BANKING TERMINOLOGY – AN

INTRODUCTION
What is a Bank?
• Accepts deposits from customers
Pays interest on these deposits (Main source of expenditure)

• Makes Loans & Advances to borrowers

Receives interest on these loans (Main source of income)

• Other fee based income – Underwriting; Money Transfer;

Foreign Exchange, Guarantee fees etc.
Types of Banks
• Public Sector Banks: Majority Stake with Government and also
listed on stock exchanges (SBI)
• Private sector Banks: Majority shareholding by private
shareholders (ICICI Bank)
• Foreign Banks: Set up in a foreign country and having branch
offices in India (Citibank)
• Co-operative Banks: Retail and commercial banking organized on
a cooperative basis (TN Cooperative Bank)
• Scheduled Banks: Any bank which is listed in the 2nd schedule of
the Reserve Bank of India Act
 Scheduled banks become eligible for debts/loans at the bank rate from the
RBI; they automatically acquire the membership of clearing house
 Banks with a reserve capital of less than prescribed amount qualify as non-
scheduled banks
• Regional Rural Banks: These banks serve the rural areas and
agricultural sectors with basic banking and adequate financial
Bank’s Balance Sheet
Liabilities Assets
Capital Intangible Assets
Reserves and Surplus Tangible Assets
Liabilities – Deposits Investments
Liabilities – Borrowings Loans and Advances
Other Liabilities and Provisions Cash and Bank Balances
Sample Balance Sheet – HDFC Bank
Capital and Liabilities
• The ‘capital and liabilities’ head, as the name suggests, is
made up of the three portions —
• The net worth, which is the ‘capital’ and the ‘reserve and surplus’,
• The liabilities, which is the money that a bank owes. This money is
in the form of ‘deposits and borrowings’.
• The ‘other liabilities and provisions’.
Capital
• Net worth: Net worth is made up of the ‘share capital’ and the
‘reserves and surplus’.
• Net worth of banks is quite similar to that of a non-financial
institution,
• Banks need to maintain some reserves / balances in its balance
sheet, which one will not find in a non-financial institution.
• One such type of reserve is the ‘Statutory Reserve’, which is not
a free reserve for the bank (E.g. CRR, SLR)
• Free reserves also that banks maintain, but their proportions
are quite subjective as they differ from bank to bank (E.g.
‘Investment Reserve Account’ and ‘Foreign Currency
Translation Account’)
• Capital is a measure of Financial health of a Bank and hence
it’s an important indicator of ability to withstand risk
Different Types of Capital
• Tier 1 Capital – consists of Common stock (Equity share
capital, Retained earnings, Non-redeemable non-
cumulative preferred stock (Preference shares)
Tier 1 capital is intended to measure a bank's financial health and
is used when a bank must absorb losses without ceasing business
operations
• Tier 2 Capital – Also called as Supplementary capital
(less reliable than tier 1 capital); Consists of Undisclosed
Reserves, Revaluation Reserves, General Provisions,
Hybrid instruments, Subordinated term debt
• For calculation of regulatory capital, Tier 2 capital
restricted to 100% of Tier 1 capital
Liabilities
• Debt to equity ratio for banks is typically 10 to 20 times -
much higher than that of non-financial firms. Banks also
need funds for investing – since it is a bank’s business to
raise funds and lend the same,
• The liabilities are usually either deposits or borrowings.
• Deposits are of three kinds — demand deposits (current
accounts), savings bank deposits (savings accounts) and
term deposits (fixed deposits).
• Interest paid on fixed deposits (term deposits) > Interest
offered on demand and savings bank deposits (popularly
known as CASA or (current account and savings
accounts)
 When banks mention that they are trying to increase the share of low-
cost funds, it means that they are trying to garner more funds in the
form of CASA. This would eventually help them improve their net
interest margins (NIMs).
Liabilities (Contd.)
• Borrowings: They are somewhat similar to the debt that
non-financial companies take. Apart from deposits, banks
can also borrow funds through loans from other sources.
These can include the Reserve Bank of India as well as
other institutions and agencies, be it domestic or foreign.

• Other liabilities and provisions: This head is similar to

that of a 'current liabilities' portion of a non-financial
company. The items that can fall under this head are the
short-term obligations of a bank during a particular year.
The items that can fall under this category include bills
payable, interest accrued, provision for dividend and
contingent provisions
Contingent Liabilities
• Banks are also required to disclose their contingent
liabilities,
• These are possible future liabilities that will only become
certain on the occurrence of some future event
Commitments / guarantees given on behalf of clients
Issue of letters of credit; Acceptance of bills of exchange on behalf
of customers; Guarantees to government, foreign sellers and
others; Underwriting of shares
• Other examples – Liability on account of outstanding
forward exchange and derivative contracts are important
examples
Assets
• ‘Capital and Liabilities' is the portion from where the bank
sources the money to lend as loans,
• 'Asset's portion indicates where all and how the bank has
utilized the money.
• Apart from advances, a bank needs to put aside a portion
of its assets in various forms.
• Can be in the form of investments, deposits with the RBI,
cash balances, among others.
• A bank needs to follow regulations made by India's
central bank, the Reserve Bank of India.
Fixed assets and other assets
• Fixed assets for a bank would mainly include premises,
land, Capital Work-in-progress, Assets on lease and
furniture & fixtures.

• The 'other assets' portion includes various items such as

the interest accrued, advance tax paid, stationary and
stamps, non banking assets acquired in satisfaction of
claims, security deposits for commercial and residential
property, deferred tax assets, amongst others.

• Other assets also include “Inter-office adjustment

balances”
Investments
• This head is again divided into two parts - investments in and
outside India.
 Investments in Government Securities (G-Secs) is significant.
 A bank is required to invest in G-Secs.
 The amount that needs to be invested is dependent on the prevailing
statutory liquidity ratio (SLR).
• A bank's revenues are basically derived from the interest it
earns from the loans it gives out as well as from the fixed
income investments it makes. If credit demand is lower, the
bank increases the quantum of investments in G-Sec.
• The other investment would be somewhat common between
all firms. They could include investment in joint ventures,
subsidiaries, bonds and debentures, units, certificate of
deposits, amongst others.
Advances
• Advance - Loans given to a bank's customers (Retail or Corporate)
 Growth in advance, coupled with the prevailing interest rates is what drives the banks interest
income.
• Advances of three types
 Bills purchased & discounted,
 Cash credits, overdrafts & loans repayable on demand and
 Term loans.
 Term loans, followed by cash credits, overdraft and loans repayable on demand tend to have
a larger share in this head.
• Further, banks required to show how these assets have been covered (security).
 Covered either by tangible assets or bank/government guarantees.
 Unsecured loans also granted to customers.
 Unsecured loans constitute a much less portion (as compared to the secured loans) of the
advance pie.
• Banks required to broadly show where they have made their advances.
 Details available from various reports, including annual reports,
 Under the advance schedule, they are required to show what portion is advanced in and
outside India.
 Bifurcation is made as to how much has been advanced to the priority sector, public sector,
other banks, etc.
Cash and Bank Balances
Cash and bank balances with the RBI
• As the name suggest, this head includes the cash in hand and in ATMs that a
bank maintains as well as the amount of money deposited with the RBI.
• A bank will need to reserve a certain amount to satisfy withdrawal demands.
The proportion of deposits that a bank needs to keep with the RBI is
determined by the prevailing 'cash reserve ratio' (CRR).
• As such, CRR is essentially the percentage of cash reserves to total deposits.
The rate of the same is determined by the RBI in its monetary policies.

Balances with Banks and Money at Call and Short notice

• This head again has two parts - balance with other banks (which can be in the
form of current account or other deposit accounts) and money at call and short
notice. Banks do show these types of balances with institutions that are in and
outside India separately.
• These funds are those which banks provide (or take) to (or from) other
financial institutions at inter-bank rates. These types of loans are very short in
nature, usually lasting no longer than a week. More often than not, these funds
are used for helping banks meet reserve requirements.
CRR and SLR
Cash Reserve Ratio (CRR)
• CRR is a central bank regulation employed by most, but not all, of the
world's central banks, that sets the minimum amount of reserves that
must be held by a commercial bank.
• Bank's reserves normally consist of cash owned by the bank and stored
physically in the bank vault plus the amount of the commercial bank's
balance in that bank's account with the central bank.
• CRR presently in India is 4%

Statutory Liquidity Ratio (SLR)

• Commercial Banks required to maintain in the form of cash, gold,
government approved securities before providing credit to the customers.
Statutory liquidity ratio is determined by Reserve Bank of India
maintained by banks in order to control the expansion of bank credit.
• SLR presently in India is 18% of Net Demand and Time Liabilities
(Savings, Current and Deposit balances)
Non Performing assets
Performing vs Non Performing Asset
• A performing asset is one which does not disclose
any problems and which does not carry more than
normal risk attached to the business. Such an asset
is classified as Standard Asset
• An asset, including a leased asset, becomes non
performing when it ceases to generate income for
the bank
Dues vs. Overdues
• Dues - the principal / interest/ any charges levied
on the loan account which are payable within the
period as per the terms of sanction.
• Overdue - the principal / interest/ any charges
levied on the loan account which are payable, but
have not been paid within the period as per the
terms of sanction
• In other words, any amount due to the bank under any
credit facility is ‘overdue’ if it is not paid on the due date
fixed by the bank.
Non-Performing Asset
• A non performing asset is a loan or an advance
where:
(i) interest and/ or installment remain overdue for a period of
more than 90 days in respect of a Term Loan
(ii) The amount remains ‘out of order’ for a period of more
than 90 days, in respect of an Overdraft/ cash credit
(iii) The bills remains overdue for a period of more than 90
days in case of bills purchased and discounted
(iv) For derivative transactions (overdue receivables of a
derivative contract), if these remain unpaid for a period of 90
days from the specified due date for payment
Out of order accounts
• Outstanding balance remains continuously in
excess of the sanctioned limit/drawing power for
90 days
• Where outstanding balance in the principal
operating account is less than the sanctioned
limit/drawing power, but there are no credits
continuously for 90 days as on the date of
Balance Sheet or credits are not enough to cover
the interest debited during the same period
NPA - Asset Classification
• If the borrower does not pay dues for 90 days
after end of a quarter; the loan becomes an NPA
and it is termed as “Special Mention Account”.
SMA0 overdue up to 30 days

SMA1 overdue for 31 to 60 days

SMA2 overdue for 61 to 90 days

NPA - Asset Classification
• If this loan remains NPA for a period less than or equal to
12 months; it is termed as Sub-standard Asset.
• If sub-standard asset remains so for a period of 12 more
months; it would be termed as “Doubtful asset”. This
remains so till end of 3rd year.
• If the loan is not repaid even after it remains sub-standard
asset for more than 3 years, it may be identified as
unrecoverable by internal / external audit and it would be
called loss asset.
Types of NPA
• Gross NPA: Gross NPAs are the sum total of all loan assets that are
classified as NPAs as per RBI guidelines as on Balance Sheet date.
Gross NPA reflects the quality of the loans made by banks. It consists
of all non standard assets like sub-standard, doubtful, and loss assets.
Gross NPAs Ratio : Gross NPAs
Gross Advances
• Net NPA: Net NPAs are those type of NPAs in which the bank has
deducted the provision regarding NPAs. Net NPA shows the actual
burden of banks. Since in India, bank balance sheets contain a huge
amount of NPAs and the process of recovery and write off of loans is
very time consuming, the provisions the banks have to make against
the NPAs according to the central bank guidelines, are quite significant.
That is why the difference between gross and net NPA is quite high.
Net NPAs Ratio: Gross NPAs – Provisions
Gross Advances - Provisions
Income Recognition
• Internationally income from non­-performing assets (NPA)
is not recognized on accrual basis but is booked as
income only when it is actually received.
• Banks should not charge and take to income account
interest on any NPA. This will apply to Government
guaranteed accounts also.
• Fees and commissions earned by the banks as a result of
re­negotiations or rescheduling of outstanding debts
should be recognized on an accrual basis over the period
of time covered by the re­negotiated or rescheduled
extension of credit.
Income Recognition –
Reversal of Income
• If any advance, including bills purchased and discounted,
becomes NPA, the entire interest accrued and credited to
income account in the past periods, should be reversed if
the same is not realized. This will apply to Government
guaranteed accounts also.
• In respect of NPAs, fees, commission and similar income
that have accrued should cease to accrue in the current
period and should be reversed with respect to past
periods, if uncollected.
Appropriation of recovery
in NPAs
• Interest realized on NPAs may be taken to income
account provided the credits in the accounts towards
interest are not out of fresh/ additional credit facilities
sanctioned to the borrower concerned.

• In the absence of a clear agreement between the bank

and the borrower for the purpose of appropriation of
recoveries in NPAs (i.e. towards principal or interest due),
banks should adopt an accounting principle and exercise
the right of appropriation of recoveries in a uniform and
consistent manner.
Provisioning Norms
(Minimum)
Asset Category Secured Loans Unsecured Loans
Standard Assets (*) 0.40% NA
Sub Standard Assets 15% 25%
Doubtful Assets (Upto 1 year) 25% 100%
Doubtful Assets (1-3 years) 40% 100%
Doubtful Assets > 3 years 100% 100%
Loss Assets Completely written off or
100% provision

* - Provision amount varies for different types

of loans; 0.25% for farm credit
Implication of NPA
• The most important implication of the NPA is that a bank
can neither credit the income nor debit to loss, unless
either recovered or identified as loss.
• If a borrower has multiple accounts, all accounts would be
considered NPA if one account becomes NPA.

Master Circular of RBI-

Master circular of RBI
http://iibf.org.in/documents/IRAC.pdf
https://taxguru.in/rbi/npa-overview.html
https://taxguru.in/chartered-accountant/bank-audit-npa-ass
et-classification.html
Capital Adequacy Ratio
• Indicator of how well a bank can meet its
obligations
• Also known as capital-to-risk weighted assets
ratio (CRAR),
• Ratio compares capital to risk-weighted assets
• Closely watched by regulators to determine a
bank's risk of failure
• Downside of using CAR is that it doesn't account
for the risk of a potential run on the bank, or what
would happen in a financial crisis
Calculation of CAR
• CRAR is obtained by dividing a bank's capital by
its risk-weighted assets
• Currently, the minimum ratio of capital to risk-
weighted assets is 8% under Basel II and 10.5%
(which includes a 2.5% conservation buffer)
under Basel III.
• Indian situation
• Indian public sector banks must maintain a CAR of 12%
while Indian scheduled commercial banks are required
to maintain a CAR of 9%.
Risk Weighted Assets
• Risk-weighted assets are a bank's assets
weighted according to their risk exposure.
• For example, cash carries zero risk, but there are
various risk weightings that apply to particular
loans such as mortgages or commercial loans
Tier 1 and Tier 2 Capital
• Tier 1 Capital - core funds on hand to manage losses so
that a bank can continue operating (consists of
shareholders' equity and retained earnings) ,

• Tier-2 capital, a secondary supply of funds available from

the sale of assets once a bank closes down (revaluation
reserves, hybrid capital instruments and subordinated
term debt, general loan-loss reserves, and undisclosed
reserves)