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BASICS OF FINANCIAL SERVICES

TOPICS FOR THE ACADEMIC YEAR

UNIT 1 – FINANCIAL SYSTEM

UNIT 2 – COMMERCIAL BANKS, RBI AND DEVELOPMENT BANK

UNIT 3 – INSURANCE

UNIT 4 – MUTUAL FUND

FINANCIAL SYSTEMS

Overview of Financial System

What is Financial System

Role/ Functions of Financial System

Components of Financial System

Major Financial Intermediaries

Financial Products

Functions of Financial Systems

Regulators of Indian Financial System

OVERVIEW OF FINANCIAL SYSTEM

Economic Growth of a country depends on the

well knit financial system

FS comprises a set of sub systems defined as

components of FS.

It is a mechanism where savings are

transformed into investments

FS mobilizes the surplus funds for productive

purpose.

FINANCIAL SYSTEM

ROLE/ FUNCTIONS OF FINANCIAL SYSTEM

It serves as a link between savers and investors.

It helps in utilizing the mobilized savings of scattered savers in more efficient and effective manner.

It channelizes flow of saving into productive investment.

It assists in the selection of the projects to be financed

Reviews the performance of such projects periodically.

It provides payment mechanism for exchange of goods and services.

It provides a mechanism for the transfer of resources across geographic boundaries.

It provides a mechanism for managing and controlling the risk involved in mobilizing savings and allocating credit.

It promotes the process of capital formation by bringing together the supply of saving and the demand for investible funds.

It helps in lowering the cost of transaction and increase returns.

Reduce cost motives people to save more.

It provides you detailed information to the operators / players in the market such as individuals, business houses, Governments etc.

COMPONENTS OF INDIAN FINANCIAL MARKET

FINANCIAL PRODUCTS

Financial products refer

To instruments that help you save, invest, get insurance or get a

mortgage.

These are issued by various banks, financial institutions, stock

brokerages, insurance providers, credit card agencies and government

sponsored entities.

Financial products are categorized in terms of their type or underlying

asset class, volatility, risk and return.

TYPES OF FINANCIAL PRODUCTS

Shares

These represent ownership of a company.

Shares are initially issued by corporations to finance their business

needs

They are subsequently bought and sold by individuals in the share

market.

They are associated with high risk and high returns

Returns on shares can be in the form of dividend payouts by the

company or profits on the sale of shares in the stock market.

Shares, stocks, equities and securities are words that are generally used

interchangeably.


Bonds

These are issued by companies to finance their business operations

By governments to fund budget expenses like infrastructure and social programs.

Bonds have a fixed interest rate, making the risk associated with them lower than that with shares.

The principal or face value of bonds is recovered at the time of maturity.

Treasury Bills

These are instruments issued by the government

For financing its short term needs

They are issued at a discount to the face value

The profit earned by the investor is the difference between the face or maturity value and the price at which the Treasury Bill was issued.


Options

Options are rights to buy and sell shares

An option holder does not actually purchase shares.

Instead, he purchases the rights on the shares.

Mutual Funds

These are professionally managed financial instruments

It involve diversification of investment

Into a number of financial products, such as shares, bonds and

government securities

This helps to reduce an investor‘s risk exposure, while increasing the

profit potential.

http://www.economywatch.com/investment/financial-products.html


Certificate of Deposit

Are issued by banks, thrift institutions and credit unions

They usually have a fixed term and fixed interest rate

Annuities

These are contracts between individual investors and insurance

companies

Investors agree to pay an allocated amount of premium and at the end

of a pre-determined fixed term

The insurer will guarantee a series of payments to the insured party.

FUNCTIONS OF FINANCIAL SYSTEMS

Encouraging savings

Savings are done by households, businesses, and government

reclassify savers into— household sector, domestic private corporate sector, and the public

sector.

The household sector comprise

Individuals

Non-Government and non-corporate entities in agriculture, trade and industry

Non-profit making organisations like trusts and charitable and religious

institutions.

The public sector comprises

Central and state governments

Departmental and non departmental undertakings, the RBI, etc.

The domestic private corporate sector comprises

non-government public and private limited companies (whether financial or non-

financial)

corrective institutions.

Of these three sectors, the dominant saver

is the household sector,

followed by the domestic private corporate sector.

The contribution of the public sector to total net domestic savings is relatively small.


Mobilizing them

Financial system is a highly efficient mechanism for mobilizing savings.

In a fully-monetised economy this is done automatically

when, in the first instance, the public holds its savings in the form of money.

However, this is not the only way of instantaneous mobilization of savings.

Other financial methods used are deductions at source of the contributions to provident fund and other savings schemes.

More generally, mobilization of savings taken place when savers move into financial assets, whether currency, bank deposits, post office savings deposits, life insurance policies, bill, bonds, equity shares, etc.


Allocating them among alternative uses and users.

Another important function of a financial system is to arrange smooth,

efficient, and socially equitable allocation of credit.

With modern financial development and new financial assets, institutions

and markets are organized,

Which are playing an increasingly important role in the provision of credit.

In the allocative functions of financial institutions lies their main source of

power.

By granting easy and cheap credit to particular firms, they can shift outward

the resource constraint of these firms and make them grow faster.

On the other hand, by denying adequate credit on reasonable terms to other

firms, financial institutions can restrict the growth or even normal working of

these other firms substantially.

Thus, the power of credit can be used highly discriminately to favor some and

to hinder others.

Efficiency of a given financial system depends on the performance of these

functions.

FINANCIAL REGULATORY BODIES IN INDIA

STATUTORY BODIES VIA PARLIAMENTARY ENACTMENTS

RESERVE BANK OF INDIA (RBI)

SECURITIES EXCHANGE BOARD OF INDIA (SEBI)

INSURANCE REGULATORY AND DEVELOPMENT AUTHORITY (IRDA)

PART OF THE MINISTRIES OF GOI

FORWARD MARKET COMMISSION INDIA (FMC)

PENSION FUND REGULATORY AND DEVELOPMENT AUTHORITY

(PFRDA under the finance ministry)


RESERVE BANK OF INDIA (RBI) Is the apex monetary Institution of India

It is also called as the central bank of the country.

The Reserve Bank of India was established on April 1, 1935 in accordance with the provisions of the Reserve Bank of India Act, 1934.

The Central Office of the Reserve Bank was initially established in Calcutta

Was permanently moved to Mumbai in 1937.

The Central Office is where the Governor sits and where policies are formulated.

the Reserve Bank is fully owned by the Government of India.

SECURITIES EXCHANGE BOARD OF INDIA (SEBI)

SEBI was first established in the year 1988 as a non-statutory body for regulating the securities market

It became an autonomous body in 1992 and more powers were given through an ordinance.

Since then it regulates the market through its independent powers.

http://rbi.org.in/scripts/OccasionalPublications.aspx?head=Reserve Bank of India Act


INSURANCE REGULATORY AND DEVELOPMENT AUTHORITY (IRDA)

IRDA is a national agency of the Government of India

Based in Hyderabad (Andhra Pradesh).

It was formed by an Act of Indian Parliament known as IRDA Act 1999

Was amended in 2002 to incorporate some emerging requirements.

Mission of IRDA as stated in the act is "to protect the interests of the

policyholders, to regulate, promote and ensure orderly growth of the

insurance industry and for matters connected therewith or incidental

thereto."

PART OF THE MINISTRIES OF GOI


PENSION FUND REGULATORY AND DEVELOPMENT AUTHORITY (PFRDA

under the finance ministry)



FMC headquartered at Mumbai

Is a regulatory authority which is overseen by the Ministry of

Consumer Affairs, Food and Public Distribution, Govt. of India.

It is a statutory body set up in 1953 under the Forward Contracts

(Regulation) Act, 1952

This Commission allows commodity trading in 22 exchanges in India,

out of which three are national level.

PENSION FUND REGULATORY AND DEVELOPMENT AUTHORITY (PFRDA

under the finance ministry)

PFRDA was established by Government of India on 23rd August, 2003.

The Government has, through an executive order dated 10th October 2003,

mandated PFRDA to act as a regulator for the pension sector.

The mandate of PFRDA is development and regulation of pension sector in

India.

MAJOR FINANCIAL INTERMEDIARIES

Financial Intermediary is referred as:

An Institution

Firm

An Individual

Its functions

It performs intermediation between two or more parties in a financial context Party 1 – is a provider of service

Party 2 – is a consumer or customer

It is the combined working of the institutions, which enables the financial system to function efficiently

In any economy

Organised system of borrowers and lenders

are brought together by financial institutions

Hence they are called financial intermediaries

TYPES OF FINANCIAL INTERMEDIARIES

BANKS

CREDIT UNIONS

FINANCIAL ADVISER OR BROKER

INSURANCE COMPANIES

LIFE INSURANCE COMPANIES

MUTUAL FUNDS OR SOCIETIES

PENSION FUNDS

Borrower who borrows money from the financial Intermediaries / Institutions

Pays higher rate of interest that that received by the actual lender

Difference between interest paid and interest earned will be the profit

CATEGORIES OF FINANCIAL INTERMEDIARIES

Fee Based / Advisory Financial Intermediaries

Charges fees for the services

Service Includes

Issue Management

Portfolio Management

Stock Broking

Underwriting

Corporate Counselling

Mergers and Acquisitions

Capital restructuring

Debenture Trusteeship

CATEGORIES OF FINANCIAL INTERMEDIARIES

Asset Based Financial Intermediaries Finance specific requirements of the clientele

The required infra structure; in the form of required asset or finance is

provided for rent or interest respectively

Earn their income from the interest spread

It is the difference between the interest paid and interest earned

INTERMEIDARY ROLE IN MARKET

Intermediary Market Role

Stock Exchange Capital Market Secondary market to securities

Registrars, Depositories,

Custodians

Capital Market Issue securities to the investors

on behalf of the company and

handle share transfer activity

Investment Banker Capital Market, Credit

Market

Corporate Advisory services,

Issue of securities

Underwriters Capital Market, Credit

Market

Subscribe to unsubscribed

portion of securities

Primary Dealers, Satellite

Dealers

Money Market Market making in government

securities

Forex Dealers Forex Dealers Ensure exchange In currencies

FINANCIAL INSTITUTIONS IN INDIA

RESERVE BANK OF INDIA

COMMERCIAL BANK

FINANCIAL CORPORATION

INSURANCE COMPANIES

MUTUAL FUNDS

NABARD

POST OFFICE


RESERVE BANK OF INDIA This is the apex of the financial system

Established in 1934 and nationalized in 1949

It functions as banker to the government

Supplier and controller of money and credit

Maker of monetary policy

Collector of financial information and data

Directly / Indirectly controls the working of the rest pf the financial systems

NABARD – National Bank for Agricultural and Rural Development

For short term or long term finance for agriculture thru co-op credit system

Established in 1982


COMMERCIAL BANK Very important component of financial institutions

It is a main supply of short term and medium term credit

It includes Nationalised Bank

Private commercial Bank

Cooperative Banks

Foreign Banks

Make short term and medium term credit available to Cottage industry

Small Scale industry

Large Scale Industry

Trade and businesses

Infrastructural projects


MUTUAL FUNDS

It for people of small means

It is not possible to invest in corporate equity because of their small savings

MF are established to major banks

To mobilise small savings

and channelise the same in industrial investment

Through efficient management and minimize risk for small investors

UNIT TRUST OF INDIA was the pioneer in this sector

POST OFFICE

It runs a banking unit to collect small savings of the people

Make them available for public sector investment

National Housing Bank provides finance for construction sector

SBI runs a scheme of public provident fund


FINANCIAL CORPORATION

1948 – Industrial Finance Corporation of India (IFCI)

1956 – Industrial Credit and Investment Corporation of India

1964 – Industrial Development Bank of India

1971 – Industrial Reconstruction Bank of India

State Government established State Finance Corporation

Small Industries Development Bank of India

INSURANCE COMPANIES

Life Insurance Corporations was established along with 4 subsidiaries of General Insurance Corporation

Post 1998 private sector insurance companies came into existence Bajaj – Allianz

New York Max Life Insurance

ICICI Prudential

UNIT 4 – MUTUAL FUND

MUTUAL FUNDS

Introduction to Mutual Funds (MF)

Definition & Meaning

Origin of MF in India

Growth of MF in India

Advantages and Disadvantages of MF

Features of MF and Risk

Importance of MF

Organisation structure and Functioning of MF

Schemes of MF

Money Market MF

Emergence of Private Sector

Evaluation of the performance of MF

Steps to Evaluate Performance of MF

INTRODUCTION TO MUTUAL FUNDS (MF)

A Mutual Fund is a TRUST

That POOLS the savings of a number of investors

Who share a COMMON financial goal.

The money thus collected is then invested in capital market instruments such as

shares, debentures and other securities.

The income earned through these investments and the capital appreciation

realized is shared by its unit holders

In proportion to the number of units owned by them.

Thus, a Mutual Fund is the most suitable investment for the common person

It offers an opportunity to invest in a diversified, professionally managed basket

of securities at a relatively low cost

DEFINITION & MEANING

'Mutual Fund' An investment vehicle that is made up of a pool

of funds collected from many investors for the purpose of investing in

securities such as stocks, bonds, money market instruments and similar

assets.

THE SECURITY AND EXCHANGE BOARD OF INDIA (Mutual Funds)

REGULATIONS,1996 defines a mutual fund as a " a fund establishment in

the form of a trust to raise money 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."

ORIGIN OF MUTUAL FUND IN INDIA

The mutual fund industry in India

started in 1963

with the formation of Unit Trust of India

the initiative of the Government of India and Reserve Bank of India.

The history of mutual funds in India can be broadly divided into four distinct

phases

First Phase - 1964-1987

Second Phase - 1987-1993 (Entry of Public Sector Funds)

Third Phase - 1993- 1996 (Entry of Private Sector Funds)

Fourth Phase – 1996 – 2004 (SEBI regulation and Growth)

Fifth Phase – 2004 Onwards (Growth and Consolidation)

PHASES OF MUTUAL FUND

First Phase - 1964-1987

Unit Trust of India (UTI) was established in 1963 by an Act of Parliament.

The first scheme launched by UTI was Unit Scheme 1964.

At the end of 1988 UTI had Rs. 6,700 crores of assets under management.

Second Phase - 1987-1993 (Entry of Public Sector Funds)

1987 marked the entry of non-UTI, public sector mutual funds set up by public sector

banks and Life Insurance Corporation of India (LIC) and General Insurance Corporation of

India (GIC).

SBI Mutual Fund was the first non-UTI Mutual Fund established in June 1987

Canbank Mutual Fund (Dec 87)

Indian Bank Mutual Fund (Nov 89)

LIC established its mutual fund in June 1989

While GIC had set up its mutual fund in December 1990.

At the end of 1993, the mutual fund industry had assets under management of Rs.

47,004 crores.

PHASES OF MUTUAL FUND

Third Phase - 1993-2003 (Entry of Private Sector Funds)

Government allowed private sector funds including foreign funds management

companies to enter MF Industry

Provided wide range of choice to investors and more competition

AUM rose to about Rs 86000 crores

Fourth Phase - since February 2003

SEBI introduced Mutual Fund regulations in 1996

Brought uniform standards in MF industry

Investors interest was safeguarded by SEBI

The AUM rose to about Rs 1,39,615 crore

Fifth Phase – 2004 Onwards (Growth and Consolidation)

Industry witnessed several mergers and takeovers

AUM rose to about Rs 4,17,300 Crore

ADVANTAGES OF MUTUAL FUNDS

Portfolio Diversification Mutual Funds invest in a well-diversified portfolio of securities

It enables investor to hold a diversified investment portfolio (whether the amount of investment is big or small).

Professional Management Fund manager undergoes through various research works and has better

investment management skills

Which ensure higher returns to the investor than what he can manage on his own.

Less Risk Investors acquire a diversified portfolio of securities even with a small

investment in a Mutual Fund.

The risk in a diversified portfolio is lesser than investing in merely 2 or 3 securities.


Choice of Schemes

Mutual funds provide investors with various schemes with different investment

objectives.

Investors have the option of investing in a scheme having a correlation between

its investment objectives and their own financial goals.

These schemes further have different plans/options

Flexibility

Investors also benefit from the convenience and flexibility offered by Mutual

Funds.

Investors can switch their holdings from a debt scheme to an equity scheme and

vice-versa.

Option of systematic (at regular intervals) investment and withdrawal is also

offered to the investors in most open-end schemes.


Low Transaction Costs

Due to the economies of scale (benefits of larger volumes), mutual

funds pay lesser transaction costs.

These benefits are passed on to the investors.

Safety

Mutual Fund industry is part of a well-regulated investment environment

where the interests of the investors are protected by the regulator

All funds are registered with SEBI and complete transparency is forced.


Transparency

Funds provide investors with updated information pertaining to the

markets and the schemes.

All material facts are disclosed to investors as required by the regulator.

Liquidity An investor may not be able to sell some of the shares held by him very

easily and quickly

Whereas units of a mutual fund are far more liquid.

DISADVANTAGES OF MUTUAL FUNDS

Fees and Commission

Investor has to pay investment management fees and fund distribution costs

All funds charge administrative fees to cover their day-to-day expenses.

Some funds also charge sales commissions or "loads" to compensate brokers, financial

consultants, or financial planners.

Even if you don't use a broker or other financial adviser, you will pay a sales commission

if you buy shares in a Load Fund.

Management Risk

The portfolio of securities in which a fund invests is a decision taken by the fund

manager.

Investors have no right to interfere in the decision making process of a fund manager

Some investors find as a constraint in achieving their financial objectives.

Difficulty in Selecting a Suitable Fund Scheme

Many investors find it difficult to select one option from the plethora of funds/schemes

/ plans available.

Investors have to take advice from financial planners In order to invest in the right fund

to achieve their objectives

FEATURES OF MUTUAL FUNDS AND RISK

Funds Generation

The need and scope for MF operation has increased tremendously

Due to increase in domestic savings and improvement in deployment of investments

Basic purpose of reforms in the financial sector was To enhance the generation of domestic resources

By reducing the dependency on outside funds

MF are market based institution which can generate domestic savings

Channelize them for profitable investments

Lock in Period

MF Scheme offers document that contains a clause of lock in period Ranging from 1 – 3 years

The investors cannot trade neither redeem the units till the completion of minimum period


Multiple Options

MF schemes offers different options to the investors under one scheme

E.g. Growth oriented scheme Option 1 - Regular income

Dividend will be distributed to the investors

Option 2 - Reinvestment of Income

Dividend will be reinvested

Amount will be paid at the time of redemption

Liquidity

Open ended funds offer the facility of repurchase

Close ended funds are traded on the stock exchange after minimum lock in period

MF units can be pledged or mortgage at banks to obtain loan

Can be transferred in favor of an individual


Incentives to early subscribers

Close ended fund schemes are incentivizing investors for early

subscriptions

More often in the tax planning schemes

For e.g. if the scheme is open for 3 months the investor

may be allowed a deduction from the amount to be invested

at a certain rate, if the subscriptions were during the specified

time limits

TODAY’S SESSION – 25.06.2015

Importance of MF

Organisation structure` and Functioning of MF

Schemes of MF

Money Market MF

Emergence of Private Sector

IMPORTANCE OF MUTUAL FUNDS

Mutual funds pool money from individuals and organizations

TO invest in stocks, bonds, and other assets in different industry sectors and regions of the world.

MF can buy whole or fractional fund units directly from Fund companies or through your broker.

The price of each mutual fund unit reflects The market prices of the fund holdings,

Adjusted for management fees and expenses


Selection

Investor can choose from hundreds of mutual funds offered by dozens of mutual fund companies.

This wide selection gives you the flexibility To pick mutual funds that suit your financial objectives and

Risk tolerance.

For example, Equity and Growth Funds are suitable for aggressive investors who can tolerate periods of extreme market volatility.

Balanced Funds could be suitable for a more moderate investor looking for both capital gains and income,

Bond funds would suit conservative investors who want preservation of capital and regular income.

IMPORTANCE OF MUTUAL FUNDS Diversification

Mutual funds are a cost-effective way to diversify your portfolio across different asset categories and industry sectors.

Instead of buying and monitoring potentially dozens of stocks investors can buy a few mutual funds to achieve broad diversification at a fraction of the cost.

For example,

Equity funds offer an indirect way to invest in dozens of companies in different industry sectors,

Balanced funds offer exposure to both stocks and bonds.

Further diversification is possible within each asset category.

For example

Investor can buy mutual funds that specialize in certain industries within equities, such as technology and energy.

Similarly, international funds and emerging market funds are convenient ways to diversify geographically.


Expertise

Professional money management expertise at a reasonable cost is another important attribute of MF.

Fund managers typically have postgraduate finance degrees, and several years of stock analysis and investment management experience.

MF companies use a combination of in-house research staff and the services of external research firms to determine the composition of fund portfolios.

Fund managers may use information technology and sophisticated trading strategies to rebalance portfolios and hedge against market volatility.


Affordability

MF have leveled the playing field by bringing the financial markets closer to small investors.

For about the price of an average stock, you can participate in the capital gains and dividend distributions of potentially dozens of companies.

Investors do not have to spend a sizable amount of your savings to invest in each one of these companies separately.

MF companies are able to spread research, commissions, and related expenses over a larger asset base, which reduces the cost for individual fund investors.

Investors can reduce the costs even further by holding index mutual funds, which track major market and industry indexes.

These funds have low management fees and expenses because they do not have the research and trading costs of actively managed funds.

ORGANISATION STRUCTURE OF MUTUAL FUND

The Mutual Funds in India are regulated by SEBI MF Regulations, 1996.

Under the regulations mutual fund is formed as a Public Trust under the Indian Trusts Act, 1882.

These regulations stipulate a three tiered structure of entities –

Sponsor (creation)

Trustees

Asset Management Company (fund management)

For carrying out different functions of a mutual fund, but place the primary responsibility on the trustees.

ORGANISATION STRUCTURE OF MF - SPONSOR

The Fund Sponsor

SEBI regulations define Sponsor as any person who either itself or in association with another body corporate establishes a mutual fund.

Sponsor sets up a mutual fund to earn money by doing fund management through its subsidiary company which acts as Investment manager of the fund.

Largely, a sponsor can be compared with a promoter of a company.

Sponsors activities include Setting up a Public Trust under Indian Trust Act, 1882 (the mutual fund),

Appointing trustees to manage the trust with the approval of SEBI

Creating an Asset Management Company under Companies Act, 1956 (the Investment Manager)

Getting the trust registered with SEBI.

ORGANISATION STRUCTURE OF MF - SPONSOR

Eligibility of Sponsor

Mutual funds involve managing retail investor‘s money and hence, it becomes important to ensure that it is

run by entities with capabilities and professional merits.

SEBI (Mutual fund) Regulations, 1996 specifies the following eligibility criteria in this regard:

I. Sponsor is required to have financial services business experience of at least 5 years and a positive

Net worth in all the preceding five years.

II. Sponsors‘ Net worth in the immediately preceding year is required to be more than the capital

contribution to AMC.

III. Sponsor is required to be profit making in at least three out of the last five years including the last year.

IV. Sponsor must contribute at least 40% of the Net worth of the Asset Management Company.

Any entity, which contributes at least 40% to the Net worth of an AMC, is deemed sponsor and therefore is

required to fulfil all the requirements given in 1 to 4.

ORGANISATION STRUCTURE OF MF – TRUSTEE

Trustees –

The trust is created through a document called the trust deed

Which is executed by the fund sponsor in favor of the trustees.

Trustees manage the trust and are responsible to the investors in the mutual funds.

They are the primary guardians of the unit-holders funds and assets.

Trustees can be formed in either of the following two ways

Board of Trustees, or

A Trustee Company.

The provisions of Indian Trust Act, 1882, govern board of trustees or the Trustee Company.

A trustee company is also subject to provisions of Companies Act, 1956.

ORGANISATION STRUCTURE OF MF – TRUSTEE

Obligations of trustees

I. Trustees ensure that the activities of the mutual fund are in accordance with SEBI (mutual fund) regulations, 1996.

II. They check that the AMC has proper systems and procedures in place.

III. Trustees also make sure that all the other fund constituents are appointed and that proper due diligence is exercised by the AMC in the appointment of constituents and business associates.

IV. All schemes floated by the AMC have to be approved by the trustees.

V. Trustees review and ensure that the net worth of the AMC is as per the regulatory norms.

VI. They furnish to SEBI, on a half-yearly basis, a report on the activities of AMC.

Regulation regarding appointment of trustees I. Sponsor with prior approval of SEBI appoints trustees.

II. There should be at least four members in the board of trustees with at least 2/3rd independent.

III. A trustee of one mutual fund cannot be trustee of another mutual fund,

IV. unless he is an independent trustee in both cases and has the approval of both the boards.

V. The trustees are appointed by executing and registering a trust deed under the provisions of Indian registration Act.

VI. This trust deed is also registered with SEBI.

RESPONSIBILITIES OF TRUSTEE

The Trustees are required to fulfill several duties and obligations in accordance with SEBI (Mutual Funds) Regulations, 1996 and the Trust Deed constituting the Mutual Fund. These include

1. The Trustee and the Asset Management Company enter into an Investment Management Agreement (IMA) with the approval from SEBI.

2. The Investment Management Agreement shall contain such clauses as are mentioned in the Fourth Schedule of the SEBI (MFs) Regulations, 1996 and other such clauses as are necessary for making investments.

3. The Trustees shall have a right to obtain from the Asset Management Company such information as is considered necessary by the Trustees.

4. The Trustee shall ensure before the launch of any scheme that the Asset Management Company possesses/has done the following:

1. Systems in place for its back office, dealing room and accounting;

2. Appointed all key personnel including fund manager(s) for the Scheme(s) and submitted their bio-data which shall contain the educational qualifications, past experience in the securities market to SEBI, within 15 days of their appointment;

3. Appointed Auditors to audit its accounts;

4. Appointed a Compliance Officer to comply with regulatory requirement and to redress investor grievances;

5. Appointed Registrars and laid down parameters for their supervision;

6. Prepared a compliance manual and designed internal control mechanisms including internal audit systems; and

7. Specified norms for empanelment of brokers and marketing agents

ORGANISATION STRUCTURE OF MF – AMC

The Asset Management Company (AMC) is the investment Manager of the Trust.

The sponsor, or the trustees is so authorized by the trust deed

Appoints the AMC as the ―Investment Manager‖ of the trust (Mutual Fund) via an agreement

called as ‗Investment Management Agreement‘.

An asset management company is a company registered under the Companies Act, 1956.

Sponsor creates the asset management company

It manages the funds of the mutual fund (trust).

The mutual fund pays a small fee to the AMC for management of its fund.

The AMC acts under the supervision of Trustees and also it is subject to the regulations of

SEBI

ROLE OF ASSET MANAGEMENT COMPANY

The AMC is an operational arm of the mutual fund

AMC is responsible for carrying out all functions related to management of

the assets of the trust.

The AMC structures various schemes, launches the scheme and mobilizes

initial amount, manages the funds and give services to the investors

AMC is the first major constituent appointed

AMC solicits the services of other constituents like Registrar, Bankers,

Brokers, Auditors, Lawyers etc and works in close co-ordination with them.

AMC – RESTRICTIONS ON BUSINESS ACTIVITY

AMC focuses just on its core business

The activities of AMC‘s are not in conflict of each other

These are ensured through the following restrictions on the business activities of an AMC.

An AMC shall not undertake any business activity except

In the nature of portfolio management services,

Management and advisory services to offshore funds

These activities are not in conflict with the activities of the mutual fund.

An AMC cannot invest in any of its own schemes unless full disclosure of its intention to invest has been made in the offer document

An AMC shall not act as a trustee of any mutual fund

CUSTODIAN

The responsibility of safe keeping of the securities is on the custodian.

Securities, which are in material form, are kept in safe custody of a custodian and securities

Which are in ―De-Materialized‖ form, are kept with a Depository participant, who acts on the advice of custodian.

Custodian ensures That delivery has been taken of the securities, which are bought,

They are transferred in the name of the mutual fund.

Funds are paid out when securities are bought.

Custodians keep the investment account of the mutual fund.

They collect and account for the dividends and interest receivables on mutual fund investments.

Keep track of various corporate actions like bonus issue, rights issue, and stock split; buy back offers, open offer etc

Act on these as per instructions of the Investment manager.

RESPONSIBILITY OF CUSTODIAN

Provide post-trading and custodial services to the Mutual Fund;

Keep securities and other instruments belonging to the Scheme in safe custody

Ensure smooth inflow/outflow of securities and such other instruments as and when necessary, in the best interests of the unit holders;

Ensure that the benefits due to the holdings of the Mutual Fund are recovered; and

Be responsible for loss of or damage to the securities due to negligence on its part or on the part of its approved agents.

The Custodian normally charge portfolio fee, transaction fee and out - of -pocket expenses in accordance with the terms of the Custody Agreement

OTHER CONSTITUENTS – REGISTRAR AND TRANSFER

AGENCY

A mutual fund manages money of many unit-holders across cities and towns of the country.

Investor servicing typically include

processing investors‘ application,

recording the details of investors,

sending them account statements and

other reports on periodical basis

processing dividend payouts,

making changes in investor details

and keeping investor records updated

by adding details of new investors and

by removing details of investors who withdraw their funds from the mutual funds.

It is impractical and expensive for any mutual fund to have adequate workforce all over India for this purpose.

MF use Registrars and transfer agents, which provide services to many mutual funds.

This ensures quality services across all location and keeps the costs lower for the unit-holders.

OTHER CONSTITUENTS – AUDITOR

Auditor Investor money is held by the trustees in trust.

Regulation has ensured proper accounting norms to ensure fair and responsible record keeping of investor‘s money.

Separate books of account are maintained for each scheme of the mutual fund and individual annual report is prepared.

The books of accounts and the annual reports of the scheme are audited by auditors.

The AMC is a company under companies act, 1956 and therefore is required to get its accounts audited as per the provisions of the companies act.

In order to maintain high standards of integrity and transparency regulations the auditor of the mutual fund schemes and

the auditor of the AMC will have to be different.

OTHER CONSTITUENTS – BROKER

Brokers are registered members of the stock exchange

Services are utilized by AMCs to buy and sells securities on the stock exchanges.

Many brokers also provide the Investment Manager (AMC) with research reports on the performance of various companies, sector and market outlook,

investment recommendations

Regulations have imposes restrictions on the involvement of brokers in the investment process of any mutual fund in the following ways-

If a broker is RELATED to the sponsor or its associate, then AMC shall not purchase or sell securities through that broker in excess of 5%

of the aggregate of purchase and sale of securities made by the mutual fund in all its schemes.

For transactions through ANY OTHER BROKER AMC can exceed the limit of 5% provided it has recorded justification in writing

Report of such exceeding has been sent to the trustee on a quarterly basis

REGULATION / REGULATORS OF MF

Securities and Exchange Board of India (SEBI) Is the primary regulator of mutual funds in India.

SEBI is also apex regulator of capital markets.

Issuance and trading of capital market instruments and the regulation of capital market intermediaries is under the purview of SEBI.

Apart from SEBI, mutual funds follow the regulations of other regulators in limited manner.

RBI RBI acts as regulator of sponsors of bank-sponsored mutual funds,

especially in case of funds offering guaranteed/assured returns.

No mutual fund is allowed to bring out a guaranteed returns scheme without taking approval from RBI

Companies Act, 1956 Asset Management Company and Trustee Company will be subject to the provisions of the

Companies Act, 1956.

REGULATION / REGULATORS OF MF

Stock Exchange Closed-end funds might list their units on a stock exchange.

In such a case, the listings are subject to the listing regulation of stock exchanges.

Mutual funds have to sign the listing agreement and abide by its provisions,

which primarily deal with periodic notifications and disclosure of information that may impact the trading of listed units.

Indian Trusts Act, 1882 Mutual funds are formed and registered as a public trusts under the Indian trusts Act, 1882.

They have to follow the provisions of the Indian Trusts Act, 1882.

Ministry of Finance (MoF) The finance ministry is the supervisor of both the RBI and SEBI.

The MoF is also the appellate authority under SEBI regulations.

Aggrieved parties can make appeals to the MoF on the SEBI rulings relating to mutual funds.

MUTUAL FUND SCHEME

TYPES OF MUTUAL FUND

GEOGRAPHICAL CLASSIFICATION DOMESTIC FUNDS

Mobilises resources within the country

Market is limited to the boundary of the nation in which fund operates

Mutual Fund can invest only in securities which are issued and traded in domestic financial markets

OFFSHORE FUNDS Facilitate cross border flow of funds

Open domestic commercial markets to international investors

Can invest in securities of foreign countries

TYPES OF MUTUAL FUND

CLASSIFICATON BY STRUCTURE

Open-Ended SCHEME-

It is available for subscription all through the year

This scheme allows investors to buy or sell units at any point in time.

High liquidity. Investors can buy and sell units at Net Asset Value

This does not have a fixed maturity date.

Close Ended Scheme

In India, this type of scheme has a fixed maturity period

Investors can invest only during the initial launch period known as the NFO (New Fund Offer)

period

Trading in the scheme can be done through stock exchanges

Market Price on stock exchange can differ from the NAV on account of demand and supply

Fund has not interaction with investors till redemption except for paying dividends / bonus

Interval Fund

Operating as a combination of open and closed ended schemes,

It allows investors to trade units at pre-defined intervals

OPEN ENDED SCHEME

Open-Ended SCHEME- This scheme allows investors to buy or sell units at any point in time. This does not have a fixed maturity date.

Debt/ Income a major part of the investable fund are channelized towards debentures, government securities,

and other debt instruments.

Although capital appreciation is low (compared to the equity mutual funds),

this is a relatively low risk-low return investment avenue

which is ideal for investors seeing a steady income.

Money Market/ Liquid This is ideal for investors looking to utilize their surplus funds in short term instruments

These schemes invest in short-term debt instruments

Seek to provide reasonable returns for the investors.

Equity/ Growth Equities are a popular mutual fund category amongst retail investors.

Although it could be a high-risk investment in the short term

investors can expect capital appreciation in the long run.

If you are at your prime earning stage and looking for long-term benefits, growth schemes could be an ideal investment.

OPEN ENDED SCHEME

Index Scheme Index schemes is a widely popular concept in the west.

These follow a passive investment strategy where your investments replicate the movements of benchmark indices like Nifty, Sensex, etc

Sectoral Scheme Sectoral funds are invested in a specific sector like infrastructure, IT, pharmaceuticals, etc.

or segments of the capital market like large caps, mid caps, etc

This scheme provides a relatively high risk-high return opportunity within the equity space.

Tax Saving As the name suggests, this scheme offers tax benefits to its investors.

The funds are invested in equities thereby offering long-term growth opportunities.

Tax saving mutual funds (called Equity Linked Savings Schemes) has a 3-year lock-in period.

Balanced This scheme allows investors to enjoy growth and income at regular intervals.

Funds are invested in both equities and fixed income securities

the proportion is pre-determined and disclosed in the scheme related offer document.

These are ideal for the cautiously aggressive investors.

MONEY MARKET MUTUAL FUNDS

A money market fund's purpose is

To provide investors with a safe place to invest easily

accessible, cash-equivalent assets.

It is an open ended mutual fund

Money market securities must be highly liquid and of the highest quality

It is a type of mutual fund characterized as a low-risk, low-return investment.

Because money market funds have relatively low returns

Investors such as those participating in employer-sponsored retirement plans, might not want to use money market funds as a long-term investment option

MONEY MARKET MUTUAL FUNDS

Because they will not see the capital appreciation they require to meet

their financial goals.

Money market funds have no loads (fees that some mutual funds charge

for entering or exiting the fund).

Some money market funds also provide investors with tax-advantaged

gains

By investing in municipal securities that are tax-exempt at the federal

and/or state level.

A money-market fund might also hold short-term U.S. Treasury securities

(T-bills), certificates of deposit and corporate commercial paper.

PURPOSE OF MONEY MARKET MUTUAL FUNDS FOR

INVESTORS

There are three instances when money market mutual funds investors invest, because of their liquidity, are particularly suitable investments.

Money market mutual funds offer a convenient parking place for cash reserves when an investor is not quite ready to make an investment or

Is anticipating a near-term cash expense for a non-investment purpose.

Money market mutual funds offer ultimate safety and liquidity.

This means that investors will have an expected sum of cash at the very moment that they need it.

An investor holding a basket of mutual funds from a single fund company Investor may occasionally want to transfer assets from one fund to another.

If, however, the investor wants to sell a fund before deciding on another fund to purchase, a money market mutual fund offered by the same fund company may be a good place to park the proceeds of sale.

Then, at the appropriate time, the investor may exchange his or her money market mutual fund holdings for shares of the other funds in the fund family.

To benefit the clients Brokerage firms regularly use money market mutual funds to provide cash management services.

Putting a client's dormant cash into money market mutual funds will earn the client an extra percentage point (or two) in annual returns above those earned by other possible investments.

http://www.investopedia.com/terms/l/liquidity.asp

http://www.investopedia.com/articles/mutualfund/04/081104.asp

CATEGORIES OF MONEY MARKET MUTUAL FUNDS

Money market mutual funds may contain a specific type of money market security or a combination of securities across a wide spectrum:

One class of fund, limits its asset purchases to U.S Treasury

securities.

Second class of money market funds purchases both

U.S. government securities and

investments in various government sponsored enterprises (GSEs).

The third and largest class of money market mutual funds invests

in a variety of money market securities

that offer the highest degree of security.

CATEGORIES OF MONEY MARKET MUTUAL FUNDS

Another important categorization for money market mutual funds relates to their taxable or tax-exempt status.

Taxable funds invest in securities such as Treasury bills and commercial paper,

whose interest income is subject to income taxation

Tax-exempt funds Invest exclusively in securities that are issued by state and local governments and are

exempt from income taxation.

Appeal to investors who are in higher federal tax brackets

Who are seeking tax savings on the overall interest income generated by their portfolios.

Have the potential to offer a triple- benefit tax exemption for some investors

Some tax-exempt funds purchase only securities issued by governments within a particular state.

If an investor can find such a fund for his or her home state, that investor can earn interest income that is exempt from federal, state and perhaps even local income

EVALUATION OF PERFORMANCE OF MF

Evaluation of MF is based on few aspects. They are

Net Asset Value (NAV)

Cost related to mutual fund

Returns

Holding Period Return (HPR)

NET ASSET VALUE OF MUTUAL FUND

Net Asset Value (NAV) = Market value of all the assets – Liabilities related to these assets

NAV is calculated as a value per unit of holding

As the value of assets and liabilities changes daily the NAV also changes daily

This NAV is receivable when the unit holder surrenders the Mutual Fund

As the unit holder is a part owner of all the assets and liabilities : Returns are calculated between the two elements (a) NAV & (b) Cost of MF

Based on NAV the performance of the fund can be evaluated

Higher the NAV higher the returns

NAV is calculated as

NAV = Net assets of the scheme / Nos. of units outstanding

Net asset of the scheme =

MV of investments+

Receivables +

other accrued income +

other assets –

accrued expenses –

Other Payables –

Other Liabilities

COST OF MUTUAL FUND

COST:

To run a MF scheme, some cost has to be incurred.

Inverse relationship with return High cost less return and Low cost high return

MF costs are primarily of two types Initial expenses – related to establishment of MF

Recurring expenses – Cost of technical analyst; administration cost; advertisement cost; maintenance cost of MF

Evaluation of MF can be done on from its cost involved

Expense ratio relates to the extent of assets used to run the MF

It is inclusive of Travel cost

Management consultancy

Advisory fees

Expense ratio has to be calculated Expense ratio = Expenses / Average value of portfolio

RETURNS ON MUTUAL FUND

MF can be evaluated from its return point of view.

Investors derive three types of income from owning mutual fund units

Capital gain from disbursement

Cash Dividend

Changes in the fund’s NAV per unit (Unrealized Capital Gain)

For an investor who holds a MF for one year, the one year holding

period return is

Returns = {Capital gain from disbursement + Cash Dividend} + {Changes in

the fund’s NAV per unit (Unrealized CapitalGain) / Base NAV}

HOLDING PERIOD RETURN (HPR)

MF can be evaluated from the holding period return point of view

HPR can be in the following term:

Capital gain earned

Dividend earned

Changes in the price of NAV

RATIO’S USED FOR EVALUATION OF MF

Sharpe Ratio

Treynor Ratio

Jensen‘s Alpha Ratio

SHARPE’S RATIO The Sharpe ratio was derived in 1966 by Noble Laureate William F. Sharpe to measure adjusted

performance

It is calculated by subtracting the risk free rate from the rate of return for a portfolio and dividing the result from the standard deviation of the portfolio returns.

It tells us whether the returns of a portfolio are due to smart investment decisions or a result of excess risk.

The greater a portfolio Sharpe‘s ratio, the better its risk adjusted performance has been

The Sharpe ratio is a risk-adjusted measure of return. It is often used to evaluate the performance of a portfolio.

The ratio helps to make the performance of one portfolio comparable to that of another portfolio by making an adjustment for risk.

A fund with higher Sharpe ratio is preferable as it indicates that the fund has higher risk premium for every unit of standard deviation risk

Sharpe ratio = rp-rf / sd p rp is the rate of return of a mutual fund

Rf is the risk free rate

Sd p is the standard deviation of a mutual fund

SHARPE’S RATIO

For example,

Manager A generates a return of 15%

Manager B generates a return of 12%,

it would appear that manager A is a better performer.

If manager A, who produced the 15% return, took much larger risks than manager B, In that case that

manager B has a better risk-adjusted return.

To continue with the example, say

If the risk free-rate is 5%,

Manager A's portfolio has a standard deviation of 8%,

Manager B's portfolio has a standard deviation of 5%.

The Sharpe ratio for manager A would be 1.25 {(15%-5%)/ 8%}

while manager B's ratio would be 1.4, {(12%-5%)/ 8%}

which is better than manager A.

Based on these calculations, manager B was able to generate a higher return on a risk-adjusted basis.

A ratio of 1 or better is considered good, 2 and better is very good, and 3 and better is considered

excellent.

TREYNOR RATIO

It is a measurement of the returns earned in excess of that which could have

been earned on a riskless investment

Developed by Jack Treynor, the Treynor ratio (also known as the "reward-to-

volatility ratio")

Treynor Ratio is a measurement of efficiency Good performance efficiency is

measured by a high ratio.

Higher Treynor ratio indicates better performance of fund

The Treynor measure adjusts excess return for systematic risk

Utilizing the relationship between annualized risk-adjusted return and risk.

TREYNOR RATIO

Treynor Ratio utilizes "market" risk (beta) instead of total risk (standard

deviation).

The Treynor ratio relies on beta, which measures an investment's sensitivity

to market movements, to gauge risk.

The ratio indicates return per unit of systematic risk

It attempts to measure how well an investment has compensated its

investors given its level of risk.

The formula to calculate Treynor Ratio is

S = {Returns from portfolio – Return of risk free environment}/ Beta of portfolio

JENSEN’S ALPHA RATIO

It is based on systematic risk rather than total risk

It is suitable for evaluating a portfolio‘s performance in combination with other portfolio‘s

The measure is usually very close to zero

A positive alpha means that return tends to be higher than expected given the beta statistics

A negative alpha indicates that the fund is an under performer

Alpha measures the value added of the portfolio given its level of systematic risk

It is the difference between a fund‘s actual return and the return on a benchmark portfolio with same risk

UNIT II

COMMERCIAL BANK


DEVELOPMENTS BANK OF INDIA

COMMERCIAL BANK

Bank and its features

Meaning and function of commercial banks

Investment policy of commercial banks

Liquidity in Banks – Factors affecting liquidity

Balance sheet of commercial bank

NPA‘s (Meaning Causes, Imapct and measures to reduce

Interest Rate Reforms

Capital Adequacy Norms

FEATURES OF A BANK Financial institutions

It is a financial institutions which deals with money and other related services

Accepting Deposits Banks accept deposits from the public

Deposits can be withdrawn either on demand or after a certain period

Lending of money The bank advances loans to those who need it

The bank gives short term and medium term loans.

Bank money Bank operates mostly with cash and bank money such as cheques, drafts, etc

Services to Customer Bank provides nos of services to its customers

It makes direct payments on behalf of its customers and receives money on behalf of customer

Vital role The bank plays vital role in modern business

It would be difficult to conduct business activities in a smooth manner

A bank has a vital aid to trade

PRIMARY FUNTION – COLLECTION OF DEPOSITS

SAVINGS DEPOSIT FIXED DEPOSITS CURRENT DEPOSITS RECURRING

DEPOSIT

It encourages saving

habits

Lump sum amount

is deposited for a

specific period

It is operated by

businessmen

It is operated by

salaried persons or

small traders

Rate of interest is

low

Rate of interest

varies with the

period of deposit

Withdrawals are

freely allowed

Certain sum of

money is periodically

deposited

Withdrawals are

allowed with

restrictions

Withdrawals take

place on or after the

maturity date

No interest paid Withdrawal is

permitted only after

the expiry of certain

period

Suitable for salary

and wage earners

Account holder can

close the account

before maturity date

Account holders get

the benefit of

overdraft facility

Higher rate of

interest is paid

Account can be

opened in single or

joint name

People with large

surplus funds go for

Fixed deposits

GRANTING OF LOANS AND ADVANCES

OVERDRAFT CASH CREDITS

It is given to current account holders CC is allowed upto a specific limit fixed in

advance. Separate CC account is

maintained

A certain amount is sanctioned as OD. It

can be withdrawn within a certain period of

time, say 3 months.

It can be given to current account holders

and to other who do not have a current

account with the bank

Interest is charged on actual amount

withdrawn

Interest is charged on the amount

withdrawn

It is granted against a collateral It is given against a security of tangible

assets and / or guarantees

Provided to business and non business

organisation

Advance is given for a longer period and a

larger amount of loan is sanctioned

GRANTING OF LOANS AND ADVANCES

LOANS DISCOUNTING OF BILLS OF EXCHANGE

Lump sum loan amounts are given. Bank can advance money by discounting

or by purchasing bills of exchange both

domestic and foreign bills It is for short term period for e.g. one year

or Medium term period for e.g. five years

Repayment of money can be in

installments, spread over a period of time

or in lump sum

Bank pays the bill amount to the drawer or

beneficiary of the bill by deducting usual

discount charges

Loans are granted to meet long term

working capital needs and for expansion

and modernization

On maturity, the bill is presented to the

drawee or acceptor of the bill and the

amount is collected

Interest is charged on the actual amount

sanctioned whether withdrawn or not

The bank can get the bill rediscounted with

the All India financial institutions such as

Small Industries Bank of India (SIDBI),

Export Import Bank of India (EXIM Bank) The rate depends on the amount of loan

and period of loan

Loans are normally secured against

tangible assets of the company

SECONDARY FUNCTIONS

The secondary functions of commercial bank can be classified

under the following heads.

Agency functions

General utility functions

Miscellaneous functions

AGENCY FUNCTIONS

COLLECTION OF CHEQUES:

Commercial banks collect the cheques, bills of exchange, etc, on behalf of their customers.

Banks collect local and outstation cheques and bills of exchange through clearing house facilities provided by the central bank

COLLECTION OF INCOME:

The commercial banks collect dividends, interest on investment, pension and rent of property due to the customers.

When any income is collected by the bank, a credit voucher is sent to the customer for information.

PAYMENT OF EXPENSES:

The banks make payment of insurance premiums, rent, trade subscription, school fee and other obligation of the customers.

When any expense is paid by the bank, a debit voucher is sent to the customer for information.

DEALER IN SECURITIES:

The banks carry out purchase and sale of securities on behalf of their customers.

Banks do it well because they are aware of the market conditions.

AGENCY FUNCTION

ACTS AS TRUSTEE

The banks act as trustee to manage trust property as per instructions of property owners.

Banks are required to follow the terms and conditions of trust deed.

ACTS AS AN AGENT:

Commercial bank sometimes acts as an agent on behalf of its customers at home or abroad in

dealing with other banks or financial institutions.

OBEYS STANDING INSTRUCTIONS:

Sometimes, customer may order his bank to do something on his behalf regarding the conduct of

his account.

This written order is called standing instruction. The bank being the agent of its customer obeys the

standing instructions.

ACTS AS TAX CONSULTANT:

Commercial bank acts as tax consultant to its client.

The commercial bank prepares general sales tax return, income tax return, etc. Tiles the same with

tax authorities.

GENERAL UTILITY FUNCTIONS

PROVIDES LOCKERS FACILITIES:

Commercial banks provide lockers facilities to its customers for safe custody of Jewelery, shares, securities and other valuables.

This has minimized the risk of losing due to theft.

ISSUE OF TRAVELER'S CHEQUE:

Bank issues traveler's cheques to the customers for traveling in and outside the country.

FOREIGN EXCHANGE:

Commercial banks deal in foreign exchange.

This enables the individuals and businessmen to obtain foreign currency in exchange of their home currency.

For dealing in foreign exchange, commercial banks have to obtain permission from the central bank.

TRANSFER OF MONEY:

Commercial banks provide facilities for the transfer of money to any place within and outside the country.

The funds are transferred by means of draft, telephonic transfer, electronic transfer etc.

FINANCES FOREIGN TRADE:

A commercial bank finances foreign trade by accepting foreign bills of exchange.

Bank also issues letter of credit on behalf of its customers to facilitate foreign trade.

According to Sir Ramesh Poget: "The issuing of letters of credit is the basic function of a bank."

GENERAL UTILITY FUNCTIONS

TRADE INFORMATION:

Commercial banks collect and provide trade information and tender advice to its customers about financial matters.

Issues credit cards: Banks issue credit cards to their trustworthy and valued customers.

This facilitates the customers to pay for their necessities of life.

MODARABA COMPANY:

The commercial banks act as Modaraba and leasing companies under the provisions of Modaraba Companies Ordinance, 1980.

PURCHASE PTCS:

Commercial banks underwrite or purchase Participation Term Certificate (PTCs), Term Finance Certificates (TFCs) and Modaraba Certificates.

This helps the companies to raise their capital.

FINANCIAL STANDING:

Commercial banks answer reference letters regarding the financial standing and business reputation of customers.

Banks provide this information with great care and utmost secrecy.

TRANSFER OF MONEY:

Commercial banks provide facilities for the transfer of money to any place within and outside the country.

The funds are transferred by means of draft, telephonic transfer, electronic transfer etc.

MISCELLANEOUS FUNCTIONS

COLLECTION OF UTILITY BILLS:

Commercial banks provide facilities for the collection of utility bills from general public on behalf of government bodies.

This facilitates the public to pay utility bills in time.

ZAKAT COLLECTION:

Commercial banks collect Zakat from their account holders and deposit the same into Central Zakat Fund, according to Zakat and Usher ordinance - 1980.

HAJJ SERVICES:

The commercial banks provide free Hajj sendees to the intending pilgrims.

Banks receive Hajj applications.

Banks also facilitate to form Hajj groups.

Banks make necessary arrangements for the training of intending pilgrims.

QARZ-E-HASNA:

The commercial banks provide Qarz-e-Hasna to deserving patients for medical treatment and to students for higher studies within the country and abroad.

The Qarz-e-Hasna is refund Ale in easy installments,

ELECTRONIC BANKING AND E-BANKING:

Electronic banking is offering improved services to the customers as fellows:

ATM Cards

Credit Cards

Electronic transfer of money

INVESTMENT POLICY OF COMMERCIAL BANKS

A bank makes investments for the purpose of earning profits.

First it keeps primary and secondary reserves to meet its liquidity requirements.

This is essential to satisfy the credit needs of the society by granting short-term loans to its customers.

Whatever is left with the bank after making advances is invested for long period to improve its earning capacity.

Distinction between a loan and an investment LOAN

The bank gives a loan to a customer for a short period on condition of repayment.

It is the customer who asks for the loan.

By advancing a loan, the bank creates credit which is a temporary source of fund for the bank.

INVESTMENT An investment is the outlay of its funds for a long period without creating any credit.

A bank makes investments in government securities and in the stocks of large reputed industrial concerns

while in the case of a loan the bank advances money against recognised securities and bills.

However, the goal of both is to increase its earnings.


The investment policy of a bank consists of earning high returns on its unloaned resources.

But it has to keep in view the safety and liquidity of its resources so as to meet the potential demand of its customers.

Since the objective of profitability conflicts with those of safety and liquidity, the wise investment policy is to strike a judicious balance among them.

Therefore, a bank should lay down its investment policy in such a manner so as to ensure the safety and liquidity of its funds and at the same time maximise its profits.

This requires adherence to certain principles.


MANDATORY INVESTMENT Mandatory requirement of Banking Regulation Act, it is compulsory to invest

Minimum 3% as Cash Reserve Fund (CRR) &

25% as Statutory Liquid Reserve(SLR – Investment in Govt. & other Asset

LOANS AND ADVANCES Bank can invest upto 75% of own funds and upto 70% of deposits in loans and advances.

Out of which

After observing the prescribed norms for priority sector and weaker section of the society.

Balance can be advanced as per Loan Policy of the Bak

Keeping in view the ceiling of maximum amount of advances

To a single person

Similar type of business

On similar type of securities to minimize the risk involved.

Investment with Other Citizen Co-Operative Banks Banks will not make any investment with these banks

Except undertaking normal transaction in the accounts opened for clearing and transfer of funds purpose


Investment in Other Banks Banks may invest any surplus funds in any commercial, Private, and Co- operative

banks.

If any such bank gives very high rate of interest than the financial position has to be analysed.

Investment of the liquid surplus funds from time to time has to be made.

There should not be any difficulty in meeting out the funds requirement for daily clearing adjustment and

Payment of deposit on due dates of maturity.

Investment in non – SLR Debt Securities Investment may be made in Liquid funds enjoying good market credit rating and

also trading in GOI Securities

Such investment must not exceed 10% of the total deposits of the bank

Investment in other Institutions, Corporations, and Companies Bank will not invest its surplus funds in any other institution, Companies,

Corporations, even if the rates are attractive


Investment in share money of Cooperative Institutions Bank may invest 2% of its personal funds in the share money of cooperative

institutions

But it will be in accordance with the directives of RBI.

Investment in Private Companies: Bank will not make any investment in private companies or in Shares /

Debentures of other institutions other than cooperative institutions

Investment in Govt Securities Government Securities will mean securities issued by the Central and State

Governments.

Cash Management Cash Balance will be kept within the fixed limit

Excess cash will affect the profitability of the bank

BALANCE SHEET OF COMMERCIAL BANKS

Commercial bank's balance sheet has two main sides

The liabilities and

The assets.

From the study of the balance sheet of a bank we come to know

about a system which a bank has followed for raising funds and

allocation of these funds in different asset categories.

Bank can have others money with it.

It can be in terms of shareholders share capita, or

depositors deposits. This money is the bank's liabilities.

On the other hand bank's own sources of income leads to generation of assets for bank.

BALANCE SHEET OF COMMERCIAL BANKS

Liabilities Assets

a. Share Capital a. i. Cash in Hand

b. Reserve Funds ii. Cash with the Central

Bank (RBI)

c. Deposits iii. Cash with the other banks

i. Fixed Deposits b. Money at short

ii. Saving Deposits c. Bills and securities

discounted

iii.Current Deposits d. Investment of bank

iv. Other Deposits e. Loans and Advances given

d. Borrowings f. Other Assets

e. Other liabilities

LIABILITIES OF COMMERCIAL BANKS Share capital

The contribution which shareholders have contributed for starting the bank.

Reserve funds Are the money, which the bank has accumulated over the years from its undistributed profits to meet

contingencies.

They belong to shareholders

Deposits The money are owned by customers and therefore it is a liability of a bank.

There can be various kinds of deposits and recurring deposits.

At the same time they are assets of the company as the bank can make use of these funds to get interest yielding assets.

Borrowings Bank can borrow from central and other commercial banks; and other financial institutions.

These borrowings are also treated as bank's liabilities.

Other Liabilities Miscellaneous liabilities are incurred by bank

They include bills payable, viz drafts, travellers cheques, pay slips etc.

It includes Income tax provisions

ASSETS OF COMMERCIAL BANKS

Cash Balances Banks holds cash to meet the day to day withdrawals of deposits by its customer.

Bank's cash in hand, cash with other banks and cash with RBI are its assets.

In India, commercial banks are obliged to keep a certain proportion of deposits with in the form of CRR with RBI.

Cash has perfect liquidity but yields no interest.

Money at call and short notice It refers to short term loans made in money market.

Such loans are borrowed by speculators in stock exchange market.

Bank makes money available at short notice to other banks and financial institutions for a very short period of 1-14 days.

These forms of assets are highly liquid and interest earning too.

At a comparatively low rate

These loans are repayable on demand at the option of either lender / borrower.

Bill discounted Bank funds are invested in commercial bills which are usually for 3 months

Banks also invest in treasury bills.

These are self liquidating in nature

ASSETS OF COMMERCIAL BANKS

Investments Investment in various kind of securities is a major part of assets of a bank

Commercial bank invests in Govt. securities, shares etc.

Securities and Bonds are known as secondary reserves because they are transferable and interest yielding.

Banks prefer medium and short term securities.

Secondary reserve fails to convert securities in to cash at the same time.

Loans and Advances It is the most important asset item in the Balance Sheet of a bank.

Profitability of the bank depends on the extent to which it grants loans and advances to customers

Banks mostly grant short term working capital loans so that they can have fair liquidity with high profitability

Other Assets It includes Fixed Assets, furniture and fixtures etc.

It will also include the net position of inter office account.

FACTORS AFFECTING LIQUIDITY OF BANKS

Statutory Requirements Every commercial bank has to keep a min cash balance.

Extent of reserves held by bank depends upon the statutory requirements like CRR and SLR.

Limits are fixed by RBI

Commercial banks have to maintain liquid assets in the form of gold and approved securities

Nature of Money Market It will be easy for banks to buy and sell securities if the money market is fully developed

In such case need for cash will be less

Banking Habits Banking habits of customer has direct bearing on cash balance and liquidity position

In developed countries for making payments cheques are used, hence use of cash is less

In developing countries banking habits are not fully developed, so bank has to maintain large cash reserve

Structure Of Banks Under unit banking every bank is an independent unit. They have to keep high degree of liquidity

Under branch banking, the cash reserves can be centralized in head office.

Branches can have smaller liquid reserves.


Business Condition In industrialized countries, business in brisk and speculative activities are

undertaken

Hence demand for money is large

In agricultural countries, during off season, demand is less

Therefore banks can manage with small cash balances

Monetary Transactions During busy season such as festival times, harvest season, beginning of month banks

will have to keep large percentage of cash

The size of liquid funds also depends on the number and magnitude of monetary transaction

Nature of Deposits The nature of deposits also determines the liquidity requirements of a bank

Larger the demand for short term deposits, larger will be the liquidity


Number and Size of Deposits

When the number and size of deposit rise banks will have to keep more liquidity and

vice versa

Clearing House Facility

When clearing house is available, then large transactions can be made through book

adjustments

This will reduce cash requirements of commercial banks

Liquidity Policy of Other Banks

A bank decides to hold large cash balances will have more customers due to

goodwill.

Hence other banks will also try to improve their liquidity position to attract

customers

The liquidity position of one bank will depend on the liquidity policy of other banks

NON PERFORMING ASSETS (NPA’S)

Definition: A non performing asset (NPA)

Is a loan or advance

For which the principal or interest payment

Remained overdue for a period of 90 days.

Causes for creation of NPA

EXTERNAL CAUSES INTERNAL CAUSES

1. Natural calamities and climate

conditions

2. Recessions

3. Changes in Government policies

4. Changes in economic conditions

5. Industry related problems

6. Technical Problems

7. Impact of liberalisation on industries

1. Internal defaulters.

2. Project Failure relates to improper

project reports

3. Poor knowledge of product risk

4. Overdependence

5. Lack of professionalism

6. Non observance of system and

procedures

7. Non Insistence of collateral

8. Lack of post sanction monitoring

IMPACT OF NPA’S

Profitability:

NPAs put detrimental impact on the profitability as banks stop to earn income

Attract higher provisioning compared to standard assets on the other hand.

On an average, banks are providing around 25% to 30% additional provision on incremental NPAs

which has direct bearing on the profitability of the banks.

Asset (Credit) contraction:

The increased NPAs put pressure on recycling of funds

Reduces the ability of banks for lending more

Results in lesser interest income.

It contracts the money stock which may lead to economic slowdown.

Liability Management

In the light of high NPAs, Banks tend to lower the interest rates on deposits on one hand

Likely to levy higher interest rates on advances.

This may become hurdle in smooth financial intermediation process

Hampers banks‘ business as well as economic growth.

IMPACT OF NPA’S Capital Adequacy

As per Basel norms, banks are required to maintain adequate capital on risk-weighted assets on an ongoing basis.

Every increase in NPA level adds to risk weighted assets which warrant the banks to shore up their capital base further.

Capital has a price tag ranging from 12% to 18% since it is a scarce resource.

Shareholders‘ confidence:

Normally, shareholders are interested to enhance value of their investments through higher dividends and market capitalization

It is possible only when the bank posts significant profits through improved business.

The increased NPA level is likely to have adverse impact on the bank business as well as profitability

Thereby the shareholders do not receive a market return on their capital and sometimes it may erode their value of investments.

Banks whose Net NPA level is 5% & above are required to take prior permission from RBI to declare dividend and also stipulate cap on dividend payout.

Public confidence:

Credibility of banking system is also affected greatly due to higher level NPAs

It shakes the confidence of general public in the soundness of the banking system.

The increased NPAs may pose liquidity issues which is likely to lead run on bank by depositors.

the increased incidence of NPAs not only affects the performance of the banks but also affect the economy as a whole.

IMPACT OF NPA’S

In a nutshell, the high incidence of NPA has cascading impact on all important

financial ratios of the banks viz.,

Net Interest Margin,

Return on Assets,

Profitability,

Dividend Payout,

Provision coverage ratio,

Credit contraction etc.,

which may likely to erode the value of all stakeholders including Shareholders,

Depositors, Borrowers, Employees and public at large. Reduces earning capacity of

the assets

CONTROLLING NPA’S

Major steps taken to solve the problems of NPA are as follows

Debt Recovery Tribunals (DRT) Narasimham Committee Report (1991) recommended the setting up of Special

Tribunals to reduce the time required for settling cases

22 DRT’s and 5 Debt Recovery Appellate Tribunals were set up.

This is insufficient to solve the problems of the country

Lok Adalats Suitable for recovery of small loans

Recover NPA up to Rs 5 lacs; both suit filed and non suit filed

Lok Adalats avoid the legal process

The Public Sector Bank has recovered Rs 40 Crores by Sept 2001

Compromise Settlements It is a simple mechanism for recovery of NPA

Applied to advances below Rs 10 Crores

It covers suit filed cases and cases pending with courts & DRT

Cases of willful default and fraud were excluded

CONTROLLING NPA’S

Securitisation Act 2002 = Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act 2002 is popularly know as Securitisation. This act enables the banks to issue notices to defaulters

Who have to pay the debts within 60 days

Once the notice is issued the borrower cannot sell or dispose the assets without the consent of the lender

It empowers the bank to take the possession of the assets and management of the company

The lenders can recover the dues by selling the assets or changing the management of the firm

The act enables the establishment of Asset Reconstruction Companies for acquiring NPA

Credit Information Bureau A good information system is required to prevent loans from turning into a NPA

If a borrower is a defaulter to one bank, the information is available to all banks

To avoid any further lending to the defaulter

CIB can help by maintaining a data bank which can be assessed by all lending institutions

INTEREST RATE REFORMS HIGHLIGHTS

The Narasimhan Committee advocate that interest rates should be allowed to be determined by market forces.

Since 1992 interest rates has become much simpler and made free for all banks

Scheduled commercial banks have now the freedom to set interest rates on their deposits subject to minimum floor rates and maximum ceiling rates

Interest rate on domestic term deposits has been decontrolled

The PLR of SBI and other banks on general advances of over Rs 2 Lakhs has been reduced

Rate of interest on bank loans above Rs2 lakhs has been fully decontrolled

The interest rate on deposits and advances of all cooperative banks have been deregulated subject to minimum lending rate of 13%

CAPITAL ADEQUACY NORMS Introduction to Capital Adequacy Norms

Along with profitability and safety, banks also give importance to Solvency.

Solvency refers to the situation where assets are equal to or more than liabilities.

A bank should select its assets in such a way that the shareholders and depositors' interest are protected.

1. Prudential Norms

The norms which are to be followed while investing funds are called "Prudential Norms."

They are formulated to protect the interests of the shareholders and depositors.

Prudential Norms are generally prescribed and implemented by the central bank of the country.

Commercial Banks have to follow these norms to protect the interests of the customers.

For international banks, prudential norms were prescribed by the Bank for International

settlements popularly known as BIS.

The BIS appointed a Basle Committee on Banking Supervision in 1988.

2. Basel Committee

Basel committee appointed by BIS formulated rules and regulation for effective supervision of the central

banks.

It, also prescribed international norms to be followed by the central banks.

This committee prescribed Capital Adequacy Norms in order to protect the interests of the customers.

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CAPITAL ADEQUACY NORMS

3. Definition of Capital Adequacy Ratio Capital Adequacy Ratio (CAR) is defined as the ratio of bank's capital to its risk assets.

Capital Adequacy Ratio (CAR) is also known as Capital to Risk (Weighted) Assets Ratio (CRAR).

India and Capital Adequacy Norms

The Government of India (GOI) appointed the Narasimham Committee in 1991 to suggest reforms in the financial sector.

In the year 1992-93 the Narasimhan Committee submitted its first report and recommended that all the banks are required to have a minimum capital of 8% to the risk

weighted assets of the banks.

The ratio is known as Capital to Risk Assets Ratio (CRAR).

All the 27 Public Sector Banks in India (except UCO and Indian Bank) had achieved the Capital Adequacy Norm of 8% by March 1997.

The Second Report of Narasimham Committee was submitted in the year 1998-99. It recommended that the CRAR to be raised to 10% in a phased manner.

It recommended an intermediate minimum target of 9% to be achieved by the year 2000 and 10% by 2002.


Concepts of Capital Adequacy Norms

Capital Adequacy Norms included different Concepts, explained as follows :-

1. Tier-I Capital

Capital which is first readily available to protect the unexpected losses is called as Tier-I Capital.

It is also termed as Core Capital.

Tier-I Capital consists of :-

Paid-Up Capital.

Statutory Reserves.

Other Disclosed Free Reserves : Reserves which are not kept side for meeting any specific liability.

Capital Reserves : Surplus generated from sale of Capital Assets.

2. Tier-II Capital

Capital which is second readily available to protect the unexpected losses is called as Tier-II Capital.

Tier-II Capital consists of :-

Undisclosed Reserves and Paid-Up Capital Perpetual Preference Shares.

Revaluation Reserves (at discount of 55%).

Hybrid (Debt / Equity) Capital.

Subordinated Debt.

General Provisions and Loss Reserves.

There is an important condition that Tier II Capital cannot exceed 50% of Tier-I Capital for arriving at the prescribed Capital Adequacy Ratio.


3. Tier III

This is arranged to meet part of market risk Changes in interest rate / exchange rate / equity prices /commodity prices etc.

Assets must be limited to 250% of a banks Tier I capital, be unsecured subordinated and

have a minimum maturity of 2 years

4. Risk Weighted Assets

Capital Adequacy Ratio is calculated based on the assets of the bank.

The values of bank's assets are not taken according to the book value but according to the risk factor involved.

The value of each asset is assigned with a risk factor in percentage terms.

Suppose CRAR at 10% on Rs. 150 crores is to be maintained.

This means the bank is expected to have a minimum capital of Rs. 15 crores which consists of Tier I and Tier II Capital items

subject to a condition that Tier II value does not exceed 50% of Tier I Capital.

Suppose the total value of items under Tier I Capital is Rs. 5 crores and total value of items under Tier II capital is Rs. 10 crores,

The bank will not have requisite CRAR of Rs. 15 Crores.

This is because a maximum of only Rs. 2.5 Crores under Tier II will be eligible for computation.

5. Subordinated Debt

These are bonds issued by banks for raising Tier II Capital.

They are as follows :- They should be fully paid up instruments.

They should be unsecured debt.

They should be subordinated to the claims of other creditors.

This means that the bank's holder's claims for their money will be paid at last in order of preference as compared with the claims of other creditors of the bank.

The bonds should not be redeemable at the option of the holders.

This means the repayment of bond value will be decided only by the issuing bank.

NEXT SESSION


DEVELOPMENT CO-OPERATIVE BANK

HISTORY OF RESERVE BANK OF INDIA (RBI)

The Reserve Bank of India is the central bank of the country.

The Reserve Bank of India was set up on the basis of the recommendations

of the Hilton Young Commission.

The Reserve Bank of India Act, 1934 (II of 1934)

provides the statutory basis of the functioning of the Bank,

which commenced operations on April 1, 1935.

The Bank was constituted to

Regulate the issue of banknotes

Maintain reserves with a view to securing monetary stability and

To operate the credit and currency system of the country to its

advantage.


The Bank began its operations By taking over from the Government the functions so far being performed by the

Controller of Currency

From the Imperial Bank of India, the management of Government accounts and public debt.

The existing currency offices at Calcutta, Bombay, Madras, Rangoon, Karachi, Lahore and Cawnpore (Kanpur) became branches of the Issue Department. Offices of the Banking Department were established in Calcutta, Bombay, Madras, Delhi and Rangoon.

Burma (Myanmar) separated from the Indian Union in 1937 Reserve Bank continued to act as the Central Bank for Burma till Japanese

Occupation of Burma and later up to April, 1947.

After the partition of India, the Reserve Bank served as the central bank of Pakistan upto June 1948

when the State Bank of Pakistan commenced operations.

The Bank was nationalised in 1949.


An interesting feature of the Reserve Bank of India was that at its very inception,

The Bank was seen as playing a special role in the context of development, especially Agriculture.

When India commenced its plan endeavors, the development role of the Bank came into focus,

Especially in the sixties when the Reserve Bank, in many ways, pioneered the concept and practise of

using finance to catalyse development.

The Bank was also instrumental in institutional development

Helped set up institutions like the

Deposit Insurance and Credit Guarantee Corporation of India,

the Unit Trust of India,

the Industrial Development Bank of India,

the National Bank of Agriculture and Rural Development,

the Discount and Finance House of India etc. to build the financial infrastructure of the country.

With liberalization,

the Bank's focus has shifted back to core central banking functions like

Monetary Policy,

Bank Supervision and Regulation, and

Overseeing the Payments System and

onto developing the financial markets.

MANAGEMENT AND ADMINISTRATION OF RBI

The Reserve Bank of India is managed by well-structured administrative machinery.

The organization structure of the RBI can be easily understood with the help of the following chart:

The management of the RBI is entrusted to the central and local boards.

The Central in 1927 Board consists of the following members:

We can observe from the table that all members of Central Board are appointed by the Central

Government.

The Governor and the Deputy Governors are appointed as executives in the bank and by virtue of their

position in the bank; they become members of the Central Board.

The other directors of Central Board are appointed for a four year term (excepting the official of

Government of India) by Government under RBI Act, 1934.

The Governor is assisted in the performance of his duties by the Deputy Governors and the Executive

Directors.

MANAGEMENT AND ADMINISTRATION OF RBI

The Governor and Deputy Governors hold office as per their terms of appointment and eligible for reappointment.

The executive directors are whole time officials of the bank, with salaries.

They are however not members of Central Board.

Appointment of members of Central Board are so made that two directors retire every year.

A retiring director is eligible for reappointment.

The local Boards consist of 5 members appointed by the Central Government.

The appointment will be made so as to secure adequate representation of regional and economic interest of the areas concerned.

The local Board will have a Chairman elected from amongst the members of the local Board.

MANAGEMENT AND ADMINISTRATION OF


The members of the local Board hold office for a period of 4 years and are eligible for reappointment.

The duties of the local Board are to advise the Central Board in respect of matter referred to it and perform such functions as

The management of the RBI is entrusted to the central and local boards.

The Central in 1927 Board consists of the following members:

May be delegated to it by the Central board from time to time. The powers of the local Board are very limited.

No person may be a director if:

(a) He is a salaried officer of the Government

(b) If he is insolvent, of unsound mind or

(c) If he is an officer or employee of any bank or a director of a bank other than cooperative bank.

The Governor or Deputy Governor or a Director may be removed from office by the Central Government.

A Director ceases to hold office if he is absent for 3 consecutive meetings of the Board. (This provision does not apply in the case of the Governor, Deputy Governor or the official Director).

MANAGEMENT AND ADMINISTRATION OF


A member of the Parliament or of a State Legislature cannot be a Director unless He ceases to be member of the Parliament or State Legislative within two months from the date

of being appointed as director of the bank.

At least six meetings of the Central Board must be held every year.

Any three directors can require the Governor to convene a meeting of the Board.

The Governor and, in his absence, the Deputy Governor presides over such meetings.

The organizational structure of RBI is divided into two parts, The Internal Organisation and

The External Organisation.

The internal structure includes The central office of the bank.

The central office consists of various departments for the efficient discharge of its functions.

The external structure includes Its local offices, situated at important metropolitan cities of India.

In other places where the RBI does not have its offices, the State Bank of India and its subsidiaries act as its agents

FUNCTIONS OF RBI

1. Issue of Bank Notes:

The Reserve Bank of India has the sole right to issue currency notes

except one rupee notes which are issued by the Ministry of Finance.

Currency notes issued by the Reserve Bank are declared unlimited legal tender throughout the country.

Currently it is in the denomination of Rs 2, 5, 10,20,50,100,500 and 1000.

RBI also takes action to control circulation of fake currency.

This concentration of notes issue function with the Reserve Bank has a number of advantages:

(i) it brings uniformity in notes issue;

(ii) it makes possible effective state supervision;

(iii) it is easier to control and regulate credit in accordance with the requirements in the economy; and

(iv) it keeps faith of the public in the paper currency.

2. Banker to Government:

Reserve Bank manages the banking needs of the government.

It has to-maintain and operate the government‘s deposit accounts.

It collects receipts of funds and makes payments on behalf of the government.

It represents the Government of India as the member of the IMF and the World Bank.

FUNCTIONS OF RBI

3. Custodian of Cash Reserves of Commercial Banks

The commercial banks hold deposits in the Reserve Bank and

RBI has the custody of the cash reserves of the commercial banks.

4. Custodian of Country‘s Foreign Currency Reserves

The Reserve Bank has the custody of the country‘s reserves of international currency, and

this enables the Reserve Bank to deal with crisis connected with adverse balance of payments position.

5. Lender of Last Resort

The commercial banks approach the Reserve Bank in times of emergency to tide over financial difficulties, and

The Reserve bank comes to their rescue though it might charge a higher rate of interest.

6. Central Clearance and Accounts Settlement

Commercial banks have their surplus cash reserves deposited in the Reserve Bank,

It is easier to deal with each other and settle the claim of each on the other through book keeping entries in the books of the Reserve Bank.

The clearing of accounts has now become an essential function of the Reserve Bank.

7. Controller of Credit

Credit money forms the most important part of supply of money, and since

the supply of money has important implications for economic stability,

the importance of control of credit becomes obvious.

Credit is controlled by the Reserve Bank in accordance with the economic priorities of the government.

SUPERVISORY FUNCTIONS

Issue of license: Under the banking regulations act 1949, the RBI has been given powers to grant licenses to

commence new banking operation

Grants license to open new branches for existing branches for existing banks

RBI provides banking services in areas that do not have this facilty

Prudential norms Issues guidelines for credit control and management

Is a members of the banking committee standards of capital adequacy norms and asset classification

Corporate Governance RBI has the power to control the appointment of the chairman and directors of in India.

The RBI has powers to appoint additional directors in banks

Transparency norms Every bank will have to disclose the charges for providing services

Customers have the right to know these changes.

SUPERVISORY FUNCTIONS OF RBI

KYC norms To curb money laundering and prevent the use of the banking

system for financial crimes RBI has ―Know Your Customer‖ guidelines

Every bank has to ensure KYC norms are applied before allowing someone to open an account

Audit and Inspection Procedure of audit and inspection is controlled by the RBI through

on site and off site monitoring system

On site inspection is done by RBI on the basis of ―CAMELS‖ C – Capital Adequacy

A – Asset Quality

M – Management

E – Earning

L – Liquidity

S – Systems and control

SUPERVISORY CONTROL

Foreign exchange control

RBI has a crucial role in foreign exchange transactions

It does due diligence on every foreign transactions, including the inflow and outflow of foreign transactions

It takes steps to stop the fall in value of Indian Rupee

Takes necessary steps to control the current account deficit

Give support to promote export and the RBI provides a variety of options for NRI‘s

Development

RBI is responsible for implementation of govt policies related to agriculture and rural development

Ensures flow of credit to other priority sectors as well

Provides specialize support for rural development

Priority sector lending is also in key focus area o the RBI

SUPERVISORY CONTROL

Controller of Credit

It holds the cash reserves of all the schedule banks

Controls credit operations of banks through quantitative and qualitative

controls

Controls the banking system through the system of licencing, inspection

and calling for information

It acts as the lender of the last resort by providing rediscount facilities to

scheduled banks

Risk Management

Provides guidelines to banks for taking the steps that are necessary to

mitigate risk

RBI do this through risk management in Basel Norms

PROMOTIONAL FUNCTIONS OF RBI

Development of the financial system Financial system comprises the financial institutions, financial markets and

financial instruments

The sound and efficient financial system is a precondition of the rapid economic development of the nation

The RBI has encouraged establishment of main banking and non banking institutions to cater to the credit requirements of diverse sectors of the economy

Development of Agriculture RBI has to provide special attention for the credit need of agriculture and allied

activities

It has rendered service in this direction by increasing the flow of credit to this sector

Collection of Data RBI collects process and disseminates statistical data on several topics

It includes interest rate, inflation, savings and investments etc.

Data proves to be quite useful for researchers and policy makers

PROMOTIONAL FUNCTIONS OF RBI Provision of Industrial Finance

Rapid industrial growth is the key to faster economic development

The adequate and timely availability of credit to small, medium and large industry is very significant

RBI has always been instrumental in setting up special financial institutions such as ICICI, IDBI, SIDBI, and EXIM Bank

Provisions of Training Provides essential training to the staff of the banking industry

Has setup training colleges at several places

National Institute of Bank Management (NIBM), Bankers Staff College(BSC) and College of Agriculture Banking(ACB)

Publications of Report RBI has separate publication division

This division collects data and publishes data on several sectors of the economy

The reports and bulletins are regularly published

It includes weekly report Annual Report, Report on Trend and progress of commercial Bank

This information is made available to the public also at a cheaper rate

PROMOTIONAL FUNCTION OF RBI

Promotion of banking habits RBI tries to promote banking habits in the country

It institutionalize savings and takes measures for an expansion of the banking network

It has set up many institutions such as the Deposit Insurance Corporation – 1962

Unit Trust of India – 1964

IDBI – 1964

NABARD – 1982

NHB – 1988

These organizations develop and promote banking habits among the people.

During economic reforms it has taken many initiatives for encouraging and promoting banking in India

Promotion of Export through Refinance Encourages the facilities for providing finance for foreign trade

EXIM and ECGC are supported by refinancing their lending for export purpose

DEVELOPMENT BANKS

Introduction

Definition and meaning

Characteristics

Functions

Nature / structure

Main Development Banks

DEFINITION OF DEVELOPMENT BANK

There is no precise definition of development bank.

William Diamond and Shirley Bosky consider industrial finance and development corporations as ‗development banks‘

Fundamentally a development bank is a term lending institution.

Development bank is essentially a multi-purpose financial institution with a broad development outlook.

A development bank is defined as a financial institution concerned with Providing all types of financial assistance (medium as well as long term) to

business units,

In the form of loans, underwriting, investment and guarantee operations, and

Promotional activities — economic development in general, and

Industrial development.

In short, a development bank is a development- oriented bank.

FEATURES OF DEVELOPMENT BANK

It is a specialised financial institution.

It provides medium and long term finance to business units.

Unlike commercial banks, it does not accept deposits from the public.

It is not just a term-lending institution. It is a multi-purpose financial institution.

It is essentially a development-oriented bank.

Its primary object is to promote economic development by promoting investment and entrepreneurial activity in a developing economy.

It encourages new and small entrepreneurs and seeks balanced regional growth.

FEATURES OF DEVELOPMENT BANK

It provides financial assistance not only to the private sector but also to the public sector undertakings.

It aims at promoting the saving and investment habit in the community.

It does not compete with the normal channels of finance, Finance already made available by the banks and other

conventional financial institutions.

Its major role is of a gap-filler,

To fill up the deficiencies of the existing financial facilities.

Its motive is to serve public interest rather than to make profits. It works in the general interest of the nation.

FUNCTIONS OF DEVELOPMENT BANK

Selecting economically viable business units after careful study and providing them loan assistance

Providing risk capital to the business units

Providing medium and long term loans to projects

Investing in the share capital or debentures of business firms

Helping business firms in the sale of share and debentures

Providing guarantee to the loans raised by business units

FUNCTIONS OF DEVELOPMENT BANK

Providing guidance to the management regarding technology.. Market, labour etc.

Designing developmental projects and evaluating them after they start functioning

Finding developmental projects and encouraging their initiation and implementation by making loan assistance available

Appointing experts from different fields for providing guidance to the entrepreneurs

Conduct of surveys and research

Coordinating among the financial institutions working in the field of agriculture, industry and trade and other development institution

UNIT III - INSURANCE

INSURANCE

REINSURANCE

PURPOSE AND NEED OF INSURANCE

DIFFERENT KINDS OF LIFE INSURANCE PRODUCT

BASIC IDEA ABOUT FIRE INSURANCE

BASIC IDEA ABOUT MARINE INSURANCE

BASIC IDEA ABOUT BANCASSURANCE

DEFINITION OF INSURANCE A promise of compensation for specific potential future losses

in exchange for a periodic payment.

Insurance is designed to protect the financial well-being of an individual, company or other entity in the case of unexpected loss.

Some forms of insurance are required by law, while others are optional.

Agreeing to the terms of an insurance policy creates a contract between the insured and the insurer.

In exchange for payments from the insured (called premiums),

the insurer agrees to pay the policy holder a sum of money upon the occurrence of a specific event.

In most cases, the policy holder pays part of the loss (called the deductible), and the insurer pays the rest.

DEFINITION OF INSURANCE

Insurance is a cooperative form of distributing a certain risk over a group of persons who are exposed to it. – Ghosh and Agarwal

Insurance is a contract in which a sum of money is paid to the assured as consideration of insurer‘s incurring the risk of paying a large sum upon a given contingency. – Justice Tindall

Insurance is an instrument of distributing the loss of few among many. – Disnadle

The collective bearing of risk is Insurance. – W. Beverideges

Insurance may be defined as a social device providing financial compensation for the effects of misfortune, the payments being made from the accumulated contribution of all parties participating in the scheme. – D.S. Hansell

DEFINITION OF INSURANCE

Insurance by lessening uncertainty, frees the individual from same element of risk. – Relph H. Wherry & Monroe Newman

Insurance is a contract by which one party, for a compensation called the premium assumes particular risk of the other party and promises to pay to him or his nominee a certain or ascertainable sum of money on a specified contingency. – E.W. Patterson

Insurance is purchased to offset the risk resulting from hazardous which exposes a person to loss. – Robert I. Mehr and Emerson Cammack

Insurance has been defined as a plan by which large numbers of people associate themselves, to shoulders of all, risks attach to individuals. – Magee D.H.

Insurance is a device for the transfer to an insurer of certain risks of economic loss that would otherwise come by the insured. – Allen Z. Mayerson

CHARACTERISTICS OF INSURANCE

1. Sharing of Risk:

Insurance is a device to share the financial losses which might befall on an individual or his family on the happening of a specified event.

The event may be death of a bread-winner to the family in the case of life insurance,

marine-perils in marine insurance,

fire in fire insurance and

other certain events in general insurance, e.g., theft in burglary insurance,

accident in motor insurance, etc.

The loss arising from these events if insured are shared by all the insured in the form of premium.

2. Co-operative Device:

The most important feature of every insurance plan is the co-operation of large number of persons who, in effect,

agree to share the financial loss arising due to a particular risk which is insured.

Such a group of persons may be brought together voluntarily or through publicity or through solicitation of the agents.

An insurer would be unable to compensate all the losses from his own capital.

By insuring or underwriting a large number of persons, he is able to pay the amount of loss.

Like all cooperative devices, there is no compulsion here on anybody to purchase the insurance policy.


3. Value of Risk:

The risk is evaluated before insuring to charge the amount of share of an insured,

It is called, consideration or premium.

There are several methods of evaluation of risks.

If there is expectation of more loss, higher premium may be charged.

The probability of loss is calculated at the time of insurance.

4. Payment at Contingency:

The payment is made at a certain contingency insured.

If the contingency occurs, payment is made.

The life insurance contract is a contract of certainty, because the contingency, the death or the expiry of term, will certainly occur, the payment is certain.

In other insurance contracts, the contingency is the fire or the marine perils etc., may or may not occur.

If the contingency occurs, payment is made, otherwise no amount is given to the policy-holder.

In certain types of life policies, payment is not certain due to uncertainty of a particular contingency within a particular period.

For example, in term-insurance then, payment is made only when death of the assured occurs

within the specified term, may be one or two years.

In case of Endowment policy payment is made only at the survival of the insured at the expiry of the period.


5. Amount of Payment:

The amount of payment depends upon the value of loss occurred

due to the particular insured risk provided insurance is there up to that amount.

In life insurance, the purpose is not to make good the financial loss suffered.

The insurer promises to pay a fixed sum on the happening of an event.

If the event or the contingency takes place,

the payment does fall due if the policy is valid and in force at the time of the event,

like property insurance, the dependents will not be required to prove the occurring of loss and the amount of loss.

It is immaterial in life insurance what was the amount of loss at the time of contingency.

But in the property and general insurances, the amount of loss as well as the happening of loss, are required to be proved.


6. Large Number of Insured Persons

To spread the loss immediately, smoothly and cheaply, large number of persons should be insured.

The co-operation of a small number of persons may also be insurance but it will be limited to smaller area.

The cost of insurance to each member may be higher. So, it may be unmarketable.

Therefore, to make the insurance cheaper, it is essential to insure large number of persons or property because

the lesser would be cost of insurance and so, the lower would be premium.

In past years, tariff associations or mutual fire insurance associations were found to share the loss at cheaper rate.

In order to function successfully, the insurance should be joined by a large number of persons.

7. Insurance is not Charity:

Charity is given without consideration but insurance is not possible without premium.

It provides security and safety to an individual and to the society although it is a kind of business because in consideration of premium it guarantees the payment of loss.

It is a profession because it provides adequate sources at the time of disasters only by charging a nominal premium for the service.


8. Insurance is not a gambling:

The insurance serves indirectly to increase the productivity of the community by eliminating worry and increasing initiative.

The uncertainty is changed into certainty by insuring property and life because the insurer promises to pay a definite sum at damage or death.

From a family and business point of view all lives possess an economic value which may at any time be snuffed out by death, and

it is as reasonable to ensure against the loss of this value as it is to protect oneself against the loss of property.

In the absence of insurance, the property owners could at best practice only some form of self-insurance, which may not give him absolute certainty.

In absence of life insurance,

saving requires time;

but death may occur at any time and

the property, and family may remain unprotected.

Thus, the family is protected against losses on death and damage with the help of insurance.


8. Insurance is not a gambling: contd..

From the company's point of view, the life insurance is essentially non-speculative;

in fact, no other business operates with greater certainties.

From the insured point of view, too, insurance is also the antithesis of gambling.

Nothing is more uncertain than life and life insurance offers the only sure method of changing that uncertainty into certainty.

Failure of insurance amounts gambling because the uncertainty of loss is always looming. In fact, the insurance is just the opposite of gambling.

In gambling, by bidding the person exposes himself to risk of losing, in the insurance; the insured is always opposed to risk, and will suffer loss if he is not insured.

By getting insured his life and property, he protects himself against the risk of loss.

In fact, if he does not get his property or life insured he is gambling with his life on property.

INSURANCE COMPANY OPERATIONS

Rate Making Refers to the pricing of insurance

Total premium charged must be adequate for paying all claims and expenses during the policy period

Rates and premiums are determined by an actuary

Using the company’s past loss experience and industry statistics

Production Refers to the sales and marketing activities of insurers

Agents are often referred to as producers

Life Insurers have an agency or sales department

Property and liability insurers have marketing department

A agent should be a competent professional

with a high degree of technical knowledge in a particular area of insurance

Who places the need of his or her clients first


Underwriting Refers to the process of selecting, classifying and pricing applicants for

insurance

Objective of the company is to produce a profitable book of business

A statement of underwriting policy establishes policies that are consistent with the company’s objective

Such as acceptable classes of business

Amounts of insurance that can be written

A line underwriter makes a daily decisions concerning the acceptance or rejection of business

There are three important principles of underwriting Must select prospective insures according to the company’s underwriting

standards

Should achieve a proper balance within each rate classification In class underwriting, exposure units with similar loss – producing characteristics are

grouped together and charged the same rate

Underwriting should maintain equity among the policy holders


Underwriting is carried out by an agent collecting information from the following documents. The application

The agent’s report

An inspection Report

Physical inspection

Physical examination

Attending physician’s report

After reviewing the information The underwriter can accept the application

Accept the application subject to restrictions or modifications &

Reject the application


Claims settlement

Settlement is completed only on verification of a covered loss

Subsequently fair and prompt payment of claims is made if it is justified

Some law prohibits unfair claims practices

Refusing to pay claims without conducting a reasonable investigation

Not attempting to provide prompt, fair and equitable settlements

Offering lower settlements to compel insured to institute lawsuits to recover amounts due.

The claim process begins with a notice of loss

The claim is investigated and claims adjustor determines if a covered loss has occurred & the amount of loss

The adjustor requires a proof of loss before the claim is paid and

later the adjustor decides if the claim should be paid or denied

Policy provisions address how disputes may be resolved

PRINCIPLES OF INSURANCE

1. Nature of contract:

Nature of contract is a fundamental principle of insurance contract.

An insurance contract comes into existence

when one party makes an offer or proposal of a contract and

the other party accepts the proposal.

A contract should be simple to be a valid contract.

The person entering into a contract should enter with his free consent.

2. Principal of utmost good faith:

Under this insurance contract

both the parties should have faith over each other.

As a client it is the duty of the insured to disclose all the facts to the insurance company.

Any fraud or misrepresentation of facts can result into cancellation of the contract.


3. Principle of Insurable interest:

Under this principle of insurance, the insured must have interest in the subject matter of the insurance.

Absence of insurance makes the contract null and void.

If there is no insurable interest, an insurance company will not issue a policy.

An insurable interest must exist at the time of the purchase of the insurance.

For example, a creditor has an insurable interest in the life of a debtor,

A person is considered to have an unlimited interest in the life of their spouse etc.

The owner of a taxicab has insurable interest in the taxicab

because he is getting income from it.

But, if he sells it, he will not have an insurable interest left in that taxicab.

From above example, we can conclude that, ownership plays a very crucial role in evaluating insurable interest.

Every person has an insurable interest in his own life.


4. Principle of indemnity:

Indemnity means security, protection and compensation given against damage, loss or injury.

According to the principle of indemnity, an insurance contract is signed only for getting protection

against unpredicted financial losses arising due to future uncertainties.

Insurance contract is not made for making profit else its sole purpose is to give compensation in

case of any damage or loss.

In an insurance contract, the amount of compensations paid is in proportion to the incurred losses.

The amount of compensations is limited to the amount assured or the actual losses, whichever is

less.

The compensation must not be less or more than the actual damage.

Compensation is not paid if the specified loss does not happen due to a particular reason during a

specific time period.

Thus, insurance is only for giving protection against losses and not for making profit.

In case of life insurance, the principle of indemnity does not apply because the value of human life

cannot be measured in terms of money.


5. Principal of subrogation:

The principle of subrogation enables the insured to claim the amount from the third party responsible for the

loss.

It allows the insurer to pursue legal methods to recover the amount of loss,

For example, if you get injured in a road accident, due to reckless driving of a third party,

the insurance company will compensate your loss and

will also sue the third party to recover the money paid as claim.

For example :-

Mr. Ramesh insures his house for Rs 1 Crore.

The house is totally destroyed by the negligence of his neighbor Mr. Suresh.

The insurance company shall settle the claim of Mr. Ramesh for Rs 1 Crore.

At the same time, it can file a law suit against Mr. Suresh for Rs 1.25 Crore, the market value of the

house.

If insurance company wins the case and collects Rs 1.25 Crores from Mr. Suresh

Then the insurance company will retain Rs 1 Crore (which it has already paid to Mr. Ramesh) plus other

expenses such as court fees.

The balance amount, if any will be given to Mr. Ramesh, the insured.

PRINCIPLES OF INSURANCE 6. Double insurance: Double insurance denotes

insurance of same subject matter with two different companies or

with the same company under two different policies.

Insurance is possible in case of indemnity contract like fire, marine and property insurance.

Double insurance policy is adopted where the financial position of the insurer is doubtful.

The insured cannot recover more than the actual loss and cannot claim the whole amount from both the insurers.

For example :-

Mr. John insures his property worth Rs 1,00,00,000 with two insurers

―TATA AIG Ltd." for Rs 40,00,000 and "MetLife Ltd." for Rs 60,00,000.

John's actual property destroyed is worth Rs 60,00,000,

Mr. John can claim the full loss of Rs 60,00,000 either from TATA AIG Ltd. or MetLife Ltd.,

OR He can claim Rs 36,00,000 from AIG Ltd. and Rs 24,00,000 from MetLife Ltd.

If the insured claims full amount of compensation from one insurer then he cannot claim the same compensation from other insurer and make a profit.

Secondly, if one insurance company pays the full compensation then it can recover the proportionate contribution from the other insurance company.

PRINCIPLES OF INSURANCE 7. Principle of proximate cause:

Proximate cause literally means the ‗nearest cause‘ or ‗direct cause‘.

This principle is applicable when the loss is the result of two or more causes.

The proximate cause means; the most dominant and most effective cause of loss is considered.

This principle is applicable when there are series of causes of damage or loss.

For example :-

A cargo ship's base was punctured due to rats and so sea water entered and cargo was damaged.

Here there are two causes for the damage of the cargo ship – (i) The cargo ship getting punctured because of rats, and

(ii) The sea water entering ship through puncture.

The risk of sea water is insured but the first cause is not.

The nearest cause of damage is sea water which is insured and therefore the insurer must pay the compensation.

In case of life insurance, the principle of Causa Proxima does not apply.

Whatever may be the reason of death (whether a natural death or an unnatural death)

The insurer is liable to pay the amount of insurance.


8. Principle of loss Minimisation

According to the Principle of Loss Minimization,

insured must always try his level best to minimize the loss of his insured property,

in case of uncertain events like a fire outbreak or blast, etc.

The insured must take all possible measures and necessary steps to control and reduce

the losses in such a scenario.

The insured must not neglect and behave irresponsibly during such events just because

the property is insured.

Hence it is a responsibility of the insured to protect his insured property and avoid further

losses.

For example :-

Assume, Mr. John's house is set on fire due to an electric short-circuit.

In this tragic scenario, Mr. John must try his level best to stop fire by all possible means,

like first calling nearest fire department office, asking neighbours for emergency fire

extinguishers, etc.

He must not remain inactive and watch his house burning hoping, "Why should I worry? I've

insured my house."

REINSURANCE

REINSURANCE

Reinsurance is a process

whereby one entity takes on all or part of the risk

covered under a policy issued by an insurance company

in consideration of a premium payment.

Definition:

It is a process whereby one entity (the reinsurer)

takes on all or part of the risk covered under a policy

issued by an insurance company

in consideration of a premium payment.

In other words, it is a form of an insurance cover for insurance companies.

Description:

Unlike co-insurance where several insurance companies come together to issue one single risk,

reinsurers are typically the insurers of the last resort.

The insurance business is based on laws of probability

which presupposes that only a fraction of the policies issued would result in claims.

REINSURANCE

The total sum insured by an insurance company would be several times its

net worth.

It is based on this same probability of loss that insurance companies fix the

insurance premium.

The premiums are fixed in such a manner that the total premium collected

would be enough to pay for the total claims incurred after providing for

expenses.

However, there is a possibility that in a bad year, the total value of claims

may be much more than the premium collected.

REINSURANCE

If the losses are of a very large magnitude,

there is a chance that the net worth of the company would be wiped out.

It is to avoid such risks that insurance companies take out policies.

Secondly, insurance companies take the support of reinsurers

when they do not have the capacity to provide a cover on their own.

Broadly, reinsurance can be classified under two heads –

treaty reinsurance and

facultative reinsurance.

REINSURANCE

Reinsurance can help a company by providing:

Risk Transfer - Companies can share or transfer of specific risks with other companies

Arbitrage - Additional profits can be garnered by purchasing insurance elsewhere for less than the premium the company collects from policyholders.

Capital Management - Companies can avoid having to absorb large losses by passing risk; this frees up additional capital.

Solvency Margins - The purchase of surplus relief insurance allows companies to accept new clients and avoid the need to raise additional capital.

Expertise - The expertise of another insurer can help a company obtain a proper rating and premium.

REASONS FOR REINSURANCE

Improve service to the reinsured by increasing the company‘s underwriting capacity and to expand the market

Making the profit stable by balancing peak risks / losses

Dividing the risk to as many as possible insurer

Protecting against uncertain losses arise due to natural disaster, explosions, disaster due to airlines etc.

Obtaining advice and suggestions regarding pricing, retention and policy coverages

PARTIES IN REINSURANCE

Primary insurer

Is the company which gives insurance policy to the customers intends to be insured

Are the largest buyers of reinsurance

Primary insurers tries to reduce the risk by taking reinsurance of the insurance

Reinsurer

Reinsurer is the person who gives the insurance for the insurance

Reinsurer insures the insurance of primary insurer

Reinsurer bears the risk of loss of the primary insurer in exchange of premium charged by him to primary insurer

Insured

Insured is the ultimate customer of the insurance

Who insures his life or property against any losses

PARTIES IN REINSURANCE

Retrocessionaires

A retrocession is reinsurance ceded by a reinsurer to another insurance or reinsurance company

In order to release a part of risks it was written

In this way stabilizing its results and homogenizing its liabilities

The party who does this activity is called as Retrocessionaires

Reinsurance Brokers

There are different way through which international reinsurer can establish the relation with insurer of a specific country

The person who acts as a mediator between these two is called as reinsurance broker

In certain form of reinsurance and in specific conditions they are used.

WHAT IS CEDED BUSINESS?

FUNCTIONS OF REINSURANCE

Some of the functions of reinsurance include:

Stabilization of profitability

Provides large limit capacity

Catastrophe protection

Supports high growth in premium volume

Provides help with the underwriting process

Facilitates withdrawal from a particular risk or line of

business


Stabilization of profitability:

As captive owners and risk managers know, losses incurred sometimes

fluctuate widely from year to year.

Large swings in losses incurred can make it difficult, if not impossible, to

forecast profitability of a particular line of business, or in total.

While showing profitability in a pure captive may not be as critical as it is to

say, a risk retention group or commercial insurer,

Most business owners like to see a reasonably steady flow of profits to

protect their capital and surplus and to support growth, if necessary.

Purchasing reinsurance is particularly helpful in smoothing the peaks and

valleys of a captives loss experience,

The law of large numbers doesn't apply to captive operations.


Provides large limit capacity: Captives frequently provide a high limit of insurance on one or a limited number of

policies. For example, a hospital captive may wish to insure the excess professional liability

exposure of its parent. A captives capacity for retaining such coverage is limited by capital and surplus,

regulatory and other factors. Partnering with a reinsurer to accept a particularly high risk allows the captive to provide

lines of coverage and limits that would otherwise not be feasible.

Catastrophe protection: Captives insure property-liability coverages which are frequently concentrated in

geographic or economic regions. Catastrophic exposures such as hurricanes, industrial explosions or the like can

tremendously effect loss experience. Purchasing "cat" coverage is therefore also related to the stabilization function described

above.


Supports high growth in premium volume: As with any business, new endeavors are particularly risky. As a company enters into a new line of business, geographic region, or adds

significant premium volume, it may wish to purchase some kind of reinsurance.

Risk retention groups, in particular, may wish to temper the risk of accepting large increases in premium volume, as their writings are generally more sensitive to market forces than pure captives.

Provides help with the underwriting process: Partnering with a reinsurer can greatly improve a captive's ability to

accurately underwrite a risk. Reinsurers accumulate vast underwriting knowledge working with large

numbers of primary insurers across a wide variety of business lines. This expertise can be particularly helpful to captive insurers who generally

have limited in-house underwriting capacity.


Facilitate withdrawal from a particular risk or line of business: For a variety of reasons, a captive may decide to withdraw entirely from

a particular risk or line of business.

Once a decision is made to withdraw,

management frequently enter into agreements with reinsurers to accept all outstanding loss and loss expense reserves associated with that book of business, at an agreed upon price.

Due to the time value of money,

the captive can generally pay the reinsurer an amount that is somewhat less than the total estimated liability for loss and loss expense at the time of transfer.

TODAY’S SESSION 17.07.2015

Life Insurance

Definition

Types of Insurance Products

Fire Insurance

Definition

Types of Fire Policies

Marine Insurance

Features

Operation of Marine Insurance

Types of Marine Insurance

Procedure for claim settlement

Bancassurance

DEFINITION

DEFINITION of 'Life Insurance‗

A protection against the loss of income that would result if the insured passed away.

The named beneficiary receives the proceeds and

is thereby safeguarded from the financial impact of the death of the insured.

INVESTOPEDIA EXPLAINS 'Life Insurance'

The goal of life insurance is to provide a measure of financial security for your family after you die.

Before purchasing a life insurance policy, you should consider your financial situation and the standard of living you want to maintain for your dependents or survivors.

For example, who will be responsible for your funeral costs and final medical bills?

Would your family have to relocate?

Will there be adequate funds for future or ongoing expenses such as daycare, mortgage payments and college?

It is prudent to re-evaluate your life insurance policies annually or when you experience a major life event like marriage, divorce, the birth or adoption of a child, or purchase of a major item such as a house or business.

DEFINITION

Definition of ‘Life Insurance’

It is a contract between the insured and the insurer

Insurer promises to pay a certain some of money to the insured on the even of happening for which it is insured

It is a contract to pay a sum insured at the time of maturity of the contract or

payment of loss for untimely death

It is a long term contract which provides a sense of security to the insured and his family.

DEFINITION of 'Term Life Insurance'

A policy with a set duration limit on the coverage period.

Once the policy is expired, it is up to the policy owner to decide whether to renew the term life insurance policy or to let the coverage end.

This type of insurance policy contrasts with permanent life insurance, in which duration extends until the policy owner reaches 100 years of age (i.e. death).

BENEFITS OF LIFE INSURANCE POLICY

Insured’s family will be safeguarded

It helps in compulsory savings

It improves the lifestyle

It helps in borrowing loan

It helps in certain disability and helps to face future uncertainties

It helps in tax benefits under section 80C

It aid as source of income in old age

LIFE INSURANCE PRODUCTS

LIFE INSURANCE PRODUCTS

1. TERM LIFE INSURANCE

The insurance company pays a specific lump sum to the designated beneficiary in case of the death of the insured.

These policies are usually for 5, 10, 15, 20 or 30 years.

Term life insurance are the most popular in advance countries but were not so popular in India.

The entry of the private operators and aggressive marketing by few players this kind of policies are becoming popular.

The premium on such type of policies is comparatively quite low

These policies do not carry cash value

TERM INSURANCE BENEFITS & DISADVANTAGES

BENEFITS OF TERM LIFE

INSURANCE

DISADVANTAGES OF TERM LIFE

INSURANCE

1. The premium payable on these policies is

low as they do not carry any cash value.

2. One can afford for quite high value

insurance policies

1. If one survives the period of the policy,

he / she does not get any money at the

end of the policy.

2. The premium on such policies keeps on

increasing with age mainly because the

risk of death of older people is more.

3. Over the page of 60, these policies

become difficult to afford.

2. ENDOWMENT POLICIES

These policies provide for period payment of premiums.

A lump sum amount either in the event of death of the insured or

On the date of expiry of the policy, whichever occurs earlier.

LIFE INSURANCE PRODUCT

3. PERMANENT LIFE INSURANCE : A portion of the money paid as premiums is invested in a fund that earns interest on a tax-deferred

basis.

Over a period of time, this policy will accumulate certain "cash value"

You will be able to get back either during the period of the policy or

At the end of the policy.

Your need for life insurance can change over a lifetime.

At any age, You should consider your individual circumstances and

The standard of living you wish to maintain for your dependents.

In most cases, you need life insurance only if someone depends on you for support.

Your life insurance premium is based on the Type of insurance you buy,

The amount you buy and

Your chance of death while the policy is in effect.

This type of policy Provides protection for your dependents by paying a death benefit to your designated beneficiary upon your

death,

But it also allows you to use some part of the money while you are alive or at the end of the policy.

Some examples of such policies are :- Whole Life, Universal Life and Variable-Universal Life.


4. MONEY BACK POLICIES

These policies provide for periodic payments of partial survival benefits

during the term of the policy itself.

A unique feature associated with this type of policies is that

In the event of death of the insured during the policy term,

The designated beneficiary will get the full sum assured

Without deducting any of the survival benefit amounts,

Which have already been paid as money-back components.

The Bonus on such policies is also calculated on the full sum

assured.

This policy offers the payment of partial survival benefits (money

back), as is determined in the insurance contract, while the insured is

still alive.


5. ANNUITY / PENSION POLICIES / FUNDS

This policies / funds require the insured to pay the premium as a single lump sum or through installments paid over a certain number of years.

The insured in return will receive back A specific sum periodically from a specified date onwards

The returns can be monthly, half yearly or annually

Either for life or for a fixed number of years.

In case of the death of the insured, or after the fixed annuity period expires for annuity payments, The invested annuity fund is refunded,

With some additional amounts as per the terms of the policy.

Annuity policy / fund does not provide any life insurance cover

It offers a guaranteed income either for life or a certain period.

Therefore, this type of insurance is taken so as to get income after the retirement.

FIRE INSURANCE

DEFINITION OF 'FIRE INSURANCE'

Insurance that is used to cover damage to a property caused by fire.

Fire insurance is a specialized form of insurance beyond property insurance

It is designed to cover the cost of replacement,

reconstruction or

repair beyond what is covered by the property insurance policy.

Policies cover damage to the building itself, and

may also cover damage to nearby structures,

personal property and expenses associated with not being able to live in or use the property if it is damaged.

CHARACTERISTICS OF FIRE INSURANCE

Fire insurance is a contract of indemnity.

The insurer is liable only to the extent of the actual loss suffered.

If there is no loss there is no liability even if there is a fire.

Fire insurance is a contract of good faith.

The policy-holder and the insurer must disclose all the material facts known to them.

Fire insurance policy is usually made for one year only.

The policy can be renewed according to the terms of the policy.

The contract of insurance is embodied in a policy called the fire policy.

Such policies usually cover specific properties for a specified period.


Insurable Interest: A fire policy is valid only if the policy-holder has an insurable interest in the

property covered.

Such interest must exist at the time when the loss occurs.

In English cases it has been held that the following persons have insurable interest for the purposes of fire insurance- Owner;

Tenants,

Bailees, including carriers;

Mortgages and

Charge-holders.

In case of several policies for the same property, Each insurer is entitled to contribution from the others.

After a loss occurs and payment is made, the insurer is subrogated to the rights and interests of the policy-holder.

An insurer can reinsure a part of the risk.


Fire policies cover losses caused proximately by fire. The term loss by fire is interpreted liberally.

Example:

A women hid her jewellery under the coal in her fireplace.

Later on she forgot about the jewellery and lit the fire.

The jewellery was damaged.

Held, she could recover under the fire policy.

Nothing can be recovered under a fire policy If the fire is caused by a deliberate act of policy-holder.

In such cases the policy-holder is liable to criminal prosecution.

Fire policies generally contain a condition that the insurer will not be liable If the fire is caused by riot, civil disturbances, war and explosions.

In the absence of any specific expectation the insurer is liable for all losses caused by fire,

Whatever may be the causes of the fire.


Assignment: According to English law a policy of fire insurance can be assigned only with the

consent of the insurer.

In India such consent is not necessary and the policy can be assigned as a chose-in-action under the Transfer of Property Act.

The insurer is bound when notice is given to him.

But the assignee cannot be recovering damages unless he has an insurable interest in the property at the time when the loss occurs.

A stranger cannot sue on a fire policy.

Payment of Claims: Fire policies generally contain a clause providing that

upon the occurrence of fire the insurer shall be immediately notified

so that the insurer can take steps to salvage the remainder of the property and

can also determine the extent of the loss.

Insurance companies keep experts on their staff of value the loss.

If in a policy there is an international over valuation of the property by the policy-holder,

The policy may be avoided on the ground of fraud.

TYPES OF FIRE POLICIES

1. Specific Policy

The liability of the insurer is limited to a specified sum which is less than the value of property.

2. Valued Policy

The insurer agrees to pay a specific sum irrespective of the actual loss suffered.

A valued policy is not a contract of indemnity.

3. Average Policy

Where a property is insured for a sum which is less than its value,

the policy may contain a clause that the insurer shall not be liable to pay the full loss

but only that proportion of the loss which the amount insured for, bears to the full value of the property.

Such a clause is called the average clause and policies containing an average clause are called average policies.

The phrase “subject to average” is equivalent to the insertion of an average clause.

“Lloyd’s Fire Policies are usually expressed to be “subject to average”.

TYPES OF FIRE POLICIES

4. Floating Policy

When one policy covers property situated in different places it is called a floating policy.

Floating policies are always subject to an average clause.

5. Reinstatement or replacement Policy

The insurer undertakes to pay no the value of the property lost,

But the cost of replacement of the property destroyed or damaged.

The insurer may retain an option to replace the property instead of paying cash.

6. Combined Policies

A single policy may cover losses due to a variety of cases,

E.g. fire together with burglary, third party losses, etc.

A fire policy may include loss of profits,

I.e. the insurer may undertake to indemnify the policy holder not only for the loss caused by fire but also for the loss of profits

For the period during which the establishment concerned is kept closed owing to the fire

TYPES OF FIRE EXTINGUISHERS

MARINE INSURANCE Marine insurance is concerned with overseas trade.

International trade involves transportation of goods from one country to another country by ships.

There are many dangers during the transshipment.

The persons who are importing the goods will like to ensure the safe arrival of their goods.

The shipping company wants the safety of the ship.

So marine insurance insures the coverage of all types of risks which occur during the transit..

Marine insurance may be called

A contract whereby the insurer undertakes to indemnify the insured in a manner and to the extent thereby agreed upon against marine losses.

Marine insurance has two branches:

Ocean Marine Insurance: Ocean marine insurance covers the perils of the sea

Inland Marine Insurance. Is related to the inland risks on the land.

Marine insurance

is one of the oldest forms of insurance. It has developed with the expansion of trade.

It was started during the middle ages in Italy and then in England.

The sending of goods by the sea involves many perils; so it was necessary to get the goods insured.

In modern times marine insurance business is well organized and is carried on scientific lines.

FEATURES OF MARINE INSURANCE

Offer & Acceptance It is a prerequisite to ay contract

The goods under marine insurance will be accepted after the offer is accepted by the insurance company

E.g. a proposal submitted to the insurance company along with the insurance premium cheque on 01/04/2015,

But the insurance company accepted the proposal on 15/04/2015.

The risk will be covered from 15/04/2015 and any loss prior to this date will not be covered under marine insurance

Payment of Premium Owner must ensure that the premium is paid in advance to cover the risk

If the payment is made through cheque and if the cheque is dishonored than the coverage of risk will not exist


Contract of indemnity

This principle means that the insured will be compensated only to the extent of

loss suffered.

He will not be allowed to earn profit from marine insurance.

The underwriter provides to compensate the insured in cash and not to replace

the cargo or the ship.

The money value of the subject-matter is decided at the time of taking up the

policy.

Sometimes the value is calculated at the time of loss also.

E.g.

if the property under marine insurance is insured for Rs20 lakh

and during transit it is damaged to the extent of Rs10 lakh

than the insurance company will not pay more than 10 lakh

FEATURES OF MARINE INSURANCE Utmost good faith:

The marine contract is based on utmost good faith on the part of the parties.

The burden of this principle is more on the insured than on the underwriter.

The insured should give full information about the subject to the insured.

He should not withhold any information.

If a party does act in good faith, the other party is at liberty to cancel the contract.

Insurable Interest:

Insurable interest means that the insured should have interest in the subject when it is to be insured.

He should be benefited by the safe arrival of commodities and he should be prejudiced by loss or damage of goods.

The insured may not have an insurable interest at the time of acquiring a marine insurance policy,

he should have a reasonable, expectation of acquiring such interest.

The insured must have insurable interest at the time of loss or damage,

otherwise he will not be able to claim compensation.


Insurable Interest:

Insurable interest means that the insured should have interest in the subject when it is to be insured.

He should be benefited by the safe arrival of commodities and he should be prejudiced by loss or

damage of goods.

The insured may not have an insurable interest at the time of acquiring a marine insurance policy,

he should have a reasonable, expectation of acquiring such interest.

The insured must have insurable interest at the time of loss or damage,

otherwise he will not be able to claim compensation.

The insurable interest will depend on the nature of contract.

E.g.

1. Mr. A sends the goods to Mr. B on FOB (Free on Board) it means that the insurance is to be

arranged by Mr. B. If any loss arises during the transit than Mr. B is entitled to get the

compensation

2. Mr. A sends the goods to Mr. B on CIF (Cost, Insurance and Freight) basis it means that the

insurance is to be arranged by Mr. A. If any loss arises during the transit than Mr A is entitled to get

the compensation


Period of Insurance Policy It is the normal time taken for a particular transit.

Will not exceed one year.

It can be issued for a single transit or for specific period but not more than a year

Deliberate Act If the goods or loss occurs during transit because of deliberate act of an

owner

That damage or loss will not be covered under the policy

Claims The owner must inform the insurance company immediately

So that the insurance company can take necessary steps to determine the loss

TYPES OF MARINE INSURANCE

Cargo Insurance:

Cargo insurance caters specifically to the cargo of the ship and also pertains to the belongings of a ship’s voyagers.

Hull Insurance:

Hull insurance mainly caters to the torso and hull of the vessel along with all the articles and pieces of furniture in the ship.

This type of marine insurance is mainly taken out by the owner of the ship in order to avoid any loss to the ship in case of any mishaps occurring.

Liability Insurance:

Compensation is sought to be provided to any liability occurring on account of a ship crashing or colliding and on account of any other induced attacks.


Voyage Policy:

A voyage policy is that kind of marine insurance policy which is valid for a particular voyage.

Time Policy:

A marine insurance policy which is valid for a specified time period – generally valid for a year – is classified as a time policy.

Mixed Policy:

A marine insurance policy which offers a client the benefit of both time and voyage policy is recognized as a mixed policy.

Open (or) Un-valued Policy:

The value of the cargo and consignment is not put down in the policy beforehand.

Therefore reimbursement is done only after the loss to the cargo and consignment is inspected and valued.


Freight Insurance:

Offers and provides protection to merchant vessels’ corporations which stand a

chance of losing money

In the form of freight in case the cargo is lost due to the ship meeting with an

accident.

It solves the problem of companies losing money because of a few

unprecedented events and accidents occurring.

Valued Policy:

A valued marine insurance policy is the opposite of an open marine insurance

policy.

In this type of policy, the value of the cargo and consignment is ascertained and

is mentioned in the policy document beforehand

thus making clear about the value of the reimbursements in case of any loss to

the cargo and consignment.


Port Risk Policy:

This kind of marine insurance policy is taken out in order to ensure the safety of the ship while it is stationed in a port.

Wager Policy:

If the insurance company finds the damages worth the claim then the reimbursements are provided, else there is no compensation offered.

Wager policy is not a written insurance policy and as such is not valid in a court of law.

Floating Policy:

Where only the amount of claim is specified and all other details are omitted till the time the ship embarks on its journey, is known as floating policy.

For clients who undertake frequent trips of cargo transportation through waters, this is the most ideal and feasible marine insurance policy.

PROCEDURE FOR CLAIM SETTLEMENT

Intimation It is the responsibility of the insured to intimate the insurer about the loss

without any delay.

Policy Submission Original Certificate of policy has to be submitted to the company.

It is the evidence that the subject matter is insured

Bill of Lading Bill of lading serves as evidence that goods are actually shipped

In bill of lading the details of cargo are written

Survey Report After arising of loss, it should be surveyed and a report should be prepared

It shows the cause and extent of the loss.

The report is very important for claim settlement

PROCEDURE FOR CLAIM SETTLEMENT Debit Note

The insured has to submit one debit note for the amount of claim which will serve as claim bill

The master of the vessels usually makes a protest on arrival of goods at destination before Notary Public

In this protest the captain declares that the damage is not due to his mistake

Invoice The invoice enables the insurer to ensure the insurance value should not cross

the cost value

Invoice contain the nature of goods, price and other details

Letter of Subrogation This legal document is supplied by the insurer, which transfers the rights of the

claimant against third party

Bill of Entry The custom authorities shows the amount of duty aid, date of arrival, proceeds

of the sale of goods repairs or replacement bills in case of damage etc.

CLAIM SETTLEMENT FOR INLAND TRANSIT

Original policy or certificate of insurance

Invoice

Certificate of loss

Original railway receipts

Copy of the claim lodged

Letter of subrogation

Special power of attorney duly signed

Letter of undertaking

Claim bill after adjustment of salvage value

BANCASSURANCE

Definition: Bancassurance means selling insurance product through banks.

Banks and insurance company come up in a partnership

the bank sells the tied insurance company's insurance products to its clients.

Description: Bancassurance arrangement benefits both the firms.

the bank earns fee amount (non interest income) from the insurance company

the insurance firm increases its market reach and customers.

The bank acts as an intermediary, helping insurance firm reach its target customer

in order to increase its market share.

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