Institute of Chartered Financial Analysts of India (ICFAI) University 2006 Certification Finance Management of Financial Institutions - II - Question Paper

Arrangements have to be made for cleaning of computer and other systems by skilled people so that in the process of cleaning the working of the system should not be hampered.

Fifth Principle -"Shitsuke" –Discipline:

We can think of discipline in every thing we do starting from punctuality to dedication and commitment to the work that we are doing.

Believe in the 5S principles and make it a 'Habit' to yield the desired outcomes.

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7. Implementation problems

The steps to be followed are:

· Form a 5S steering committee.

– The Steering Committee is the governing body for all 5S related activities.

– The overall planning, implementation, and review of all activities, is its primary responsibility.

– The committee formulates the Master Implementation/Action Plan, conducts 5S valuation or audits, promotes 5S at all levels of organization. It plans and executes promotional activities. It monitors the progress of the 5S program.

· The steering committee to develop a step-by-step date wise target and action plan.

· Emphasis is laid on Visual Control.

– Monitoring.

– Classifying – chart to provide the location of every file.

– Improving Efficiency—reducing the time to look for an item.

– Differentiating and coordinating—for storage, operations, equipment.

· The committee sets the 5S standards to be achieved in the Bank.

· The committee conducts the 5S audit.

· Sustaining 5S: The 5S activity has to be sustained on a continuous basis. For this, Continuous Improvement Activities (CIP) are to be encouraged in terms of style, work cycle time and overall efficiency. The Steering committee has a crucial role to play in ensuring that the already increased efficiency is further improved and the work place becomes an environment of a ‘movement towards perfection’.

Today, banks are facing stiff and cut-throat competition. To improve its bottom-line, the only viable way is to improve productivity of its work-force as the bank cannot think of either increasing the interest rate on its advances or decrease the rate of interest paid on its deposits.

By implementing the 5S principles on the lines said above, the staff would be happy in the 1st instance as they work in a place which is neat and clean and are in a position to retrieve info with lowest loss of time as every thing is orderly and classified. Due to the discipline brought in by 5S principles, the customers would also be happy since they love to visit the branch again and again and have more dealings and an enduring relationship. These would outcome in ‘Customer Delight’ ultimately leading to increased business and improved bottom-line for the bank.

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Caselet 2

8. In India, RBI draft guidelines describe credit derivatives as:

A financial instrument that permits 1 party (protection buyer) to transfer credit risk of an asset, to a different party (protection seller) without truly selling the asset. Credit derivative is derivative contract that seeks to split the credit risk from a credit product and transfer it from 1 party to 1 or more other parties.

They are usually described as “off-balance sheet financial instruments that permit 1 party to transfer credit risk of a reference asset, which it owns, to a different party without truly selling the asset”. It, therefore, “unbundles” credit risk from the credit instrument and trades it separately. Credit Linked Notes (CLNs), a different form of credit derivative product, also achieves the identical purpose, though CLNs are on-balance sheet products. a different way of describing credit derivative is that it is a financial contract outlining potential exchange of payments in which at lowest 1 leg of the cash flow is linked to the “performance” of a specified underlying credit sensitive asset.

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9. A Credit Linked Note (CLN) is a structured note with fixed income security. When the contract is entered, the issuers pay a periodic interest and principal amount less the lost amount (if the credit event occurs).

The basic design of a CLN is that it pays a coupon and redeems at par given no credit events have occurred on reference entity. If a credit event does occur, the note is redeemed for an amount equal to par minus the loss on the defaulted credit.

In a CLN structure, an Special Purpose Vehicle (SPV) or trust, which is generally set-up by the protection buyer, problems the CLNs and the proceeds from these notes are again reinvested in highly rated government bonds. However, if required, the CLN can also get rated by a reputed credit rating agency.

The CLN is a combination of both regular note and a credit choice. Since it is a regular note, it has coupon, maturity, redemption and it is considered to be an on balance sheet item. Most important point to be noted is, in the structure, the coupon or the principal of the note is linked to the performance of a credit event. It offers lenders (i.e., bank) a hedge against the credit risk and investors a higher yield for buying this credit exposure compared to buying a publicly traded debt, thereby, creating a win-win situation for all the players involved in this transaction. Generally, the CLNs are routed through a trust or Special Purpose Vehicle (SPV), which again collateralizes with highly rated securities. Investors buy the notes issued by SPV or trust which pays coupon collected from collateral return plus the premium during the life of the note.

At the maturity of the note, the investors will receive the entire amount if no credit event occurs, but if it does, then, the investors will get the par amount less the default amount. Thereby, the investors are acting as protection sellers, where they are selling credit protection to banks in exchange for a very high yield. Thus, the CLNs allow a bank to lay-off its credit exposure to other parties.

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10. Impediments for Credit Derivatives in India

In India, derivatives market is still in introduction stages but has arrived in a developing country like India much faster than expected and is very slowly gaining momentum. But, there are certain key problems which need special attention. They include:

· Investor education: The participation of retail investors is almost insignificant. They are needed to be more educated on the problem.

· Absence from the seller side: In the Indian context, the seller side market is absent. For the segment to develop there comes the role of the government and other regulatory bodies, as they can aid the development of a credit derivative market by providing impetus in the needed areas.

· Absence of separate and matured debt market: The absence of a matured debt market with less liquidity creates a issue for the growth of derivatives as liquidity and quantities of trade is very important for the derivatives market.

· The role of SPV: The use of Special Purpose Entity as a conduit is yet to become popular in India.

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Caselet 3

11. The fundamental flaw in Basel I was, that it was only dealing with the credit risk and knowingly ignored the market and operational risk exposures of banks. Further, the "one size fits all" or "Broadbrush" approach of Basel I, i.e., applying the identical risk weight to all claims against a category of counterparties was highly misleading. For example, all Governments were provided a risk weight of zero, all banks 20% and all corporates 100% irrespective of their underlying risk. The capital cushion thus found was, therefore, not adequate to give safeguard in an increasingly risk driven world full of innovative banking products and the market and operational risk exposures of banks.

Under the revised Basel Capital Accord, loans to small businesses (i.e., SMEs) generally fall in the 100% risk-weight category. If banks prefer to rate these with the help of credit rating agencies, the maximum risk weight for a highly risky SSI could be 150%. But in that case it is possible that the banks have the choice of not rating them and assigning them a maximum risk weight of 100% meant for unrated category, although RBI says that as part of the supervisory review process, the Reserve Bank would also consider whether the credit quality of unrated corporate claims held by individual banks should warrant a standard risk weight higher than 100%.

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12. As per the guidelines, claims that meet all the 4 criteria listed beneath may be included in a regulatory retail portfolio and assigned a risk-weight of 75%.

(i) Orientation criterion - The exposure is to an individual person or persons or to a small business; Small business is 1 where the total annual turnover is less than Rs. 50 cr

(ii) Product criterion - The exposure takes the form of any of the following: revolving credits and lines of credit (including credit cards and overdrafts), personal term loans and leases and small business facilities and commitments.

(iii) Granularity criterion - Banks must ensure that the regulatory retail portfolio is sufficiently diversified to a degree that decreases the risks in the portfolio, warranting the 75% risk weight.

(iv) Low value of individual exposures - The maximum aggregated retail exposure to 1 counterpart should not exceed the threshold limit of rupees 1 crore to 5 crores depending on the total capital of the bank.

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Earning:   Approval pending.