Prepared by

M SANDEEP REDDY(PF: 6534759)

m.reddy3@sbi.co.in

It is a material of BANK FINANCIAL MANAGEMENT. This

contains questions asked in previous question papers
and some expected questions. It may help CAIIB
aspirants to revise the subject before exam

Prepared by
M SANDEEP REDDY (JAIIB, CAIIB)
PF: 6534759
Email: m.reddy3@sbi.co.in
Prepared by
M SANDEEP REDDY(PF: 6534759)
m.reddy3@sbi.co.in

BANK FINANCIAL MANAGEMENT

 In terms of RBI guidelines, interest on FCNR deposits is payable at
prevailing LIBOR plus 200bps for a period of 1 year to less than 3
years and LIBOR plus 300 bps for a period of 3 years to 5 years
 Nostro account – “Our account with You”
 Vostro account – “Your account with Us”
 Loro account – “his account with them”
 A dealer has to maintain two positions – funds position and
currency position
 In Forex market all rates quoted are generally Spot Rates
 Export bills drawn in foreign currency, purchased/discounted,
must be crystallized into rupee liability, in case of delay in
realization of export bills which would be done at TT selling rate
 In terms of FEDAI rules, the effective date of realization of an
export bill is the date of credit in the banks’s ‘nostro’ account in
case of Foreign Currency bills, and in case of Rupee bills the
effective date of realisation is the date of debit in the ‘vostro’
account
 There are 5 parties to any forfaiting transaction
 External Commercial Borrowings(ECBs) can be availed under
Automatic or Approval Route
 Systemic risk is the failure of the whole banking sytem
 Tier 1 capital is also called Core capital
 Tier 2 capital is also called Supplementary capital
 Treasury bill is issued weekly on each Wednesday
Prepared by
M SANDEEP REDDY(PF: 6534759)
m.reddy3@sbi.co.in

 The multiplier effect reduces the importance of currency in

circulation
 Liquidity Adjustment Facility(LAF) is used to monitor day-to-day
liquidity in the market
 Mirror account is the shadow account of Nostro account
 Chips – USA
 Fedwire – USA
 Chaps – LONDON
 Target – EUROPE
 Red Clause LC enables the beneficiary to avail pre-shipment credit
from the nominated/advising bank
 The publication no.600 of ICC, is the latest version of UCPDC and
was made effective 1 July 2007
 Stand by Letter of Credit are a substitute of guarantees
 In India, Export trade is regulated by Directorate General of
Foreign Trade(DGFT) which functions under Ministry of
Commerce and Industries
 The settlement of the Cash Management Bills(CMB) auction is on
T+1 basis
 FEDAI requires banks to undertake profit/loss evaluation of forex
positions at the end of each month
 Only in case of GBP(Great Britain Pound), Euro, AUD(Australian
Dollars) and NZD(Newzealand Dollars), the currencies are quoted
as indirect rates
Prepared by
M SANDEEP REDDY(PF: 6534759)
m.reddy3@sbi.co.in

 All currencies are quoted as per unit of foreign currency = INR,

while JPY, Indonesian Rupiah & Kenyan Shilling are to be quoted
as 100 units of foreign currency
 The Chicago Mercantile Exchange introduced the world’s first
exchange traded currency future contract
 NRIs are not permitted to make investments in Small Savings
Schemes, including PPF
 In India, Export Trade is regulated by Directorate General of
Foreign Trade(DGFT)
 In India, export credit is guaranteed by ECGC(Export Credit
Guarantee Corporation) of India
 ECGC of India classifies the country into seven categories:
i)Insignificant Risk – A1
ii)Low Risk – A2
iii)Moderately Low Risk – B1
iv)Moderate Risk – B2
v)Moderately High Risk – C1
vi)High Risk – C2
vii)Very High Risk – D
 The unspent foreign exchange can be deposited by the resident in
the Resident Foreign Currency Account(RFCD), with any
authorized dealer
 SWIFT has introduced new system of authentication of messages
between banks replacing Bilateral Key Exchange with RMA. RMA
stands for Relationship Management Application
Prepared by
M SANDEEP REDDY(PF: 6534759)
m.reddy3@sbi.co.in

 In the case of country risk, banks will adopt the country risk
classification given by ECGC
 A zero coupon deposit of Rs.5000 is to be doubled in 5 years by
investing in a 5-year bond at an annual coupon of 10%. Here bank
is facing Reinvestment risk
 All assets in the banking book are generally held until maturity
 Model risk is a type of operational risk
 CCIL undertakes settlement in various instruments generally on
Net basis

Business Line Beta Factors:

i)Payment and Settlement – 18%

ii)Trading and sales – 18%

iii)Corporate Finance – 18%

iv)Commercial banking – 15%

v)Agency Services – 15%

vi)Retail Banking – 12%

vii)Asset Management – 12%

viii)Retail Brokerage – 12%

 As per FEDAI, all foreign currency inward remittances upto an

equivalent amount of USD 5000 shall be immediately converted
into Indian rupees
Prepared by
M SANDEEP REDDY(PF: 6534759)
m.reddy3@sbi.co.in

 When the Indian markets are about to close, the New York
market is about to begin its day
SMA Sub Basis for Classification
Categories
SMA-0 Principal or interest payment not overdue for more than 30 days but
account showing signs of incipient stress
SMA-1 Principal or interest payment overdue between 31-60 days
SMA-2 Principal or interest payment overdue between 61-90 days

 The Tier 1 Capital should be in the nature of Going-Concern

Capital, i.e., capital which can absorb losses without triggering
bankruptcy of the bank
 The Tier 2 Capital should be in the nature of Gone-Concern
Capital, i.e., capital which would absorb losses only in a situation
of liquidation of the bank
 The supplier’s credit extended by the overseas supplier, for a
period of more than six months from the date of shipment and
upto less than 3 years has been termed as Trade Credit
 Any credit extended for three years or more shall be in the
category of External Commercial Borrowings(ECBs)
 Foreign Tourists who are on a short visit to India on tourist visa
can open Non-Resident Ordinary Rupee Account(NRO)
 In a Letter of Credit, an invoice is a commercial document
 In a perfect market, with no restrictions on finance and trade, the
interest factor is the basic factor in arriving at the forward trade
 Forex markets are highly dynamic
Prepared by
M SANDEEP REDDY(PF: 6534759)
m.reddy3@sbi.co.in

 The exchange rates of major currencies fluctuate every four

seconds which effectively means it registers 21600 changes in a
day

Business Lines Sub-groups Activities

Corporate Finance Corporate finance, Mergers and acquisitions,
Municipal/Govt. underwriting, privatizations,
finance, Merchant securisitations, research, govt.
Banking Advisory debts, debt & equity
Services syndications, IPO, secondary
private placements
Trading and Sales Sales, Market making, Fixed income, equity, foreign
Prorietary positions, exchanges, commodities, credit,
Treasury Prime funding, own position securities,
Brokerage lending and repos, brokerage,
debt
Retail Banking Retail Banking Retail lending and deposits,
banking services, trust and sales
Private Banking Private Lending and Deposits, banking services, trust
Card Services and estates, investment advice
merchant/commercial/corporate
cards, private labels and retail
Commercial Banking Commercial Banking Project finance, real estate,
export finance, trade finance,
factoring, leasing, lending,
guarantees, bills of exchange
Payments and External Clients Payments and collections, funds
Settlement transfer, clearing and settlement
Agency Services Custody Escrow, depository receipts,
corporate actions Corporate agency securities lending, Issuer and
Corporate trust paying agents
Asset Management Discretionary and non Pooled, segregated, retail,
discretionary fund institutional, closed, open
Prepared by
M SANDEEP REDDY(PF: 6534759)
m.reddy3@sbi.co.in

management
Retail Brokerage Retail Brokerage Execution and full service

 In 1957 the Government of India established Export Risks

Insurance Corporation(ERIC) to provide credit risk insurance to
exporters, which was then transformed to Export Credit
Guarantee Corporation Ltd in 1964
 Cash Management Bills are issued for maturities less than 91 days
 The risk that the interest rate of different assets, liabilities and off-
balance sheet items may change in different magnitude is termed
as basis risk
 The risk arising owing to non-enforceability of contract against a
counterparty is the Legal Risk

Export Declaration Forms

GR form Exports made otherwise than by post
PP form Exports made by post parcel
SOFTEX form Export of software in non-physical form
SDF form With the introduction of Electronic Data
Interchange(EDI) system at certain Customs offices,
where shipping bills are processed electronically, the
GR form has since been replaced by a declaration in
form SDF(Statutory Declaration Form)

 All export bills, remaining unrealized beyond 6 months from the

date of export, should be reported in XOS statement to RBI, on
half yearly basis
Prepared by
M SANDEEP REDDY(PF: 6534759)
m.reddy3@sbi.co.in

Prudential Limits for Transactions in Call/Notice Money Market

Sr. Participant Borrowing Lending
No.
1 Scheduled On a fortnightly average basis, On a fortnightly average basis,
Commercial borrowing outstanding should lending outstanding should not
Banks not exceed 100 per cent of exceed 25 per cent of their capital
capital funds (i.e., sum of Tier I funds. However, banks are allowed
and Tier II capital) of latest to lend a maximum of 50 per cent
audited balance sheet. of their capital funds on any day,
However, banks are allowed to during a fortnight.
borrow a maximum of 125 per
cent of their capital funds on
any day, during a fortnight.
2 Co-operative Outstanding borrowings of State No limit.
Banks Cooperative Banks/District
Central Co-operative Banks/
Urban Co-operative Banks in
call/notice money market, on a
daily basis should not exceed 2.0
per cent of their aggregate
deposits as at end March of the
previous financial year.
3 PDs PDs are allowed to borrow, on PDs are allowed to lend in
average in a reporting fortnight, call/notice money market, on
up to 225 per cent of their net average in a reporting fortnight, up
owned funds (NOF) as at end- to 25 per cent of their NOF.
March of the previous financial
year.

 Treasury activity is highly leveraged

 RBI has permitted banks to borrow and invest through their
overseas correspondents in foreign currency subject to a ceiling of
100% of their Tier-1 capital or USD 10 million whichever amount
is higher
 CRILC- Central Repository of Information on Large Credits
Prepared by
M SANDEEP REDDY(PF: 6534759)
m.reddy3@sbi.co.in

 RBI has set up a Central Repository of Information on Large

Credits(CRILC) to collect, store and disseminate credit data to
lenders
 Banks investments are classified into Held till Maturity(HTM),
Available for Sale(AFS) and Held for Trading(HFT)
 RBI, at its discretion, can increase or decrease the SLR, subject to
a cap of 40%
 Borrowers are required to submit duly certified Form 83, which
also contains terms and conditions of the ECB, to obtain Loan
Registration Number(LRN) from RBI
 INFINET has been developed by IDRBT
 Liquidity Coverage Ratio = (Stock of HQLA / Total Net cash
outflows over the next 30 calendar days) x 100

Commercial paper:

 Minimum Maturity: 7 days

 Maximum Maturity: 1 year
 Corporates, primary dealers and financial institutions are eligible
to issue commercial paper
 Banks are permitted to invest in CP only if it is in demat form
 The issue of CP should be for a minimum amount of Rs.5 lacs
 As per RBI guidelines, the principal requirements are: i) the issuing
company should have minimum credit rating of P2 ii) net worth as
per last balancesheet must not be below Rs.4 cr iii) any advances
from bank must be under standard asset classification of the bank
Prepared by
M SANDEEP REDDY(PF: 6534759)
m.reddy3@sbi.co.in

Certificates of Deposit(CD):

 CD is primarily meant for high net worth individuals, the minimum

amount of deposit being Rs.1 lac and period of maturity may
range between 15 days and 1 year. It is more expensive to the
bank, as the CD attracts stamp duty

Cash Management Bills(CMBs):

i) CMBs are issued for maturities less than 91 days

ii) The settlement of the auction is on T+1 basis
 The value of a derivative is determined by the value of the
underlying
 In Indian Rupee market only plain vanilla type swaps are
permitted
 The option is known to be at-the-money(ATM) if the strike price
is same as the spot price of the currency
 The option is in-the-money(ITM) if the strike price is less than the
forward rate in case of a call option or if the strike price is more
than the forward rate in case of a put option
 The option is out-of-money(OTM) if the strike price is more than
the forward rate in case of a call option or if the strike price is less
than the forward rate in case of a put option
 Tier III capital will be limited to 250% of bank’s Tier I capital that is
required to support market risk. This means that a minimum of
about 28.5% of market risk needs to be supported by Tier I capital
Prepared by
M SANDEEP REDDY(PF: 6534759)
m.reddy3@sbi.co.in

 Protection of risk in a transaction usually through derivative

products is called hedge
 For the organization point of view treasury is considered to be
service centre
 Treasury bills are issued by Government of India(GoI)
 The Altman’s Z Score forecasts the probability of a company
entering bankruptcy within a 12-month period
 Securitisation refers to a transaction where financial securities
are issued against the cash flow generated from a pool of assets
 Balances held in the Nostro accounts do not earn any interest
 All repo settlements are routed through Clearing Corporation of
India Ltd(CCIL)
 The treasury is segregated into three main divisions: Front
Office(Dealing Room), Back Office(Treasury Administration) and
Mid Office(Risk Management)
 The Front office generates deals with counter-party banks
(purchase and sale of foreign exchange, securities etc & lending
and borrowing operations)
 The Back office is responsible for confirmation, accounting and
settlement of the deals
 The Mid office is responsible for risk management and
management information systems(MIS)
 Stop loss limits represent the final stage of controlling trading
operations
 Market risk is also known as price risk
Prepared by
M SANDEEP REDDY(PF: 6534759)
m.reddy3@sbi.co.in

 The three main components of market risk are liquidity risk,

interest rate risk and currency risk
 Carry refers to interest cost of funds locked in a trading position
 Options are divided into two types according to their mode of
settlement. An American type option can be exercised any time
before the expiry date. European type option can be exercised
only on the expiry date. In India we use only European type of
options
 An option without any conditionalities is called Plain vanilla
option
 A proportion per thousand is called as per mile
 The ultimate responsibility for designing and implementation of
ICAAP lies with Bank’s board of directors
 Arbitrage is an operation by which one can make risk free profit
by undertaking offsetting transactions
 Operations in forex carried to cover the risk of fluctuations in
forex rates is called as Hedging
 The value of the currency is decided by supply and demand
factors for a particular currency under floating exchange rate
 FEDAI is a non-profit making body, established in 1958, with the
approval of RBI
 Beneficiary of inward remittance should be compensated in case
the proceeds are not paid within 10 days from the date of receipt
of remittance, or an advice of receipt is not sent within 3 days.
Such compensation will be at 2% p.a over the savings bank rate
 Speculative deals provide depth and liquidity to the market
Prepared by
M SANDEEP REDDY(PF: 6534759)
m.reddy3@sbi.co.in

 Entities authorized to buy and sell foreign currency notes, coins

and traveller’s cheques are called Full Fledged Money Changers
(FFMCs) while those authorized only to buy are called Restricted
Money Changers(RMCs)
 FEDAI prescribes code of conduct for forex dealers
 Settlement risk is the risk of failure of the counter party during
the course of settlement, due to the time zone differences,
between the two countries to be exchanged
 Pre-settlement risk is the risk of failure of the counter party
before maturity of the contract
 The Tier II capital is limited to a maximum of 100% of Tier I capital
 Premature payment of a term loan will result in Embedded option
risk
 Portfolio risk is called the risk at aggregated level
 VaR is not enough to assess market risk of a portfolio. Stress
testing is desirable because it helps in assessing risk due to
abnormal movement of market parameters
 The risk of settlement that arises from time-difference came to be
known as Herstatt Risk
 The International Chamber of Commerce(ICC) was established in
1919 at Paris
 Exchange Earners Foreign Currency(EEFC) account is non interest
bearing current account
Prepared by
M SANDEEP REDDY(PF: 6534759)
m.reddy3@sbi.co.in

Countries under Asian Clearing Union:

i) Bangladesh
ii) Myanmar
iii) Islamic Republic of Iran
iv) Pakistan
v) Srilanka
vi) Nepal
vii) Maldives
 A small exporter is defined as an exporter whose anticipated total
export turnover for the period of 12 months ahead is not more
than Rs.50 lacs
 Export Turnover policy is for the benefit of large exporters who
contribute not less than Rs.10 lacs per annum towards premium
 A Large Exposure is defined as any exposure to a counter party or
group of counter parties which is equal to 10% of bank’s eligible
capital base(defined as Tier I capital)
 The sum of all the exposure values of a bank to a single
counterparty must not be higher than 20% of the bank’s available
eligible capital base at all times
 The sum of all the exposure values of a bank to a group of
connected counterparties must not be higher than 25% of the
bank’s available eligible capital base at all times
 If the realizable value of security is less than 50% of the value
assessed by the bank then such account is classified under
doubtful category
Prepared by
M SANDEEP REDDY(PF: 6534759)
m.reddy3@sbi.co.in

 If the realizable value of security is less than 10% of the

outstanding in the borrowal accounts, the existence of security
should be ignored and the asset should be classified as loss asset
 The Basel Committee on Banking Supervision(BCBS) has published
13 principles under “Principles for Sound Liquidity Risk
Management and Supervision”
 As per the Basel II norms, total capital ratio should not be lower
than 8%
 The primary function of Treasury is to manage liquidity to meet
CRR requirement
 Front office is headed by Chief Dealer
 Downside potential only captures possible losses ignoring profit
potential
 Volatility captures both upside and downside deviations
 The key driver in managing a business is seeking enhancement in
Risk Adjusted Return on Capital(RAROC)

Six Core promoters of CCIL:

i) State Bank of India

ii) Industrial Development Bank of India
iii) ICICI Ltd
iv) Life Insurance Corporation of India
v) Bank of Baroda
vi) HDFC Bank
Prepared by
M SANDEEP REDDY(PF: 6534759)
m.reddy3@sbi.co.in

 The Treasury’s transactions with customers are known as

Merchant business
 Treasury plays three distinct roles:
a) Liquidity Management
b) Proprietary positions
c) Risk Management
 Foreign Exchange Management Act of India(FEMA) of 2000 has
replaced the earlier Foreign Exchange Regulation Act(FERA)
 The process of integrating domestic market with global markets,
characterized by free capital flows and minimum regulatory
intervention is called globalization
 The principal factor contributing to integration of treasury activity
is globalization
 The treasury is run by a few specialist staff, engaged in high-value
transactions, per transaction size generally not being below Rs.50
million
 The operational costs in Treasury are low as compared to branch
banking, whether retail or wholesale
 Any residual position of a bank at the end of day- overbought or
oversold is known as ‘open’ position
 Treasury will maintain an ALM Book, a Merchant Book and a
trading Book
 Speculation is buying or selling an asset only for the purpose of
making profit from movement of the asset price over a period of
time
Prepared by
M SANDEEP REDDY(PF: 6534759)
m.reddy3@sbi.co.in

 Collateralised Borrowing and Lending Obligation(CBLO) is a money

market instrument launched by Clearing Corporation of India
Ltd(CCIL) with original maturity of 1 day to 1 year
 91-day T-bill is issued weekly on each Wednesday, 182-day T-bill
is issued fortnightly on Wednesday preceding non-reporting
Friday and 364-day T-bill is also issued fortnightly on Wednesday
preceding reporting Friday
 Debenture may be convertible or non convertible
 Government Securities are issued by Public Debt Office of
Reserve Bank of India on behalf of Government of India
 Conventional banking operation in money market was confined to
lending surplus and borrowing funds when required
 Trading is a speculative activity
 VaR is most commonly used to measure overnight risk, or risk
over short periods, say, over 1 month
 All the free markets are highly susceptible to speculation
 Treasury largely operates in inter bank markets which are almost
free of credit risk
 The treasury activity is highly leveraged – the risk capital allocated
to Treasury may range between 2% to 5% of size of transactions
handled, hence the return on capital is quite high
 FX Clear is a forex dealing system developed by CCIL for foreign
exchange transactions
 The risk of losing capital is much higher in Treasury than credit
business
Prepared by
M SANDEEP REDDY(PF: 6534759)
m.reddy3@sbi.co.in

 Treasury has a very low funding requirement, which we call as

high leverage
 Transactions, once confirmed in treasury, are irrevocable – hence
no corrective action is possible
 The participants in the derivatives market generally exchange
ISDA agreement
 Minimum capital requirement for the domestic and foreign banks
is prescribed by Reserve Bank of India
 Liabilities and net worth form the sources of the bank funds
whereas assets represent uses of funds to generate revenue for
the bank
 The heart of bank financial management is risk management
 Asset Liability management is the act of planning, acquiring and
directing the flow of funds through an organization
 The strategy of actively managing the composition and mix of
assets and liabilities portfolio is called balance sheet restructuring
 Economic equity ratio is the ratio of the shareholder funds to the
total assets
 Capital is a cushion to protect the bank from an extremely
unfavorable outcome
 The loss absorption capacity of Tier II capital is lower than that of
Tier I capital
 In India Banks are required to maintain minimum 9% CRAR
 The Basel II capital requirements apply to ‘internationally active’
banks
Prepared by
M SANDEEP REDDY(PF: 6534759)
m.reddy3@sbi.co.in

 Short term bond must have an original maturity of atleast 2 years

 Currency and interest rate swaps with basic structure, without
inbuilt options or knock out levels is called Plain Vanilla type
swap
 The tenor of dated government securities can be upto 30 years
 STRIPS are instruments where in each cash flow of the fixed
coupon security is converted into a separate tradable Zero
coupon bond and traded
 Minimum amount of securities that needs to be submitted for
stripping/reconstitution will be Rs.1 crore and multiples there of
 Banks are required to review the Base rate atleast once in a
quarter with the approval of board or the Asset Liability
Management Committees(ALCOs)
 At macro level, Asset Liability Management involves the
formulation of critical business policies, efficient allocation of
capital and designing of products with appropriate pricing
strategies
 At micro level the Asset Liability Management aims at achieving
profitability through price matching while ensuring liquidity by
means of maturity matching
 Banks are required to report credit information, including
classification of an account as SMA to CRILC on all their borrowers
having aggregate fund based and non fund based exposure of
Rs.50 million and above with them(Rs.5 crores). However crop
loans are exempted from such reporting but banks should
continue to report their other agriculture loans