STUDY MATERIAL PROFESSIONAL PROGRAMME BANKING LAW AND PRACTICE MODULE ELECTIVE PAPER 9.1 ICSI House, 22, Institutional Area, Lodi Road, New Delhi 110 003 tel 011-4534 1000, 4150 4444 fax +91-11-2462 6727 email info@icsi.edu website www.icsi.edu i © THE INSTITUTE OF COMPANY SECRETARIES OF INDIA TIMING OF HEADQUARTERS Monday to Friday Office Timings – 9.00 A.M to 5.30 P.M Public Dealing Timings Without financial transactions – 9.30 A.M to 5.00 P.M With financial transactions – 9.30 A.M to 4.00 P.M Phones 41504444, 45341000 Fax 011-24626727 Website www.icsi.edu E-mail info@icsi.edu Laser Typesetting by AArushi Graphics, Prashant Vihar, New Delhi, and Printed at Tan Prints ii BANKING LAW AND PRACTICE Company Secretaries have a pivot role to play in the Banking and Financial Sector A Company Secretary can work as a compliance officer in a banking and financial institution and play an important role in ensuring compliance to complicated legal, regulatory and supervisory issues all the time, transcending various spheres of banking operations So, in order to build the capacity of Companies Secretaries to work as a compliance officer in Banks and to provide them a specialized knowledge in Banking laws and practice, a paper on Banking Laws and Practice has been added as an elective paper The students who want to pursue their career in Banking and financial sector may chose this subject The syllabus and content of this paper has been developed in joint association of Indian Institute of Banking and Finance and the syllabus covers most of the aspects from gamut of banking The objective of including this paper is to give a specialized knowledge of law and practice relating to banking An attempt has been made to cover fully the syllabus prescribed for each module/subject and the presentation of topics may not always be in the same sequence as given in the syllabus Candidates are also expected to take note of all the latest developments relating to the subjects covered in the syllabus by referring to RBI circulars, financial papers, economic journals, latest books and publications in the subjects concerned Although due care has been taken in publishing this study material, yet the possibility of errors, omissions and/ or discrepancies cannot be ruled out This publication is released with an understanding that the Institute shall not be responsible for any errors, omissions and/or discrepancies or any action taken in that behalf Should there be any discrepancy, error or omission noted in the study material, the Institute shall be obliged if the same are brought to its notice for issue of corrigendum in the Student Company Secretary In the event of any doubt, students may write to the Directorate of Academics and Perspective Planning in the Institute for clarification at blap@icsi.edu and sudhir.dixit@icsi.edu iii SYLLABUS MODULE III, ELECTIVE PAPER 9.1: Banking Law and Practice (100 Marks) Level of Knowledge: Expert Knowledge Objective: To acquire specialized knowledge of law and practice relating to Banking Detailed Contents: Overview of Banking System Regulatory Framework and Compliances A Provisions of RBI Act 1935, Banking Regulation Act 1949, Prevention of Money Laundering Act, 2002 B Government and RBI’s Powers Opening of New Banks and Branch Licensing Constitution of Board of Directors and their Rights Banks Share Holders and their Rights CRR and SLR Concepts CashCurrency Management Winding up - Amalgamation and Mergers Powers to Control Advances - Selective Credit Control – Monetary and Credit Policy Audit and Inspection Supervision and Control - Board for Financial Supervision – its Scope and Role Disclosure of Accounts and Balance Sheets Submission of Returns to RBI, Corporate Governance Legal Aspects of Banking Operations Case Laws on Responsibility of Paying and Collecting Banker Indemnities or Guarantees - Scope and Application – Obligations of a Banker - Precautions and Rights - Laws relating to Bill Finance, LC and Deferred Payments - Laws Relating to Securities - Valuation of Securities - Modes of Charging Securities Lien, Pledge, Mortgage, Hypothecation etc - Registration of Firms/Companies - Creation of Charge and Satisfaction of Charge Banking Related Laws Law of Limitation - Provisions of Bankers Book Evidence Act -Special Features of Recovery of Debts Due to Banks and Financial Institutions Act, 1993 TDS Banking Cash Transaction Tax Service Tax, Asset Reconstruction Companies, The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, The Consumer Protection Act, 1986, Banking Ombudsman Lok Adalats, Lender’s Liability Act Banker - Customer Relations The legal relationship between the Banker and Customer, the Multifarious Transactions between them and the Rights and Duties of the Parties springing out of such relationship Nature of Banking Business Legal Nature of Banker-Customer Relationship and their Mutual Rights and Duties Special Categories of Customers, such as Corporations, Partnership Firms, Hindu Joint Families, Unincorporated Bodies, Trusts, Joint Account Holders, Minors, Nominee Accounts, Liquidator, Mercantile Agents, Non-Resident Indians, Foreigners and the Legal Incidence of Each Different Types of Accounts such as Current Accounts, Savings Bank Account and Fixed Deposits Other Transactions between Banker and Customer such as Safe Deposit Vaults, Financial Advice, Letters of Introduction and Other Services Rendered by Banks Special features of the relationship between banker and customer - Their mutual rights and duties - lien - Power to combine different accounts - Secrecy of account iv Loans and Advances Law, Practice and Policies governing the employment of the funds in the hands of the banker with special reference to the lending banker State Policy on Loans and Advances - Priority sector advances and socioeconomic policies - Financial inclusion - Self- Employment Schemes - Women Entrepreneurs - Small Scale Industries - Agricultural Finance, Export Finance, etc – Micro Finance - How the banker profitably uses the fund - Call loans and loans repayable at short notice - Loans and advances - Overdrafts - Legal control over bank’s deployment of funds Securities for Banker’s Loans The legal issues involved in and the practice governing the different kinds of securities for banker’s advances and loans Guarantees, pledge, lien, mortgage, charge – subject matters of collateral security Corporate Securities Documents of title to goods Land and Buildings Book debts Life Policies Factoring; Bill Discounting; Bank Guarantees; Letters of Credit; Commercial Papers Financial Analysis of Banks Introduction; Role of financial analysis in financial management; Techniques of Financial Analysis; DuPont Model of Financial Analysis; Special issues in Financial Analysis of Banking Industry Financial System Contemporary and Emerging Issues: An Overview Introduction; Role of Financial System; Capital Flow Through Intermediary Financial Institutions; Direct Capital Flow; Primary Market Products; Primary Market Issue Facilitators; Secondary Market; Economic Importance of Financial Markets 10 International Banking Management International Banking: An Overview, Legal & Regulatory Framework, International Banking Operations Management, Risk Management in International Banking, Special Issues: Technology and International Banking; Globalisation and International Banking; Financial Innovations in International Banking 11 Electronic Banking and IT in Banks IT in Banking: An Introduction IT Applications in Banking- Computer-Based Information Systems for Banking; Electronic Banking; Electronic Fund Management, Enabling Technologies of Modern Banking- Electronic Commerce and Banking; Supply Chain Management; Customer Relationship Management; Integrated Communication Networks for Banks Security and Control Systems - Cybercrimes and fraud management Planning and Implementation of Information Systems 12 Risk Management in Banks Risk Management: An Overview, Credit Risk Management, Liquidity and Market Risk Management, Operational Risk Management, Special Issues- Risk Management Organisation; Reporting of Banking Risk; Risk Adjusted Performance Evaluation Basel III 13 Ethics and Corporate Governance in Banks Ethics and Business, Corporate Governance, Corporate Social Responsibility, Governance in Financial Sector v LIST OF RECOMMENDED BOOKS MODULE ELECTIVE PAPER 9.1 : BANKING LAW AND PRACTICE The students may refer to the given books and websites for further knowledge and study of the subject : READINGS M.L.Tannan, revised by : Banking Law and Practice, Wadhwa & Company, Nagpur C.R Datta & S.K Kataria A.B Srivastava and K Elumalai : Seth’s Banking Law, Law Publisher’s India (P) Limited R.K Gupta : BANKING Law and Practice in Vols.Modern Law Publications Prof Clifford Gomez : Banking and Finance - Theory, Law and Practice, PHI Learning Private Limited J.M Holden : The Law and Practice of Banking, Universal Law Publishing vi ARRANGEMENT OF STUDY LESSONS Study Lesson No Topic Overview of Banking System Regulatory Framework and Compliances Legal Aspects of Banking Operations Banking Related Laws Banker - Customer Relations Loans and Advances Securities for Banker’s Loans Financial Analysis of Banks Financial System Contemporary and Emerging Issues: An Overview 10 International Banking Management 11 Electronic Banking and IT in Banks 12 Risk Management in Banks 13 Ethics and Corporate Governance in Banks Annexures vii CONTENTS FINANCIAL, TREASURY AND FOREX MANAGEMENT LESSON OVERVIEW OF BANKING SYSTEM Indian Banking System – Evolution Reserve Bank of India as a Central Bank of the Country State Bank of India and Its associate (Subsidiaries) Banks Nationalization of Banks Regional Rural Banks Local Area Banks New Private Sector Banks Different Types of Banks in India Commercial Banks Co-Operative Banking System National Bank for Agriculture and Rural Development (NABARD) Small Industries Development Bank of India (SIDBI) National Housing Bank (NHB) 10 Export Import Bank of India (EXIM Bank) 10 Functions of Commercial Banks 11 LESSON ROUND UP 12 SELF TEST QUESTIONS 12 LESSON REGULATORY FRAMEWORK AND COMPLIANCES Reserve Bank of India Act, 1934 16 Banking Regulation Act, 1949 16 Setting Up of a New Bank 18 Branch Licensing 19 Branch Authorisation Policy for Commercial Banks 19 New Bank Licensing Policy, 2013 20 Banks’ Share Holders and their Rights 23 Cash Reserve Ratio 24 Statutory Liquidity Ratio (SLR) 26 Currency Chests 28 Currency Printing and Coin Minting 28 viii Page Quantitative/General Credit Control 29 Selective Credit Control 30 RBI as a Controller of foreign Exchange 31 RBI as Banker to the Government 31 RBI as Lender of the Last Resort 31 Monetary and Credit Policy 32 Audit and Inspection of Banking Company 32 Supervision and Control of Banking Companies 34 Board for Financial Supervision 34 Winding Up – Amalgamation and Mergers of Banks 34 Reserve Bank as Liquidator 35 Disclosure of Accounts and Balance Sheets of Banks 36 Submission of Returns to RBI 42 Fraud – Classification and Reporting 43 Corporate Governance 47 Effective Corporate Governance Practices 48 Corporate Governance in Banks 48 Prevention of Money Laundering Act, 2002 (PMLA) 48 Banking Codes and Standards Board of India (BSCSBI) 50 The Banking Ombudsman Scheme 51 LESSON ROUND UP 53 SELF TEST QUESTIONS 54 LESSON BANKER – CUSTOMER RELATIONSHIP Meaning of a Banking Company 58 Relationship as Debtor and Creditor 60 Banker as Trustee 61 Banker as Agent 62 Obligations of a Banker 63 Pass Book and Statement of Account 67 Precautions to Be Taken By the Banker and the Customer 69 Garnishee Order 70 Rights of the Attaching Creditor 73 Rights of a Banker 73 Exceptions to the Right of General Lien 75 ix Page Right of Set-off 76 Right to Charge interest and incidental Charges, Etc 78 Various Types of Customers 79 Closing of a Bank Account - Termination of Banker-Customer Relationship 82 Various Deposit Schemes 83 Deposits – General 83 Demand Deposits 84 Term Deposits 86 Hybrid Deposits or Flexi Deposits Or Multi Option Deposit Scheme (MODS) 88 Tailor-Made Deposit Schemes 89 Special Schemes for Non-Resident Indians (NRIs) 90 ‘Know Your Customer’ (KYC) Guidelines of the RBI 92 Customer Identification Procedure 93 Customer Identification Requirements 93 Specimen Signature 95 Power of Attorney 96 Closing of a Bank Account - Termination of Banker-Customer Relationship 96 Insurance of Bank Deposits 97 Salient Features of Deposit insurance 97 Nomination 98 Settlement of Claims 98 LESSON ROUND UP 99 SELF TEST QUESTIONS 100 LESSON LEGAL ASPECTS OF BANKING OPERATIONS Introduction 104 Legal aspects of a Cheque 104 Definition of a Cheque 104 Different Types of Cheques 104 Crossing of a Cheque 105 Cheque Crossed Generally 105 Cheque Crossed Specially 105 Payment of Cheque Crossed Generally Or Specially 105 Cheque Bearing “Not Negotiable” 105 Double Crossing 106 x 360 PP-BL&P It may be noted that the purpose underlying the application of haircut is to capture the market-related volatility inherent in the value of exposures as well as of the eligible financial collaterals Where the volatility-adjusted exposure amount is greater than the volatility-adjusted collateral amount (including any further adjustment for foreign exchange risk), banks shall calculate their risk-weighted assets as the difference between the two multiplied by the risk weight of the counterparty Banks have two ways of calculating the haircuts viz (i) Standard supervisory haircuts; using parameters set by the Basel Committee, and (ii) Own estimate haircuts, using banks’ own internal estimates of market price volatility Banks in India shall use only the standard supervisory haircuts for both the exposure as well as the collateral The Standard Supervisory Haircuts (assuming daily mark-to-market, daily re-margining and a 10 business-day holding period), expressed as percentages, are given in detail in the RBI Circular Eligible Financial Collateral in Comprehensive approach Cash, Gold, Securities issued by Central & State Governments, KVP, NSC (no lock in period is operational), LIC policies, Debt securities (rated by a chosen rating agency), Debt Securities ( not rated by a chosen Credit Rating Agency in respect of which banks should be sufficiently confident about the market liquidity), Units of Mutual Funds, etc are eligible financial instruments for recognition in the Comprehensive Approach Calculation of capital requirement For a collateralised transaction, the exposure amount after risk mitigation is calculated as follows: E* = max {0, [E x (1 + He) - C x (1 - Hc - Hfx)]} Where: E* = the exposure value after risk mitigation E = current value of the exposure for which the collateral qualifies as a risk mitigant He = haircut appropriate to the exposure C = the current value of the collateral received Hc = haircut appropriate to the collateral Hfx = haircut appropriate for currency mismatch between the collateral and exposure The exposure amount after risk mitigation (i.e., E*) will be multiplied by the risk weight of the counterparty to obtain the risk-weighted asset amount for the collateralised transaction (Illustrative examples calculating the effect of Credit Risk Mitigation is furnished in the RBI Circular) (e) On Balance Sheet Netting – On-balance sheet netting is confined to loans/advances and deposits Under this technique, banks have legally enforceable netting arrangements involving specific lien with proof of documentation Capital requirement is reckoned on the basis of net credit exposure Banks may calculate capital requirements on the basis of net credit exposures subject to some conditions as listed in the Circular (f) Guarantees – Explicit, irrevocable, and unconditional guarantees may be taken as credit protection in calculating capital requirements Guarantees issued by entities with lower risk weight as compared to the counterparty will lead to reduced capital charges since the protected portion of the counterparty exposure is assigned the risk weight of the guarantor, whereas the uncovered portion retains the risk weight of the underlying counterparty Detailed operational requirements for guarantees eligible for being treated as a CRM are given in the RBI Circular Capital charge for Market Risk Market Risk relates to risk of losses in on-balance sheet and off-balance sheet positions arising on account of movement in market prices The market risk positions subject to capital charge requirement are risks pertaining Annexures 361 to interest rate related instruments in trading books and equities and Foreign Exchange risk (including gold and other precious metals) in both trading and banking books Trading book for the purpose of capital adequacy will include: (g) Securities included under the Held for Trading (HFT) category (h) Securities included under the Available for Sale (AFS) category (i) Open gold position limits (j) Open foreign exchange position limits (k) Trading positions in derivatives, and (l) Derivatives entered into for hedging trading book exposures Banks are required to manage the market risks in their books on an ongoing basis and ensure that the capital requirements for market risks are being maintained on a continuous basis, i.e at the close of each business day Banks are also required to maintain strict risk management systems to monitor and control intra-day exposures to market risks Capital for market risk would not be relevant for securities which have already matured and remain unpaid These securities will attract capital only for credit risk On completion of 90 days delinquency, these will be treated on par with NPAs for deciding the appropriate risk weights for credit risk Measurement of capital charge for Interest Rate Risk The capital charge for interest rate related instruments would apply to current market value of the instruments in bank’s trading book and banks are required to maintain capital for market risks on an ongoing basis by mark to market their trading positions on a daily basis The minimum capital requirement is measured/ expressed in two ways viz (i) Specific Risk charge and (ii) General Market Risk (dealt separately) In view of possible longer holding period and higher risk thereto in respect of debt securities held under AFS category, banks are required to hold capital charge for market risk equal to or greater of the Specific Risk Capital charge or Alternative Total Capital Charge (i) Specific Market Risk The capital charge for specific risk is designed to protect against an adverse movement in the price of an individual security owing to factors related to the individual issuer both short (short position is not allowed in India except in derivatives) and long positions The specific risk charges and Alternative Total Capital Charge for various kinds of exposures are detailed in Tabular Form in the RBI Circular (ii) General Market Risk It relates to charge towards interest rate risk in the portfolio, where long and short position (which is not allowed in India except in derivatives & Central Govt securities) in different securities or instruments can be offset The capital requirements for general market risk are designed to capture the risk of loss arising from changes in market interest rates General Market Risk is the sum of the following four components:(a) The net short (short position is not allowed in India except in derivatives) or long position in the whole trading book; (b) a small proportion of the matched positions in each time-band (the “vertical disallowance”); (c) a larger proportion of the matched positions across different time-bands (the “horizontal disallowance”), and 362 PP-BL&P (d) a net charge for positions in options, where appropriate The Basel Committee has suggested two broad methodologies for computation of capital charge for market risks viz Standardised Method and Internal Risk Management models method of which banks have been advised to adopt Standardised Method as banks have not yet developed their Internal Risk Management system Under the standardised method there are two principal methods of measuring market risk viz a “maturity” method and a “duration” method It has been decided to adopt standardised “duration” method as the same is more accurate method to arrive the capital charge Accordingly, banks are required to measure the general market risk charge by calculating the price sensitivity (modified duration) of each position separately The mechanics under the method - Time band and assumed changes in yield are detailed in the Circular for reference Measurement for capital charge for Equity Risk The capital charge for equities would apply on their current market value in bank’s trading book The Minimum capital requirement, to cover the risk of holding or taking positions in equities in the trading book is detailed in the Circular The instruments covered include equity shares, whether voting or non-voting, convertible securities that behave like equities, for example: units of mutual funds, and commitments to buy or sell equity Capital charge for specific risk (akin to credit risk) will be 11.25% or capital charge in accordance with the risk warranted by external rating of the counterparty, whichever is higher and specific risk is computed on banks’ gross equity positions (i.e the sum of all long and all short equity positions - short equity position is, however, not allowed for banks in India) In addition, the general market risk charge will also be 9% on the gross equity positions These capital charges will also be applicable to all trading book exposures, which are exempted from capital market exposure ceilings for direct investments Specific Risk Capital Charge for banks’ investment in Security Receipts will be 13.5% (equivalent to 150 per cent risk weight) Since the Security Receipts are by and large illiquid and not traded in the secondary market, there will be no General Market Risk Capital Charge on them Measurement of capital charge for Foreign Exchange Risk The bank’s net open position in each currency shall be calculated by summing: (f) The net spot position (i.e all asset items less all liability items, including accrued interest, denominated in the currency in question); (g) The net forward position (i.e all amounts to be received less all amounts to be paid under forward foreign exchange transactions, including currency futures and the principal on currency swaps not included in the spot position); (h) Guarantees (and similar instruments) that are certain to be called and are likely to be irrecoverable; (i) Net future income/expenses not yet accrued but already fully hedged (at the discretion of the reporting bank); (j) Depending on particular accounting conventions in different countries, any other item representing a profit or loss in foreign currencies; (k) The net delta-based equivalent of the total book of foreign currency options The open positions both Foreign exchange and gold are at present risk-weighted at 100% and the capital charge for market risks in foreign exchange and gold open position is 9% These open positions, limits or actual whichever is higher, would continue to attract capital charge at 9% This capital charge is in addition to the capital charge for credit risk on the on-balance sheet and off-balance sheet items pertaining to foreign exchange and gold transactions Measurement of capital charge for Credit Default Swap (CDS) in the trading book, Capital charge for Counterparty Credit Risk, Capital charge for Counterparty Risk for Collaterised Transactions in CDS, Aggregation of the capital Annexures 363 charge for Market Risks, Treatment for Illiquid Positions, Valuation Methodologies, etc are detailed in the RBI Circular for reference Capital charge for Operational Risk Operational risk is termed as the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events This includes legal risk, but excludes strategic and reputational risk Legal risk includes, but is not limited to, exposure to fines, penalties, or punitive damages resulting from supervisory actions, as well as private settlements Measurement Methodologies Three methods for calculating operational risk capital charges in continuum of increasing sophistication and risk sensitivity are provided under NCAF viz (iv) The Basic Indicator Approach (BIA) (v) The Standardised Approach (TSA), and (vi) Advanced Measurement Approach (AMA) Banks are advised, to begin with, to adopt the Basic Indicator Approach (BIA) and RBI would review the capital requirement under BIA for general credibility and in case it is found any laxity, appropriate Supervisory action under Pillar will be considered Under BIA, banks are required to hold capital for operational risk equal to the average positive annual gross income over the previous years In case the gross income for any year is negative or zero, the same should be excluded while calculating the average RBI will initiate necessary supervisory action under Pillar in case the negative gross income distorts banks Pillar I capital charge (the working is illustrated in the RBI Circular) B Supervisory Review and Evaluation Process (SREP) – (Pillar 2) The objective of Supervisory Review Process (SRP) is to:(c) Ensure that banks have adequate capital to support all the risks in their business; and (d) Encourage them to develop and use better risk management techniques for monitoring and managing their risks This in turn would require a well-defined internal assessment process within banks through which they assure the RBI that adequate capital is indeed held towards the various risks to which they are exposed The process of assurance could also involve an active dialogue between the bank and the RBI so that, when warranted, appropriate intervention could be made to reduce the risk exposure of the bank or augment / restore its capital Thus, Internal Capital Adequacy Assessment Process (ICAAP) is an important component of the SRP The main aspects to be addressed under SRP/ICAAP would include:(a) The risks that are not fully captured by the minimum capital ratio prescribed under Pillar 1; (b) The risks that are not at all taken into account by the Pillar 1; and (c) The factors external to the bank The capital adequacy ratio prescribed under Pillar is only the minimum and addresses only the three risks viz credit, market and operation risks, holding of additional capital might be necessary for banks to take care of the possible under-estimation of risks under the Pillar and the actual risk exposure of a bank vis-à-vis the quality of its risk management architecture Some of the risks which are generally exposed to but not fully captured in the regulatory CRAR include:(a) Interest rate risk in the banking book; 364 PP-BL&P (b) Credit concentration risk; (c) Liquidity risk; (d) Settlement risk; (e) Reputational risk; (f) Strategic risk; (g) Risk of under-estimation of credit risk under the Standardised approach; (h) Model risk i.e., the risk of under-estimation of credit risk under the IRB approaches; (i) Risk of weakness in the credit-risk mitigants; (j) Residual risk of securitisation, etc It is, therefore, only appropriate that the banks make their own assessment of their various risk exposures, through a well-defined internal process, and maintain an adequate capital cushion for such risks Banks were advised to develop and put in place, with the approval of their Boards, an ICAA P, in addition to a bank’s calculation of regulatory capital requirements under Pillar 1, commensurate with their size, level of complexity, risk profile and scope of operations The ICAAP was operationalised w.e.f March 2008 by foreign banks and March 2009 by Indian Banks Based on the three mutually reinforcing Pillars i.e Pillar 1, Pillar 2, and Pillar 3, the Basel Committee lays down four key principles under the SRP as under:(e) Banks are required to have a process for assessing their overall capital adequacy in relation to their risk profile and a strategy for maintaining their capital levels (f) Evaluation of banks’ internal capital adequacy assessments and strategies as well as their ability to monitor and ensure their compliance with the regulatory capital ratios by Supervisors (g) Supervisors should expect banks to operate above the minimum regulatory capital ratios and should have the ability to require banks to hold capital in excess of the minimum (h) Supervisors should intervene at an early stage to prevent capital from falling below the minimum levels required to support the risk characteristics of a particular bank and should require rapid remedial action if capital is not maintained or restored The Principles a & c relates to the supervisory expectations while others i.e b & d deals with the role of the supervisors under Pillar This necessitates evolvement of an effective ICAAP for assessing their capital adequacy based on the risk profiles as well as strategies for maintaining their capital levels Pillar also requires the Supervisory authorities to put in place an evaluation process known as Supervisory Review and Evaluation Process (SREP) and to initiate supervisory measures as may be necessary This would also facilitate RBI to take suitable steps either to reduce exposure of the bank or augment/restore its capital Based on the principles, responsibilities have been casted on banks and Supervisors under SREP and based on which banks are expected to operate above the minimum regulatory capital ratios commensurate with their individual risk profiles, etc Under SREP, the RBI will assess the overall capital adequacy through comprehensive evaluation along with Annual Financial Inspection (AFI) based relevant data and ICAAP document being received from banks and available information ICAAP and SREP are important components of Pillar Every bank (except LABs & RRBs) should have an ICAAP both at solo and consolidated levels and the responsibility of designing and implementation of the ICAAP rests with the Board Before embarking on new activities or introducing new products the senior management should identify and review the related risks arising from these potential new products or activities and ensure that the infrastructure and internal controls necessary to manage the related risks are in place Annexures 365 Banks are required to put in place an effective MIS which should provide the board and senior management a clear and concise manner with timely and relevant information concerning their institutions’ risk profile including risk exposure MIS should be capable of capturing limit breaches (concentrations) and same should be promptly reported to senior management, as well as to ensure that appropriate follow-up actions are taken Risk management process should be frequently monitored and tested by independent control areas and internal and external auditors The ICAAP should form an integral part of the management and decision-making culture of a bank The implementation of ICAAP should be guided by the principle of proportionality and RBI expects degree of sophistication in the ICAAP in regard to risk measurement which should commensurate with the nature, scope, scale and the degree of complexity in the bank’s business operations Operational aspects of ICAAP The ICAAP of banks is expected normally to capture the risk universe, viz Credit Risk, Market Risk, Operational Risk, interest rate risk in the banking book, credit concentration risk and liquidity risk Other risks include reputational risk and or business or strategic risk, Off-balance sheet Exposure and Securitisation Risk etc (Various risks are briefly outlined in the RBI Circular) Bank’s risk management process including the ICAAP should be consistent with the existing RBI guidelines on these risks If banks adopt risk mitigation techniques, they should understand the risk to be mitigated and reckoning its enforceability and effectiveness on the risk profile of the bank Sound Stress Testing Practices Stress testing that alerts bank management to adverse unexpected outcomes related to a broad variety of risks and provides an indication to banks of how much capital might be needed to absorb losses should large shocks occur It is an important tool that is used by banks as part of their internal risk management Moreover, stress testing supplements other risk management approaches and measures Sound Compensation Practices Risk management must be embedded in the culture of a bank and should be under the critical focus of the Senior Management of the bank For developing and maintaining a broad and deep risk management culture over time, compensation policies may be drawn which should be linked to longer-term capital preservation and the financial strength of the firm, and should consider risk-adjusted performance measures In addition, a bank should provide adequate disclosure regarding its compensation policies to stakeholders C Market Discipline - (Pillar – 3) Market Discipline is termed as development of a set of disclosure requirements so that the market participants would be able to access key pieces of information on the scope of application, capital, risk exposures, risk assessment processes, and in turn the capital adequacy of the institution It is considered as an effective means of informing the market about a bank’s exposure to those risks and provides comparability Non-compliance of the prescribed disclosure requirement attracts penalty including financial penalty Market discipline can contribute to a safe and sound banking environment Hence, non-compliance with the prescribed disclosure requirements would attract a penalty, including financial penalty It is recognized that the Pillar disclosure framework does not conflict with the requirement under accounting standards which are broader in scope RBI will consider future modifications to the Market Discipline disclosures as necessary in the light of its ongoing monitoring of this area and industry developments Banks should have a formal disclosure policy approved by the Board of Directors that addresses the bank’s approach for determining what disclosures it will make and the internal controls over the disclosure process The Pillar disclosures as introduced under Basel III would become effective from 01.07.2013 and the first set of disclosures as required should be made by banks as on 30.09.2013 (with exception of Post March 31, 2017 template (dealt separately) 366 PP-BL&P Pillar applies at the top consolidated level of the banking group to which the Capital Adequacy Framework applies Disclosures related to individual banks within the groups would not generally be required to be made by the parent bank Banks are required to make Pillar disclosures at least on a half yearly basis, irrespective of whether financial statements are audited, with the exception i.e Capital Adequacy, Credit Risk: General Disclosure for all banks; and Credit Risk: Disclosures for Portfolios subject to the Standardised Approach These are to be made at least on a quarterly basis by banks All disclosures must either be included in a bank’s published financial results/ statements or at a minimum, must be disclosed on bank’s website Banks are required to make disclosures in the prescribed format by RBI Banks are also required to maintain a ‘Regulatory Disclosures Section’ on their website where all information relating to disclosures will be made available to the market participants The link should be prominently provided on the home page of the website so as to make it easily accessible An archive for at least three years of all templates relating to prior reporting periods should be made available by banks on their websites Post March 31, 2017 Disclosure Template A common template which will be used by banks to report the details of their regulatory capital after March 31, 2017 i.e after the transition period for the phasing-in of deductions is over It is designed to meet the Basel III requirement to disclose all regulatory adjustments The template enhances consistency and comparability in the disclosure of the elements of capital between banks and across jurisdictions Template during the Transitional Period During the transition period of phasing-in of regulatory adjustments under Basel III in India i.e from April 1, 2013 to March 31, 2017, banks will use a modified version of the post March 31, 2017 template This template is designed to meet the Basel III requirement for banks to disclose the components of capital which will benefit from the transitional arrangements Main Features Template A common template has been designed to capture the main features of all regulatory capital instruments issued by a bank at one place This disclosure requirement is intended to meet the Basel III requirement to provide a description of the main features of capital instruments Other Disclosure Requirements This disclosure enables banks in meeting the Basel III requirement to provide the full terms and conditions of capital instruments on their websites Banks operating in India are required to make additional disclosures in respect of:(e) Securitisation exposures in the trading book; (f) Sponsorship of off-balance sheet vehicles; (g) Valuation with regard to securitisation exposures; and (h) Pipeline and warehousing risks with regard to securitisation exposures D Capital Conservation Buffer Framework Objective The capital conservation buffer (CCB) is designed to ensure that banks build up capital buffers during normal times (i.e outside periods of stress) which can be drawn down as losses incurred during a stressed period The requirement is based on simple capital conservation rules designed to avoid breaches of minimum capital requirements Outside the period of stress, banks should hold buffers of capital above the regulatory minimum When buffers have been drawn down, one way banks should look to rebuild them is through reducing discretionary Annexures 367 distributions of earnings This could include reducing dividend payments, share buybacks and staff bonus payments Banks may also choose to raise new capital from the market as an alternative to conserving internally generated capital In the absence of raising capital from the market, the share of earnings retained by banks for the purpose of rebuilding their capital buffers should increase the nearer their actual capital levels are to the minimum capital requirement The capital conservation buffer can be drawn down only when a bank faces a systemic or idiosyncratic stress A bank should not choose in normal times to operate in the buffer range simply to compete with other banks and win market share This aspect would be specifically looked into by RBI during the SREP The banks which draw down their capital conservation buffer during a stressed period should also have a definite plan to replenish the buffer as part of its ICAAP and strive to bring the buffer to the desired level within a time limit agreed to with RBI during the SREP The framework of capital conservation buffer will enable the banks to:(a) Strengthen the ability of banks to withstand adverse economic environment conditions, (b) Help increase banking sector resilience both going into a downturn; and (c) Provide the mechanism for rebuilding capital during the early stages of economic recovery By retaining a greater proportion of earnings during a downturn, banks will be able to help ensure that capital remains available to support the ongoing business operations / lending activities during the period of stress Therefore, this framework is expected to help reduce pro-cyclicality Framework Banks are required to maintain a capital conservation buffer of 2.5% of RWA in the form of Common Equity Tier capital above the regulatory minimum capital requirement of 9% CCB is to be phased-in over a period of years in a uniform manner of 0.625% per year, commencing from 31.3.15 Banks should not distribute capital (i.e pay dividends or bonuses in any form) in case capital level falls within this range The constraints imposed are related to the distributions only and are not related to the operations of banks The distribution constraints imposed on banks, when their capital levels fall into the range, increase as the banks’ capital levels approach the minimum requirements The minimum capital conservation ratios a bank must meet at various levels of the Common Equity Tier capital ratios is shown as under:Minimum capital conservation standards for individual bank CET Ratio after including the current periods of retained earnings Minimum Capital Conservation Ratios (in % of earnings) 5.5% - 6.125% 100% >6.125% - 6.75% 80% >6.75% - 7.375% 60% >7.375% - 8.0% 40% >8.0% 0% It may be observed from the above that a bank with a Common Equity Tier capital ratio in the range of 6.125% to 6.75% is required to conserve 80% of its earnings in the subsequent financial year (i.e payout not more than 20% in terms of dividends, share buybacks and discretionary bonus payments is allowed) Basel III minimum capital conservation standards apply with reference to the applicable minimum CET1 capital and applicable CCB During the transition period, banks may refer to the level of ratios provided by RBI in the Circular for meeting the minimum capital conservation ratios at various levels of the CET capital ratios 368 PP-BL&P Capital conservation buffer is applicable both at the solo level (global position) as well as at the consolidated level, i.e restrictions would be imposed on distributions at the level of both the solo bank and the consolidated group E Leverage Ratio Framework The leverage ratio provisions in the Basel III document are intended to serve as the basis for testing the leverage ratio during the parallel run period The Basel Committee will test a minimum Tier leverage ratio of 3% during the parallel run period from January 1, 2013 to January 1, 2017 The leverage ratio is calibrated to act as a credible supplementary measure to the risk based capital requirements The main objective of the leverage ratio framework is:(a) constrain the build-up of leverage in the banking sector, helping avoid destabilising deleveraging processes which can damage the broader financial system and the economy; and (b) reinforce the risk based requirements with a simple, non-risk based “backstop” measure During the period of parallel run, banks should strive to maintain their existing level of leverage ratio but, in no case the leverage ratio should fall below 4.5% A bank whose leverage ratio is below 4.5% may endeavor to bring it above 4.5% as early as possible Final leverage ratio requirement would be prescribed by RBI after the parallel run taking into account the prescriptions given by the Basel Committee The leverage ratio shall be maintained on a quarterly basis The basis of calculation at the end of each quarter is “the average of the month end leverage ratio over the quarter based on the definitions of capital (i.e the capital measure) and the total exposure (i.e the exposure measure) respectively as detailed in the RBI Circular (The criteria for Classification as Common Shares (Paid up Equity Capital) for Regulatory Purposes for Indian Banks as well as Foreign Banks, Detailed guidelines on issuance of various Debt Instruments viz Innovative Perpetual Debt Instrument (IPDI), Perpetual Non-cumulative Preference Shares (PNCPS), Debt Capital Instruments, Perpetual Cumulative Preference Shares (PCPS), Credit Default Swaps (CDS), Illustrations on Credit Risk Mitigation (Loan Exposures) – Calculation of Exposure Amount for Collateralised transactions, Illustrations on computation of capital charge for Counterparty Credit Risk (CCR) – Repo Transactions, Measurement of capital charge for Market Risks in respect of Interest Rate Derivatives and Options, An Illustrative Approach for Measurement of Interest Rate Risk in the Banking Book (IRRBB) under Pillar 2, Redeemable Noncumulative Preference Shares (RNPS), Redeemable Cumulative Preference Shares (RCPS), Subordinated Debts, Guidelines on Securitisation of Standard Assets, Illustrative Approach on Measurement of Capital Charge for Market Risks in respect of Interest Rate Risk and Derivatives, etc are given in detail in the RBI Master Circular which also may be referred) (Source: RBI M Circular dt 01.07.13) Test Papers 369 PROFESSIONAL PROGRAMME BANKING LAW AND PRACTICE PP-BL&P/2013 TEST PAPERS This Test Paper set contains three Test Papers Test Papers 1/2013, 2/2013, 3/2013 The maximum time allowed to attempt each paper is hours Students may send any of Test Papers for evaluation While writing answers, you should take care not to copy from the study material, text books or other publications Instances of blatant copying from any source will be viewed seriously and can also lead to suspension and cancellation of your registration 370 PP-BL&P WHILE WRITING THE RESPONSE SHEETS TO THE TEST PAPERS GIVEN AT END OF THIS STUDY MATERIAL, THE STUDENTS SHOULD KEEP IN VIEW THE FOLLOWING WARNING AND DESIST FROM COPYING WARNI NG Time and again, it is brought to our notice by the examiners evaluating response sheets that some students use unfair means in completing postal coaching by way of copying the answers of students who have successfully completed the postal coaching or from the suggested answers/study material supplied by the Institute A few cases of impersonation by handwriting while answering the response sheets have also been brought to the Institute’s notice The Training and Educational Facilities Committee has viewed seriously such instances of using unfair means to complete postal coaching The students are, therefore, strongly advised to write response sheets personally in their own hand-writing without copying from any original source It is also brought to the notice of all students that use of any malpractice in undergoing postal or oral coaching is a misconduct as provided in the explanation to Regulation 27 and accordingly the studentship registration of such students is liable to be cancelled or terminated The text of regulation 27 is reproduced below for information : “27 Suspension and cancellation of examination results or registration In the event of any misconduct by a registered student or a candidate enrolled for any examination conducted by the Institute, the Council or the Committee concerned may suo motu or on receipt of a complaint, if it is satisfied that, the misconduct is proved after such investigation as it may deem necessary and after giving such student or candidate an opportunity to state his case, suspend or debar the person from appearing in any one or more examinations, cancel his examination result, or studentship registration, or debar him from future registration as a student, as the case may be Explanation – Misconduct for the purpose of this regulation shall mean and include behaviour in a disorderly manner in relation to the Institute or in or near an Examination premises/centre, breach of any regulation, condition, guideline or direction laid down by the Institute, malpractices with regard to postal or oral tuition or resorting to or attempting to resort to unfair means in connection with the writing of any examination conducted by the Institute” Test Paper 1/2013 371 PROFESSIONAL PROGRAMME BANKING LAW AND PRACTICE TEST PAPER 1/2013 Time Allowed : Hours Maximum Marks : 100 Attempt Questions (a) what you mean by Commercial Bank? Classify the commercial banks in India (10 Marks) (b) Write a short note on Prevention of Money Laundering Act, 2002 (PMLA) with reference to Banking (10 Marks) (a) State the Powers of banks under the SARFAESI Act (b) What are the general principles of secured advances by a bank (10 Marks) (10 Marks) (a) what you mean by Banking Ombudsman Scheme? Which complains may be registered to the banking ombudsman? (10 Marks) (b) What are the precautions which a bank should keep while acting as an investor? (a) what are the various securities which a bank may accept for an advance? (b) What you mean by Real Time Gross Settlement? State its basic features (a) What are the three pillars of Basel II State in detail (b) What are the special Features of a Banker’s Right of General Lien? (10 Marks) (10 Marks) (10 Marks) (10 Marks) (10 Marks) What you mean by endorsement of cheque, State different types of endorsement and different aspects of laws relating to the endorsement of cheque? (20 Marks) 372 PP-BL&P TEST PAPER 2/2013 (This Test Paper is based on entire Study Material) Time Allowed : Hours Maximum Marks : 100 Note: Answer Any Questions What you mean by Fraud Classification In Banks? Which types of frauds are required to be reported to the Reserve Bank of India and in what manner? (20 Marks) (a) What you mean by National Electronic Funds Transfer (NEFT)? State its basic features and advantages (10 Marks) (b) What you mean by Debentures? What are the Precautions to be taken while taking debentures as security? (10 Marks) What you mean by Primary Market? Which are the main facilitators in Primary Market issue? State their role as well (20 Marks) (a) what are the Legal Issues in International Banking Transactions? (10 Marks) (b) What you mean by Core Banking Solution (CBS)? State the role of CBS in Indian Banking sector (10 Marks) (a) What you mean by KYC Norms in Banking State the KYC norms to be followed while opening the bank account of a company (10 Marks) (b) What are the circumstances in which a bank may close the Account of a customer? State in detail (10 Marks) Write a short note on four of the following (a) Current Account and its Features (b) Export Import Bank of India (EXIM Bank): (c) Documents of Title to Goods? (d) Red Herring Prospectus (RHP) (e) Insurance of Bank Deposits (5 Marks each) Test Paper 3/2013 373 TEST PAPER 3/2013 Time Allowed : Hours Maximum Marks : 100 Note: Answer Any Questions What are the BASEL Committee recommendations for Corporate Governance in Banks? State in detail (20 Marks) What are the different types of risk faced by a bank? State the risk management mechanism in Banks in detail (20 Marks) (a) What you mean by Electronic Clearing System (ECS)? State its basic features (10 Marks) (b) What are the various aspects of Cyber Crime in Banks? State in detail (10 Marks) (a) What you mean by Off-shore Banking unit? State its basic features (10 Marks) (b) What are the reasons of operational risk in banking sector? (a) What are the Precautions to be taken while executing loan documents? (10 Marks) (10 Marks) (b) What you mean by CREDIT WORTHINESS OF BORROWERS ? How the credit worthiness of a borrower is judged by a bank (10 Marks) Write the differences between four of the following (a) Current Bank Account and Saving Bank Account (b) Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR): (c) Bank as a trustee and bank as an agent (d) Term Deposit and Recurring Deposit with a bank (e) Term Loan and working Capital Loan (5 Marks each) ... 191 SELF TEST QUESTIONS 192 LESSON SECURITIES FOR BANK LOANS General Principles of Secured Advances 196 Land/Real Estate as a Security for the Loan/Advance 197 xiii Page Stocks and Shares as a Security... Operations Banking Related Laws Banker - Customer Relations Loans and Advances Securities for Banker? ?s Loans Financial Analysis of Banks Financial System Contemporary and Emerging Issues: An Overview... The Law and Practice of Banking, Universal Law Publishing vi ARRANGEMENT OF STUDY LESSONS Study Lesson No Topic Overview of Banking System Regulatory Framework and Compliances Legal Aspects of Banking