1.

1 AN OVERVIEW OF IFS

The liberalisation of the financial sector in India which formed a key part of the overall
liberalisation process, blurred the distinction between various financial intermediaries and
promoted greater efficiency and competiveness in the financial markets. With the growth of the
debt capital markets and entry of mutual funds, disintermediation have gradually set in. The
‘system’ stands for a set of bodily organs like composition or concurring in function, a scheme of
Classification and a Method of Organisation. ‘Finance’ holds the key to all human activities.
Finance is the study of money — its nature, creation, behaviour, regulation and administration.
So all these activities dealing in finance are organised in a system, known as the “financial
system.” The term financial system is a set of interrelated activities/services, working together to
achieve some predeterminad purpose or goal. It includes different markets, institutions,
instruments, services and mechanisms, which influence the generation of savings, investment,
capital formation and growth. According to Robinson, the primary function of the system is “to
provide a link between savings and investment for the creation of new wealth and to permit
portfolio adjustment in the composition of the existing wealth.

1.2 EVOLUTION OF INDIAN FINANCIAL SYSTEM

The evolution of the financial system has been interlinked with the growth of macroeconomics.
In India, the evolution of the financial systems reflected its political, social and economic needs
and aspirations. The government has exerted its influence, over the flow of credit, interest rates,
credit control and direction. If is also a big borrower as well as regulator of the financial system.
A bulk contributor of the Indian Financial System is the public sector, even though cooperatives
and private sectors are there to compete with other institutions.

1.3 CLASSIFICATION OF INDIAN FINANCIAL SYSTEM

The Indian financial system is broadly classified into two groups: (i) Organised Sector, and (ii)
Unorganised Sector

There are users of the financial services and also providers of financial services. The provides are
Reserve Bank of India, commercial banks, financial institutions, money and capital markets and
informal financial enterprises.

Organised Sector – The organised sector consists of a network of banks, other financial and
investment institutions and a range of financial instruments, which together function in fairly
developed capital and money markets. Short-term funds are provided by the commercial and
cooperative banks. About 83% of such banking business are managed by 21 leading public sector
banks. In addition to commercial banks, there is a network of cooperative and development,
regional rural banks at district, city and block levels. During the last two decades Indian banks
have diversified into areas such as merchant banking, mutual funds, learning, factoring, foreign
exchange and corporate treasury services. The financial institutions in India mainly consist of
public sector banks (21), private sector banks (22), regional rural banks (56), small finance banks
(8), payment banks (11), urban cooperative banks (53), state cooperative banks (31), district
central cooperative banks (373), NBFCs (11,769 registered with RBI and 34,754 unregd.) and
institutions of mutual funds (42). Hence the organised financial system comprises the following
subsystems:
 Commercial banks (public and private sector)
 Cooperative banks/Cooperative societies
 Development banking (Long-term financial institutions provider)
 Money markets; and
 Financial institutions
Unorganised Financial System It comprises relatively less controlled in regulated moneylenders,
indigenous bankers, lending pawnbrokers, landlords, traders etc. There are other financial
companies like Chit Funds and Nidhi Cos. etc., which are also not regulated by RBI or the
government.

An Overview of banking:
1. ‘bank’ is derived from the French word ‘Banco’ – which means a Bench or Money exchange
table
2. money lenders or money changers used to display (show) coins of different countries in big
heaps (quantity) on benches or tables for lending or exchanging
3. Money- evolution of money- stages
4. Greece, Rome, Egypt, and Babylon suggest that temples loaned money in addition to keeping
it safe. The fact that temples often functioned as the financial centers of their cities is one reason
why they were inevitably ransacked during wars
5. Romans-banking in a separate building- Julius Caesar initiated the practice of allowing
bankers to confiscate land instead of loan payments.
6. 1557, Philip II of Spain managed to burden his kingdom with so much debt due to several
pointless wars that he caused the world’s first national bankruptcy
Evolution of Banking
Adam Smith Gives Rise to Free-Market Banking
• Self-regulating economy, moneylenders and bankers managed to limit the state’s involvement
in the banking sector and the economy as a whole.
• This free-market capitalism and competitive banking found fertile ground in the New World,
where the United States of America was about to emerge.
• Alexander Hamilton-the first secretary of the U.S. Treasury, established a national bank that
would accept member banknotes at par, thus keeping banks afloat through difficult times
• J.P. Morgan & Co. emerged at the head of the merchant banks during the late 1800s. It was
connected directly to London, then the world’s financial center, and had considerable political
clout in the United States
• World War II and the Rise of Modern Banking
• The Industrial Revolution brought significant advancements in technology, transportation, and
manufacturing.
• Branch Banking and Spread of Networks (19th - 20th Century)
The evolution of banking in India
Phase 1:
Pre- and early post-Independence
Banking in India started in the 1700s-pre-independence phase saw about 600 banks Bank of
Bombay-the first bank in India, set up in 1720, while Bank of Hindustan, which is seen as one of
India's first modern banks, was founded in Calcutta in 1770 only to shut operations in 1832 -
mid-1800s merged and called themselves Imperial Bank of India-State Bank of India
(1947-1969)
• The Reserve Bank of India (RBI) was established in April 1935, but was nationalized on 1
January 1949.
• In 1949, the Banking Regulation Act was enacted, which empowered the RBI to regulate,
control, and inspect the banks in India.
• In 1955, the Government nationalized the State Bank of India (Formerly, Imperial Bank of
India) with extensive banking facilities on a large scale, especially in rural and semi urban areas.
• As a result, the State Bank of India (SBI) was formed to act as the principal agent of the RBI to
handle banking transactions of the Union and State Governments all over the country.
• Seven banks forming subsidiaries of the SBI were also nationalized in 1960.
• During those days, the public had lesser confidence in the banks and deposit mobilization was
low in banks. Rather, the savings bank facility provided by the Postal department was considered
comparatively safer. Moreover, funds were largely given to traders.
1969-1991
• 14 major commercial banks were nationalised in the first phase of bank nationalization during
this period.
• Nationalization in this context, is the process of transforming private assets into public assets
by bringing them under the public ownership of a national or state government.
• In the second phase, 7 more banks were nationalized
. • Regional Rural Banks (RRBs) were created to serve the rural masses.
1991 onwards
• The banking sector reforms in India started as a follow up measures of the economic
liberalization and financial sector reforms in the country.
• The reforms were aimed at making the Indian banking industry more competitive, versatile,
efficient, and free from the government’s control.
• As a result, licenses were provided to a small number of private banks. Gradually, foreign
direct investment (FDI) in the banking sector was also relaxed. It has gone up to 74% with some
restrictions.
Phase 2: Nationalisation to Liberalisation
post-independence phase-
14 commercial banks were nationalised in 1969-Later in 1980, six more banks were nationalised.
The following financial institutions were established to add more purpose to the banking system
and address more specific segments:
• NABARD to aid agricultural activities
• EXIM to develop exports and imports
• National Housing Board to fund housing projects
• SIDBI to finance small-scale Indian industries
• Set up as special purpose vehicles to drive the mentioned industry to sector, these banks
added a new angle to how banks were used as a part of national policies.
• Meanwhile, Mumbai got its first automated teller machine (ATM) in 1987.
Banking System
“structural network of institutions that provide financial in a country. It deals with the ownership
of banks, the structure of the banking system, functions performed, and the nature of business”-
Banking System
The elements of the banking system:
A. Commercial banks- accept deposits and lend loans and advances
B) Investment banks- deal with capital market issues and trading
C) Central bank- regulates the banking system by setting monetary policies besides many other
functions like currency issue

What is a Bank?
1. “A bank is an institution whose debts are widely accepted in settlement of other people’s
debts to each other”- Prof. Sayers
2. “A banking company means any company which transacts the business of banking.
Banking means accepting for the purpose of lending or investment, of deposits of money from
the public, repayable on demand or otherwise and withdrawable by cheque, draft or otherwise”-
Indian Banking Company Act 1949.

SCARDB-State Cooperative Agriculture & Rural Development Banks,

PCARDB-Primary Cooperative Agriculture & Rural Development Banks
MUDRA-Micro Units Development & Refinance Agency Ltd,
NBFC-Non-Banking Financial Corporation

Banking Regulation Act, 1949

1. Banking Companies Act 1949,- from Sixteen March of 1949 and changed to Banking
Regulation Act 1949 from the first March of 1966.
2. The Banking and Regulations Act was enacted to safeguard the interest of the depositors and
to control the abuse of powers by controlling the banks by any means necessary and to the
interest of the Indian economy in general.
• This Act gives supervisory and regulatory powers to RBI over the Coop banks.
• But basically all cooperative banks are registered under the Cooperative Societies Act and the
powers regarding incorporation, management, and elections to the Board of Directors still rest
with the Registrar of Coop societies of the State or Centre concerned.
• So all cooperative banks come under dual control ie., RBI and RCS.

Objectives of the Banking Regulation Act

1. To safeguard the interest of depositors;
2. To develop banking institutions on sound lines;
3. To attune the monetary and credit system to the larger interests and priorities of the nation.
4. The Act gives the Reserve Bank of India (RBI) the ability to permit banks, have regulation over
shareholding and casting ballot rights of investors; oversee the arrangement of the sheets and
the board; manage the activities of banks; set down guidelines for reviews; control ban,
consolidations and liquidation; issue mandates in light of a legitimate concern for public great
and on banking strategy, and force punishments. In 1965, the Act was revised to incorporate
cooperative banks under its domain by adding Section 56. Cooperative banks, which work just in
one state, are shaped and run by the state government. Yet, RBI controls the permitting and
directs the business operations.

Highlights of the Banking Regulation Act 1949

• Prohibition of Trading (Section 8): a bank can’t straightforwardly or in a roundabout way
manage trading or bargaining of products.
• Non-banking asset (Section 9): A bank can’t hold any non-movable property, but obtained
except its utilisation, for any period passing a long time from the date of securing thereof.
• Management (Section 10): each bank will have one of its directors as Chairman on its Board of
Directors. It additionally expresses that at least 51% of the complete number of individuals from
the Board of Directors of a bank will comprise people who have extraordinary information or
practical involvement with bookkeeping, farming, banking, financial aspects, money, regulation
and others.
• Minimum capital (Section 11): Section 11 (2) of the Banking Regulation Act, 1949, states that
no bank will initiate or carry on business in India, except if it has least settled up capital and
money held endorsed by the RBI.
• Payment of commission (Section 13): According to Section 13, a bank isn’t allowed to pay
straightforwardly or in a roundabout way via commission, business, rebate or compensation on
issues of its portions more than 2.5% of the PSR.
• Payment of dividend (Section 15): no bank will deliver any dividend on its portions until all its
capital costs (counting primer costs, association costs, share selling commission, business, a
measure of misfortunes caused and different things of use not addressed by tangible resources)
have been discounted.

Importance of Banking Regulation Act 1949

• The Banking Regulation Act provides the capacity to RBI to permit banks and the regulation
of the shareholding awards capacity to RBI to direct the arrangement of the boards and the
executives’ individuals from banks
• It additionally sets down bearings for reviews to be overseen by RBI, and controls
consolidating and liquidation
• RBI issues directives on banking strategy in light of a legitimate concern for public interest
and can force punishments whenever required
• Co-operative Banks were formed under this act in the year of 1965 The Banking Regulation
(Amendment) Bill, 2017.
 TheBanking Regulation (Amendment) Bill, 2017 was introduced in Lok Sabha by the Minister of
Finance, Mr. Arun Jaitley, on July 24, 2017. It seeks to amend the Banking Regulation Act, 1949 to
insert provisions for handling cases related to stressed assets. Stressed assets are loans where the
borrower has defaulted in repayment or where the loan has been restructured (such as by changing
the repayment schedule). It will replace the Banking Regulation (Amendment) Ordinance, 2017.

• Initiating insolvency proceedings: The central government may authorise the Reserve Bank of India
(RBI) to issue directions to banks for initiating proceedings in case of a default in loan repayment.
These proceedings would be under the Insolvency and Bankruptcy Code, 2016.

• Issuing directions on stressed assets: The RBI may, from time to time, issue directions to banks for
resolution of stressed assets.

• Committeetoadvise banks: The RBI may specify authorities or committees to advise banks on
resolution of stressed assets. The members on such committees will be appointed or approved by
the RBI.

• Applicability to State Bank of India: The Bill inserts a provision to state that it will also be applicable
to the State Bank of India, its subsidiaries, and Regional Rural Banks

What is Retail Banking?

Retail banking is, however, quite broad in nature; it is a banking service that is geared primarily
towards individual consumers. Retail banking is usually made available by commercial banks as well
as smaller community banks. Unlike wholesale banking, retail banking focuses strictly on consumer
markets. Retail banking entities provide a wide range of personal banking services, including offering
savings and checking accounts, bill paying services as well as debit and credit cards. Through retail
banking, consumers may also obtain mortgages and personal loans. Although retail banking is, for
the most part, mass-market driven, many retail banking products may also extend to small and
medium-sized businesses. Today much of retail banking is streamlined electronically via Automated
Teller Machines (ATMs) or through virtual retail banking known as online banking. Related ancillary
services include credit cards or depository services. Today's retail banking sector is characterized by
three basic characteristics:

• Multiple products (deposits, credit cards, insurance, investments and securities);

• Multiple channels of distribution (call centre, branch, Internet and kiosk); and

• Multiple customer groups (consumer, small business, and corporate).

Globalization has carved new benchmarks in the Indian banking industry. Every bank, irrespective of
its size and origin, has started chanting the 'retail banking' mantra. Since retail banking has evolved
new standards; banks have started redrawing their strategies to suit the present needs. Banking as a
whole is undergoing a change. The traditional approach of "the sellers' market" for banking-related
products and services has been redefined to a "buyers' market" in recent years. Gone are the days
where getting a retail loan was somewhat cumbersome. All these emphasize the momentum that
retail banking is experiencing in the Indian economy in recent years. A larger option for the
consumer is getting translated into a larger demand for financial products and customization of
services is fast becoming the norm than a competitive advantage. With the retail banking sector
expected to grow at a rate of 30%, players are focusing more and more on the retail and are waking
up to the potential of this sector of banking. At the same time, the banking sector as a whole is
witnessing structural changes in regulatory frameworks and securitization and stringent NPA norms
are expected to be in place by 2004, which means the faster one adapts to these changing dynamics
the faster is one expected to gain the advantage

Retail Banking in India

Retail banking in India is not a new phenomenon. It has always been prevalent in India in various
forms. For the last few years, it has become synonymous with mainstream banking for many banks.
The typical products offered in the Indian retail banking segment are housing loans, consumption
loans for purchase of durables, auto loans, credit cards and educational loans. The loans are
marketed under attractive brand names to differentiate the products offered by different banks.

The Report on Trend and Progress of India, 2003-04 has shown that the loan values of these retail
lending typically range from Rs.20,000 to Rs.100 lakh. The loans are generally for a duration of five to
seven years, with housing loans granted for a longer duration of 15 years. Credit card is another
rapidly growing sub-segment of this product group. In recent past, retail lending has turned out to
be a key profit driver for banks with retail portfolio constituting 21.5 per cent of total outstanding
advances as on March 2004. The overall impairment of the retail loan portfolio worked out much
less then the Gross NPA ratio for the entire loan portfolio.

It can be inferred that except loans against shares / bonds, the share of every component of retail
credit has increased three-fold. The declining interest rate and the incentives that are granted to the
housing sector and being translated into higher home loans while the entry of public sector into the
personal loan segment, apart from the aggressive forays of new private sector banks are pushing up
the growth of the growth of these segments. Within the retail segment, the housing loans had the
least gross asset impairment. In fact, retailing makes ample business sense in the banking sector.
While new generation private sector banks have been able to create a niche in this regard, the public
sector banks have not lagged behind. Leveraging their vast branch network and outreach, public
sector banks have aggressively forayed to garner a larger slice of the retail pie. By international
standards, however, there is still much scope for retail banking in India. After all, retail loans
constitute less than seven per cent of GDP in India vis-a-vis about 35 per cent for other Asian
economies. As retail banking in India is still growing from modest base, there is a likelihood that the
growth numbers seem to get somewhat exaggerated. One, thus, has to exercise caution is
interpreting the growth of retail banking in India. The Indian players are bullish on the retail business
and this is not totally unfounded. There are two main reasons behind this. Firstly, it is now
undeniable that the face of the Indian consumer is changing. This is reflected in a change in the
urban household income pattern. The direct fallout of such a change will be the consumption
patterns and hence the banking habits of Indians, which will now be skewed towards retail products.
At the same time, India compares pretty poorly with the other economies of the world that are now
becoming comparable in terms of spending patterns with the opening up of our economy. For
instance, while the total outstanding retail loans in Taiwan is around 41% of GDP, the figure in India
stands at less than 5%. The comparison with the West is even more staggering. Another comparison
that is natural when comparing retail sectors is the use of credit cards. Here also, the potential lies in
the fact that of all the consumer expenditure in India in 2001, less than 1% was through plastic, the
corresponding US figure standing at 18%.
 Advantage of Retail Banking

Retail banking has its own advantages and that overpower its disadvantages. The advantages could
be analyzed from two perspectives:

1. Recourse side

a. Retail deposits are stable and contribute to core deposits.

b. They are interest-insensitive and less baring for additional interest.

c. They constitute low cost funds for the banks.

d. Effective CRM with customers builds a strong customer base.

e. Retail banking increases the subsidiary business of the banks.

2. Assets side

a. Retail banking results in better yields and better bottom line.

b. Retail segment is a good avenue for funds deployment.

c. The consumer loans are presumed to be of lower risk and NPA perception.

d. It helps in economic revival.

e. It ensures innovative product development.

f. It involves minimum marketing efforts.

Wholesale Banking
• Wholesale banking, on the other hand, is the provision of financial products and services to
corporate clients, financial institutions, and other large organizations. Wholesale banks offer services
such as cash management, trade finance, mergers and acquisitions, and investment banking to their
clients.

• Wholesale banks typically work with large corporations and financial institutions that require large
amounts of capital for their operations.

• Wholesale banks generate revenue by charging fees for services such as underwriting (individual or
institution takes on financial risk for a fee), advisory services, and syndicated loans (two or more
lenders jointly provide loans for one or more borrowers on the same loan terms and with different
duties and sign the same loan agreement). According to a report, the global wholesale banking
market was valued at USD 257 billion in 2021 and is expected to grow at a CAGR of 5.5% between
2021 and 2026.

Retail Banking vs. Wholesale Banking

• 1. Customer Base- The primary difference between retail banking and wholesale banking is their
customer base. Retail banks serve individual customers, while wholesale banks serve corporate
clients, financial institutions, and other large organizations.

• 2. Products and Services- Another significant difference between the two types of banking is the
products and services they offer. Retail banks offer a range of financial products and services that
are designed to meet the needs of individual customers. Wholesale banks, on the other hand, offer a
range of specialized financial products and services that are tailored to the needs of corporate
clients and financial institutions.

• 3. Revenue-Retail banks generate revenue by charging customers for services such as overdraft
fees, ATM fees, and credit card interest. Wholesale banks, on the other hand, generate revenue by
charging fees for services such as underwriting, advisory services, and syndicated loans.

• 4. Risk-Retail banking is generally considered to be less risky than wholesale banking. Retail banks
deal with individual customers who have a lower risk profile, while wholesale banks deal with large
corporations and financial institutions that have a higher risk profile

5. Regulation-Retail banking is subject to more stringent regulations than wholesale banking. This is
because retail banks deal with individual customers who do not have the same level of financial
knowledge as corporate clients and financial institutions.

• While some banks still focus on wholesale or retail banking, many economies no longer have fully
independent wholesale or retail banks. The majority of banks combine their retail and wholesale
banking activities. Some banks have dedicated divisions or units that work with corporate clients.

• Both wholesale and retail banking demand various levels of expertise and understanding. There
are, nevertheless, several widely shared crucial success characteristics, such as client focus,
technological investment, etc.

• In short, banks must adapt to the competitive climate and arm themselves with contemporary
banking practices to handle the escalating competition.

International banking

Meaning International banking is just like any other banking service, but it takes place across
different nations or internationally. To put it another way, it is an arrangement of financial services
by a residential bank of one country to the residents of another country. Most multinational
companies and individuals use this banking facility for transacting.

Example Suppose Microsoft, an American company is functioning in London. It is in need of funds to

meet its working capital requirements. In such a scenario, Microsoft can avail of the banking services
in form of loans, overdrafts or any other financial service through banks in London. Here, the
residential bank of London shall be giving its services to an American company. Therefore, the
transaction between them is said to be a part of an international banking facility. International
Banking – features: –

Expansion: International Banking assists traders to expand their business and trade activities beyond
the boundaries of a nation. Economic growth and conducive climate for carrying out the business
activities in new nations are the factors because of which many enterprises are looking beyond the
borders of their own nations for their business growth. Competitive advantages in respect of price,
demand and supply factors, future growth opportunities, cost of production and operating costs,
etc., are some of the other important factors for expansion of international trade and finance. In
view of this, the presence of banks across the nations have led to the growth of international
banking.

Legal and Regulatory framework: Flexible legal and regulatory framework encourages traders and
investors to enter into the international markets. Quick approval to set up business, less complicated
compliance requirements and stable political situations help many new players to enter into a
number of nations to expand their activities Also, due to lesser tax rates or no taxes to be payable,
certain tax havens play important roles as off shore banking centers which encourages many
international banking units to open their branches in such off shore centers.

Cost of Capital: The operating efficiency of an enterprise depends upon the average cost of capital.
Many companies enter into new emerging markets to take advantages of the lower cost of capital in
such markets. Banks as a financial intermediary play an important role as source of funds. Banks
through their professional skills take advantage of the arbitrage opportunity in different
international markets and increase their profits.

Current account and Capital account transactions: Banks play crucial role in export and import trade.
By providing different types of financial and non financial support, banks help enterprises, corporate
customers and individuals doing business in different countries, by extending trade finance and
investment opportunities. Banks also facilitate movement of funds (inward and outward
remittances) through their network and correspondent banking arrangements.

Risks: Different risks paved ways for diversification, thereby global investors look for alternative
destinations to invest their savings with twin objectives of safety of funds 4 and better returns. In
view of their presence in different time zones, international banks also face various risks.

Benefits

Flexibility: International banking facility provides flexibility to multinational companies to deal in

multiple currencies. The major currencies that multinational companies or individuals can deal with
include the euro, dollar, pounds, sterling, and rupee. The companies having headquarters in other
countries can manage their bank accounts and avail of financial services in other countries through
international banking without any hassle.

Accessibility: International banking provides accessibility and ease of doing business to companies
from different countries. An individual or MNC can use their money anywhere around the world.
This gives them the freedom to transact and use their money to meet any requirement of funds in
any part of the world. International banking allows the business to make international bill payments.
The currency conversion facility allows the companies to pay and receive money easily. Also,
benefits like overdraft facilities, loans, deposits, etc. are available every time for overseas
transactions.

Accounts: Maintenance A multinational company can maintain the records of global accounts in a
fair manner with the help of international banking. All the transactions of the company are recorded
in the books of banks across the globe. By compiling the data and figures, the accounts of the
company can be maintained.

Globalization and growing economies around the world have led to the development of
international banking facilities. The world is now a marketplace and each business wants to exploit
it. Geographical boundaries are no more a concern. With access to technology, banking facilities
have grown vastly. One prime example of it is international banking. In the years to come, such
banks would see higher growth and higher profitability. Big business houses are expanding
themselves at a rapid pace. 5 To maintain the growth, these businesses will need the financial
services of international banking. Therefore, the demand for its facilities will increase.
Types of Services Offered

To arrange trade finance: An international bank arranges the finance for the traders who want to
deal with the foreign country.

To arrange foreign exchange: The core services provided by the international bank are to arrange a
foreign exchange for the import-export purpose.

To hedge the funds: The international bank hedge the funds by buying the securities at the lower
price level and sell it when the price level rising.

Offer investment banking services: It also offers an investment banking services by signing
underwriting of shares, financial decisions for investment.

Reasons for International Banking

• Low marginal costs – Managerial and marketing knowledge developed at home can be used
abroad with low marginal costs.

• Knowledge advantage – The foreign bank subsidiary can draw on the parent bank’s knowledge of
personal contacts and credit investigations for use in that foreign market.

• Home nation information services – Local firms in a foreign market may be able to obtain more
complete information on trade and financial markets in the multinational bank’s home nation than is
obtainable from foreign domestic banks.

• Prestige Very large multinational banks have high perceived prestige, which can be attractive to
new clients.

• Regulatory advantage – Multinational banks are often not subject to the same regulations as
domestic Banks Wholesale defensive strategy – Banks follow their multinational customers abroad
to avoid losing their business at home and abroad.

• Retail defensive strategy – Multinational banks also compete for retail services such as travellers
checks and the tourist and foreign business market.

• Transactions costs – Multinational banks may be able to circumvent government currency

controls.

• Growth – Foreign markets may offer opportunities for growth not found domestically.

• Risk reduction – Greater stability of earnings with diversification

Risk Management
Risk management systems should include:

1. Effective oversight by the board of directors,

2. Adequate risk management policies and procedures,

3. Accurate systems for reporting country exposures,

4. Effective processes for analyzing country risk,

5. Forward-looking country risk rating systems,

6. Country exposure limits,

7. Regular monitoring of country conditions,

8. Periodic stress testing of foreign exposures, and

9. Adequate internal controls and audit function.

Policies and Procedures

• Articulate a strategy for conducting international activities;

• Specify appropriate products, services, and affiliates (e.g., banks, branches, affiliates, joint
ventures, etc.);

• Identify allowed and disallowed activities;

• Describe major risks in applicable countries or regions;

• Establish risk tolerance limits;

• Develop standards and criteria for analyzing and rating country risk;

• Delineate clear lines of responsibility and accountability for country risk management decisions;

• Require periodic reporting of country risk exposures and policy exceptions to senior management
and the board; and

• Ensure compliance with regulatory guidance and reporting requirements.

International Lending Risks

• Credit Risk refers to the potential inability of a borrower to comply with contractual credit terms.
Evaluation of foreign credit risk is similar to domestic credit analysis and requires the review of
appropriate information, including the amount of credit requested, loan purpose, collateral,
anticipated terms, and repayment source.

• Currency Risk reflects the possibility that variations in value of a currency will adversely affect the
value of investments denominated in a foreign currency. Currency conversion exposure exists in
every international credit extension, and currency risk can affect financial transactions in several
ways. For borrowers, rapid depreciation in the home currency relative to the borrowing currency can
significantly increase debt service requirements. For lenders, rapid appreciation or depreciation in
currencies can substantially affect profit or loss depending on how the institution finances the
assets.

Forms of International Lending

• Trade Finance- The most common function of international banking is the financing of trade.
Generally, several types of trade credit facilities are used by banks, with the most common types
being letters of credit and bankers acceptance financing. Exporters may be willing to ship goods on
open account (self-financed) to credit-worthy customers in developed countries, but are often
unwilling to accept the risk of shipping goods without established bank financing when dealing with
an importer in a high-risk, or developing country. Other types of trade finance instruments and
methods, such as discounting of trade acceptances and direct trade advances, are also covered in
this section.
• Letters of Credit Letters of credit are issued in many forms depending on the type and
circumstances of the underlying transaction. Historically, the use of letters of credit involved many
documents and was labor intensive. However, automation has made it easier to create letters of
credit, verify documents evidencing shipped goods, and collect payments.

• Commercial documentary letters of credit are instruments in which a bank (issuing bank) agrees to
pay money on behalf of the customer (account party/buyer/ importer) to the party
(beneficiary/seller/exporter) named in the instrument

Standby letters of credit are another type of instrument used to facilitate international transactions.
This instrument guarantees payment to the beneficiary by the issuing bank in the event of default or
nonperformance by the account party (the bank’s customer). A standby letter of credit is payable
against an official statement of default or nonperformance (whereas a commercial documentary
letter of credit is normally payable against the presentation of documents conveying or securing title
to goods, such as a bill of lading). Some of the most common purposes for standby letters of credit
include:

• Standby credit for the account party’s performance under a contract award. In this case, the
beneficiary presents the issuing bank a draft accompanied by a statement to the effect that the
contract bidder (account party) did not perform under an awarded contract. The issuing bank is
obligated to pay the beneficiary and seek reimbursement from the account party (customer).

• Standby credit for the account party’s borrowing or advances from another bank. This
arrangement requires the issuing bank to reimburse the lending bank if the account party
(customer) does not repay their loan.

• Standby credit to back commercial paper or other obligations of the bank’s customers

• Back-to-back letters of credit are another type of trade finance transaction that examiners may
encounter in international banks. Though the term back-to-back does not appear on the letter of
credit, this situation is similar to a confirmed letter of credit, except that two separate letters of
credit are issued.

• Bankers Acceptances Most letters of credit are part of ongoing transactions that evolve from
letters of credit to sight or time drafts, acceptances, notes or advances. Bankers acceptances are a
common method of financing international trade that was facilitated by a letter of credit. These
instruments are used to finance the successive stages of transactions that move goods from a point
of origin to a final destination.

 Every bank engaged in international lending should be guided by a formal, written, board-
approved policy. Content will vary depending on the risk profile of the bank and the extent
of its international activities, but certain factors should be addressed in almost all situations.
These include basic credit standards for international lending, a statement of the bank’s
international lending objectives, a description of its system for credit approval, and the
establishment of committee and officer lending authorities. In addition, the policy should
define procedures that ensure the board of directors is regularly apprised of the size,
performance, and risk profile of the international loan portfolio. Defining geographic loan
limits is one of the most significant components of an adequate international lending policy.
Limits should be set according to estimates of where the bank can profitably lend (in
accordance with its strategic objectives, financial capacity, and personnel resources).
Maximum aggregate limits should be established for each political entity where credit is
 advanced, based on a comprehensive country risk analysis. Banks should also consider
establishing country and credit sub-limits by transaction type. Limits should be considered
for specific countries, as well as groups

Other International Activities

• Investments In addition to international loans and deposit placements, international banks may
periodically allocate capital, through international capital markets, to investments such as foreign
debt securities or debentures. Banks use the international capital markets to invest funds at a
competitive advantage to lending. Capital market activities have increased for several reasons,
including:

• Excessive loan losses incurred on emerging-market loans,

• Small spreads between the interest earned on loans and the interest expense of foreign deposits,

• Increasingly stringent risk-based regulatory capital standards, and

• Global recessions and regional financial crises.

• Private Banking: Many banks market personalized services to high net worth customers through a
separate unit of the bank commonly known as the private- or personal-banking department. Private
banking is an important business line for many financial institutions as it encourages wealthy
individuals to develop banking relationships and can generate substantial fee income.

• Cash management,

• Funds transfers,

• Asset management (e.g., trust, investment advisory),

• Lending services, • Financial planning (e.g., tax and estate planning),

• Custody services, and

• Other support as requested.

Correspondent Banking Financial institutions can use U.S. banking relationships to provide services
to foreign banks, yet limit their overall exposure to foreign activities. Correspondents provide a
range of services to banks located in other countries that do not have local offices, or whose local
offices are prohibited from engaging in certain types of activities. This arrangement allows the
foreign bank to offer these services more efficiently and economically. Banking services performed
through a foreign correspondent bank arrangement may include:

• Cash Management, • International Funds Transfers, • Check Clearing, • Pouch Activities (Foreign
exchange services; Overnight investment; Electronic banking; Funds transfers; Automated clearing
house transactions (Automated Clearing House network); Prepaid access; Third-party payment
processors) • Foreign Exchange Services, • Sweep Accounts/Overnight Investments, • Trade
Financing, and • Payable-through accounts (PTAs)-pass-through” or “pass-by” accounts (access to
correspondent bank a/c

• Deposit Accounts Deposit gathering and retention activities of international banks arise from the
exercise of other banking activities, such as: • Receipt of wire transfers, • Compensating or collateral
balances required against credit facilities, • Disbursement of loan proceeds, • Payments for trade
transactions, and • Savings or cash-management balances of private banking customers.

Payable-through Accounts (PTAs) are used directly by customers of the correspondent bank to
transact business on their own behalf. • Brokered Deposits- generally represent funds the bank
obtains, directly or indirectly, by or through a deposit broker or agent. Historically, internationally
active banks have not relied heavily on funds obtained through deposit brokers to supplement their
traditional funding sources. • Deposit Sweep - programs are often offered by internationally active
banks. These sweep programs exist primarily to facilitate the cash management needs of customers
who might otherwise move their account to an entity offering higher yields.

Borrowings- generated through the international department include all non-deposit liabilities.
Common forms of borrowings include:

1.Federal funds purchased (overnight and term); • Bills payable to the Federal Reserve; • Notes and
trade bills rediscounted with central banks; • Short sales from trading securities; • Overdrafts on
deposit accounts; • Notes, acceptances, import drafts, or trade bills sold with the bank’s
endorsement or guarantee; and • Notes or other obligations sold subject to repurchase agreements.
All international borrowing transactions should be treated similarly to domestic transactions and be
properly recorded on the general ledger and reported in Call Reports

I. J.P.Morgan-What we offer • Our international banking services are tailored to be delivered at the
local level. Supported by a network of advisers across markets and geographies, our innovative
solutions—from investment and commercial banking to payments processing and asset
management—help drive business growth while creating positive impact in local communities
around the world. • UCO Bank • NRI Banking • Foreign Currency Loans • Finance/Services to
Exporters • Finance/Services to Importers • Remittances • Forex & Treasury Services • Resident
Foreign Currency (Domestic) Deposits • Correspondent Banking Services II. YES BANK's International
Banking offers their clients domestic and international banking solutions and collaborates with other
banks to fulfil their business requirements in India. We manage relationships with more than 900
correspondent banks and maintain connections with multi-lateral agencies, sovereign wealth funds,
and development banks

Role and functions of capital markets

“Capital markets are essential in driving economic growth by efficiently allocating resources,
facilitating wealth generation for investors, and ensuring liquidity and transparency in financial
transactions. They play a pivotal role in price determination and risk diversification, serving as the
backbone for global investment. Capital Markets offer various investment options like stocks
(offered by companies that seek to raise money for expansion projects, further corporate growth, or
dilution of owner's shares which is the decrease in ownership percentage for existing shareholders
when a company issues or reserves new shares of stock) and bonds (creditors to the company),
helping in wealth creation, price setting, and economic growth. These markets ensure efficient use
of resources, transparency, and opportunities for investors to grow their money while supporting
businesses' expansion and innovation.
Functions of capital markets
1. Mobilizing Savings for Investment

a. Mobilizing Savings for investment-channeling personal or institutional savings into productive

investments.

b. Individual and institutional investors purchase securities like stocks, bonds, or mutual funds,
effectively converting their savings into investment capital.

c. This capital is then used by companies, governments, or other entities to finance projects,
operations, or expansions. This process not only helps in funding economic activities but also allows
savers to potentially earn returns on their investments, thereby contributing to overall economic
growth and development

2. Price Determination- market establishes the value of securities like stocks and bonds-process
occurs through the interaction of supply (sellers) and demand (buyers) within the market-company
performance, economic conditions, and investor sentiment.

• Price of securities fluctuates, reflecting their real-time market value.

• This mechanism ensures transparency and efficiency in trading, helping investors make informed
decisions based on the perceived value and potential of different financial assets.

3. Risk Diversification- strategy to spread investment across various financial instruments, sectors, or
markets to minimize the risk of loss. By investing in a mix of assets like stocks, bonds, and mutual
funds, investors can reduce the impact of potential losses in any one area.

✓ By investing in a mix of assets like stocks, bonds, and mutual funds, investors can reduce the
impact of potential losses in any one area.

✓ This is based on the principle that not all markets or sectors move in the same direction
simultaneously.

✓ Diversifying investments helps in balancing the portfolio, ensuring that the downfall in one
investment is offset by stability or gains in others.

4. Providing Liquidity- offer investors the ability to quickly buy or sell securities with ease.

1. This liquidity means investors can convert their investments into cash rapidly, without significantly
affecting the price of the asset.

2. It's essential for the smooth functioning of the market.

3. It also ensured that investors had access to their money when needed, enhancing confidence in
the market.

4. High liquidity in capital markets is crucial for both individual investors and the broader economy.
5. Information Dissemination- ensuring transparency and informed decision-making. I. These
markets act as hubs for the distribution of vital financial information, including company earnings,
stock performance, market trends, and economic indicators.
II This flow of information enables investors to analyze potential investments more accurately and
make educated choices.

III It also ensures that all market participants have equal access to critical data, helping maintain a
level playing field and promoting overall market efficiency and investor confidence.

6. Facilitating Economic Growth- fundamental function of capital markets. They channel savings and
investments into productive uses, such as funding new business ventures, supporting infrastructure
projects, or expanding existing companies.

• Thisinflux of capital stimulates business activities, creates jobs, and drives technological
advancements.

• By efficiently allocating resources where they can yield the highest returns, capital markets play a
pivotal role in stimulating the overall economic development and growth of a country, contributing
to a healthier, more robust economy

7. Enhancing Corporate Governance- markets impose regulatory standards and transparency

requirements on publicly traded companies.

❑ This compels companies to operate with greater accountability, ethical standards, and
management efficiency. Regular financial reporting, mandatory disclosures, and external audits are
part of these governance standards.

❑ Such measures protect investors' interests, improve public trust, and encourage more
responsible business practices.

❑ Ultimately, this leads to better-managed companies and a more stable, trustworthy market
environment.

8. Wealth Generation- individuals and institutions grow their wealth by investing in various financial
instruments. Capital markets offer a range of investment options like stocks, bonds, and mutual
funds, which have the potential for capital appreciation and dividend income. Outcome-yield
significant returns, contributing to the accumulation of wealth for investors-benefits individual
investors-fuels economic growth by reinvesting and circulating wealth within the economy.

9 Resource Allocation- refers to the efficient distribution of financial resources among various
entities and projects. Capital markets channel funds from savers and investors to businesses,
governments, and other institutions that require capital for growth, development, or operational
purposes. By aligning capital with the most promising and productive opportunities, these markets
ensure that funds are invested where they can yield the highest returns. This process is crucial for
optimal economic growth, as it directs capital to where it's most needed and can be most effectively
utilized.

10. Global Investment Opportunities- refer to the access they provide to a wide range of
international investment options. Investors can diversify their portfolios beyond local markets by
investing in foreign stocks, bonds, and mutual funds. This global reach allows investors to tap into
the growth potential of different economies and industries worldwide. It also helps in spreading risk,
as market fluctuations in one country can be balanced by stability or gains in another, enhancing the
prospects for portfolio growth and stability.

Securities and Exchange Board of India

 SEBI is a statutory body and a market regulator, that controls the securities market in India-
established on 12 April 1988 (non-statutory body for regulating the securities market) -given
statutory powers on 30 January 1992 through the SEBI Act, 1992. The basic functions of Sebi are to
protect the interests of investors in securities and to promote and regulate the securities market.
Sebi is run by its board of members. The board consists of a Chairman (Madhabi Puri Buch from 1st
March 2022) and whole-time (4) and part-time members (4). The chairman is nominated by the
union government. The others include two members from the finance ministry, one member from
the Reserve Bank of India, and five other members who are also nominated by the Centre. The
headquarters of Sebi is situated in Mumbai and the regional offices are located in Ahmedabad,
Kolkata, Chennai, and Delhi

History of Sebi
Before Sebi came into existence, Controller of Capital Issues was the regulatory authority; it derived
authority from the Capital Issues (Control) Act, 1947. In 1988, Sebi was constituted as the regulator
of capital markets in India. Initially, Sebi was a non-statutory body without any statutory power.
Following the passage of the Sebi Act by Parliament in 1992, it was given autonomous and statutory
powers

Securities Appellate Tribunal (SAT)

• Technical Advisory Committee

• Committee for review of structure of infrastructure institutions

• Advisory Committee for the SEBI Investor Protection and Education Fund

• Takeover Regulations Advisory Committee • Primary Market Advisory Committee (PMAC)

• Secondary Market Advisory Committee (SMAC)

• Mutual Fund Advisory Committee

• Corporate Bonds & Securitisation Advisory Committee

Functions and powers of Sebi

1. Sebi controls the activities of stock exchanges, safeguards the rights of shareholders, and also
guarantees the security of their investment.

2. It also aims to check fraudulence by harmonising its statutory regulations and self-regulating
business.

3. The regulator also enables a competitive professional market for intermediaries

4. Apart from the above functions, Sebi provides a marketplace in which the issuers can increase
finance properly.

5. It also ensures the safety and supply of precise and accurate information from the investors.

6. Sebi analyses the trading of stocks and safes the security market from malpractices.

7. It controls the stockbrokers and sub-stockbrokers.

8. It provides education regarding the market to the investors to enhance their knowledge.
9. To approve by-laws of stock exchanges.

10 To require the stock exchange to amend its bylaws.

11 Inspect the books of accounts and call for periodical returns from recognized stock exchanges.

12 Inspect the books of accounts of financial intermediaries.

13 Compel certain companies to list their shares in one or more stock exchanges.

14 Registration brokers.

Responsibilities of SEBI
• To promote the development of the Securities Market and to regulate the Securities Market.

• To Protect the Interest of Investor in Securities.

• To overview the market operations, organizational structure and administrative control of

exchange.

• Registration and regulation of the working of the intermediaries.

• To prohibit the unfair trade practices in the market.

• Promoting and regulating self-regulatory organizations.

• To provide education for the investors and to give training for the intermediaries.

• To regulate substantial acquisition of shares and to take over it.

• Performing such functions and exercising such powers under the provisions of the securities
contracts (Regulations) Act 1956 as may be delegated to it by the central government.

MUTUAL FUNDS
• A mutual fund is an investment vehicle where many investors pool their money to earn returns on
their capital over a period. This corpus of funds is managed by an investment professional known as
a fund manager or portfolio manager.

• It is his/her job to invest the corpus in different securities such as bonds, stocks, gold, and other
assets and seek to provide potential returns.

• The gains (or losses) on the investment are shared collectively by the investors in proportion to
their contribution to the fund.

Why invest in mutual funds.

1. Professional expertise-Consider a situation where you purchase a new car. But the catch here is
that you don’t know how to drive. Now, you have two options:

i) you can learn how to drive

ii) you can hire a full-time driver Here, a professional fund manager takes care of your investments
and strives hard to provide reasonable returns. And just as you would pay the driver for his
chauffeuring services, you have to pay specific fees for the professional management of your mutual
fund investments.
2. Returns-One of the biggest mutual fund benefits is that you have the opportunity to earn
potentially higher returns than traditional investment options offering assured returns. This is
because the returns on mutual funds are linked to the market’s performance.

3. Diversification- Don’t put all your eggs in one basket-investing in different asset classes and
diversifying your portfolio.

4.Tax benefits- tax deduction of up to Rs. 1.5 lakh by investing in Equity Linked Savings Schemes
(ELSS) eligible under Section 80C of the Income Tax Act-lock-in period of 3 years. Another tax benefit
is indexation benefit available on debt funds. In case of traditional products, all interest earned is
subject to tax-debt mutual funds, only the returns earned over and above the inflation rate
(embedded in cost inflation index {CII}) are subject to tax-help investors earn higher post-tax returns.

Types of funds based on asset class

1. Debt funds- monthly income plans (MIPs), short-term plans (STPs), liquid funds, and fixed
maturity plans (FMPs). Debt funds (also known as fixed-income funds) invest in assets like
government securities and corporate bonds. These funds aim to offer reasonable returns to the
investor and are considered relatively less risky. These funds are ideal for a steady income and are
averse to risk.

2. Equity funds In contrast to debt funds, equity funds investment in stocks. Capital appreciation is
an important objective for these funds- returns on equity funds are linked to the market movements
of stocks, higher degree of risk. They are a good choice to invest for long-term goals such as
retirement planning or buying a house as the level of risk comes down over time.

3. Hybrid funds- combination of equity and debt targeted at different types of investors. Hybrid
funds invest in a mix of both equity and fixed-income securities. Based on the allocation between
equity and debt (asset allocation), hybrid funds are further classified into various sub categories:

1. Open-ended mutual funds- are mutual funds where an investor can invest on any business day.
These funds are bought and sold at their Net Asset Value (NPV per unit is the market value of
securities of a scheme divided by the total number of units of the scheme on a given date). Open-
ended funds are highly liquid because one can redeem their units from the fund on any business day
at your convenience.

2. Close-ended mutual funds- pre-defined maturity period. Investors can invest in the fund only
when it is launched and can withdraw their money from the fund only at the time of maturity. These
funds are listed just like shares in the stock market. However, they are not very liquid because
trading volumes are very less.

Types of funds based on investment objective •

Mutual funds can also be classified based on investment objectives.

1. Growth funds- objective is capital appreciation. These funds put a significant portion of the
money in stocks. These funds can be relatively more risky due to high exposure to equity and hence
it is good to invest in them for the long-term.

2. Income funds- provide investors with a stable income- debt funds that invest mostly in bonds,
government securities and certificate of deposits, -suitable for different -term goals and for investors
with a lower-risk appetite.
3. Liquid funds- money in short-term money market instruments like treasury bills, Certificate of
Deposits (CDs), term deposits, commercial papers and so on- help to park your surplus money for a
few days to a few months or create an emergency fund.

4. Tax saving funds- offer tax benefits under Section 80C of the Income Tax Act- claim deductions up
to Rs 1.5 lakh each year. Equity Linked Saving Scheme (ELSS) -tax saving funds

Money market
• The Money Market is a market for lending and borrowing of short-term funds.

• It deals in funds and financial instruments having a maturity period of one day to one year.

• It covers money and financial assets that are close substitutes for money.

• The instruments in the money market are of short term nature and highly liquid.

Indian money market

• The Indian money market consists of two segments, namely organized sector and unorganized
sector.

• The organized sector is within the direct purview of RBI regulation.

• The unorganized sector comprises indigenous bankers, money lenders, and unregulated non
banking financial institutions

• Structure of money market (Indian Financial System)

• Call and Notice Money Market

• Treasury Bills Market

• Commercial Bills Market

• Market for Certificates of Deposits (CDs)

• Market for Commercial Papers (CPs)

• Repos Market

• Money Market Mutual Funds (MMMFs)

• Discount & Finance House of India (DFHI)

. • Indigenous Bankers

• Money Lenders

• Unregulated Non-Bank Finances

• Intermediaries (Chit Funds, Nidhis and Loan Companies)

• Finance Brokers
Institutions of the Money Market
• Central banks

• Commercial banks

• Financial institutions

• Discount (discount bills on behalf of others) and bill brokers (intermediaries between borrowers
and lenders)

• NBFCs

• Acceptance houses (merchant bankers with HQ in other countries and facilitate exporters,
importers, lenders, and borrowers)

Functions Of Money Market

1. Economic development of the country- Provide short term funds -Ensures regular supply of funds
through its sub- markets and instruments -Helps in economic development by providing financial
assistance to trade, commerce and industry.

2. Profitable investment- Helps commercial banks to use their excess reserves in profitable
investments. Maximize profits by investing their excess reserves. -Excess reserves are invested in
near-money assets which are highly liquid and can be easily converted into cash.

3. Help to government: Borrows short-term funds at very low interest rates.

4. Help to Commercial Bank: the banks with a deficit of funds can raise funds from money market at
a low rate of interest.

5. Encouragement to Savings and investment-it encourages saving and investment by transferring

funds from one sector to another sector.

6. Provide funds-short term

7. Helps in monetary policy

8.Helps in financial mobility

9. Promotes liquidity and safety

Debt Markets & Forex Market

‘The debt market plays a pivotal role in the economy as it helps in efficient mobilization and
allocation of resources in the economy, besides financing the development activities of the
Government. There is a well-segmented debt market in India comprising Government Securities (G-
Sec) Market, Corporate Bond Market and Money Market. Indian debt market is predominantly a
wholesale market, with dominant institutional investor participation.’ Classification of bond market:
1. Primary debt market and secondary debt market

2. Government and corporate bond market based on the nature of the issuer

3. Domestic, foreign, and euro bond markets based on the nature of bond issuance.
 4. International bond market is divided into three broad bond market groups viz domestic bonds,
foreign bonds, and euro bonds. Domestic bonds are issued locally by a domestic borrower and are
denominated in the local currency of the country of issue. Foreign bonds are issued on a local
market by a foreign borrower and are usually denominated in the local currency and foreign bond
issues and trading are under the supervision of local authorities.

Components of Debt Market

• Private Corporate Debt Market

• PSU Debt Market

• Government Securities Markets (usually referred to as the G-Sec market)

The key functions of Debt Markets are:

• Efficient mobilization and allocation of resources in the economy.

• Financing the development activities of the Government.

• Transmitting indications for implementation of the monetary policy.

• Facilitating liquidity management in tune with overall short-term and long-term objectives.

• Reduction in the borrowing cost of the Government and enable mobilization of resources at a
reasonable cost.

• Provide greater funding avenues to public-sector and private-sector projects and reduce the
pressure on institutional financing .
Debt market participants
Forex market
“The international business context requires trading and investing in assets denominated in
different currencies. Foreign assets and liabilities add a new dimension to the risk profile of a firm or
an investor's portfolio: foreign exchange risk.”

BANCASSURANCE
➢ Bancassurance is an arrangement between a bank and an insurance company allowing the
insurance company to sell its products to the bank’s client base.

➢ This partnership arrangement can be profitable for both companies.

FEATURES
1. Bank cannot pay a premium on behalf of the customer.

2. It can use only two insurance companies in one bank.

3. All commissions are disclosed in the annual accounts report.

4. A bank always focuses on its banking business.

5. For an insurance company, the network of a bank is useful for the sale.

6. It improves profitability.

7. It increases customer lifetime value.

8. It can offer all the financial facilities under one roof

TYPES OF BANCASSURANCE
 Life Insurance Products
 Term insurance plans
 Endowment plans
 Unit linked insurance plans
 Non-Life Insurance Products
 Health insurance
 Marine insurance
 Property insurance
 Key men insurance

ADVANTAGES OF BANCASSURANCE

To banking institutions

➢ Diversification of product and customer portfolio

➢ Improved Profitability and Non-Interest Fee Income

➢ Customer Loyalty and Retention

➢ Cost-effective use of existing Resources

➢ Increased customer lifetime value

To customers

➢ One stop-shop for all financial needs

➢ Improved application and policy processing time

➢ Ease of Renewals

➢ Trust in insurance products and services

➢ Customized product and expert advice

To insurance companies

➢ High Market Penetration Rate

➢ Relevant offer generation and customer engagement

➢ Increased operational efficiency and reduced costs

➢ High service and product responsiveness

➢ Increased Premium Turnover

DISADVANTAGES OF BANCASSURANCE

➢ Association and dependence may cause conflict of interest between the partners leading to new
operational and performance risk.

➢ The conflict of interest between bank products and insurance products and their policies could
confuse the customers regarding where to make the investment

➢ For such synergy to work, it requires intensive planning and monitoring which could a lot to the
participating company.

➢ This requires huge initial investment and trained employees.

IRDA
• The Insurance Regulatory and Development Authority of India (IRDAI) has formed a taskforce to
look into various aspects of the bancassurance channel, including mis-selling.

• “Despite the large network of the banks through their branches across the length and breadth of
the country, their contribution of banks as corporate agents is only 5.93 per cent of non-life
premium and 17.44 per cent of the new business premium for life insurance for the year 2023-24,”
the regulator said in a circular

. • “One of the ways of reaching the last mile and making available insurance products to the nook
and corner of the country is leveraging the vast bank branch network,’‘ it said.
Bancassurance Model
1. Pure Distributor Model – In this model, the bank offers a product of insurance companies. They
offer more than one company’s product. Insurance companies pay commissions to the bank like
management fees, etc.

2. Strategic Alliance Model – In this model, there is a linkup between the insurance company and
the bank. Bank will offer only those products which the insurance company wants to sell.

3. Joint Venture Model – The bank participates in product and distribution design in this model.
There is joint decision-making and high system integration for infrastructure utilization.

4. Financial Service Group – In this, all the facilities of financial activities are under one roof

Strategic Challenges •
Strategic Challenges: These developments are expected to challenge traditional bancassurers in the
following ways:

1. The shift away from manufacturing to pure distribution requires banks to better align the
incentives of different suppliers with their own.

2. Increasing sales of non-life products, to the extent those risks are retained by the banks, require
sophisticated products and risk management.

3. The sale of non-life products should be weighted against the higher cost of servicing those
policies.

4. Banks will have to be prepared for possible disruptions to client relations arising from more
frequent non-life insurance claims

Risk Mitigation
• Trade credit insurance by virtue of its structure provides relief as the last resort for a seller.
Wherein despite of best effort to choose the genuine buyers, provide best of products and services
as per requirement and delivering as per the schedule expected from seller, the buyer fails to pay on
the due date.

• The policy is designed in a fashion, wherein once the buyer crosses the due date of payment, the
seller is expected to inform the insurer after a pre-decided period about the non-payment. The seller
however is expected to continue chasing the buyer for payment.

• The insurer assesses the buyer-seller transaction for unpaid dues and assist seller to recover the
over dues amicably. However, if the amicable recovery fails within a specified time, the insurer pays
the seller by way of indemnity and take subrogation of right to recovery from buyer

Risk Management in Banking

• Banking risk management is the process of a bank identifying, evaluating, and taking steps to
mitigate the chance of something bad happening from its operational or investment decisions. This
is especially important in banking, as banks are responsible for creating and managing money for
others.
 • Typically, risk teams separate fraud and compliance operations, resulting in separate teams for
fraud risk management, responsible for managing risk associated with fraud operations, and
compliance risk management, responsible for managing risk associated with compliance operations.

Importance of Risk Management in Banking

“Banks are cornerstone institutions of national and global financial systems. So while they are
allowed to have some degree of risk, they are typically afforded much less risk than other industries.
This is because if they fail, it slows or halts the creation and exchange of money, which has far-
reaching impacts on the rest of the economy.”

• Avoid wasting or needlessly losing the money they need to stay in business

• Avoid disruptions to their operations

• Maintain confidence from investors and customers to continue doing business with them

• Comply with laws and regulations to avoid paying non-compliance fines

• Identification: Defining the nature of risks, including where they originate from and why they pose
a threat to the bank.

• Assessment and Analysis: Evaluating how likely a risk will pose a threat to the bank, and how grave
that threat will likely be. This helps a bank prioritize which risks deserve the most attention.

• Mitigation: Designing and implementing bank policies and processes that limit the chance that
risks will become threats, and that minimize the damage threats may cause.
• Monitoring: Gathering data on threat prevention and incident response to determine how well a
bank risk management strategy is working. This also involves researching emerging risk trends to
determine if a bank’s risk management framework needs (or will need) updating.

• Cooperation: Establishing relationships between risks and mitigation strategies across different
areas of the bank’s operations to create a more centralized and coordinated threat response system.
• Reporting: Documenting and reviewing information related to the bank’s risk management efforts
to gauge their effectiveness. This is also used to track how the bank’s overall risk profile changes
over time

Type of Risks

Risk may be defined as ‘possibility of loss’, which may be financial loss or loss to the image or
reputation. Banks like any other commercial organisation also intend to take risk, which is inherent
in any business. Higher the risk taken, higher the gain would be. But higher risks may also result into
higher losses. However, banks are prudent enough to identify, measure and price risk, and maintain
appropriate capital to take care of any eventuality. The major risks in banking business or ‘banking
risks’, as commonly referred, are listed below –

 Liquidity Risk

 Interest Rate Risk

 Market Risk

 Credit or Default Risk

 Operational Risk

Liquidity Risk

It can be also defined as the possibility that an institution may be unable to meet its maturing
commitments or may do so only by borrowing funds at prohibitive costs or by disposing assets at
rock bottom prices.

(a) Funding Risk: Funding Liquidity Risk is defined as the inability to obtain funds to meet cash
flow obligations. For banks, funding liquidity risk is crucial. This arises from the need to
replace net outflows due to unanticipated withdrawal/ non-renewal of deposits (wholesale
and retail).
(b) Time Risk: Time risk arises from the need to compensate for nonreceipt of expected inflows
of funds i.e., performing assets turning into non-performing assets.
(c) Call Risk: Call risk arises due to crystallisation of contingent liabilities. It may also arise when
a bank may not be able to undertake profitable business opportunities when it arises.

Interest Rate Risk

Interest Rate Risk arises when the Net Interest Margin or the Market Value of Equity (MVE)
of an institution is affected due to changes in the interest rates. In other words, the risk of an
adverse impact on Net Interest Income (NII) due to variations of interest rate may be called
Interest Rate Risk (Sharma, 2003). It is the exposure of a Bank’s financial condition to
adverse movements in interest rates. The following are the types of Interest Rate Risk –
(a) Gap or Mismatch Risk: A gap or mismatch risk arises from holding assets and liabilities and
Off-Balance Sheet items with different principal amounts, maturity dates or re-pricing dates,
thereby creating exposure to unexpected changes in the level of market interest rates.
(b) Yield Curve Risk: Banks, in a floating interest scenario, may price their assets and liabilities
based on different benchmarks, i.e., treasury bills’ yields, fixed deposit rates, call market
rates, MIBOR etc. In case the banks use two different instruments maturing at different time
horizon for pricing their assets and liabilities then any non-parallel movements in the yield
curves, which is rather frequent, would affect the NII. Thus, banks should evaluate the
movement in yield curves and the impact of that on the portfolio values and income.
(c) Basis Risk: Basis Risk is the risk that arises when the interest rate of different assets, liabilities
and off-balance sheet items may change in different magnitude. For example, in a rising
interest rate scenario, asset interest rate may rise in different magnitude than the interest
rate on corresponding liability, thereby creating variation in net interest income.
(d) Embedded Option Risk: Significant changes in market interest rates create the source of risk
to banks’ profitability by encouraging prepayment of cash credit/demand loans, term loans
and exercise of call/put options on bonds/ debentures and/ or premature withdrawal of
term deposits before their stated maturities. The embedded option risk is experienced in
volatile situations and is becoming a reality in India. The faster and higher the magnitude of
changes in interest rate, the greater will be the embedded option risk to the banks’ Net
Interest Income. The result is the reduction of projected cash flow and the income for the
bank
(e) Reinvested Risk: Reinvestment risk is the risk arising out of uncertainty with regard to
interest rate at which the future cash flows could be reinvested. Any mismatches in cash
flows i.e., inflow and outflow would expose the banks to variation in Net Interest Income.
This is because market interest received on loan and to be paid on deposits move in
different directions.
(f) Net Interest Position Risk: Net Interest Position Risk arises when the market interest rates
adjust downwards and where banks have more earning assets than paying liabilities. Such
banks will experience a reduction in NII as the market interest rate declines and the NII
increases when interest rate rises. Its impact is on the earnings of the bank or its impact is
on the economic value of the banks’ assets, liabilities and OBS positions.

Market Risk

The risk of adverse deviations of the mark-to-market value of the trading portfolio, due to
market movements, during the period required to liquidate the transactions is termed as Market
Risk (Kumar et al., 2005). This risk results from adverse movements in the level or volatility of
the market prices of interest rate instruments, equities, commodities, and currencies. It is also
referred to as Price Risk.

he term Market risk applies to (i) that part of IRR which affects the price of interest rate
instruments, (ii) Pricing risk for all other assets/ portfolio that are held in the trading book of the
bank and (iii) Foreign Currency Risk.

(a) Forex Risk: Forex risk is the risk that a bank may suffer losses as a result of adverse exchange
rate movements during a period in which it has an open position either spot or forward, or a
combination of the two, in an individual foreign currency.

(b) Market Liquidity Risk: Market liquidity risk arises when a bank is unable to conclude a large
transaction in a particular instrument near the current market price.
Default or Credit Risk

Credit risk is more simply defined as the potential of a bank borrower or counterparty to fail to
meet its obligations in accordance with the agreed terms. In other words, credit risk can be
defined as the risk that the interest or principal or both will not be paid as promised and is
estimated by observing the proportion of assets that are below standard. Credit risk is borne by
all lenders and will lead to serious problems, if excessive.

There are two variants of credit risk which are discussed below –

(a) Counterparty Risk: This is a variant of Credit risk and is related to non-performance of the
trading partners due to counterparty’s refusal and or inability to perform. The counterparty risk
is generally viewed as a transient financial risk associated with trading rather than standard
credit risk.

(b) Country Risk: This is also a type of credit risk where nonperformance of a borrower or
counterparty arises due to constraints or restrictions imposed by a country. Here, the reason of
nonperformance is external factors on which the borrower or the counterparty has no control.

Operational Risk

Two of the most common operational risks are discussed below

Basel Committee for Banking Supervision has defined operational risk as ‘the risk of loss resulting
from inadequate or failed internal processes, people and systems or from external events’. Thus,
operational loss has mainly three exposure classes namely people, processes and systems

(a) Transaction Risk: Transaction risk is the risk arising from fraud, both internal and external,
failed business processes and the inability to maintain business continuity and manage
information.

(b) Compliance Risk: Compliance risk is the risk of legal or regulatory sanction, financial loss or
reputation loss that a bank may suffer as a result of its failure to comply with any or all of the
applicable laws, regulations, codes of conduct and standards of good practice. It is also called
integrity risk since a bank’s reputation is closely linked to its adherence to principles of integrity
and fair dealing.

Other Risks

(a) Strategic Risk: Strategic Risk is the risk arising from adverse business decisions, improper
implementation of decisions or lack of responsiveness to industry changes. This risk is a function
of the compatibility of an organisation’s strategic goals, the business strategies developed to
achieve those goals, the resources deployed against these goals and the quality of
implementation.

(b) Reputation Risk: Reputation Risk is the risk arising from negative public opinion. This risk may
expose the institution to litigation, financial loss or decline in customer base.
Best Practices for Banking Risk Management
• Establish an institution-wide risk governance framework

• Prioritize identity verification & authentication for everyone who interacts with the bank

• Automate tasks related to risk management, like transaction monitoring

• Keep up with both individual cases and overall risk reporting

• Continually assess, analyze, and act on risk metrics

Recent Developments in the Indian Financial System

1. THE CONSTITUTIONAL VALIDITY OF THE AADHAAR SCHEME UPHELD BY SUPREME COURT

2. RBI TO FORM REGULATORY SANDBOX FOR FINTECH AND TO SETP UP DATA SCIENCE LAB -keep
pace with innovation in the digital lending space.

3. IRDAI TO MIGRATE TO RISK-BASED CAPITAL REGIME - risk-based capital (RBC) regime in order to
improve protection for policyholders- current Solvency Based Rules were not helpful in assessing
whether the capital held is adequate enough for the risks inherent in the insurance business.

4. LIQUIDITY BOOST- SLR UNDER THE BASEL-III CALCULATIONS RBI - 2 per cent increase in the
treasury holdings of banks as high-quality liquid assets (HQLAs) under the Basel III calculations,
potentially releasing up to Rs 2 lakh crore. 5. Finance Bill 2017 to create a Payments Regulatory
Board in the Reserve Bank of India by replacing the existing Board for Regulation and Supervision of
Payment and Recent Developments in Indian Financial System Settlement Systems (BPSS).

6. 20 LAKH PEOPLE JOIN MODIFIED JANDHAN SCHEME, TOTALLING ACCOUNT HOLDERS TO 32.61
CRORES As per the latest data released by the Finance Ministry, 20 lakh people have joined the
modified Pradhan Mantri Jan Dhan Yojna (PMJDY), taking the total number of account holders in this
flagship financial inclusion programme to 32.61 crore.

7. Natinal Payment Corporation of India has been honored with Economic Times Awards 2018 for
Change agent of the year. Ranging from creating the National Financial Switch for all ATM
transactions and a centralised cheque clearance mechanism to the IMPS instant bank-to-bank fund
transfer and smartphone-based Unified Payments Interface (UPI).

8. Post Payments Bank (IPPB) in order to ensure financial inclusion for the masses.

9. RBI TO CONDUCT OMO TO INFUSE LIQUIDITY- Based on the assessment of prevailing liquidity
conditions in the econony, the Reserve Bank has decided to conduct purchase of government
securities under Open Market Operations for an aggregate amount of Rs 100 billion (Rs 10,000
crore).

10. Union Ministry of Commerce and Industry has developed National Logistics Portal to ensure
ease of trading in international and domestic markets.

11. Reserve Bank of India (RBI) liberalises some aspects of the external commercial borrowings
(ECBs) policy including those related to rupee-denominated bonds to help check rupee depreciation.
12. PayU India has received a licence from the Reserve Bank of India to operate its own non-banking
financial company, a development that will provide a big boost to the fintech in growing its
consumer credit business.
13. Debt Recovery Tribunal (DRTs), following the amendment to rules of Recovery of Debts due to
Banks and Financial Institutions Act, 1993.

14.BOB, VIJAYA AND DENA BANK MERGER: PROPOSAL TO CREATE SECOND LARGEST PSU LENDER

FACTORING

MEANING AND DEFINITION OF FACTORING

Like securitisation factoring also is a financial innovation. Factoring provides resources to finance
receivables. It also facilitates the collection of receivables. The word factor is derived from the Latin
word facere. It means to make or do or to get things done. Factoring simply refers to selling the
receivables by a firm to another party. The buyer of the receivables is called the factor. According to
this agreement the factor undertakes the receivables, the credit, the collection task, and the risk of
bad debt. The firm selling its receivables (client) receives the value of the receivables minus a
commission charge as compensation for the risks the factor assumes. Thereafter, customers make
direct payments to the factor. In some cases receivables are sold to factor at a discount. In this case
factor does not get commission. According to this arrangement, customers make direct payment to
the client. It should be noted that both factoring and securitisation provide financing source for
receivables. In factoring, the financing source is the factor. But in securitisation, the public
(investors) who buys the securities is the factoring source.

OBJECTIVES OF FACTORING

Factoring is a method of converting receivables into cash. There are certain objectives of factoring.
The important objectives are as follows:

1. To relieve from the trouble of collecting receivables so as to concentrate in sales and other major
areas of business.

2. To minimize the risk of bad debts arising on account of non-realisation of credit sales.

3. To adopt better credit control policy.

4. To carry on business smoothly and not to rely on external sources to meet working capital
requirements.

5. To get information about market, customers’ credit worthiness etc. so as to make necessary
changes in the marketing policies or strategies.

TYPES OF FACTORING

There are different types of factoring. These may be briefly discussed as follows:

1. Recourse Factoring: In this type of factoring, the factor only manages the receivables without
taking any risk like bad debt etc. Full risk is borne by the firm (client) itself.

2. Non-Recourse Factoring: Here the firm gets total credit protection because complete risk of total
receivables is borne by the factor. The client gets 100% cash against the invoices (arising out of
credit sales by the client) even if bad debts occur. For the factoring service, the client pays a
commission to the factor. This is also called full factoring.

3. Maturity Factoring: In this type of factoring, the factor does not pay any cash in advance. The
factor pays clients only when he receives funds (collection of credit sales) from the customers or
when the customers guarantee full payment.
4. Advance Factoring: Here the factor makes advance payment of about 80% of the invoice value to
the client.

5. Invoice Discounting: Under this arrangement the factor gives advance to the client against
receivables and collects interest (service charge) for the period extending from the date of advance
to the date of collection.

6. Undisclosed Factoring: In this case the customers (debtors of the client) are not at all informed
about the factoring agreement between the factor and the client. The factor performs all its usual
factoring services in the name of the client or a sales company to which the client sells its book
debts. Through this company the factor deals with the customers. This type of factoring is found in
UK.

7. Cross boarder factoring: It is similar to domestic factoring except that there are four parties, viz,
a) Exporter, b) Export Factor, c) Import Factor, and d) Importer.

It is also called two-factor system of factoring. Exporter (Client) enters into factoring arrangement
with Export Factor in his country and assigns to him export receivables. Export Factor enters into
arrangement with Import Factor and has arrangement for credit evaluation & collection of payment
for an agreed fee. Notation is made on the invoice that importer has to make payment to the Import
Factor. Import Factor collects payment and remits to Export Factor who passes on the proceeds to
the Exporter after adjusting his advance, if any. Where foreign currency is involved, factor covers
exchange risk also.

PROCESS OF FACTORING (FACTORING MECHANISM)

1. The firm (client) having book debts enters into an agreement with a factoring
agency/institution.
2. The client delivers all orders and invoices and the invoice copy (arising from the credit sales)
to the factor.
3. The factor pays around 80% of the invoice value (depends on the price of factoring
agreement), as advance.
4. The balance amount is paid when factor collects complete amount of money due from
customers (client’s debtors).
5. Against all these services, the factor charges some amounts as service charges. In certain
cases the client sells its receivables at discount, say, 10%. This means the factor collects the
full amount of receivables and pays 90% (in this case) of the receivables to the client. From
the discount (10%), the factor meets its expenses and losses. The balance is the profit or
service charge of the factor.
6. Thus there are three parties to the factoring.
7. They are the buyers of the goods (client’s debtors), the seller of the goods (client firm i.e.
seller of receivables) and the factor.
8. Factoring is a financial intermediary between the buyer and the seller.
FEATURES (NATURE) OF FACTORING
From the following essential features of factoring, we can understand its nature:
1. Factoring is a service of financial nature. It involves the conversion of credit bills into
cash. Account receivables and other credit dues resulting from credit sales appear in the
books of account as book credits.
2. The factor purchases the credit/receivables and collects them on the due date. Thus the
risks associated with credit are assumed by the factor.
3. A factor is a financial institution. It may be a commercial bank or a finance company. It
offers services relating to management and financing of debts arising out of credit sales.
It acts as a financial intermediary between the buyer (client debtor) and the seller
(client firm).
4. A factor specialises in handling and collecting receivables in an efficient manner.
5. Factor is responsible for sales accounting, debt collection, credit (credit monitoring),
protection from bad debts and rendering of advisory services to its clients.
6. Factoring is a technique of receivables management. It is used to release funds tied up
in receivables (credit given to customers) and to solve the problems relating to
collection, delays and defaults of the receivables.
FUNCTIONS OF A FACTOR
Factor is a financial institution that specialises in buying accounts receivables from
business firms. A factor performs some important functions. These may be discussed as
follows:
1. Provision of finance: Receivables or book debts is the subject matter of factoring. A
factor buys the book debts of his client. Generally a factor gives about 80% of the value
of receivables as advance to the client. Thus the nonproductive and inactive current
assets i.e. receivables are converted into productive and active assets i.e. cash.
2. Administration of sales ledger: The factor maintains the sales ledger of every client.
When the credit sales take place, the firm prepares the invoice in two copies. One copy
is sent to the customers. The other copy is sent to the factor. Entries are made in the
ledger under open-item method. In this method each receipt is matched against the
specific invoice. The customer’s account clearly shows the various open invoices
outstanding on any given date. The factor also gives periodic reports to the client on the
current status of his receivables and the amount received from customers. Thus the
factor undertakes the responsibility of entire sales administration of the client.
3. Collection of receivables: The main function of a factor is to collect the credit or
receivables on behalf of the client and to relieve him from all tensions/problems
associated with the credit collection. This enables the client to concentrate on other
important areas of business. This also helps the client to reduce cost of collection.
4. Protection against risk: If the debts are factored without resource, all risks relating to
receivables (e.g., bad debts or defaults by customers) will be assumed by the factor. The
factor relieves the client from the trouble of credit collection. It also advises the client
on the creditworthiness of potential customers. In short, the factor protects the clients
from risks such as defaults and bad debts.
5. Credit management: The factor in consultation with the client fixes credit limits for
approved customers. Within these limits, the factor undertakes to buy all trade debts of
the customer. Factor assesses the credit standing of the customer. This is done on the
basis of information collected from credit relating reports, bank reports etc. In this way
the factor advocates the best credit and collection policies suitable for the firm (client).
In short, it helps the client in efficient credit management.
6. Advisory services: These services arise out of the close relationship between a factor
and a client. The factor has better knowledge and wide experience in the field of
finance. It is a specialised institution for managing account receivables. It possesses
extensive credit information about customer’s creditworthiness and track record. With
all these, a factor can provide various advisory services to the client. Besides, the factor
helps the client in raising finance from banks/financial institutions.
ADVANTAGES OF FACTORING
A firm that enters into factoring agreement is benefited in a number of ways. Some of
the important benefits of factoring are summarised as follows:
1. Improves efficiency: Factoring is an important tool for efficient receivables
management. Factors provide specialised services with regard to sales ledger
administration, credit control etc. Factoring relieves the clients from botheration of
debt collection.
2. Higher credit standing: Factoring generates cash for the selling firm. It can use this
cash for other purposes. With the advance payment made by factor, it is possible for
the client to pay off his liabilities in time. This improves the credit standing of the client
before the public.
3. Reduces cost: The client need not have a special administrative setup to look after
credit control. Hence it can save manpower, time and effort. Since the factoring
facilitates steady and reliable cash flows, client can cut costs and expenses. It can avail
cash discounts. Further, it can avoid production delays.
4. Additional source: Funds from a factor is an additional source of finance for the
client. Factoring releases the funds tied up in credit extended to customers and solves
problems relating to collection, delays and defaults of the receivables.
5. Advisory service: A factor firm is a specialised agency for better management of
receivables. The factor assesses the financial, operational and managerial capabilities of
customers. In this way the factor analyses whether the debts are collectable. It collects
valuable information about customers and supplies the same for the benefits of its
clients. It provides all management and administrative support from the stage of
deciding credit extension to the customers to the final stage of debt collection. It
advocates the best credit policy suitable for the firm.
6. Acceleration of production cycle: With cash available for credit sales, client firm’s
liquidity will improve. In this way its production cycle will be accelerated.
7. Adequate credit period for customers: Customers get adequate credit period for
payment of assigned debts.
8. Competitive terms to offer: The client firm will be able to offer competitive terms to
its buyers. This will improve its sales and profits.

LIMITATIONS OF FACTORING
The main limitations of factoring are outlined as below:
1. Factoring may lead to over-confidence in the behaviour of the client. This results in
overtrading or mismanagement.
2. There are chances of fraudulent acts on the part of the client. Invoicing against non-
existent goods, duplicate invoicing etc. are some commonly found frauds. These would
create problems to the factors.
3. Lack of professionalism and competence, resistance to change etc. are some of the
problems which have made factoring services unpopular.
4. Factoring is not suitable for small companies with lesser turnover, companies with
speculative business, companies having large number of debtors for small amounts etc.
5. Factoring may impose constraints on the way to do business. For non - recourse fac–
oring most factors will want to pre- approve customers. This may cause delays.
Further ,the factor will apply credit limits to individual customers.
FORFAITING

Generally there is a delay in getting payment by the exporter from the importer. This makes it
difficult for the exporter to expand his export business. However, for getting immediate payment,
the concept of forfeiting shall come to the help of exporters. The concept of forfaiting was originally
developed to help finance German exports to Eastern block countries. In fact, it evolved in
Switzerland in mid 1960s.

MEANING OF FORFAITING

The term ‘forfait’ is a French world. It means ‘to surrender something’ or ‘give up one’s right’. Thus
forfaiting means giving up the right of exporter to the forfaitor to receive payment in future from the
importer. It is a method of trade financing that allows exporters to get immediate cash and relieve
from all risks by selling their receivables (amount due from the importer) on a ‘without recource’
basis. This means that in case the importer makes a default the forfaitor cannot go back to the
exporter to recover the money.

CHARACTERISTICS OF FORFAITING

The main characteristics of forfaiting are:

1. It is 100% financing without recourse to the exporter.

2. The importer’s obligation is normally supported by a local bank guarantee (i.e., ‘aval’).

3. Receivables are usually evidenced by bills of exchange, promissory notes or letters of credit.

4. Finance can be arranged on a fixed or floating rate basis.

5. Forfaiting is suitable for high value exports such as capital goods, consumer durables, vehicles,
construction contracts, project exports etc.

6. Exporter receives cash upon presentation of necessary documents, shortly after shipment.

ADVANTAGES OF FORFAITING

The following are the benefits of forfaiting:

1. The exporter gets the full export value from the forfaitor.

2. It improves the liquidity of the exporter. It converts a credit transaction into a cash transaction.

3. It is simple and flexible. It can be used to finance any export transaction. The structure of finance
can be determined according to the needs of the exporter, importer, and the forfaitor.

4. The exporter is free from many export credit risks such as interest rate risk, exchange rate risk,
political risk, commercial risk etc.

5. The exporter need not carry the receivables into his balance sheet.

6. It enhances the competitive advantage of the exporter. He can provide more credit. This increases
the volume of business.

7. There is no need for export credit insurance. Exporter saves insurance costs. He is relieved from
the complicated procedures also.
 8. It is beneficial to forfaitor also. He gets immediate income in the form of discount. He can also sell
the receivables in the secondary market or to any investor for cash.

DIFFERENCE BETWEEN FACTORING AND FORFAITING:

Forfaiting and factoring have similarities. Both have similar features of advance payment and non
recourse dealing. But there are some differences between them. The differences are as follows:

Factoring Forfaiting
Used for short term financing. Used for medium term financing.
May be with or without recourse. Always without recourse.
Applicable to both domestic and export Applicable to export receivables only.
receivables.
Normally 70 to 85% of the invoice value is 100% finance is provided to the exporter.
provided as advance.
The contractor is between the factor and the The contract is between the forfaitor and the
seller. exporter.
Other than financing, several other things like It is a financing arrangement only.
sales ledger administration, debt collection etc.
is provided by the factor.
A bulk finance is provided against a number of It is based on a single export bill resulting from
unpaid invoices. only a single transaction.
No minimum size of transaction is specified. There is a minimum specified value per
transaction.