Certified credit professionals numerical

  

Numericals:



Assets
Net Fixed Assets - 800
Inventories - 300
Preliminary Expenses - 100
Receivables - 150
Investment In Govt. Secu - 50
Total Assets - 1400
Liabilities
Equity Capital - 200
Preference Capital - 100
Term Loan - 600
Bank C/C - 400
Sundry Creditors - 100
Total Liabilities – 1400


1. Debt Equity Ratio = ?
a. 1:1
b. 1:2
c. 2:1
d. 2:3
Ans - c
Explanation :
600 / (200+100) = 2 : 1
2. Tangible Net Worth = ?
a. 100
b. 200
c. 300
d. 400
Ans - b
Explanation :
Only equity Capital i.e. = 200
3. Total Liabilities to Tangible Net Worth Ratio = ?
a. 7:2
b. 11:2
c. 13:2
d. 15:2
Ans - b
Explanation :
Total Outside Liabilities / Total Tangible Net Worth : (600+400+100) / 200 = 11 : 2
4. Current Ratio = ?
a. 1:1
b. 1:2
c. 2:1
d. 3:1
Ans - a

Explanation :
(300 + 150 + 50 ) / (400 + 100 ) = 1 : 1



Q.2

Assets

Net Fixed Assets - 265

Cash - 1

Receivables - 125

Stocks - 128

Prepaid Expenses - 1

Intangible Assets - 30

Total - 550

Liabilities

Capital + Reserves - 355

P & L Credit Balance - 7

Loan From S F C - 100

Bank Overdraft - 38

Creditors - 26

Provision of Tax - 9

Proposed Dividend - 15

Total - 550

1. Current Ratio = ?

= (1+125 +128+1) / (38+26+9+15)

= 255/88

= 2.89 : 1

2. Quick Ratio = ?

(125+1)/88

= 1.43 : 11

3. Debt Equity Ratio = ?

= LTL / Tangible NW

= 100 / (362 – 30)

= 100 / 332

= 0.30 : 1

4. Proprietary Ratio = ?

= (T NW / Tangible Assets) x 100

= [(362 - 30 ) / (550 – 30)] x 100

= (332 / 520) x 100

= 64%

5. Net Working Capital = ?

= CA - CL

= 255 - 88

= 167

6. If Net Sales is Rs.15 Lac, then What would be the Stock Turnover Ratio in Times ?

= Net Sales / Average Inventories/Stock

= 1500 / 128

= 12 times approximately

7. What is the Debtors Velocity Ratio if the sales are Rs. 15 Lac?



= (Average Debtors / Net Sales) x 12

= (125 / 1500) x 12

= 1 month

8. What is the Creditors Velocity Ratio if Purchases are Rs.10.5 Lac?

= (Average Creditors / Purchases ) x 12

= (26 / 1050) x 12

= 0.3 months

.............................................



Q.3 Current Ratio of a firm is 1 : 1. What will be the Net Working Capital ?

a. 0

b. 1

c. 100

d. 200

Ans - a

Explanation :

It suggest that the Current Assets is equal to Current Liabilities hence the NWC would be

0

(since NWC = C.A - C.L)

.............................................

Q.4 Suppose Current Ratio is 4 : 1. NWC is Rs.30,000/-. What is the amount of Current

Assets ?

a. 10000

b. 30000

c. 40000

d. 50000

Ans - c

Explanation :

Let Current Liabilities = a

4a - 1a = 30,000

a = 10,000 i.e. Current Liabilities is Rs.10,000

Hence Current Assets would be

4a = 4 x 10,000 = Rs.40,000/-

.............................................

Q.5 The amount of Term Loan installment is Rs.10000/ per month, monthly average interest

on TL is Rs.5000/-. If the amount of Depreciation is Rs.30,000/- p.a. and PAT is

Rs.2,70,000/-. What would be the DSCR ?

a. 1

b. 1.5

c. 2

d. 2.5

Ans - C

Explanation :

DSCR = (PAT + Depr + Annual Intt.) / Annual Intt + Annual Installment

= (270000 + 30000 + 60000 ) / 60000 + 12000

= 360000 / 180000

= 2

.............................................

Q. 6     A Company has Net Worth of Rs.5 Lac, Term Liabilities of Rs.10 Lac. Fixed Assets worth

RS.16 Lac and Current Assets are Rs.25 Lac. There is no intangible Assets or other Non

Current Assets. Calculate its Net Working Capital.

a. 1 lac

b. 2 lac

c. - 1 lac





d. - 2 lac

Ans - c

Explanation :

Total Assets = 16 + 25 = Rs. 41 Lac

Total Liabilities = NW + LTL + CL = 5 + 10 + CL = 41 Lac

Current Liabilities = 41 – 15 = 26 Lac

Therefore Net Working Capital = CA – CL = 25 – 26 = (-) 1 Lac

.............................................

Q. 7  Merchandise costs - Rs. 250000, Gross Profit - Rs. 23000, Net Profit - Rs. 15000. Find

the amount of sales.

a. 227000

b. 235000

c. 265000

d. 273000

Ans - d

Explanation :

Amount of sales = Merchandise costs + Gross Profit

= 250000 + 23000

= 273000

.............................................

Q.8 Total Liabilities of a firm is Rs.100 Lac and Current Ratio is 1.5 : 1. If Fixed Assets and

Other Non Current Assets are to the tune of Rs. 70 Lac and Debt Equity Ratio being 3 :

1. What would be the Long Term Liabilities?

a. 40 Lacs

b. 60 Lacs

c. 80 Lacs

d. 100 Lacs

Ans - b

Explanation :

Total Assets = Total Liabilities = 100 Lac

Current Asset = Total Assets - Non Current Assets

= Rs. 100 L - Rs. 70 L

= Rs. 30 L

If the Current Ratio is 1.5 : 1

then Current Liabilities works out to be Rs. 20 Lac.

That means, Net Worth + Long Term Liabilities = Rs. 80 Lacs.

If the Debt Equity Ratio is 3 : 1,

then Debt works out to be Rs. 60 Lacs and equity Rs. 20 Lacs.

Therefore the Long Term Liabilities would be Rs.60 Lac.

.............................................

Q.9 Current Ratio = 1.2 : 1.

Total of balance sheet being Rs.22 Lac.

The amount of Fixed Assets + Non Current Assets is Rs. 10 Lac.

What would be the Current Liabilities?

a. 10 Lacs

b. b. 12 Lacs

c. 16 Lacs

d. 22 Lacs

Ans - a

Explanation :

Total Assets is Rs.22 Lac.

Fixed Assets + Non Current Assets is Rs. 10 Lac

Then Current Assets = 22 – 10 = Rs. 12 Lac.

Current Ratio = 1.2 : 1

Current Liabilities = Rs. 10 Lac

.............................................







Q.10 M/s Raj&co's balance sheet included the following accounts:

Cash: 10,000

Accounts Receivable: 5,000

Inventory: 5,000

Stock Investments: 1,000

Prepaid taxes: 500

Current Liabilities: 15,000

Find the Quick Ratio

Quick Ratio = Cash + Cash Equivalents + Short Term Investments + Marketable

Securities + Accounts Receivable) / Current Liabilities

= (10000+5000+1000) / 15000

= 16000 / 15000

= 1.07

.................................

Q.11 M/s Raj&co's balance sheet included the following accounts:

Inventory : 5,000

Prepaid taxes : 500

Total Current Assets : 21,500

Current Liabilities : 15,000

Find the Quick Ratio

Quick Ratio = (Current assets – Inventory - Advances - Prepayments Current Liabilities) /

Current Liabilities

= (21500 - 5000 - 500) / 15000

= 16000 / 15000

= 1.07

.................................

Q.12 XYZ Pvt Ltd has the following assets and liabilities as on 31st March 2015 (in Lakhs) :

Non Current Assets

Goodwill 75

Fixed Assets 75

Current Assets

Cash in hand 25

Cash in bank 50

Short term investments 45

Inventory 25

Receivable 100

Current Liabilities

Trade payables 100

Income tax payables 60

Non Current Liabilities

Bank Loan 50

Deferred tax payable 25

Find the Quick Ratio

Quick Ratio = (Cash in hand + Cash at Bank + Receivables + Marketable Securities) /



Current Liabilities

= (25+50+45+100) / 160

= 220 / 160

= 1.375

.................................





Q.14 GHI Ltd. manufacturers two products :Product G and Product H. The Variable cost of the manufacture is as

follows:

Product G Product H

Direct Material 3 10

Direct Labour (Rs.6 per hour) 18 12

Variable Overhead 4 4

Product G sells for Rs.40 and Product H at Rs.30. During the month of January, the Company is having

only 21000 of direct labour. The maximum production capacity of Product G is 5000 units and Product H is

10000 units.

From the above facts, answer the following:

I. The contribution from Product G and H together is-----

a) Rs.32

b) Rs.19

c) Rs.27

d) Rs.40

II. The contribution per labour hour from Product H is-----

e) Rs. 4

f) Rs. 2

g) Rs. 3

h) Rs. 5

III. The contribution per labour hour from Product G is-----

a) Rs.2

b) Rs.5

c) Rs.15

d) Rs.3





Q.15 Read the following and answer

Cost / unit

Raw material 50

Direct labour 20

Overheads 40

Total cost 110

No. of units 10,000

No. of units

Sold on credit 8000

Average raw material in stock : 1 month

Average work in progress : ½ month

Average finished goods in stock : ½ month

Credit by supplier : 1 month

Credit to debtor : 2 months

Take 1 year = 12 months

1) Investment of working capital in raw material inventory is

(a) 41666

(b) 50000

(c) 33333

(d) 10000

2) Investment in working capital for finished goods is

a) 45833

b) 49090

c) 56453

d) 50000

Sole , Multiple Banking Arrangement, Consortium Lending, Syndication

 Sole , Multiple Banking Arrangement, Consortium Lending, Syndication  

Sole Banking Arrangement: Sole banking arrangement is a lending by single bank to a large borrower, subject to the resources available with it and limited to the exposure limits imposed by the Reserve Bank of India. Many a times when you propose to approach to new bank for funding, they propose for sole banking that their complete banking should be transferred to their bank. This is done for two reasons one is to get complete business and second is very important is having complete monitoring of fund flow and cash flow of the firm.

 Multiple Banking Arrangement, Consortium Lending, Syndication: Multiple Banking: When the credit requirements of a borrower are beyond the capacity of a single bank or that the bank does not want to take more exposure on a particular borrower, he may then resort to multiple banking. It is an arrangement where a borrower borrows simultaneously from more than one bank independent of each other, under separate loan documents with each bank. Securities are charged to each bank separately. Remember, this is different from Consortium and Syndication

Consortium lending
Consortium lending also called joint financing or participation financing. It is a system of financial emerged due to consequential increase in demand for funds of substantial magnitude and inability of individual banks to take care of the entire fund requirement
of large borrowers. The system of consortium lending provides scope and opportunity to share risk amongst banks. The system is considered to be mutually beneficial to the banks as well as customers. Under multiple banking, there is no coordination among banks regarding appraisal, documentation, other terms and advances. In such a situation borrowers got the upper hand by playing one bank against the other. It was, therefore, necessary to formalize these credit arrangements to safeguard the interest of the banks. It is mainly catered in case of large corporate and certain mid-sized borrowers.

Syndication Lending
 Reserve Bank of India has permitted the banks to adopt syndication route to provide credit in lieu of consortium advance. A syndication credit differs from consortium advance. A syndicated credit differs from consortium advances in certain aspects.

The salient features of a syndicated credit are as follows:

 1. It is an agreement between two or more banks to provide a borrower a credit facility using common documents of the borrower.

2. The prospective borrower gives a mandate to a bank, commonly referred as a lead bank (lead manager), to arrange credit on his behalf. The mandate gives the commercial terms of the credit and the prerogatives of the mandated bank in resolving contentious issue in the course of the transaction of complete syndication.

3. The mandated bank prepares an information Memorandum about the borrower in consultation with the latter and distributes the same among st the prospective banks, inviting them to participate in the credit proposal.

What is a 'Syndicated Loan'
A syndicated loan, also known as a syndicated bank facility, is a loan offered by a group of lenders – referred to as a syndicate – who work together to provide funds for a single borrower. The borrower could be a corporation, a large project or a sovereignty, such as a government. The loan can involve a fixed amount of funds, a credit line or a combination of the two.

VERY IMPORTANT FOR CAIIB BFM EXAM CGTMSE

  Credit Guarantee Fund Trust For Micro And Small Enterprises (CGTMSE) or Credit Risk Guarantee Fund Trust for Low Income Housing (CRGFTLIH)

In case the advance covered by CGTMSE or CRGFTLIH guarantee becomes nonperforming, no provision need be made towards the guaranteed portion. The amount outstanding in excess of the guaranteed portion should be provided for as per the extant guidelines on provisioning for non-performing assets. An illustrative example is given below:

Example

Outstanding Balance	Rs. 10 lakhs
CGTMSE/CRGFTLIH Cover	75% of the amount outstanding or 75% of the unsecured amount or Rs.37.50 lakh, whichever is the least
Period for which the advance has remained doubtful	More than 2 years remained doubtful (say as on March 31, 2014)
Value of security held	Rs. 1.50 lakhs

Provision required to be made

Balance outstanding	Rs.10.00 lakh
Less: Value of security	Rs. 1.50 lakh
Unsecured amount	Rs. 8.50 lakh
Less: CGTMSE/CRGFTLIH cover (75%)	Rs. 6.38 lakh
Net unsecured and uncovered portion:	Rs. 2.12 lakh
Provision for Secured portion @ 40% of Rs.1.50 lakh	Rs.0.60 lakh
Provision for Unsecured & uncovered portion @ 100% of Rs.2.12 lakh	Rs.2.12 lakh
Total provision required	Rs.2.72 lakh

RATIOS USED FOR CREDIT ASSESSMENT

  RATIOS USED FOR CREDIT ASSESSMENT

A. LIQUIDITY RATIO
1. Current Ratio
Formula: Current Assets/Current Liabilities
Current asset and current liabilities are those receivable or payable respectively within a
period of 12 months or one operating cycle.
It is a measure of liquidity of the company. A company with a current ratio less than one
does not have the capital on hand to meet its short-term obligations if they were all due
at once, while a current ratio greater than one indicates that the company should be
able to remain solvent in the short-term.
The ratio in standalone basis will not provide a meaningful interpretation. An in-depth
analysis of the quality of the current assets and liabilities will provide a better picture of
the company’s liquidity position.
For example, a company may have a very high current ratio but their accounts
receivable is low quality. Perhaps they have not been able to collect from their
customers quickly which may be hidden in the current ratio. Further If inventory is
unable to be sold, the current ratio may still look acceptable, but the company may be
headed for default.
A current ratio less than one would not be concerning if the company has a much higher
receivables turnover than payables turnover. For example, retail companies collect very
quickly from consumers but have a long time to pay their suppliers.
2. Liquid ratio / Acid Test ratio / Quick ratio
Formula: (Current Assets – Inventory – Prepaid expenses) / (Current Liabilities –
Bank borrowings)
The ratio indicates the backing available to liquid liabilities in the form of liquid assets.
Liquid assets are those current assets which can be converted to cash without reduction
in value and almost immediately.
B. TURNOVER RATIO
1. Fixed Assets turnover ratio
Formula: Net Sales/Fixed Assets (WDV)
The ratio indicates the capability of organization to achieve sales viz-a-viz the
investment in fixed assets. Higher the ratio, better the efficiency of the organization.

2. Current Assets turnover ratio
Formula: Net Sales/Current Assets
The ratio indicates the capability of organization to achieve sales viz-a-viz the
investment in current assets. Higher the ratio, better the efficiency of the organization.
3. Working capital turnover ratio
Formula: Net Sales/Working capital
The ratio indicates the capability of organization to achieve sales viz-a-viz the
investment in working capital. Higher the ratio, better the efficiency of the organization.
4. Inventory/Stock turnover ratio
Formula: Cost of goods sold/Average inventory
Net sales/Average Inventory
Cost of goods sold/Cost inventory
Net sales/Closing inventory
In normal condition, a higher ratio is desirable. However low level of inventory may also
lead to the company not being able to adhere to delivery schedules. Though low level of
inventory maintenance will reduce the carrying cost and thereby higher profits,
sometimes higher maintenance of inventory may also lead to increase in volume of
sales thereby leading to higher profits.
5. Debtors Turnover ratio
Formula: Net Credit sales/Closing sundry debtors
The average collection period computed as above should be compared with the normal
credit period allowed to customers. If the average collection period is more than the
normal credit period, it may indicate over investment in debtors, over extension of credit
period, liberalization of credit terms and ineffective collection procedure among others.
6. Capital turnover ratio
Formula: Sales/Capital Employed
The ratio indicates the efficiency of the organization in respect of capital utilization.
Higher ratio is desirable.

C. SOLVENCY RATIO
1. Debt Equity ratio
Formula: External/Shareholders funds’
Long term liabilities/Shareholder Funds
If the ratio is higher, it indicates higher external borrowings, and it increases the risk of
investment in such an organization. The best possible to way to increase earnings to
shareholders is to borrow funds from outside because
(i) Cost of equity is high
(ii) Return on investment paid to creditors is a tax-deductible expenditure
2. Proprietary ratio
Formula: Total Assets/ Owners funds
Fixed Assets/Owners funds
Current Assets/Owners funds
The ratio indicates the extent to which the owner’s funds are sunk in different kind of
assets. If owners’ funds exceed fixed asset, it indicates owner’s funds are used to
finance current assets and if vice-versa, it indicates that fixed assets are financed by
long term or short term creditors.
3. Fixed assets/Capital Employed ratio
Formula: (Fixed assets/Capital Employed) X 100
A high ratio indicates a major portion of long term funds is being used for fixed assets
rather than working capital. A high ratio coupled with declining current ratio indicates
urgent need for introduction of long term funds for financing working capital.
4. Interest coverage ratio.
Formula: Profit before Interest and taxes / Interest charges
The ratio indicates protection available to the lenders of long term capital in the form of
funds available to pay interest charges. Though a high ratio is desirable, a very high
ratio indicates under-utilization of borrowing capacity of the organization.

5. Debt service coverage ratio.
The ratio is calculated in two ways, Gross DSCR and Net DSCR
Formula:
Gross DSCR = (Cash accruals + Term loan interest)/ (Term loan installment +
Term loan interest
Net DSCR = Cash accruals / Term loan installment
The ratio indicates the level of serviceability of debt viz-a-viz the cash accruals
generated by the company. The higher the ratio, better the company’s financial position
to service interest and installment.
D. PROFITABILITY RATIO
1. Gross profit ratio
Formula: (Gross profit/Net sales) X 100
By comparing Gross Profit percentage to Net Sales we can arrive at the Gross Profit
Ratio which indicates the manufacturing efficiency as well as the pricing policy of the
concern.
Alternatively, since Gross Profit is equal to Sales minus Cost of Goods Sold, it can also
be interpreted as below:
Alternate formula = [ (Sales – Cost of goods sold)/ Net Sales] x 100
A higher Gross Profit Ratio indicates efficiency in production of the unit.
2. Net Profit ratio
Formula: (Net profit/Net sales) X 100
The ratio indicates that portion of the sales which is available to the owners after the
consideration of all types of expenses and costs, either operating or non-operating,
normal or abnormal. A high ratio is considered desirable.
3. Operating ratio
Formula: {(Manufacturing cost of goods sold + operating expenses) / Net sales}
X100
A high ratio indicates that only a small margin of sales is available to meet expenses in
the form of interest, dividend and other-operating expenses.

E. OVERALL PROFITABILITY RATIO
1. Return on assets (ROA)
Formula: (Net profit/Assets) X 100
It measures the profitability of investments and a higher ratio is desirable. The ratio
does not indicate the profitability of various sources of funds, which finance the total
assets.
2. Return on capital employed (ROCE)
Formula: (Net profit + Interest on long term sources) / Capital employed
The ratio indicates the profitability of capital employed. A higher ratio indicates a better
and profitable use of long term funds of owners and creditors.
3. Return on shareholders’ funds
Formula: (Net profit after taxes + total shareholders’ funds) X 100
The ratio indicates whether the firm has earned sufficient returns for its shareholders or
not. A higher ratio is desirable.
F. MISCELLANEOUS RATIO
1.Capital gearing ratio.
Formula: Fixed Income Bearing securities / Equity capital
A high ration indicates that in the capital structure, fixed income bearing securities are
more in comparison to the equity capital and company will be highly geared which is
considered a highly unstable situation. A high gearing ratio is advantageous from the
equity shareholders’ point of view.
2. Earnings per share (EPS)
Formula: (Net Profit after taxes – Preference dividend) / Number of equity shares
outstanding
The ratio is calculated based on current profit and not based on retained profit. The ratio
only indicates the profits available to shareholders on per share basis and not the
quantum of earnings paid to owners by way of dividend or how much of earnings is
retained in the business.

3. Price earnings ratio (P/E ratio)
Formula: Market price per share / Earning per share
The ratio measures the expectation of the investors and an ideal investor will compare
between the current price and future EPS also.
4. Dividend payment ratio (D/P ratio)
Formula: (Dividend per share / Earning per share) X 100
The ratio indicates the policy of the management to pay cash dividend.
1 - D/P ratio indicates the retained profits in the business available for future expansion.

Risk management very Important Terms

    Risk management very  Important Terms 

Capital Funds

Equity contribution of owners. The basic approach of capital adequacy framework is that a bank should have sufficient capital to provide a stable resource to absorb any losses arising from the risks in its business. Capital is divided into different tiers according to the characteristics / qualities of each qualifying instrument. For supervisory purposes capital is split into two categories: Tier I and Tier II. 

Tier I Capital

A term used to refer to one of the components of regulatory capital. It consists mainly of share capital and disclosed reserves (minus goodwill, if any). Tier I items are deemed to be of the highest quality because they are fully available to cover losses Hence it is also termed as core capital. 

Tier II Capital

Refers to one of the components of regulatory capital. Also known as supplementary capital, it consists of certain reserves and certain types of subordinated debt. Tier II items qualify as regulatory capital to the extent that they can be used to absorb losses arising from a bank's activities. Tier II's capital loss absorption capacity is lower than that of Tier I capital. 

Revaluation reserves

Revaluation reserves are a part of Tier-II capital. These reserves arise from revaluation of assets that are undervalued on the bank's books, typically bank premises and marketable securities. The extent to which the revaluation reserves can be relied upon as a cushion for unexpected losses depends mainly upon the level of certainty that can be placed on estimates of the market values of the relevant assets and the subsequent deterioration in values under difficult market conditions or in a forced sale. 

Leverage

Ratio of assets to capital. 

Capital reserves

That portion of a company's profits not paid out as dividends to shareholders. They are also known as undistributable reserves and are ploughed back into the business. 

Deferred Tax Assets

Unabsorbed depreciation and carry forward of losses which can be set-off against future taxable income which is considered as timing differences result in deferred tax assets. The deferred Tax Assets are accounted as per the Accounting Standard 22. 

Deferred Tax Liabilities

Deferred tax liabilities have an effect of increasing future year's income tax payments, which indicates that they are accrued income taxes and meet definition of liabilities. 

Subordinated debt

Refers to the status of the debt. In the event of the bankruptcy or liquidation of the debtor, subordinated debt only has a secondary claim on repayments, after other debt has been repaid. 

Hybrid debt capital instruments

In this category, fall a number of capital instruments, which combine certain characteristics of equity and certain characteristics of debt. Each has a particular feature, which can be considered to affect its quality as capital. Where these instruments have close similarities to equity, in particular when they are able to support losses on an ongoing basis without triggering liquidation, they may be included in Tier II capital. 

BASEL Committee on Banking Supervision

The BASEL Committee is a committee of bank supervisors consisting of members from each of the G10 countries. The Committee is a forum for discussion on the handling of specific supervisory problems. It coordinates the sharing of supervisory responsibilities among national authorities in respect of banks' foreign establishments with the aim of ensuring effective supervision of banks' activities worldwide. 

BASEL Capital accord

The BASEL Capital Accord is an Agreement concluded among country representatives in 1988 to develop standardised risk-based capital requirements for banks across countries. The Accord was replaced with a new capital adequacy framework (BASEL II), published in June 2004. BASEL II is based on three mutually reinforcing pillars hat allow banks and supervisors to evaluate properly the various risks that banks face. These three pillars are:

Minimum capital requirements, which seek to refine the present measurement framework

supervisory review of an institution's capital adequacy and internal assessment process;

market discipline through effective disclosure to encourage safe and sound banking practices 

Risk Weighted Asset

The notional amount of the asset is multiplied by the risk weight assigned to the asset to arrive at the risk weighted asset number. Risk weight for different assets vary e.g. 0% on a Government Dated Security and 20% on a AAA rated foreign bank etc. 

CRAR(Capital to Risk Weighted Assets Ratio)

Capital to risk weighted assets ratio is arrived at by dividing the capital of the bank with aggregated risk weighted assets for credit risk, market risk and operational risk. The higher the CRAR of a bank the better capitalized it is. 

Credit Risk

The risk that a party to a contractual agreement or transaction will be unable to meet its obligations or will default on commitments. Credit risk can be associated with almost any financial transaction. BASEL-II provides two options for measurement of capital charge for credit risk 

1.standardised approach (SA) - Under the SA, the banks use a risk-weighting schedule for measuring the credit risk of its assets by assigning risk weights based on the rating assigned by the external credit rating agencies.

2. Internal rating based approach (IRB) - The IRB approach, on the other hand, allows banks to use their own internal ratings of counterparties and exposures, which permit a finer differentiation of risk for various exposures and hence delivers capital requirements that are better aligned to the degree of risks. The IRB approaches are of two types:

a) Foundation IRB (FIRB):The bank estimates the Probability of Default (PD) associated with each borrower, and the supervisor supplies other inputs such as Loss Given Default (LGD) and Exposure At Default (EAD). 

b) Advanced IRB (AIRB):In addition to Probability of Default (PD), the bank estimates other inputs such as EAD and LGD. The requirements for this approach are more exacting. The adoption of advanced approaches would require the banks to meet minimum requirements relating to internal ratings at the outset and on an ongoing basis such as those relating to the design of the rating system, operations, controls, corporate governance, and estimation and validation of credit risk components, viz., PD for both FIRB and AIRB and LGD and EAD for AIRB. The banks should have, at the minimum, PD data for five years and LGD and EAD data for seven years. In India, banks have been advised to compute capital requirements for credit risk adopting the SA. 

Market risk

Market risk is defined as the risk of loss arising from movements in market prices or rates away from the rates or prices set out in a transaction or agreement. The capital charge for market risk was introduced by the BASEL Committee on Banking Supervision through the Market Risk Amendment of January 1996 to the capital accord of 1988 (BASEL I Framework). There are two methodologies available to estimate the capital requirement to cover market risks: 

1) The Standardised Measurement Method: This method, currently implemented by the Reserve Bank, adopts a 'building block' approach for interest-rate related and equity instruments which differentiate capital requirements for 'specific risk' from those of 'general market risk'. The 'specific risk charge' is designed to protect against an adverse movement in the price of an individual security due to factors related to the individual issuer. The 'general market risk charge' is designed to protect against the interest rate risk in the portfolio.

2) The Internal Models Approach (IMA): This method enables banks to use their proprietary in-house method which must meet the qualitative and quantitative criteria set out by the BCBS and is subject to the explicit approval of the supervisory authority. 

Operational Risk

The revised BASEL II framework offers the following three approaches for estimating capital charges for operational risk:

1) The Basic Indicator Approach (BIA): This approach sets a charge for operational risk as a fixed percentage ("alpha factor") of a single indicator, which serves as a proxy for the bank's risk exposure. 

2) The Standardised Approach (SA): This approach requires that the institution separate its operations into eight standard business lines, and the capital charge for each business line is calculated by multiplying gross income of that business line by a factor (denoted beta) assigned to that business line.

3) Advanced Measurement Approach (AMA): Under this approach, the regulatory capital requirement will equal the risk measure generated by the banks' internal operational risk measurement system. In India, the banks have been advised to adopt the BIA to estimate the capital charge for operational risk and 15% of average gross income of last three years is taken for calculating capital charge for operational risk. 

Internal Capital Adequacy Assessment Process (ICAAP)

In terms of the guidelines on BASEL II, the banks are required to have a board-approved policy on internal capital adequacy assessment process (ICAAP) to assess the capital requirement as per ICAAP at the solo as well as consolidated level. The ICAAP is required to form an integral part of the management and decision-making culture of a bank. ICAAP document is required to clearly demarcate the quantifiable and qualitatively assessed risks. The ICAAP is also required to include stress tests and scenario analyses, to be conducted periodically, particularly in respect of the bank's material risk exposures, in order to evaluate the potential vulnerability of the bank to some unlikely but plausible events or movements in the market conditions that could have an adverse impact on the bank's capital. 

Supervisory Review Process (SRP)

Supervisory review process envisages the establishment of suitable risk management systems in banks and their review by the supervisory authority. The objective of the SRP is to ensure that the banks have adequate capital to support all the risks in their business as also to encourage them to develop and use better risk management techniques for monitoring and managing their risks. 

Market Discipline

Market Discipline seeks to achieve increased transparency through expanded disclosure requirements for banks. 

Credit risk mitigation

Techniques used to mitigate the credit risks through exposure being collateralised in whole or in part with cash or securities or guaranteed by a third party. 

Mortgage Back Security

A bond-type security in which the collateral is provided by a pool of mortgages. Income from the underlying mortgages is used to meet interest and principal repayments. 

Derivative

A derivative instrument derives its value from an underlying product. There are basically three derivatives 

a) Forward Contract- A forward contract is an agreement between two parties to buy or sell an agreed amount of a commodity or financial instrument at an agreed price, for delivery on an agreed future date. Future Contract- Is a standardized exchange tradable forward contract executed at an exchange. In contrast to a futures contract, a forward contract is not transferable or exchange tradable, its terms are not standardized and no margin is exchanged. The buyer of the forward contract is said to be long on the contract and the seller is said to be short on the contract.

b) Options- An option is a contract which grants the buyer the right, but not the obligation, to buy (call option) or sell (put option) an asset, commodity, currency or financial instrument at an agreed rate (exercise price) on or before an agreed date (expiry or settlement date). The buyer pays the seller an amount called the premium in exchange for this right. This premium is the price of the option.

c) Swaps- Is an agreement to exchange future cash flow at pre-specified Intervals. Typically one cash flow is based on a variable price and other on affixed one. 

Duration

Duration (Macaulay duration) measures the price volatility of fixed income securities. It is often used in the comparison of interest rate risk between securities with different coupons and different maturities. It is defined as the weighted average time to cash flows of a bond where the weights are nothing but the present value of the cash flows themselves. It is expressed in years. The duration of a fixed income security is always shorter than its term to maturity, except in the case of zero coupon securities where they are the same. 

Modified Duration

Modified Duration = Macaulay Duration/ (1+y/m), where 'y' is the yield (%), 'm' is the number of times compounding occurs in a year. For example if interest is paid twice a year m=2. Modified Duration is a measure of the percentage change in price of a bond for a 1% change in yield. 

Non Performing Assets (NPA)

An asset, including a leased asset, becomes non performing when it ceases to generate income for the bank. 

Net NPA

Gross NPA - (Balance in Interest Suspense account + DICGC/ECGC claims received and held pending adjustment + Part payment received and kept in suspense account + Total provisions held). 

Coverage Ratio

Equity minus net NPA divided by total assets minus intangible assets. 

Slippage Ratio

(Fresh accretion of NPAs during the year/Total standard assets at the beginning of the year)*100 

Restructuring

A restructured account is one where the bank, grants to the borrower concessions that the bank would not otherwise consider. Restructuring would normally involve modification of terms of the advances/securities, which would generally include, among others, alteration of repayment period/ repayable amount/ the amount of installments and rate of interest. It is a mechanism to nurture an otherwise viable unit, which has been adversely impacted, back to health. 

Substandard Assets

A substandard asset would be one, which has remained NPA for a period less than or equal to 12 months. Such an asset will have well defined credit weaknesses that jeopardize the liquidation of the debt and are characterised by the distinct possibility that the banks will sustain some loss, if deficiencies are not corrected. 

Doubtful Asset

An asset would be classified as doubtful if it has remained in the substandard category for a period of 12 months. A loan classified as doubtful has all the weaknesses inherent in assets that were classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, - on the basis of currently known facts, conditions and values - highly questionable and improbable. 


Loss Asset

A loss asset is one where loss has been identified by the bank or internal or external auditors or the RBI inspection but the amount has not been written off wholly. In other words, such an asset is considered uncollectible and of such little value that its continuance as a bankable asset is not warranted although there may be some salvage or recovery value. 

Off Balance Sheet Exposure

Off-Balance Sheet exposures refer to the business activities of a bank that generally do not involve booking assets (loans) and taking deposits. Off-balance sheet activities normally generate fees, but produce liabilities or assets that are deferred or contingent and thus, do not appear on the institution's balance sheet until and unless they become actual assets or liabilities. 

Current Exposure Method



The credit equivalent amount of a market related off-balance sheet transaction is calculated using the current exposure method by adding the current credit exposure to the potential future credit exposure of these contracts. Current credit exposure is defined as the sum of the positive mark to market value of a contract. The Current Exposure Method requires periodical calculation of the current credit exposure by marking the contracts to market, thus capturing the current credit exposure. Potential future credit exposure is determined by multiplying the notional principal amount of each of these contracts irrespective of whether the contract has a zero, positive or negative mark-to-market value by the relevant add-on factor prescribed by RBI, according to the nature and residual maturity of the instrument. 

Risk Management::(Most Important)

  01 RBI implemented the Basel-III recommendations in India, w.e.f:

a) 01.01.2013, b. 31.03.2013, c. 01.04.2013, d. 30.09.2013
02 Basel III recommendations shall be completely implemented in India by:
31.03.2020, b. 31.03.2019 c. 31.03.2618 d. 31.03.2017
03 Basel III capital regulations were released by Basel Committee on Banking Supervision (BCBS) during as a
Global Regulatory Framework for more resilient banks and banking systems:
December 2010, b. March 2011, c. December 2011, d. December 2012