following information:
Fixed Assets — 500 cr, Investment in Central govt. securities — Rs.5000 cr. In standard loan accounts, the Retail loans — Rs.3000 cr, House
Loans- Rs.2000 cr (all individual loans below Rs.30 lac and fully secured by mortgage), Other loans — Rs.10000 cr. Sub-standard secured
loans — Rs.500 cr, sub-standard unsecured loans Rs.150 cr, Doubtful loans Rs.800 cr (all DF-1 category and fully secured) and other assets-
Rs.200 cr.
Based on this information, by using Standard Approach for credit risk, answer the following questions.
01What is the amount of risk weighted assets for retail loans?:a)Rs.3000 cr b)Rs.2500 cr c)Rs.2250 cr d)Zero, as retail loans are risk free
02What is the amount of risk weighted assets for housing loans?: a)Rs.2000 cr b)Rs.1800 cr c) Rs.1500 cr d) Rs.1000
cr
03What is the amount of risk weighted assets for investment in govt. securities: a)Rs.5000 cr b) Rs.2500 cr c)Rs.1000 cr
d)nil
04What is the amount of risk weighted assets for sub-standard secured accounts?: a)Rs.250 cr b)Rs.500 cr c)Rs.750 cr d)Rs.1000 cr
05What is the amount of risk weighted assets for sub-standard unsecured accounts? : a)Rs.75cr b) Rs.112.50 cr c)Rs.150
cr d)Rs.225 cr 06What is the amount of risk weighted assets for
doubtful accounts?: a)Rs.400 cr b)Rs.600 cr c) Rs.800 cr d)Rs.1600 cr
Answers: 1-c 2-d 3-d 4-c 5-c 6-c
Explanations:
Que-1: RW is 75% on retail loans. RW value = 3000 x 75% = 2250
Que-2: RW is 50% on housing loans for individual loan up to Rs.30 lac. RW value = 2000 x 50% = 1000
Que-3: On claims against Central govt., the risk weight is zero. 5000 x 0% = 0
Que-4: RW is 150%, if the provision is less than 20% and 100%, if the provisions is 20% and 50%, where the provision is 50% of the
outstanding balance. In sub-standard secured account, the provision being 10%, RW is 150%. Hence RWA = 500 x 150% = 750 cr
Que-5: RW is 150%, if the provision is less than 20%, nd 100%, if the provisions is 20% and 50%, where the provision is 50% of the
outstanding balance. In sub-standard unsecured account, the provision being 20%, RW is 100%. Hence RWA = 150 x 100% = 150 cr
Que-6: RW is 150%, if the provision is less than 20% and 100%, if the provisions is 20% and 50%, where the provision is 50% of the
outstanding balance. In doubtful up to one year category (DF1) account, the provision being 20%, RW is 100%. Hence RWA = 800 x
100% = 800 cr
Case Study — 8 : NPA provisioning
International Bank has provided the following information relating to its advance portfolio as on Mar 31, 2010:
Total advances Rs.40000 cr. Gross NPA 9% and Net NPA 2%. Based on this information, answer the following questions?
01Considering that all the standard loan accounts represent general advances, what is the amount of provision for standard loan accounts:
a)Rs.160 cr b)Rs.151.90 cr c)Rs.145.60 cr d)Rs.141.50 cr
02What is the provision on NPA accounts?: a)Rs.3600 cr b)Rs.3200 cr c)Rs.2800 cr d)Incomplete information. Cannot be calculated.
03What is the total amount of provisions on total advances,including the standard accounts?: a)Rs:3612.30 cr b)Rs.2945.60 cr
c)Rs.2840.20 cr d) Incomplete information. Cannot be calculated.
04What is the amount of gross NPA ?: a)Rs.4000 cr b)Rs.3600 cr c) Rs.3200 cr d)Rs.2800 cr
05What is the amount of net NPA?: a)Rs.800 cr b)Rs.1000 cr c)Rs.1200 cr d)Incomplete information.
06What is the provision coverage ratio for NPA?: a) 70% b)74.3% c)75.2% d)77.8%
07What is the minimum amount of provisions to be maintained by the bank to meet the provisioning coverage ratio of 70%.: a)Rs.3600 cr
b)Rs.3200 cr c)Rs.2880 cr d)Rs.2520 cr
Answers: 1-c 2-c 3-b 4-b 5-a 6-d 7-d
Explanations: Que-1: Standard

account Total = 40000 cr — 9% NPA = 3600 cr. = 40000 — 3600 = 36400 cr. Provision at 0.4% = 36400 x 0.4% = 145.60 cr
Que-2: Provision on NPA = Gross NPA 9% - net NPA 2% = 7% i.e. 40000 x 7% = 2800 cr.
Que-3: Provision on NPA = Gross NPA 9% - net NPA 2% = 7% i.e. 0000 x 7% = 2800 cr. Provision on standard accounts Rs.145.60 cr. Hence
total provision = 2945.60 cr. Que-4: 40000 x 9% = 3600 cr
105
Que-5: 40000 X 2% = 800 cr Que-6: Total
provision on NPA / Gross NPA = 2800 / 3600 = 77.8% Que-7: Gross
NPA x 70% = 3600 x 70% =2520cr
Case Study — 9 : Default Probabilities
International Bank has provided following information on its advances portfolio: Default nrobabilit
Rating AAA AA A BBB BB B CCC
3 year 0.04% 0.15% 0.30% 1.10% 6.0% 25.0% 40.0%
5 year 0.10% 0.40% 0.60% 2.00% 10.0% 35.0% 45.0%
The base rate of the bank = 11% which is charged for AAA category borrowers for a 3 year loan.The load factor is added to base rate by 1%
for AA, 2% for A, 3% for BBB, 4% for BB accounts.The load factor is further increased by 0.5% for each additional maturity year over 3
years.
Based on this information, answer the following questions?:
01Which of the following loans shall have the highest expected loss if there is no amortization and entire loan is payable on maturity only.:
a)Rs.600 lac — 3 year loan to A rated borrower b)Rs.50 lac — 5 year loan to BB rated borrower c)Rs.400 lac — 3 year loan to BBB
rated borrower d)Rs.2500 lac — 5 year loan to AA rated borrower
02Banks has given a loan of Rs.400 lac to an A rated company for 5 years out of which 2 year period has already lapsed and there has been
no default. Present outstanding is Rs.300 lac in the loan. EAD is 100% and LGD 50%. What is the expected loss on this account?: a)Rs.45000
b)Rs.54000 c)Rs.63000 d)Rs.72000
03Taking into account the above risk policy of the bank, which loan shall earn the lowest return? : a)BB — 3 year b)BBB — 5 year c)A — 5 year
d)AAA — 3 year
04Bank wants to sanction a loan to AA rated borrower which is repayable in 5 years. What interest rate should be charged by the bank?:
a)11.0% b) 11.5% c)12.5% d)13%
05As on Mar 31.3.2009, bank had 200 BBB rated account out of which 10% account migrated to default category by 31.3.2010. What is
increase in no. of accounts in default category?: a)20 b)25 c)30 d)35
Answers:1-d 3-d 4-d 5-a
Explanations: Que-1: AA rated

borrower is having the largest amount, due to which here the expected loss would be highest.
Que-2: 300 x 0.30 x 50% = Rs.45000 (remaining period of load is 3 year. Hence 0.30% default probability has been taken)
Que-3: AAA loan shall have the lowest interest rate as the period is least and rating is highest.
Que-4: Base rate + load factor for AA rating + load factor for 5 year over 3 year maturity.11% + 1.0% + 1% = 13%
Que-5: 200 x 10% = 20
Case Study —10 : Pre-shipment and post-shipment Loan

An exporter approaches the Popular Bank for pre-shipment and post-shipment loan with estimated sales of Rs. 100 lakh. The bank sanctions a
limit of Rs. 50 lakh, with 25 % margin for pre-shipment loan on FOB value and margins on bills of 10 % on foreign demand bills and 20 % on
foreign usance bills.The firm gets an order for USD 50,000 (CIF) to Australia. On 1.1.2011 when the USD/INR rate was Rs.43.50 per USD,
the firm approached the Bank for releasing pre-shipment loan (PCL), which is released.On 31.3.2011, the firm submitted export documents,
drawn on sight basis for USD 45,000 as full and final shipment. The bank purchased the documents~at Rs.43.85, adjusted the PCL outstanding
and credited the balance amount to the firm's account, after recovering interest for Normal Transit Period (NTP).The documents were realized
on 30.4.2011 after deduction of foreign bank charges of USD 450. The bank adjusted the outstanding post shipment advance against the
bill.Bank charged interest for pre-shipment loan @ 7 % up to 90 days and, @ 8% over 90 days up to 180 days. For Post shipment credit the
Bank charged interest @ 7 % for demand bills and @ 7.5 % for usance (D/A) documents up to 90 days and @ 8.50 % thereafter and on all
overdues, interest @ 10%.
01.What is the amount that the Bank can allow as PCL to the exporter against the given export order, considering the profit margin of 10% and
insurance and freight cost of 12% ?: a)Rs.2200000 b)Rs.1650000 c)Rs.1485000 d)Rs.1291950
02What is the amount of post shipment advance that can be allowed by the Bank under foreign bills purchased, for the bill submitted by
the exporter?:a)Rs.1980000 b)Rs.1775925 c)Rs.1973250 d)Rs.2192500
03.What will be the period for which the Bank charges concessional interest on DP bills, from date of purchase of the bill?: a)90 days b)25
days c)31 days d)Up to date of realization 04In the above case, when should the bill be crystallized (latest date), if the bill
remains unrealised for over two months, from the date of purchase (ignore holidays)?: a)On 30.4.2011 b)On 24.4.2011 c)On 24.5.2011
d)On 31.5.2011 05 What rate of interest will be applicable for
charging interest on the export bill at the time of realisation, for the days beyond Normal Due Date (NDD)?: a)8% b)7% c)7.5 %
d)10 %
Answers: 1-d 2-c 3-b 4-c 5-d
Explanations: 1FOB value = = 50000

x 43.50 = 2175000 — 24000 (12% of
2175000) = 1914000 — 191400 (10% profit margin) = 1722600 430650 (25% margin) = 1291950 2)
45000 x 43.85 = 1973250 3)Concessional rate wil' be charged for normal transit
period of 25 days and there after overdue interest will be charged.
4)Crystallisation will be done when the bill becomes overdue after 25 days of normal transit period. Date of overdue will be 25.4.2011. If bill
remains overdue, it will be crystallised within 30 days i.e. up to 24.5.2011.
5)Rate of interest will be 10% as the overdue interest is stated as 10% in the question.
CASE STUDY11:
Modern Bank has the following assets liabilities (other than capital and Reserves) in its balance sheet: current deposits Rs.500 cr, saving bank
deposits Rs.1000 cr, term deposits Rs.3000 cr, cash in hand Rs.300 cr, call money Rs.400 cr and cash credit loans Rs.4000 cr There is
change in interest rates as under: saving bank - increase from 3.5% to 4%, FD - from 7.5% to 8.5%, call money - from 5% to 6% and cash
credit - from 12% to 12.5%
01 Calculate the adjusted gap in re-pricing assets and liabilities: a)Rs.200 cr negative b)Rs.200,cr positive c)Rs.400 cr negative d)Rs.400 cr
positive
02 On the basis of change in interest rate, calculate the amount of repricing liabilities, as per standard gap method in re-pricing assets and
106
liabilities.: a)Rs.3000 cr b)Rs.3500 cr c)Rs.2500 cr d)Rs.2400 cr
03 On the basis of change in interest rate, calculate the amount of repricing assets, as per standard gap method in re-pricing assets and liabilities.
: a)Rs.3000 cr b)Rs.3500 cr c)Rs.2500 cr d)Rs.2400 cr
04 On the basis of above information, calculate the standard gap of the bank in re-pricing assets and liabilities: a)1000 cr negative b)1000
cr positive c)1100 cr negative d)1100 cr positive
Explanation:
1. Adjusted gap = (SB + FD) - (Call money + Cash credit) = (1000 + 3000) - (400 + 4000) = - 400. Current account and cash not to be
taken, as these are not subject to repricing. 2)Repricing liabilities = (SB + FD) = 1000 x 0.5 + 3000 x 1 = 500
+ 3000 = 3500 cr. 3)Repricing assets = (Call money + cash credit) = 400 x 1 + 4000 x 0.5 = 400 + 2000 = 2400 cr
4. Repricing liabilities = (SB + FD) = 1000 x 0.5 + 3000 x 1 = 500 + 3000 = 350dcr.
Repricing assets = (Call money + cash credit) = 400 x + 4000 x 0.5 = 400 + 2000 = 2400 cr.
Gap = 3500 — 2400 = 1100 cr negative (liabilities more than assets)
Answers: 1-c 2-b 3-d 4-c
Case Study.— 12
Problem: International Bank purchased 8% gkivt. securities, with face value of Rs.1000 at Rs.1060 each for 8.510' jrield. Due to change
in yield to 9%, the value of the securities declined to Rs.1020.
01 On the basis of above information, calculate change in basis point value for each basis point increase in the yield.: a)Rs.40 b)50
paise c) 80 paise d) inadequate information
02 If there is increase in yield by 100 basis points, instead of 50 basic points as above, during this period, what will be price of security:
a)Rs.960 b)Rs.980 c)Rs.1040 d) Rs.1080
03 The bank decides to sell the security immediately, to stop the loss. How much it will lose on the sale transaction ?: a) Rs.20 per bond
b)Rs.30 per bond c)Rs.40 per bond d) inadequate information.
Explanation:
1. Change in value / change in yield = (1060-1020) / (9.00 — 8.50) = Rs.40 / 50 basis points = 80 paise
2. Change in basis point = Change in value / change in yield = (10601020) / (9.00 — 8.50) = Rs.40 / 50 basis points = 80 paise.
Change for 100 basis points = 80 p x 100 = Rs.80. Value = Old price change = 1060- 80-= 960
3. Loss = purchase price — current value at which it can be sold = 1060 -1020 = Rs.40
3. Answers: 1-c 2-a 3-c
CASE STUDY 13- Calculation of Admissible Additional Tier 1 and Tier 2 capital as per Basel III
Universal bank calculated the capital adequacy ratios as under:
Common Equity Tier 1 Ratio

8.5% of risk weighted assets 2.5% of risk weighted assets
Capital conservation buffer
PNCPS / PDI 3.5% of risk weighted assets
Tier 2 capital issued by bank 2.5% of risk weighted assets
Total capital available 17% of risk weighted assets
As per Basel III rules of RBI, for the purpose of reporting Tier 1 capital and CRAR, any excess Additional Tier 1 (AT1) capital and Tier 2 (T2)
capital will be recognised in the same proportion as that applicable towards minimum capital requirements. At min 9% total capital, the max
AT1 can be 1.5% and T2 can be max 2%.
On the basis of given information, answer the following questions:
01 What is the amount of total CET1 capital:a)9% b)10% c)11% d)12%
Explanation: Total CET1 = CET1 + CCB = 8.5% + 2.5% = 11%
02 What is the amount of PNCPS / PDI eligible for Tierl? a)3% b)2.5% c)2.125% d)1.375%
Explanation: PNCPS / PDI eligible for Tier 1 = 1.5 / 6 x 8.5 = 2.125%
03 What is the amount of PNCPS / PDI not eligible for Tier I?:a)3% b)2.5% c)2.125% d)1.375%
Explanation PNCPS / PDI not eligible for Tier 1 = 3.5 - 2.125 =1.375% 04 What is the
amount of Tier 2 eligible for CRAR? a : 2 % b : 2 . 5 % c:2.833% d:0.333%
Explanation: Tier 2 eligible for CRAR = 2 / 6 x 8.5 = 2.833% 05What is the amount of
PNCPS / PDI eligible for Tier2?: a : 2 % b : 2 . 5 % c:2.833% d:0.333%
Explanation: PNCPS / PDI eligible for Tier 2 = 2.833 - 2.5 = 0.333% 06 What is "Ate
amount of PNCPS / PDI not eligible foi Tier 2 capital?: a:1.375%b:1.042% c:2.125% d:0.333 %
Explanation: PNCPS / PDI not eligible for Tier 2 = 1.375 - 0.333 = 1.042% 07What is the total
amount of eligible capital?: a)17% b)16.43% c)15.96% d)14.13% Explanation :Total CETI = CETI + CCB = 8.5% +
2.5% = 11% PNCPS / PDI eligible for Tier 1= 1.5 / 6 x 8.5 = 2.125%PNCPS / PDI not eligible for Tier 1 = 3.5 - 2.125 = 1.375% Tier 2
eligible for CRAR = 2 / 6 x 8.5 = 2.833%PNCPS / PDI eligible for Tier 2 = 2.833 - 2.5 = 0.333%PNCPS / PDI not eligible for Tier 2 = 1.375 -
0.333 = 1.042% Total capital available := CETI + AT1 + T2 = 11% + 2.125 + 2.833 = 15.958 or 15.96%
Answers : 1-c 2-c 3-c 4-c 5-d 6-b 7-c
CASE STUDY14:
Common Equity Tier 1 Ratio 85.00

Capital conservation buffer 25.00
Total amount of PNCPS / PDI 35.00
Eligible PNCPS / PDI for ATI 21.25
Eligible Tier 1 capital 106.25
Tier 2 capital available 25.00
Tier 2 capital eligibility 28.33
107
Excess PNCPS / PDI eligible for Tier 2 capital 3.33
Total Eligible catal 134.58
On the basis of given information, answer the following questions:
01 What is the min Common Equity Tier-1 (CET1) capital to support credit and operational risk: a)108 b)66 c)24 d)18 -
02 What is the max Additional Tier-1 (ATI) capital to support credit and operational risk: a)108 b)66 c)24 d)18
03 What is the max Tier 2 (T2) capital to support credit and operational risk: a)108 b)66 c)24 d)18
04 What is the amount of total capital to support credit and operational risk: a)108 b)66 c)24 d)18
05 What is the min Common Equity Tier-1 (CET1) capital to support market risk: a)26.58 b)19 c)4.33 d)3.25
06What is the max Additional Tier-1 (AT1) capital to suppkt market risk: a)26.58 b)19 c) 4.33 d)3.25
07What is the max Tier 2 (T2) capital to support market risk: a)26.58 b)19 c)4.33 d)3.25
08What is the amount of total capital to support market risk: a)26.58 b)19 c)4.33 d)3.25
Consolidated solution for the Question I to 8.
Risk Weighted assets: Credit and operational risk Market risk 1200
100
66
Min CET1 to support credit and operational risk (1200 x 5.5)
Max AT1 within Tier 1 capital required to support credit and operational risk ((1200 x 1.5) 18
Max T2 within Tier 1 capital required to support credit and operational risk (1200 x 2) 24
Total capital to support credit and operational risk 108

Min CET1 available to suppOrt market risk (85-66) 19
Max AT1 capital within Tier 1 capital available to support market risk (21.25 — 18 = 3.25 3.25
Max T2 capital within total capital available to support market risk (28.33 — 24) 4.33
26.58
Total eligible capital to support market risk (19 + 3.25 + 4.33)
Answers : 1-b 2-d 3-c 4-a 5-h 6-b 7-d 8-a

108

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CAIIB MADE EASY : PAPER - 2

BANK FINANCIAL MANAGEMENT

[THIS BOOK IS MADE FOR LAST MINUTE FINAL

PARTICULARS PAGE NO.

MODULE – A ( INTERNATIONAL BANKING ) 03-42

MODULE - B ( RISK MANAGEMENT ) 42-60

MODULE - C ( TREASURY MANAGEMENT ) 60-69

MODULE –D ( BALANCE SHEET MANAGEMENT ) 70-86

QUESTIONS BANK ( RECALLED QUESTIONS & PRACTICE TEST ) 87-108

Compiled by Mr. Sanjay Kumar Trivedy, Sr. Mgr., RSTC, mumbai

MODULE - A : International Banking :

MODULE - B : Risk Management :

Risk-Concept - Risk in Banks - Risk Management Framework - Organisational

MODULE - C : Treasury Management :

Concepts and function; instruments in the treasury market, development of new

MODULE - D : Balance Sheet Management :

Prudential norms-Capital Adequacy. Implementation of Basel-II guidelines : RBI

Compiled by Mr. Sanjay Kumar Trivedy, Sr. Mgr., RSTC, mumbai

Foreign Exchange Market and its Participants

Compiled by Mr. Sanjay Kumar Trivedy, Sr. Mgr., RSTC, mumbai

Compiled by Mr. Sanjay Kumar Trivedy, Sr. Mgr., RSTC, mumbai

MAIN FEATURES OF FUTURES CONTRACTS FEATURES OF FUTURES MARKETS

2)Futures contracts have standard contract terms. 2) Physical exchange rare.

Compiled by Mr. Sanjay Kumar Trivedy, Sr. Mgr., RSTC, mumbai

TYPES OF OPTIONS: 1. Classification based on underlying transaction

IN-THE-MONEY OPTION I AT-THE-MONEY OPTION OUT-OF-THE-MONEY OPTION

Compiled by Mr. Sanjay Kumar Trivedy, Sr. Mgr., RSTC, mumbai

Compiled by Mr. Sanjay Kumar Trivedy, Sr. Mgr., RSTC, mumbai

FOREIGN EXCHANGE_FOCILITIES_FOR RESIDENTS : As per Section 5 of FEMA resident- Indians are

Compiled by Mr. Sanjay Kumar Trivedy, Sr. Mgr., RSTC, mumbai

FX FOCILMES TO RESIDENTS OTHER THAN INDIVIDUALS

Compiled by Mr. Sanjay Kumar Trivedy, Sr. Mgr., RSTC, mumbai

Period for As per FCNR scheme Not Applicable. Not Applicable.

SUMMARY OF BANK ACCOUNTS FOR NON - RESIDENT INDIANS

Compiled by Mr. Sanjay Kumar Trivedy, Sr. Mgr., RSTC, mumbai

Compiled by Mr. Sanjay Kumar Trivedy, Sr. Mgr., RSTC, mumbai

Compiled by Mr. Sanjay Kumar Trivedy, Sr. Mgr., RSTC, mumbai

EXCHANGE CONTROL RELATING TO EXPORTS

Compiled by Mr. Sanjay Kumar Trivedy, Sr. Mgr., RSTC, mumbai

Compiled by Mr. Sanjay Kumar Trivedy, Sr. Mgr., RSTC, mumbai

3 Allowed for Export of goods, services, Construction contracts, i

POST – SHIPMENT ADVANCE DIFFERENT TYPES :

Compiled by Mr. Sanjay Kumar Trivedy, Sr. Mgr., RSTC, mumbai

Compiled by Mr. Sanjay Kumar Trivedy, Sr. Mgr., RSTC, mumbai

Compiled by Mr. Sanjay Kumar Trivedy, Sr. Mgr., RSTC, mumbai

Compiled by Mr. Sanjay Kumar Trivedy, Sr. Mgr., RSTC, mumbai

Average Maturity Period All-in-cost Ceilings over 6 month LIBOR*

Compiled by Mr. Sanjay Kumar Trivedy, Sr. Mgr., RSTC, mumbai

TRADE CREDITS FOR IMPORTS INTO INDIA

Compiled by Mr. Sanjay Kumar Trivedy, Sr. Mgr., RSTC, mumbai

Buyer or Importer on whose request the LC is opened.

UNIFORM CUSTOMS & PRACTICE:FOR DOCUMENTARY CREDITS : (UCP - 600)

ABBREVIATION CONTRACT TERMS EXPLANATION

Compiled by Mr. Sanjay Kumar Trivedy, Sr. Mgr., RSTC, mumbai

Objective Type Questions

Compiled by Mr. Sanjay Kumar Trivedy, Sr. Mgr., RSTC, mumbai

Compiled by Mr. Sanjay Kumar Trivedy, Sr. Mgr., RSTC, mumbai

Compiled by Mr. Sanjay Kumar Trivedy, Sr. Mgr., RSTC, mumbai

Compiled by Mr. Sanjay Kumar Trivedy, Sr. Mgr., RSTC, mumbai

MODULE – B : RISK MANAGEMENT

OBJECTIVES OF RISK MANAGEMENT:

RISK IN BANKING BUSINESS

BANKING BOOK TRADING BOOK OFF-BALANCE SHEET ITEMS

INTEREST RATE RISK

Compiled by Mr. Sanjay Kumar Trivedy, Sr. Mgr., RSTC, mumbai

COUNTRY RISK-RBI GUIDELINES

Compiled by Mr. Sanjay Kumar Trivedy, Sr. Mgr., RSTC, mumbai

TABLE SNOWING THE MOVEMENTS IN THE STOCK PRICE OF XYZ BANK :

Why is Volatility Estimated?

Three types (mutually OPERATIONAL RISK — CLASSIFICATION

Compiled by Mr. Sanjay Kumar Trivedy, Sr. Mgr., RSTC, mumbai

Three types (mutually OPERATIONAL RISK — CLASSIFICATION of the

Compiled by Mr. Sanjay Kumar Trivedy, Sr. Mgr., RSTC, mumbai

Three types (mutually OPERATIONAL RISK — CLASSIFICATION

RISK in BANKING INDUSTRY

TIER I CAPITAL TIER II CAPITAL TIER III CAPITAL (not