It may also have supervisory powers, to ensure that banks and other financial institutions do not behave recklessly or fraudulently. The Reserve Bank of India Act, 1934 was commenced on April 1, 1935. The Act, 1934 (II of 1934) provides the statutory basis of the functioning of the Bank. In addition to its traditional central banking functions, the Reserve bank has certain nonmonetary functions of the nature of supervision of banks and promotion of sound banking in India. The Reserve Bank Act, 1934, and the Banking Regulation Act, 1949 have given it wide powers of supervision and control over commercial and co-operative banks, relating to licensing and establishments, branch expansion, liquidity of their assets, management and methods of working, amalgamation, reconstruction, and liquidation. 3.5 KEYWORDS Industrial Finance: Loans given to boost business activities. Monetary Policy: Monetary policy is the process by which the government, central bank, or monetary authority of a country controls (i) the supply of money, (ii) availability of money, and (iii) cost of money or rate of interest, in order to attain a set of objectives oriented towards the growth and stability of the economy. Monetary theory provides insight into how to craft optimal monetary policy. Open Market Operations: Open market operations are the means of implementing monetary policy by which a central bank controls its national money supply by buying and selling government securities, or other financial instruments in open market. Monetary targets, such as interest rates or exchange rates, are used to guide this job. Agricultural Finance: Loans given to boost agricultural activities. Statutory Liquidity Ratio (SLR): Statutory Liquidity Ratio or SLR refers to the amount that all banks require to maintain in cash or in the form of gold or approved securities. Approved securities mean, bond and shares of different companies. This Statutory Liquidity Ratio is determined as percentage of total demand and percentage of time liabilities. 3.6 LEARNING ACTIVITIES 1. Write (in 2000 words) about central bank of any three countries of this world. ________________________________________________________________________ ________________________________________________________________________ 2. Case Study: 51 CU IDOL SELF LEARNING MATERIAL (SLM)
A little about YES Bank YES Bank Ltd. is the newest entrant in the Indian Banking Sector. It started operations in November 2004 and has already created a presence in the Industry by virtue of its innovative Business Model. YES Bank aims to be a state-of-the-art technology driven, high quality, private Indian Bank catering to Emerging India? The company's growing pains With no legacy systems to inherit, YES Bank was looking at associating with a complete IT partner who would: Enable the bank to take complete advantage of industry leadership with respect to the technology product portfolio offerings. Ensure service with minimum interruption for round-the-clock business operations. Provide a high performance and scalable platform. Optimise the systems with better manageability. Future proof against IT investments. YES bank needed a one-stop solution for their IT problems. The IBM solution YES Bank chose IBM to provide IT infrastructure. To address the bank's challenges, IBM proposed servers based on POWER5 technology. As there were disparate applications and security concerns, different server environments with storage consolidation was the ideal solution. All the servers would connect to the SAN Switches, which in turn would be connected to the IBM Storage for Production environment. The solution had been configured with redundant paths with no single point of failure in the connectivity to the storage and the network. The business applications powered by IBM eServers were: Core Banking - Retail and Corporate by iFlex - runs on a cluster of p550 as the database servers and x 365 as the application servers. Cash Management application by Cashtech - cluster of 520 servers. 52 CU IDOL SELF LEARNING MATERIAL (SLM)
Treasury application by Murex - cluster of 520 servers. Additionally, YES Bank also installed IBM ThinkPad and Desktops in all their offices. The result - YES bank is the future of banking YES Bank wanted to be geared up to meet its future expansion plans. The scalability of the IBM system and its virtualisation capability fitted the client requirements. The IBM infrastructure on Power5 provided YES Bank with following benefits: CMainframe-inspired features that help businesses thrive by providing higher utilisation Massive performance enhancements Greater flexibility and lower IT management costs Consistent, real-time data and information on demand robust, high-availability IT infrastructure with minimum disruption to business ________________________________________________________________________ ________________________________________________________________________ 3.7 UNIT END QUESTIONS A. Descriptive Questions Short Questions 1. RBI Issues Currency Notes. Explain. 2. What is Repo Rate and Reverse Repo Rate? 3. Explain in short about the Supervisory Functions of RBI. 4. List down the departments in RBI. 5. What is Bank Rate Policy? Long Questions 1. Write in detailed about Monetary Functions about RBI. 2. Discuss in detail about the Functions of RBI. 3. Describe Supervisory Functions of RBI. 4. Explain in detail about the Promotional and Development Functions of RBI 5. Write about the Management Structure of RBI. B. Multi-Choice Questions 53 1. _____________ need to interpret the concept of risk in a very broad sense. CU IDOL SELF LEARNING MATERIAL (SLM)
a. Indian Bank b. Canara Bank c. State Bank d. Central Bank 2. The________________ performs financial supervision under the guidance of the Board for Financial Supervision (BFS). a. RBI b. GOI c. SBI d. None of these 3. A central board of directors governs the Reserve Bank’s affairs. The ____________in keeping with the Reserve Bank of India Act, appoints this board. a. RBI b. GOI c. SBI d. None of these 4. The _________________of our country is the Reserve Bank of India (RBI). a. State Bank b. Country Bank c. Central Bank d. Co-Operative Bank 5. The________________ has been operating selective controls since 1956 in respect of certain commodities, which have been sensitive or in short supply. a. RBI b. GOI c. SBI d. None of these 54 CU IDOL SELF LEARNING MATERIAL (SLM)
Answers: 1 - d, 2 – a, 3 - b, 4 – c, 5 - a 3.8 REFERENCES Risk Management and Insurance: Perspectives in A Global Economy by Harold D. Skipper, w. Jean Kwon, Blackwell Publishing & Wiley India Risk Management & Insurance, James S. Trieschmann, Sandra G. Gustavson, South western, 1998 55 CU IDOL SELF LEARNING MATERIAL (SLM)
UNIT 4. REFORMS IN INDIAN BANKING Structure 4.0 Learning Objective 4.1 Introduction 4.2 Overview 4.3 Recommendations of Narasimhan Committee 4.4 Capital Adequacy Ratio (CAR) 4.5 Revised NPA Norms- Impact of Reforms 4.6 Summary 4.7 Keywords 4.8 Learning Activities 4.9 Unit End Questions 4.10 References 4.0 LEARNING OBJECTIVE After studying this unit, you will be able to: Describe Reforms in Indian Banking Identify what is Narasimhan Committee Describe Capital Adequacy Ratio (CAR) Describe Revised NPA Norms – Impact of Reforms 4.1 INTRODUCTION The modern banking of India came into place in the late 18th century. The Bank of Bombay, Bank of Bengal, and Bank of Madras are the first three banks to function well in India. They later merged and became the Imperial Bank of India. Post-independence it became the State Bank of India in 1955. The Reserve Bank of India entered the system in 1935 and became the monitor and regulator of the Banking System of India in 1949. The Banking Regulation Act of 1949 changed the functioning of the commercial banking sector. 56 CU IDOL SELF LEARNING MATERIAL (SLM)
Though RBI was regulating the banking economy, most of the banks except SBI were private banks. By the 1960s, the banking sector was contributing a good share to the Indian economy. It became important to regulate and control to maintain the balance in the economy. This led to the introduction of the Nationalization of Banks Act 1964. This act led to the nationalization of 14 major commercial banks in India. Though this process took place in 1969 with the president’s approval. In 1991, Rajiv Gandhi introduced Liberalisation, Privatisation, and Globalisation Policy. This led to the addition of Global banks in the country. The foreign direct investment opened up too. This also led to a relaxation in many previous policies of the government. The licensing, taxation, formation process, etc became more flexible for banking companies. In the 1990s, the Government of India formed a high-level committee to improve the functioning of financial institutions in India. They introduced different acts and reforms to strengthen the banking system. India has seen many such committees. The Banking System of India has important acts and reforms from two phases. The first phase revolves around basic policy and institutional frameworks. And the second phase revolves around structuring and developing the industry with advancements. 4.2 OVERVIEW In view of the rising deterioration of the productivity and profitability of the banking sector, the government has agreed to restructure the banking sector in order to improve the competitiveness and efficiency of its operations and increase its profitability. The Government of India has therefore named a nine-member committee headed by M. Narasimham, ex-RBI Governor, 14 August 1991. The committee was named to review the operation of the country's commercial banks and other financial institutions and to recommend steps to reshape these institutions in order to improve their effectiveness. In November 1991, the Narasimham Committee submitted its report and, on December 17, 1991, the report was presented to Parliament. In its report, the Narasimham Committee acknowledged the performance of public sector banks with regard to branch growth, household deposit mobilization, priority sector lending and the elimination of regional banking inequalities. But the banking sector suffered a severe erosion in its productivity, efficiency and profitability during this post-nationalization period. Driven investment and directed credit programs are the two most significant factors responsible for this situation, as stated by the committee. The Committee argued that the abnormally high statutory liquidity ratio (SLR-38.5 per cent) and the cash reserve ratio (CRR-15 per cent) placed a form of tax on the banking system on bankers and, for unproductive purposes, diverted a good sum from the banking fund. 57 CU IDOL SELF LEARNING MATERIAL (SLM)
Similarly, the CRR, in the form of a reserve requirement tax, reduced the banks' potential income and thus reduced the bankers' profitability. In addition, the Narasimham Committee report noted that sound banking practices were disturbed by the system of directed credit operations in the form of subsidized credit flow to under-banked and priority areas, IRDP lending, loan mela, etc. \"The Committee noted, \"In the process, the intended socially oriented loan degenerated into irresponsible lending. The Committee further noted that the 'infected' and 'contaminated' portfolios comprise approximately 20% of agricultural and small-scale industrial credit. The Committee also noted that the operating expenditure of these banks has increased significantly as a result of the phenomenal increase in branch banking, the lack of adequate supervision, rapid staff growth and accelerated promotion, the inadequate role of trade unions and the higher unit cost of lending to priority sectors. 4.3 RECOMMENDATIONS OF NARASIMHAN COMMITTEE The two committees that shaped the banking system of India are – 1. The Narasimham Committee 1991 – First Phase It was the first committee of India to suggest acts and reforms for an improved banking system. M. Narasimham was the chairman of this committee, thus justifying the name. This committee was formed right after the economic crisis. It suggested – Autonomy in Banking, Reforms in the role of RBI, Change in CRR and SLR, Recovery of Debts, Freedom of Operation, Local Area Banks, Prudential Norms, and Entry of Foreign Banks. 2. The second Narasimham Committee 1998 – Second Phase This again was headed by M Narasimhan, the 13th governor of RBI. This committee is an extension of the first one. The idea was to overview the reforms introduced after the first committee. It suggested – Development Finance Institution, Stronger banking system, the idea of Non-performing assets, Capital adequacy and tightening of provisioning norms, and, Rural and Small Industrial Credits. Many other committees followed – The Verma Committee, The Khan Committee, AK Bhuchar Committee, The Urjit Patel Committee, The Vaghul Committee, etc. Recommendations:- 1. It proposed a substantial reduction in the number of public sector banks (PSBs) through mergers and acquisitions. A 4 tier banking system was proposed. I tier 3 or 4 large banks (including SBI) which could become international incharacter. II tier 8 to 10 national banks III tier Local banks IV tier Rural banks including RRBs 58 CU IDOL SELF LEARNING MATERIAL (SLM)
2. RBI should permit the setting up of new banksin the private sector. There should be no difference in the treatment between public sector banks and private sector banks. 3. The Government should allow foreign banks to open offices in India either as branches oras subsidiaries. 4. Assets Reconstruction Fund (ARF) should be set up, to take over from the nationalized banks and financial institutions, a portion of their bad and doubtful debts, at a discount. 5. The appointment of the Chief Executive of a bank (Chairman and Managing Director) should not be based on political consideration but on professionalism and integrity andshould be made by an independent panel ofexperts. 6. The government should reduce the StatutoryLiquidity Ratio (SLR) from the present 38.5per cent to 25 per cent over the next five years. A reduction in the SLR levels would leave more funds with banks for allocation to agriculture, industry, trade, etc. 7. The Cash Reserve Ratio (CRR) should be reduced from the present high level of 15 percent to 3 to 5 per cent. 8. Banks should be given more autonomy. 9. The system of directed credit programs should be gradually phased out. 10. The RBI should, on priority, simplify the structure of interest rates. The Bank rate should be the anchor rate and all other interest rates should be closely linked to it. Despite stiff opposition from bank unions and political parties in the country, the Government of India accepted all the major recommendations of Narasimham Committee (1991) and started implementing them. 4.4 CAPITAL ADEQUACY RATIO (CAR) Healthy functioning of banks is essential for the proper functioning of an economy. As credit creation (i.e. loan disbursals) of banks is a highly risky business the safety of the depositors’ money depends on the quality of lending by banks. A bank’s failure has the potential to create chaos inan economy. This is why governments of the world pay special attention to the regulatory aspects of the banks. Banks should maximize their credit creation while minimizing the risk and continue their functioning permanently. The central banks of the world devised tools to minimize the risks of banking. The Capital Adequacy Ratio (CAR) norm regulates the banks in such a way that they can sustain the 59 CU IDOL SELF LEARNING MATERIAL (SLM)
probablerisks and uncertainties of lending. It was in 1988that the central banking bodies of the developedeconomies agreed upon provision of the CAR. The agreement was known as the Basel Accord.The accord was agreed upon at Basel, Switzerlandat a meeting of the Bank for International Settlements (BIS). It was at this time that the Basel–I norms of the CAR were agreed upon – a requirement was imposed upon the banks to maintain a certain amount of free capital (i.e., ratio) to their assets (i.e. loans and investments by the banks) as a cushion against probable lossesin investments and loans. The CAR is the percentage of total capital to thetotal risk – weighted assets. The RBI introduced the Capital-to-risk weighted assets ratio (CRAR) system for banks in India in 1992 in accordance with the standards of the BIS as part of the financial sector reforms. In the coming years, the Basel norms were extended toNBFCs also. The CAR norm was raised to 9 per cent with effectfrom March 31, 2000. Meanwhile the BIS came up with another set ofthe CAR norms, popularly known as Basel- II. TheBasel-II norm for the CAR is 12 per cent. The Basel Accords (i.e. Basel I and II) are of paramount importance to the banking world and are presently implemented by over 100 countries across the world. The main objective of the accordsis to strengthen the international banking system. Some Miscellaneous Points to Remember The first bank to open a branch in Dharavi, one of Asia’s biggest slums, is Indian Bank. The bank with the maximum number of foreign branches is Bank of India. The bank which has the humped bull ofMohenjo-Daro as its logo and has a name associated with the Indus valley civilization isIndusInd Bank. The first Indian bank to open a branch outsideIndia was Bank of India. The bank which was honoured when Mahatma Gandhi inaugurated its branch was Union Bank of India. The first Indian Bank to be listed on the NewYork Stock Exchange is ICICI Bank. 4.5 REVISED NPA NORMS- IMPACT OF REFORMS The RBI in June 2019 released a revised set of norms on stressed asset resolution which are substantially less stringent from the previous one. About the February 2018 RBI circular 60 CU IDOL SELF LEARNING MATERIAL (SLM)
Through a notification issued on Feb 12, 2018 the RBI laid down a revised framework for the resolution of stressed assets, which replaced all its earlier instructions on the subject. Banks were required to immediately start working on a resolution plan for accounts over Rs 2,000 crore, which was to be finalized within 180 days. In the case of non-implementation, lenders were required to file an insolvency application. RBI termed it necessary to substitute the existing guidelines with a harmonized and simplified generic framework for resolution of stressed assets. Also, banks have to recognize loans as non-performing even if the repayment was delayed by just one day. Not adhering to the timelines in the circular would attract stringent supervisory and enforcement actions. What did the revised framework replace? The circular went into effect on the same day that it was issued, and all existing schemes for stressed asset resolution were withdrawn with immediate effect. The circular was ostensibly intended to stop the “ever greening” of bad loans the practice of banks providing fresh loans to enable timely repayment by borrowers on existing loans. The RBI warned banks that not adhering to the timelines laid down in the circular, or attempting to evergreen stressed accounts, would attract stringent supervisory and enforcement actions. New circular of the RBI The new framework gives lenders a breather from the one-day default rule whereby they had to draw up a resolution plan (RP) for implementation within 180 days of the first default. It gives lenders (scheduled commercial banks, all-India financial institutions and small finance banks) 30 days to review the borrower account on default. During this review period, lenders may decide on the resolution strategy, including the nature of the RP and the approach for its implementation. Lenders may also choose to initiate legal proceedings for insolvency or recovery. The new circular is also applicable to small finance banks and systemically important non-deposit taking non-banking financial companies (NBFCs) and deposit-taking NBFCs. In cases where the RP is to be implemented, all lenders have to enter into an inter creditor agreement (ICA)for the resolution of stressed assets during the review 61 CU IDOL SELF LEARNING MATERIAL (SLM)
period to provide for ground rules for finalization and implementation of the RP in respect of borrowers with credit facilities from more than one lender. Under the ICA, any decision agreed to by the lenders representing 75 per cent of total outstanding credit facilities by value and 60 per cent by number will be binding upon all the lenders. In particular, the RPs will provide for payment which will not be less than the liquidation value due to the dissenting lenders. In cases where the aggregate exposure of a borrower to lenders (scheduled commercial banks, all-India financial institutions and small finance banks) is ₹2,000 crores and above, the RP has to be implemented within 180 days from the end of the review period, and the reference date has been set as June 7, 2019. In the case of borrowers in the ₹1,500 crore and above but less than ₹2,000 crore category, January 1, 2020 has been set as the reference date for implementing the RP. In the less than ₹1,500 crore category, the RBI will announce the reference date in due course. What if the Resolution Plan is delayed? There is a disincentive for banks if they delay implementing a viable resolution plan. In case the plan is not implemented within 180 days from the end of the review period, banks have to make additional provision of 20% and another 15% if the plan is not implemented within 365 days from the start of the review period. The additional provisions would be reversed if resolution is pursued under Insolvency and Bankruptcy Code (IBC). Further reforms needed Banks have to accept losses on loans (or ‘haircuts’). They should be able to do so without any fear of harassment by the investigative agencies. The Indian Banks’ Association has set up a six-member panel to oversee resolution plans of lead lenders. To expedite resolution, more such panels may be required. An alternative is to set up a Loan Resolution Authority, if necessary through an Act of Parliament. Also, the government must infuse at one go whatever additional capital is needed to recapitalize banks — providing such capital in multiple instalments is not helpful The quality of lending by PSB must be improved in future so that the same problem does not arise again. To provide Public sector banks with greater autonomy the shareholding of the government can be reduced to less than 50 percent or 33 percent. 62 CU IDOL SELF LEARNING MATERIAL (SLM)
A second requirement is that public sector banks should become board-managed institutions, with the board responsible for all appointments, including that of the chief executive officer (CEO). If the shares of the government are actually transferred to a holding company, then decisions regarding appointments could be taken by the board of the new company on the recommendation of the board of the bank. The objective of creating a genuinely commercial environment in which public sector banks can function and managements are made accountable can only be achieved if the government is willing to step back from exercising direct control. 4.6 SUMMARY The level of non-performing assets (NPAs) of the banking system in India has shown a decline in recent years, but it is still too high. Part of the problem is the carry-over of old NPAs in certain declining sectors of industry. The problem has been further complicated by the fact that there are a few banks, which are fundamentally weak and where the potential for return to profitability, without substantial restructuring, is doubtful. Narasimham Committee was appointed to examine the effectiveness of the existing financial system of the country and suggest reforms. The fundamental objective behind the capital adequacy calculation and fixing up the related norms is to strengthen the soundness and stability of the banking system. 4.7 KEYWORDS Capital-Assets Ratio: Ratio of capital employed to assets. Credit Risk: Risk of non-recovery of loans. Insolvency Risk: The risk of insolvency of debtor. Narasimham Committee: A Special committee appointed by RBI to suggest banking sector reforms Social Banking: Banking done for social development and advancement of the masses. Speculation in Shares: Buying and selling of shares in anticipation (rise/fall) in their prices. 4.8 LEARNING ACTIVITIES 1. Discuss asset management at ABN Amro Bank. 63 CU IDOL SELF LEARNING MATERIAL (SLM)
________________________________________________________________________ _______________________________________________________________________ 2. Case Study: Cash Management in a Credit Crisis Every treasurer has been forced to review how they manage their cash and liquidity since the crisis first struck. In this case study, we use a real-life example of a global insurance company and explore how treasury has dealt with the changing marketplace. Cash management background As an insurance company, the firm has substantial operational cash flow together with fiduciary money owed to insurance carriers. With such high cash balances managed by the company but owed to third parties, the financial and reputational risk of counterparty default is huge. Cash management and short-term investment is a priority for treasury, and principle preservation is the primary investment objective. With many of the banks experiencing a downgrade in credit rating, treasury is increasingly finding that it needs to spread its bank exposure risk. This is easy to do for short-term investment activity such as deposits, but it becomes more difficult when it comes to cash management. Corporates need to make decisions about the banks they want to work with based on those that are most likely to be around in the future. Like many other firms, the company has needed to focus carefully on where to place the company's cash. Even in situations when a national government has stepped in to support a bank, and not every bank can be bailed out, it could easily take three to four months to retrieve the cash, creating potentially serious liquidity problems, FX risk and a loss of return over this period. A company in this position may have to borrow to cover the liquidity gap or lose out on business investment opportunities. Short-term investments Treasury has considered government securities as investment vehicles; however, these are typically only issued in three currencies which normally create the fewest difficulties. It uses money market funds (MMFs) in Latin America, Europe and the United States. It is important to be familiar with the investment portfolio in each fund, so treasury receives regular updates on fund assets and reviews both individual holdings and asset classes to ensure that there is nothing of concern and that decisions comply with internal investment policies. Challenges remain in Latin America and Asia, where there are fewer repositories for local currencies. Treasury is looking at money market funds in Asia in recognition of the benefits of a diversified, high quality investment product, but this involves seeking 64 CU IDOL SELF LEARNING MATERIAL (SLM)
regulatory approval to place client money in these funds. The same issues apply to Middle East and Africa, and treasury is working to address these needs as well. Implementing notional cash pooling Cash pooling has been a significant way in which the company has leveraged its group cash position both before and during the current crisis. The company has had in-country cash pools in place for a number of years across Europe. In the US, treasury has established a daily sweeping structure, allowing for centralised investment activity of US cash balances. Outside the US, the situation has been more decentralised, with some countries maintaining local autonomy, resulting in external borrowings and trapped cash in-country. One of treasury's objectives is to repatriate funds more effectively and gain greater control over the global cash position. To achieve this, the company has implemented a multi-currency global notional pooling arrangement. An important element of this is the ability to allow self-funding, provide cash visibility, and centralise the management of surplus cash. The pool is now functional in 50 countries across 25 currencies. Furthermore, as central banks remove some of their countries' fiscal constraints, further countries may be added in the future in either their functional or non- functional currencies. This structure was not easy to implement, and initially, business units were worried that they would lose autonomy over their financial management, but these concerns have not been justified. Local finance departments still manage their day- to-day bank relationships and cash management, but have access to cash internally at a known benchmark rate based on a recognised market index, rather than having the uncertainty of trying to borrow externally. Business units which are net investors benefit from market-based overnight returns, and cash remains within their own accounts. As people came to understand the structure more fully, they also recognised the time savings which allowed them to concentrate more on their core business. Treasury uses their bank's system for payments. For example, a depositor will put in a credit advice for the amount it wishes to deposit, to which an overnight return is applied on receipt by treasury. The system then treats the credit as an overnight rolling deposit and applies interest accordingly. When cash is required, the business unit can make a payment request which is processed by treasury and treated effectively as an overdraft position when the account balance goes negative. Outcomes of notional cash pooling This solution has proved very effective. At a local level, business units have reliable income on investments or borrowing rates. Treasury can net intercompany payables and receivables, reducing the number of external transfers and limiting the impact on the balance sheet. When the structure was first implemented, treasury saw a significant decline in external debt, which has since remained steady even though the company has embarked on significant merger and acquisition activities. With the current cost and 65 CU IDOL SELF LEARNING MATERIAL (SLM)
uncertainty of borrowing, this has had a marked effect on the business, and there has been a considerable change to the debt to capital ratio which would be difficult to refinance in the present conditions. By implementing this structure, the company's exposure has moved from the external banks (with the exception of the cash pool bank) to the company's internal entities, a risk which it is in a greater position to control. Although in theory there is an exposure to the bank providing the global notional pool, if the bank were to default, there is a set-off clause to other participants so only a net cash position would be at risk. Surplus cash is invested in other money market funds each day to diversify investment risk, so the only risk to the cash pool bank is dealing and settlement risk. Rationalising bank relationships Another way in which the company is seeking to manage its cash and liquidity risk more effectively is to limit the number of banking partners with which it works to the highest quality banks. The company has a large number of cash management banks in place, been careful to avoid significant changes to cash management banking in order to minimise disruption to its clients. However, since the downgrading of many banks, treasury now looks at the financial strength of banking partners above all other considerations. Furthermore, the financial crisis has meant that clients have a greater understanding of the reasons why the company might need to change its banks, although there is still some education and preparation for change required. As the company operates internationally, treasury has had to prioritise its cash management focus, starting with the countries with the largest exposures. The aim is to rationalise its banking partners to a preferred partner or two in each country. In reality, there are very few banks (in some countries, only one or two) with asset bases of a sufficient scale to withstand extreme market conditions. In a pilot country, for example, treasury has appointed a primary banking partner and a limited number of collection banks for retail activities, which is a model it would like to adopt more widely. Conclusion The strategy that the company has deployed, which involves working with fewer, high quality banking providers, and pooling cash in a notional pooling structure, has reduced liquidity risk and increased the security of cash considerably. With credit becoming less readily available and more expensive, particularly at a local level, the ability to conduct self-funding has been extremely valuable; similarly, as business units deposit with the notional pool, investments can be made centrally using diversified investment vehicles, increasing security of cash. ________________________________________________________________________ _______________________________________________________________________ 66 CU IDOL SELF LEARNING MATERIAL (SLM)
4.9 UNIT END QUESTIONS A. Descriptive Questions Short Questions 1. What is Narasimham Committee? 2. What is Capital Adequacy Ratio? 3. Write a short note on Phase 1 of Narasimham Committee? 4. Write a short note on Phase 2 of Narasimham Committee? 5. Write about the February 2008 RBI Circular. Long Questions 1. Discuss Capital Adequacy Ratio in detail. 2. What are points mentioned in the new Circular of RBI? 3. What are the Recommendations of Narasimham Committee? 4. Discuss an overview about Reforms in Indian Banking 5. Describe in impact of Reforms. B. Multi-Choice Questions 1. This is the revised RBI Guidelines for private banks as the bank should have a minimum paid-up capital of Rs. ................crore to be raised to Rs. ........................ crore within three years of the start of business. a. 300/200 b. 200/300 c. 400/300 d. 300/400 2. ............................. specialisation by banks would automatically lead to their functional specialisation to a large extent. In this process, the utilisation of skilled manpower will be optimized and the quality of customer service will improve. a. Geographical b. Technical c. Analytical d. Political 3. The Committee stipulates in ...............................through VI of the paper, principles for banking supervisory authorities to apply in assessing bank's credit risk management systems. 67 CU IDOL SELF LEARNING MATERIAL (SLM)
a. Section I b. Section VI c. Section II d. Section IV 4. ...............................is the potential that a bank borrower or counterparty will fail to meet its obligations in accordance with agreed terms. a. Financial Risk b. Credit Risk c. Both Financial and Credit Risk d. None of these 5. Banks should now have a keen awareness of the need to identify, measure, monitor and Note’s control credit risk as well as to determine that they hold adequate capital against these risks and that they are adequately ............................. for risks incurred. a. Partially paid b. Adjusted c. Compensated d. All of the above Answers: 1 - b, 2 – a, 3 - c, 4 – b, 5 - c 4.10 REFERENCES Risk Management and Insurance: Perspectives in A Global Economy by Harold D. Skipper, w. Jean Kwon, Blackwell Publishing & Wiley India Risk Management & Insurance, James S. Trieschmann, Sandra G. Gustavson, South western, 1998 68 CU IDOL SELF LEARNING MATERIAL (SLM)
UNIT 5. EMERGING TRENDS IN BANKING Structure 5.0 Learning Objective 5.1 Introduction 5.2 NPCI 5.3 Products of NPCI 5.4 Summary 5.5 Keywords 5.6 Learning Activities 5.7 Unit End Questions 5.8 References 5.0 LEARNING OBJECTIVE After studying this unit, you will be able to: Describe about Emerging Trends in Banking Understand NPCI Identify regulatory members of NPCI List down Products of NPCI 5.1 INTRODUCTION In recent years, the Indian economic environment has seen a lot of changes because of reforms and measures taken by the banks. The largest change is seen in the financial sector where the banking sector is the largest player to notice this change. So, the banking sector is strong enough to withstand any sort of pressure and competition. Thus, these trends in banking have been very visible in the last few years. India, now, has a fairly stable banking sector with different classes of banks contributing to it. Thus, these include foreign banks, public banks, private sector banks, and others. Reserve Bank of India is head of all these banks. Indian banking sector can be majorly divided into three sections. Phase I – This is from 1786 to 1969 and it was the initial phase of the banking. So, in this phase, many small banks were set up. 69 CU IDOL SELF LEARNING MATERIAL (SLM)
Phase II – This phase can be considered from 1969 to 1991 where regularization, nationalization, and growth of banks comes into the picture. Phase III – This phase is from 1991 onwards and it consists of liberalization and it’s after effects. Trends in Banking In recent years, there have been many changes in the banking industry. These trends in banking have made the whole process of banking very easy. These trends include the following: RTGS – Real Time Gross Settlement RTGS was introduced in India in March 2004. It is a system through which a bank receives instruction in the form of electronic for transferring the funds from one bank account to the other bank accounts. As the name suggests, the transfer of funds between the accounts takes place in ‘real time’. The RTGS system is kept running and maintained by the RBI. So, it is operated by the RBI who provides it the faster and efficient way to transfer the funds while facilitating the various financial operations. Thus, the money send under this system is instantaneous and the beneficiary gets the money within two hours. E-cheques This technology has been developed in the US which will replace the conventional paper cheques in India. Thus, to include this method of E-cheque and make it mandatory, a negotiable instruments act has been included in the amendment. Electronic Clearing Service ECS is an electronic system that is used to make the payments and receipts that are in bulk. The payments need to be similar in nature which can be smaller in amount and repetitive in nature. Thus, this facility is specifically beneficial to government agencies and companies that make or receive large bulk payments. EFT – Electoral Funds Transfer This is a system to transfer the money from one’s bank account to other accounts. So, in this system, the concerning party that wants to make the payment instructs the bank and make a cash payment or authorizes the bank to transfer the funds directly. So, the sender should provide the bank with the complete details like the name of the receiver, account type, account number of the respective bank, city name, branch name, and other details to the bank. Thus it will ensure that the amount reaches the beneficiaries account quickly and correctly. ATM – Automatic Teller Machine 70 CU IDOL SELF LEARNING MATERIAL (SLM)
This is the most popular method in India to withdraw the money. The customers can enable this service to withdraw the money 24 by 7. It allows the customers to perform all day to day bank activities without interacting with any humans. Furthermore, these facilities are also used for the payment of funds, utility bills, etc. The other trends in the banking sector include a point of sale terminal, telebanking, and electronic data interchange. 5.2 NPCI History of NPCI: National Payments Corporation of India (NPCI), an umbrella organisation for operating retail payments and settlement systems in India, is an initiative of Reserve Bank of India (RBI) and Indian Banks’ Association (IBA). NPCI headquartered in Mumbai, Maharashtra. It was initiated under the provisions of the Payment and Settlement Systems Act, 2007. NPCI was founded in 2008, NPCI is a not-for-profit organisation registered under section 8 of the Companies Act 2013 with an intention to provide infrastructure to the entire Banking system in India for physical as well as electronic payment and settlement systems. Meaning: NPCI is a collective organization for all the retail payment companies in India. NPCI is set up under the Reserve Bank of India (RBI) and supported by Indian Banks Association. The NPCI is set up under the provision of the payment and settlement systems act 2007. The main agenda of NPCI is to provide the whole banking sector with better infrastructure to bring both physical and electronic payment and settlement systems. The retail payments for business and day-to-day transactions need to have an effective settlement system for both physical and electronic payments. To accommodate this, the NPCI exists. The Indian National Payments Corporation (NPCI) serves as the umbrella body for retail payment operations in India. This organization was set up along with the Indian Bank's Association by the Reserve Bank of India. In December 2008, NPCI was incorporated and was centrally funded by the Reserve Bank of India. In April 2009, the Certificate of Commencement of Business was given. Presently, NPCI is promoted by ten major promoter banks: Bank of India ICICI Bank HDFC Bank Citibank 71 CU IDOL SELF LEARNING MATERIAL (SLM)
HSBC State Bank of India Bank of Baroda Union Bank of India Punjab National Bank Canara Bank Who are the regulatory members of NPCI? Headquartered in Mumbai, the National Payments Corporation of India is an organisation registered under section 8 of the Companies Act 2013. The regulating board of NPCI consists of the following members: Biswamohan Mahapatra as the Non-Executive Chairman Nominees from Reserve Bank of India (RBI) Nominees from ten core promoter banks. Currently, Dilip Asbe is the current managing director and chief executive officer of NPCI. Objective: The main objective of NPCI is to consolidate, combine, and integrate multiple systems for payment with different service levels into one nationwide standard uniform and business process for all the retail payment transactions. It is set up under the guide lance and support of the central bank RBI and the Indian Banks Association. Another objective of NPCI to design and facilitate an affordable payment process or mechanism so that the common man who makes retail payments on a day-to-day basis benefits from the process by saving the cost and time. Thus NPCI exists in designing and implementing a nationwide mechanism that is affordable for retailers to use on a day-to-day basis without losing credibility and making sure the same process is standardized across the country. The uniformity is also maintained. Vision: The vision of NPCI is to be able to provide the citizens of the country the best, secure, simple, and easy to use payment option anywhere across the country for the retail payments in a significantly cost-effective way. The payments can be for day to day transactions also. NPCI’s main aim is to operate the common man’s main interest at first and to the interest of all its member banks. 72 CU IDOL SELF LEARNING MATERIAL (SLM)
The vision of NPCI is very clear on its agenda and route map to make the payments for a common man in day-to-day transactions and retail payments to be made simple, digitized, and easy to use and traceable. It is clear that we live in the digital world. With the increase in the number of transactions of retail payments, it is a critical and difficult process, but by pushing towards digital money and payment portals, no doubt the tracking and ease of usage have a significant impact. The whole transaction can be made secure and credible. This is achieved as the vision of the NPCI. Formation of NPCI Registered under section 8 of the company’s act, NPCI was founded in the year 2008. It was established by RBI and is owned by the collaboration of all major banks of the country. The paid-up capital is pooled in by the member banks, which included 10 of the country’s major entries. The NPCI is formed to create nationwide standards in payments for business and retail payments. NPCI works with 10 promoter banks but is regulated by the RBI. The board is appointed with the non-executive directors who are also RBI members, who will have the final say and control over the NPCI. 5.3 PRODUCTS OF NPCI PCI has made its valuable contribution to the banking sector through its products from time to time. The products and their significance are listed below: NFS: National Financial Switch (NFS) ATM network with 37 member banks and connecting 50,000 ATMs was taken to NPCI’s authority from the Institute for Development and Research in Banking Technology (IDRBT) on 14 December 2009. After taking over, NFS ATM network has grown many folds. As on 31 July 2019, there were 1,140 members with more than 2.41 lakh ATMs connected to the network. IMPS: Immediate Payment Service (IMPS) lets you transfer money in real-time around the clock, 365 days of the year. At the time of introducing IMPS, consumers only had the NEFT and RTGS facilities that were limited to the bank working hours. NPCI conducted a pilot study of the technology with banks such as SBI, BOI, UBI, and ICICI in August 2010. It was publicly launched on 22 November 2010. AePS: Aadhaar-enabled Payment Service (AePS) is a result of the attempt to further speed track financial inclusion in the country. AePS is a bank-led model that allows online interoperable financial inclusion transaction at PoS of any bank using the Aadhaar authentication through the retail merchant. A customer must provide details such as bank identification, Aadhaar number, and fingerprint to complete such a transaction. 73 CU IDOL SELF LEARNING MATERIAL (SLM)
CTS: Cheque Truncation System (CTS) facilitates extended cut-off time to accept customer cheques by banks and reduces timelines for clearing. CTS has also eliminated the cost involved in the paper movement. It uses the digital signature/encryption methods to prevent manipulation of data/image during transit. RuPay: RuPay is a new card payment system launched to satisfy RBI’s vision to offer a domestic, open-loop, and the multilateral system. This made it easier for Indian banks and financial institutions to implement electronic payments. The term ‘RuPay’ is a combination of Rupee and Payment. NPCI also developed RuPay Contactless payments technology using open standards. NACH: National Automated Clearing House (NACH) is a web-based solution that facilitates interbank, high volume electronic transactions that are repetitive in nature. They are well suited for bulk transactions towards the distribution of dividends, interest, subsidies, salary, pension, and more. APBS: Aadhaar Payment Bridge (APB) System is used by the government and government agencies to make direct benefit transfers with respect to various Central and state-sponsored schemes. *99#: *99# is a USSD-based mobile banking service of NPCI launched in November 2012. Then, the service had limited reach as it was available only with MTNL and BSNL networks. In August 2014, *99# was reintroduced with a wider ecosystem including 11 telephone service providers by the Prime Minister. After the launch of UPI in 2016, the *99# service aimed to take banking services to every common man in the country. UPI: Unified Payments Interface (UPI) is a system that makes multiple bank accounts to be accessed from a single mobile application. Users can make instant money transfers through mobile devices round the clock, any day of the year. The technology also features peer-to-peer collect request service with a scheduling facility. Bharat BillPay: Bharat BillPay is a system conceptualised by the Reserve Bank of India (RBI) and driven by NPCI. It is a one-stop-shop for all bill payments, such as mutual funds, insurance premiums, school fees, telecom, electricity, DTH, gas, water and more. It provides an interoperable and accessible service to across India. The system is reliable and safe for usage. You can also set up recurring payments on the window. A confirmation of the payment will be sent to you via SMS or receipt. NETC: National Electronic Toll Collection (NETC) is a nation-wide programme designed to meet the electronic tolling requirements in India. It is an interoperable toll payment solution that includes clearing house services for settlement and dispute management. NETC uses a common set of processes that enables customers to use FASTag as a payment mode at toll plazas irrespective of who controls the toll plaza. 74 CU IDOL SELF LEARNING MATERIAL (SLM)
BHIM: The introduction of the concept of UPI, an app named Bharat Interface for Money (BHIM) was launched to make payments simpler and easier. Instant bank-to-bank payments can be made using a mobile number or virtual payment address (UPI ID). BharatQR: Basically, a QR code is a series of black squares arranged in a square grid that can be read by a camera. NPCI, together with the international card schemes, developed a common standard QR code specification. This led to the creation of Bharat QR (BQR), a person-to-merchant mobile payment solution. When a merchant displays a BQR code, the user can scan the code via BQR-enabled mobile banking app and make the payment using a card-linked account. BHIM Aadhaar Pay: This is a payment interface through which you can make real-time payments to merchants using Aadhaar number or VPA of the customer followed by a round of authentication through biometrics. Such a transaction is limited to Rs. 10,000 per transaction. 5.4 SUMMARY Online banking (or Internet banking) allows customers to conduct financial transactions on a secure website operated by their retail or virtual bank, credit union or building society. The system is updated immediately after every transaction automatically. In other words, it is said that it is updated 'on-line, real time'. Through net banking one can check the status of his/ her account, place queries and also can be facilitated with a wide range of transactions simultaneously. Debit cards allow for direct withdrawal of funds from a Customer's bank account. The spending limit is determined by the user's bank depending upon available balance in the account of user. It is a special plastic card connected with electromagnetic identification that one can use to pay for things purchased directly from his bank account. Credit cards in India are gaining ground. A number of banks in India are encouraging people to use credit card. Diners Club and American Express used the concept of credit card in 1950 with the launch of charge cards in the USA. Credit card however became more popular with use of magnetic strip in 1970. A major driving force behind the rapid spread of internet banking all over the world is its acceptance as an extremely cost effective delivery channel of banking services as compared to other existing channels. However, Internet is not an unmixed blessing to the banking sector. 75 CU IDOL SELF LEARNING MATERIAL (SLM)
5.5 KEYWORDS Plastic Money: Generic term for all types of bankcards, credit cards, debit cards, smart cards, etc. Tele-Banking: Tele-banking services help customers to avail banking services right from their home. Online banking (or Internet banking): It allows customers to conduct financial transactions on a secure website operated by their retail or virtual bank, credit union or building society. UPI: Unified Payments Interface (UPI) is a system that makes multiple bank accounts to be accessed from a single mobile application. BHIM: The introduction of the concept of UPI, an app named Bharat Interface for Money (BHIM) was launched to make payments simpler and easier. Instant bank- to-bank payments can be made using a mobile number or virtual payment address (UPI ID). 5.6 LEARNING ACTIVITIES 1. Discuss Various Kinds of Cards in Standard Chartered Bank. ________________________________________________________________________ ________________________________________________________________________ 2. Compare any two banks’ features offered on their mobile apps. Find out which bank’s mobile app facilities is more convenient if you run a startup company and explain why? ________________________________________________________________________ ________________________________________________________________________ 5.7 UNIT END QUESTIONS 76 A. Descriptive Questions Short Questions 1. What is NFS? 2. What is IMPS? CU IDOL SELF LEARNING MATERIAL (SLM)
3. Which are the ten major banks promoting NPCI? 4. What is RuPay? 5. What is BHIM? Long Questions 1. Explain the trends in Banking 2. Describe history and Meaning of NPCI 3. What are the products of NPCI? Explain. 4. What are the Objectives and Formation of NPCI? 5. What are the visions of NPCI? B. Multi-Choice Questions 1. A ________________card is a plastic card which provides an alternative payment method to cash when making purchases. a. Credit Card b. Debit Card c. Business Card d. Master Card 2. EFT may be initiated by a cardholder when a .......................card such as a credit card or debit card is used. a. Receivable b. Payment c. Business Card d. Master Card 3. ECS (Debit) is used for raising ........................... to a number of accounts of consumer’s/ account holders for crediting a particular institution. a. Hold b. Credits c. Debits d. None of these 4. ________________helps the banks to build synergies between the insurance business and bank branch network. 77 CU IDOL SELF LEARNING MATERIAL (SLM)
a. Bancassurance b. Insurance c. Technology d. None of these 5. A lending institution called \"________________\" identifies the loans in its portfolio that are to be securitised. a. Lessee b. Lesser c. Money lender d. None of these Answers: 1 - b, 2 – b, 3 - c, 4 – a, 5 - b 5.8 REFERENCES Risk Management and Insurance: Perspectives in A Global Economy by Harold D. Skipper, w. Jean Kwon, Blackwell Publishing & Wiley India Risk Management & Insurance, James S. Trieschmann, Sandra G. Gustavson, South western, 1998 78 CU IDOL SELF LEARNING MATERIAL (SLM)
UNIT 6. BANKING PRODUCTS Structure 6.0 Learning Objective 6.1 Introduction 6.2 Demand Deposit 6.3 Time Deposit 6.4 Investment Products 6.5 Cross-Sell Products 6.6 Summary 6.7 Keywords 6.8 Learning Activities 6.9 Unit End Questions 6.10 References 6.0 LEARNING OBJECTIVE After studying this unit, you will be able to: Describe Demand Deposit Explain the Time Deposit Identify Investment Products List down Cross-Sell Products. 6.1 INTRODUCTION The development and improvement of banking products is a dominant area of innovation activity of banks, which has been named banking engineering. Indeed, during the creation and introduction of an innovative banking product in the market, various costs may be incurred, in particular, design costs, development of documentation for the implementation of innovations, information security costs, advertising of a new banking product, personnel training costs for the presentation of new banking products, costs for the acquisition of the necessary support (technical, software) for the implementation of innovations. 79 CU IDOL SELF LEARNING MATERIAL (SLM)
6.2 DEMAND DEPOSIT If the funds deposited can be withdrawn by the customer (depositor / account holder) at any time without any advanced notice to banks; it is called demand deposit. One can withdraw the funds from these accounts any time by issuing cheque, using ATM or withdrawal forms at the bank branches. The money as demand deposit is liquid and can be encashed at any time. The ownership of demand deposits can be transferred from one person to another via cheques or electronic transfers. There is no fixed term to maturity for Demand Deposits. The demand deposits may or may not pay interest to the depositor. For example, while we get an interest on savings accounts; no interest is paid on current accounts. As mentioned above, there are two types of demand deposits viz. savings accounts and current accounts. Current Account A current account is always a Demand Deposit and the bank is obliged to pay the money on demand. The Current accounts bear no interest and they account for the smallest fraction among the current, saving and term deposits. They provide the convenient operation facility to the individual / firm. The cost to maintain the accounts is high and banks ask the customers to keep a minimum balance. Saving Accounts Savings deposits are subject to restrictions on the number of withdrawals as well as on the amounts of withdrawals during any specified period. Further, minimum balances may be prescribed in order to offset the cost of maintaining and servicing such deposits. Savings deposits are deposits that accrue interest at a fixed rate set by the commercial banks. Term Deposits, popularly known as Fixed Deposit, is an investment instrument in which a lump-sum sum amount is deposited at an agreed rate of interest for a fixed period of time, ranging from 1 month to 5 years. Term Deposits can be availed at financial institutions like Banks, Non-Banking Financial Companies (NBFC), credit unions, post offices and building societies. 6.3 TIME DEPOSIT 1. Characteristics of Time Deposits Term/Time Deposits have unique monetary features that have made them popular among the investment circles. The essential characteristics of term deposits are: 80 CU IDOL SELF LEARNING MATERIAL (SLM)
Fixed rate of interest: The rate of interest for term deposits are fixed and are not subject to fluctuations in the market. Safety of investment: Since interest rates of the term deposit are not affected by the changes in the economy, it is one of the safest investment options available. Pre-set investment period: The investor has the freedom to choose the tenor of the investment based on the plans offered by the financial institution. Normally the interest rate offered by the institution will be higher for a longer tenor. But it is advisable to compare the interest to tenor ratios before making the investment. Interest Payment: The investor has the option to choose to receive the interest income either on maturity or periodically - monthly, quarterly or yearly. Wealth Generation: The stable interest received on the investment ensures that the investors' wealth grows even during difficult times in the market. Rollover: An investor who does not require their money on the maturity of the term deposit has an option to roll over the deposit for a fresh term. ‘Rollover’ refers to the reinvesting of maturity proceeds in a new term deposit and adding on to the interest. So, an investor doesn't have to utilize their money as soon as the term deposit matures. Penalty on premature withdrawal: Since term deposits come with a fixed tenor, it is considered ‘locked-in’. If the investor opts to withdraw from the deposit before the lock-in period ends they are liable to pay a penalty to the financial institution along with lowered interest income. Loan against deposit: If in a contingent situation the investor needs financial liquidity, they can avail a loan of up to 60-75% of the deposit amount. Taxation on interest: Under the Income Tax Act, the interest earned on the deposit is taxable income and can be subject to a Tax Deducted at the Source (TDS). Low investment limit: The lower limit of investment varies as per the financial institution, but the lower limit is generally Rs 1000. Although, there is no upper limit on how much can be invested in term deposits. Insurance on deposit: Under the RBI regulations, any deposit in a certified bank is eligible for an insurance cover of up to Rs 1 lakh under the Deposit Insurance and Credit Guarantee Corporation (DICGC). 2. Types of Term Deposit Cumulative and Non-Cumulative deposits: Cumulative term deposit is an option provided for investors who don’t need regular monetary income from the deposit. Hence, the interest earned is reinvested into the deposit and paid out as a lump sum at the end of the tenor. A non-cumulative term deposit is for investors who are looking for a regular interest pay-out. With a non-cumulative term deposit, the 81 CU IDOL SELF LEARNING MATERIAL (SLM)
interest will be credited in the investor’s account at regular intervals - monthly, quarterly or yearly. Sweep-in facility term deposit: Sweep-in is a feature that financial institutions provide where the individual can set an upper limit on their savings account. Any amount higher than that limit will be converted into a term deposit. If the savings account faces deficit, then the funds will be withdrawn from the term deposit with a loss of interest only on the funds swept in. Sweep-in term deposits usually provide a higher interest rate. Short-term and Long-term deposits: These term deposits have been classified based on the holding period of the investment. A short term deposit has a lock-in period ranging from 1 to 12 months. Short term deposits are ideal for investors looking for quick returns. Long term deposits have a lock-in period ranging from 1 to 10 years. These deposits provide a higher interest rate than the short term deposits. Senior Citizen term deposits: An individual over the age of 60 years is considered a senior citizen. Most banks or financial institutions provide a higher interest rate on term deposits for senior citizens. Senior citizens are also eligible for tax-saving term deposits at some banks. Special deposit schemes for children: There are a few special deposit schemes aimed the welfare of children. ‘Sukanya Samriddhi Account’ launched by the government aims at improving the financial stability of girl children above the age of 10 years. Different banks have different schemes focused on the financial welfare of children e.g., ‘Sishu Mangal’ deposit scheme by Allahabad Bank, Balika Shiksha Scheme by Punjab National Bank etc. Post Office Time Deposit: Post offices also provide certain financial services. One such service is the Post Office Term Deposit. It can either be opened as an individual or joint account. One can transfer their post office term deposit accounts from one post office to another or own multiple accounts in the same post office. The minimum limit for the deposit is Rs.200 and the current interest rate is 7.9% for 5 years. Any deposit for a tenor longer than 5 years is eligible for the tax benefits prescribed under Section 80C of the Income Tax Act, 1961. Tax-saver term deposits: Tax-saver deposits are eligible for a tax deduction of up to Rs 1.5 lakh under Section 80C of the Income Tax Act. These tax saver term deposits have a lock-in period of 5 years and any income above Rs 40,000 is taxable. The usual interest rates range between 5.5%-7.75%. 6.4 INVESTMENT PRODUCTS Within the investment market, investment products can be structured in various ways. Thus, investors have a wide variety of options in addition to buying an investment product 82 CU IDOL SELF LEARNING MATERIAL (SLM)
focused on the movement of a single security. Structured investment products can include mutual funds, exchange traded funds, money market funds, annuities and more. In the U.S. and globally, investment products are highly regulated requiring substantial documentation to provide investors with a detailed understanding of investment products for which they may choose to invest. Below are some basic examples of investment products offered in the investment universe. Stocks Stock investments represent equity ownership in a publicly traded company. Companies issue stock as part of a capital raising regime which funds the operations of the company. Stock investments have varying growth prospects and are typically analysed based on characteristics such as estimated future earnings and price-to-earnings ratios. Stocks can be classified in various categories and may also offer dividends adding an income pay-out component to the investment. Bonds Bonds are one of the most well-known fixed income investment products. They can be offered by governments or corporations looking to raise capital. Bonds pay investors interest in the form of coupon payments and offer full principal repayment at maturity. Investors can also invest in bond funds which include a portfolio of bonds managed by a portfolio manager for various objectives. Bonds and bond funds are typically classified by a credit rating which offers insight on their capital structure and ability to make timely payments. Derivatives Derivatives are investment products that are offered based on the movement of a specified underlying asset. Put or call options on stocks and futures based on the movement of commodities prices are a few of the market’s leading derivative investment products. There are also futures and customized investment products that allow investors to speculate on price movements or move risk between parties. Derivatives are complex investment products, so a certain level of market knowledge and experience is required. Public Provident Fund (PPF) It is the safest long-term investment option for the investors in India. It is totally tax- free. PPF account can be opened in bank or post office. The money deposited cannot be withdrawn before 15 years and an investor can earn compound interest from this account. However, the investor can extend the time frame for the next five years if the investor does not opt to withdraw the amount matured for payment at maturity date. PPF investor can take loan against PPF account when he/she experiences financial difficulties. Mutual Funds 83 CU IDOL SELF LEARNING MATERIAL (SLM)
An individual investor who wants to invest in equities and bond with a balance of risk and return generally can invest in mutual funds. Nowadays people invest in stock markets through a mutual fund. Systematic investment plan is one of the best investment options in India. Direct Equity or Share Purchase An individual can opt for investment in shares. But he has to analyse the market price of various shares traded in stock exchange, reputation of the company, consistency in the payment of dividend, the nature of the project undertaken by the company, growth prospects of industry in which a company is operating, before investing in shares. If the investment is made for a long time, it may yield good return. However, there is equally risky to invest in shares as there is no guaranteed return therein. Real Estate Investment Real estate is one of the fastest growing sectors in India. Buying a flat or plot is supposed to be the best decision amongst the investment options. The value of the real asset may increase substantially depending upon the area of location and other support facilities available therein. However, an investor in real estate has to be cautious and circumspect in verifying the genuineness of the title deeds before investing in real estate assets and also the reputation of seller of real assets. Investing in Metals Investment in metals like gold, silver and platinum is one of the oldest and evergreen investment products. The values of the metals rise slowly and steadily in line with the dynamic market conditions. But investors can liquidate the metals immediately in the market without any loss. Besides an investor can opt for investment format, like gold deposit scheme, gold ETF (exchange- traded fund), Gold Bar, Gold mutual fund etc., to get benefit in the short period of time. Post Office Saving Schemes There are different types of postal small savings schemes namely Post Office Savings Account, Post Office Recurring Deposit Account (RD), Post Office Fixed Deposit Account (FD/TD), Post Office Monthly Income Account Scheme (MIS), Senior Citizens Saving Scheme (SCSS) Public Provident Fund Account (PPF), National Savings Certificates (NSC), Kisan Vikas Patra (KVP), Sukanya Samriddhi Account (SSA). Investors can choose the appropriate postal schemes as per their needs. Postal investment schemes are the safest investments. 84 CU IDOL SELF LEARNING MATERIAL (SLM)
Public Deposits Public deposits are more beneficial than the fixed deposit in the bank, in the matter of yielding good return. An investor has to select the investment period very carefully. He/she is not allowed to withdraw money before maturity. However, the public deposits collected by companies and institutions do not offer any insurance benefits. It does not come under the control of the Reserve Bank of India. The investors who are willing to invest for long term can opt for public deposits. Unit Linked Insurance Plans (ULIP) ULIP is a life insurance linked product, which provides risk cover for the policy holder along with investment options to invest in any number of qualified investments such as stocks, bonds or mutual funds. Bank Deposits Fixed deposits (FD) enable the investor to invest the money for a specific period. The Fixed deposit can be opened from a minimum period of 7 days to a maximum period of 10 years. The fixed deposit holder can take loan against the fixed deposit receipt. The depositor cannot withdraw the fixed deposits before the maturity date. Recurring deposit (RD) account is another investment option for those people who earn regular income. This deposit can be opened for a minimum period of 1 year to a maximum period of 10 years. The Recurring deposit holder can take loan against the instalments paid. 6.5 CROSS-SELL PRODUCTS Cross-selling is a wide range of products to an existing customer is one of the corner stones of customer strategy in most financial institutions or banks that provide the financial services. It offering the right product to the right customer at a right time. Cross selling earning the confidence of customers as best retailer to satisfy a particular need of customers. The success of cross-selling program depends on various components such as well-defined business strategy, effective execution, regular monitoring & effective targeting strategy. It has proved itself to be effective or defining strategy for profitable growth in various sectors. Process of Cross Selling: Identify the opportunity Eligibility Business strategy Decision on analytics approach 85 CU IDOL SELF LEARNING MATERIAL (SLM)
Next best product to buy recommendation Strategy implementation Tracking of cross-sell campaigns Benefits: Cross selling builds up the relationship between customers & financial organization. cross selling offers benefit to both to customer & firm. FOR THE CUSTOMER: Offers the right product at a right place. Give maximum satisfaction. Better services & Multiples choices of product & services. Get effective product at lower prices. Reduce the Acquiring cost. FOR THE FIRM: Growth of new & existing customers. Enhance customer profitability & build the customer equity. Promotes diversification & innovation of a new product. Entries into new & competitive markets. 6.6 SUMMARY Bankers today have no choice except to alter their product mix, delivery channels and corporate structure to serve their functional role. There has been a great heat of competition in selling ideas, products and services under this segment between one bank to the other. Retail lending, a departure from conventional advance, offers higher yield, quicker turn, the possibility of less incidence of the account going bad or non-performing if it is monitored on an ongoing basis. There has been a great heat of competition in selling ideas, products and services under this segment between one bank to the other. Retail lending, a departure from conventional advance, offers higher yield, quicker turn, Notes the possibility of less incidence of the account going bad or non- performing if it is monitored on an ongoing basis. Corporate banking represents a wide range of banking and financial services provided to domestic and international operations of large local Corporates and local operations of multinational corporations. In order to administer a client company’s banking business and anticipate further financial needs, you must be informed about its business situation. 86 CU IDOL SELF LEARNING MATERIAL (SLM)
Corporate bonds are often listed on major exchanges (bonds there are called “listed” bonds) and ECNs like Bonds.com and Market Axes, and the coupon (i.e. interest payment) is usually taxable. Sometimes this coupon can be zero with a high redemption value. 6.7 KEYWORDS Demand deposits: An account from which deposited funds can be withdrawn at any time without any notice to the depository institution. This account allows the customer to \"demand\" money at any time. Most savings accounts are demand deposits, accessible by the account holder at any time. Fixed deposits: A fixed deposit is meant for those investors who want to deposit a lump sum of money for a fixed period; say for a minimum period of 15 days to five years and above, thereby earning a higher rate of interest in return. Investor gets a lump sum (principal + interest) at the maturity of the deposit. Gross profit ratio: Gross profit ratio (GP ratio) is the ratio of gross profit to net sales expressed as a percentage. It expresses the relationship between gross profit and sales. Gross profit = Net sales (Total Sales-Returns) - Cost of goods sold (Opening stock + Purchases + Direct Expenses - Closing stock). Time deposits: A savings account held for a fixed-term with the understanding that the depositor can only withdraw by giving written notice. The term generally is at least 30 days. Net profit ratio: The ratio of an organization's net profit to its total net sales. Comparing the net profit ratios of companies in the same sector shows which are the most efficient. 6.8 LEARNING ACTIVITIES 1. Find out what are the popular banking products offered by HDFC for investment purpose and explain. ________________________________________________________________________ ________________________________________________________________________ 2. Explain how cross selling works in ICICI Bank. 87 CU IDOL SELF LEARNING MATERIAL (SLM)
________________________________________________________________________ ________________________________________________________________________ 6.9 UNIT END QUESTIONS A. Descriptive Questions Short Questions 1. What is Short term and Long term deposits in short? 2. What is Derivatives? 3. List the process Cross-selling 4. Write in short about Special deposit schemes for children. 5. What is current account? Long Questions 1. What are the investment products in banking? Explain in detail. 2. Explain Types of Time Deposit 3. Explain Demand Deposit 4. Write in detail about Cross-Selling Products in banking 5. What are the Characteristics of Time Deposits? B. Multi-Choice Questions 1. __________bear no interest and they account for the smallest fraction among the current, saving and term deposits. a. Saving Account b. FD Account c. PF Account d. Current Account 2. __________ The mode of operation of Joint Savings Bank account can be altered by: a. All joint account holders b. Any of the joint account holders c. Mode of operation once given cannot be altered d. All of these 88 CU IDOL SELF LEARNING MATERIAL (SLM)
3. In a Joint Savings Bank account when the operational instructions are not given, cheques in the account can be drawn by: a. Any of the joint account holders. b. All the account holders jointly. c. Cheques cannot be drawn without operational instructions. d. Operations in the account cannot be permitted 4. _______________ has wider connotation and is not the same as that of retail lending. a. Retail Banking b. Phone Banking c. Internet Banking d. Insurance Banking 5. Banks cannot accept interest-free deposit, except for deposit at call; for instance, money held in current account of the ______________ does not bear any interest. a. Banker b. RBI c. Depositor d. None of these Answers 1 - d, 2 – a, 3 - b, 4 – a, 5 - c 6.10 REFERENCES Risk Management and Insurance: Perspectives in A Global Economy by Harold D. Skipper, w. Jean Kwon, Blackwell Publishing & Wiley India Risk Management & Insurance, James S. Trieschmann, Sandra G. Gustavson, South western, 1998 89 CU IDOL SELF LEARNING MATERIAL (SLM)
UNIT 7. INSURANCE Structure 7.0 Learning Objective 7.1 Introduction 7.2 Concept 7.3 Organisation Structure 7.4 Functions 7.5 Regulation & Legislation Applicable to Insurance 7.6 Summary 7.7 Keywords 7.8 Learning Activities 7.9 Unit End Questions 7.10 References 7.0 LEARNING OBJECTIVE After studying this unit, you will be able to: Explain the concept of Insurance Describe Organisational Structure of Insurance Identify Functions of Insurance companies List down Regulation and Legislation Applicable to Insurance 7.1 INTRODUCTION Insurance is a form of risk management in which the insured transfers the cost of potential loss to another entity in exchange for monetary compensation known as the premium. Insurance allows individuals, businesses and other entities to protect themselves against significant potential losses and financial hardship at a reasonably affordable rate. We say \"significant\" because if the potential loss is small, then it doesn't make sense to pay a premium to protect against the loss. After all, you would not pay a monthly premium to protect against a loss because this would not be considered a financial hardship for most. Insurance is appropriate when you want to protect against a significant monetary loss. 90 CU IDOL SELF LEARNING MATERIAL (SLM)
Take life insurance as an example. If you are the primary breadwinner in your home, the loss of income that your family would experience as a result of our premature death is considered a significant loss and hardship that you should protect them against. It would be very difficult for your family to replace your income, so the monthly premiums ensure that if you die, your income will be replaced by the insured amount. The same principle applies to many other forms of insurance. If the potential loss will have a detrimental effect on the person or entity, insurance makes sense. Everyone that wants to protect themselves or someone else against financial hardship should consider insurance. This may include: Protecting family after one's death from loss of income Ensuring debt repayment after death Covering contingent liabilities Protecting against the death of a key employee or person in your business Buying out a partner or co-shareholder after his or her death Protecting your business from business interruption and loss of income Protecting yourself against unforeseeable health expenses Protecting your home against theft, fire, flood and other hazards Protecting yourself against lawsuits Protecting yourself in the event of disability Protecting your car against theft or losses incurred because of accidents And many more Role of Insurance in Financial Systems: You will find it interesting to note that insurance is a part of financial system. Financial system may be defined as set of institutions, instruments and markets, which gather savings and channel them to their most efficient use. The system consists of individuals (savers), intermediaries, markets and users of savings. Economic activity and growth are greatly facilitated by the existence of the market in mobilizing the saving and allocating them among competing users. An economy needs institutions that impartially enforce property rights and contracts. Economic growth of a country depends on the existence of a well-functioning financial infrastructure. It is essential that the financial infrastructure be developed sufficiently so that the market operates in an efficient manner. Insurance as a part of the financial system provides valuable services to those affected by various Notes risks or contingencies. It takes care of the financial consequences of certain specific contingencies but in insurance terminology, such contingencies are called risks and they cause losses when they occur. The effect of these losses on financial system is not only negative but may be disastrous and catastrophic also. It results in substantial 91 CU IDOL SELF LEARNING MATERIAL (SLM)
burden on the financial well-being of those affected. The insurance sector supports the financial system in several ways. A few have been enumerated below: 1. It accepts the risk from people and corporate bodies who are exposed to them. 2. It collects small amounts of premium, which are pooled together to be called an insurance fund. This fund is used for investment purpose. 3. It organizes compulsory insurance in certain areas as per the provisions of the law. 4. It sells voluntary insurance covers through its sales force. 5. It settles claims arising out of insured losses. Neither the insurance company nor the insured are allowed to make profits out of insurance. If insurance company gets a surplus. 7.2 CONCEPT Insurance is a contract between two parties. One party is the insured and the other party is the insurer. Insured is the person whose life or property is insured with the insurer. That is, the person whose risks are insured is called insured. Insurer is the insurance company to whom risk is transferred by the insured. That is, the person who insures the risk of insured is called insurer. Thus insurance is a contract between insurer and insured. It is a contract in which the insurance company undertakes to indemnify the insured on the happening of certain event for a payment of consideration. It is a contract between the insurer and insured under which the insurer undertakes to compensate the insured for the loss arising from the risk insured against. Some definitions of insurance are given below: The LIC had monopoly till the late 90s when the Insurance sector was reopened to the private sector. Before that, the industry consisted of only two state insurers: Life Insurers (Life Insurance Corporation of India, LIC) and General Insurers (General Insurance Corporation of India, GIC). GIC had four subsidiary companies. With effect from December 2000, these subsidiaries have been de-linked from the parent company and were set up as independent insurance companies: Oriental Insurance Company Limited, New India Assurance Company Limited, National Insurance Company Limited and United India Insurance Company Limited. Insurance in India refers to the market for insurance in India which covers both the public and private sector organizations. It is listed in the Constitution of India in the Seventh Schedule as a Union List subject, meaning it can only be legislated by the Central government. The insurance sector has gone through a number of phases by allowing private companies to solicit insurance and also allowing foreign direct investment. India allowed private companies in insurance sector in 2000, setting a limit on FDI to 26%, which was increased to 49% in 2014. [1] However, the largest life-insurance company in 92 CU IDOL SELF LEARNING MATERIAL (SLM)
India, Life Insurance Corporation of India is still owned by the government and carries a sovereign guarantee for all insurance policies issued by it. 7.3 ORGANISATIONAL STRUCTURE Insurance companies operate under one of two business structures. These structures have their own unique features, advantages and disadvantages. The structure of the company also drives the long-term business activity and how the company operates. It may affect the investments it makes and even the types of policies it designs and sells. Mutual Structure A mutual insurance company is an insurance company that is not publicly traded. The company is effectively owned by the policyholders. Because of this, the interests of the management are aligned with those of the policyholders in a direct way. The management is incentivized to work for the long-term benefit of the policyholders, since actions that work against the policyholders may cause them to leave the company. Mutual insurers generally have only one way to make money. They must sell new policies. The exception to this is life insurers, which may also raise funds through interest on policy loans. Stock Structure A stock insurance company is publicly traded. The company is not necessarily disincentivized to work for the long-term best interest of the policyholders. However, the insurer has to balance the interests of the policyholders with that of outside stockholders. These stockholders may or may not own policies issued by the company. A stock company may raise money by selling policies or issuing more stock of the company. In the case of life insurance companies, stock insurers may encourage policyholders to take policy loans and collect interest payments. Changing Structure A mutual insurance company may demutualize. This means that the company becomes a stock company. Likewise, a stock company may mutualize. The stock company buys up all of its outstanding shares and can then do business as a mutual insurer. Product Incentives Mutual insurance companies may be incentivized to build and sell certain kinds of products. This is because policyholders own the company. The insurer may elect to pay dividends to policyholders. For life insurance companies, this means that whole life insurance which pays dividends may be favoured over universal life insurance which does not. 93 CU IDOL SELF LEARNING MATERIAL (SLM)
7.4 FUNCTIONS Insurance is defined as a co-operative device to spread the loss caused by a particular risk over a number of persons who are exposed to it and who agree to ensure themselves against that risk. Risk is uncertainty of a financial loss. It should not be confused with the chance of loss which is the probable number of losses out of a given number of exposures. It should not be confused with peril which is defined as the cause of loss or with hazard whichis a condition that may increase the chance of loss. Finally, risk must not be confused withloss itself which is the unintentional decline in or disappearance of value arising from acontingency. Wherever there is uncertainty with respect to a probable loss there is risk. Every risk involves the loss of one or other kind. The function of insurance is to spread the loss overa large number of persons who are agreed to co-operate each other at the time of loss. Therisk cannot be averted but loss occurring due to a certain risk can be distributed amongst the agreed persons. They are agreed to share the loss because the chances of loss, i.e., the time, amount, to a person are not known. Anybody of them may suffer loss to a given risk, so, the rest of the persons who are agreedwill share the loss. The larger the number of such persons the easier the process of distribution of loss, In fact; the loss is shared by them by payment of premium which is calculated on the probability of loss. In olden time, the contribution by the persons was madeat the time of loss. The insurance is also defined as a social device to accumulate funds tomeet the uncertain losses arising through a certain risk to a person insured against the risk. The functions of insurance can be studied into two parts (i) Primary Functions, and (ii) Secondary Functions. Primary Functions: Insurance provides certainty: Insurance provides certainty of payment at the uncertainty of loss. The uncertainty of loss can be reduced by better planning and administration. But, the insurance relieves the person from such difficult task. Moreover, if the subject matters are not adequate, the self- provision may prove costlier. There are different types of uncertainty in a risk. The risk will occur or not, when will occur, how much loss will be there? In other words, there are uncertainty of happening of time and amount of loss. Insurance removes all this uncertainty and the assured is given certainty of payment of loss. The insurer charges premium forproviding the said certainty. Insurance provides protection: The main function of the insurance is to provide protection against the probable chances of loss. The time and amount of loss are uncertain and at the happening of risk, the person will suffer loss in absence of insurance. The insurance guarantees the payment of loss and 94 CU IDOL SELF LEARNING MATERIAL (SLM)
thus protects the assured from sufferings. The insurance cannot check the happening of risk but can provide for losses at the happening of the risk. Risk-Sharing: The risk is uncertain, and therefore, the loss arising from the risk is also uncertain. When risk takes place, the loss is shared by all the persons who are exposed to the risk. The risk- sharing in ancient time was done only at time of damage or death; but today, on the basisof probability of risk, the share is obtained from each and every insured in the shape of premium without which protection is not guaranteed by the insurer. Secondary functions: Besides the above primary functions, the insurance works for the following functions: Prevention of Loss: The insurance joins hands with those institutions which are engaged in preventing the losses of the society because the reduction in loss causes lesser payment to the assured and so more saving is possible which will assist in reducing the premium. Lesser premium invites more business and more business cause lesser share to the assured. So again premium is reduced to, which will stimulate more business and more protection to the masses. Therefore, the insurance assist financially to the health organization, fire brigade, educational institutions and other organizations which are engaged in preventing the losses of the masses from deathor damage. It Provides Capital: The insurance provides capital to the society. The accumulated funds are invested in productive channel. The dearth of capital of the society is minimized to a greater extent withthe help of investment of insurance. The industry, the business and the individual are benefited by the investment and loans of the insurers. It Improves Efficiency: The insurance eliminates worries and miseries of losses at death and destruction of property. The carefree person can devote his body and soul together for better achievement. It improves not only his efficiency, but the efficiencies of the masses are also advanced. It helps Economic Progress: The insurance by protecting the society from huge losses of damage, destruction and death, provides an initiative to work hard for the betterment of the masses. The next factor of economic progress, the capital, is also immensely provided by the masses. The property, the valuable assets, the man, the machine and the society cannot lose much at the disaster. 95 CU IDOL SELF LEARNING MATERIAL (SLM)
7.5 REGULATION & LEGISLATION APPLICABLE TO INSURANCE The process of re-opening of the sector had begun in the early 1990s and the last decade and more has seen it been opened up substantially. In 1993, the Government set up a committee under the chairmanship of R N Malhotra, former Governor of RBI, to propose recommendations for reforms in the insurance sector. The objective was to complement the reforms initiated in the financial sector. The committee submitted its report in 1994 wherein, among other things, it recommended that the private sector be permitted to enter the insurance industry. They stated that foreign companies be allowed to enter by floating Indian companies, preferably a joint venture with Indian partners. Following the recommendations of the Malhotra Committee report, in 1999, the Insurance Regulatory and Development Authority (IRDA) was constituted as an autonomous body to regulate and develop the insurance industry. A. ORGANIZATIONAL STRUCTURE OF IRDAI: Composition of IRDAI: As per Sec. 4 of IRDAI Act, 1999, the composition of the Authority is: a) Chairman; b) Five whole-time members; c) Four part-time members, (appointed by the Government of India) IRDAI’s Head Office is at Hyderabad All the major activities of IRDAI including ensuring financial stability of insurers and monitoring market conduct of various regulated entities is carried out from the Head Office. IRDAI’s Regional Offices are at New Delhi & Mumbai The Regional Office, New Delhi focuses on spreading consumer awareness and handling of Insurance grievances besides providing required support for inspection of Insurance companies and other regulated entities located in the Northern Region. This office is functionally responsible for licensing of Surveyors and Loss Assessors. Regional Office at Mumbai handles similar activities, as in Regional Office Delhi, pertaining to Western Region. B. INSURANCE REGULATORY FRAMEWORK: 96 CU IDOL SELF LEARNING MATERIAL (SLM)
1. Insurance Regulatory and Development Authority of India (IRDAI), is a statutory body formed under an Act of Parliament, i.e., Insurance Regulatory and Development Authority Act, 1999 (IRDAI Act 1999) for overall supervision and development of the Insurance sector in India. 2. The powers and functions of the Authority are laid down in the IRDAI Act, 1999 and Insurance Act, 1938. The key objectives of the IRDAI include promotion of competition so as to enhance customer satisfaction through increased consumer choice and fair premiums, while ensuring the financial security of the Insurance market. 3. The Insurance Act, 1938 is the principal Act governing the Insurance sector in India. It provides the powers to IRDAI to frame regulations which lay down the regulatory framework for supervision of the entities operating in the sector. Further, there are certain other Acts which govern specific lines of Insurance business and functions such as Marine Insurance Act, 1963 and Public Liability Insurance Act, 1991. 4. IRDAI adopted a Mission for itself which is as follows: To protect the interest of and secure fair treatment to policyholders; To bring about speedy and orderly growth of the Insurance industry (including annuity and superannuation payments), for the benefit of the common man, and to provide long term funds for accelerating growth of the economy; To set, promote, monitor and enforce high standards of integrity, financial soundness, fair dealing and competence of those it regulates; To ensure speedy settlement of genuine claims, to prevent Insurance frauds and other malpractices and put in place effective grievance redressal machinery; To promote fairness, transparency and orderly conduct in financial markets dealing with Insurance and build a reliable management information system to enforce high standards of financial soundness amongst market players; To take action where such standards are inadequate or ineffectively enforced; To bring about optimum amount of self-regulation in day-to-day working of the industry consistent with the requirements of prudential regulation. 5. Entities regulated by IRDAI: a. Life Insurance Companies - Both public and private sector Companies b. General Insurance Companies - Both public and private sector Companies. Among them, there are some standalone Health Insurance Companies which offer health Insurance policies. c. Re-Insurance Companies 97 d. Agency Channel e. Intermediaries which include the following: Corporate Agents Brokers CU IDOL SELF LEARNING MATERIAL (SLM)
Third Party Administrators Surveyors and Loss Assessors. 6. Regulation making process: Section 26 (1) of IRDAI Act, 1999 and 114A of Insurance Act, 1938 vests power in the Authority to frame regulations, by notification. Section 25 of IRDAI Act, 1999 lays down for establishment of Insurance Advisory Committee consisting of not more than twenty five members excluding the ex-officio members. The Chairperson and the members of the Authority shall be the ex-officio members of the Insurance Advisory Committee. The objects of the Insurance Advisory Committee shall be to advise the Authority on matters relating to making of regulations under Section 26. Accordingly, the draft regulations are first placed in the meeting of Insurance Advisory Committee and after obtaining the comments/recommendations of IAC, the draft regulations are placed before the Authority for its approval. Every Regulation approved by the Authority is notified in the Gazette of India. Every Regulation so made is submitted to the Ministry for placing the same before the Parliament. 7. The Authority has issued regulations and circulars on various aspects of operations of the Insurance companies and other entities covering: Protection of policyholders’ interest Procedures for registration of insurers or licensing of intermediaries, agents, surveyors and Third Party Administrators; Fit and proper assessment of the promoters and the management Clearance /filing of products before being introduced in the market Preparation of accounts and submission of accounts returns to the Authority. Actuarial valuation of the liabilities of life Insurance business and forms for filing of the actuarial report; Provisioning for liabilities in case of non-life Insurance companies Manner of investment of funds and periodic reports on investments Maintenance of solvency Market conduct issues C. SUPERVISORY ROLE: 1. The objective of supervision as stated in the preamble to the IRDAI Act is “to protect the interests of holders of Insurance policies, to regulate, promote and ensure orderly growth of the Insurance industry”, both Insurance and Reinsurance business. The powers and functions of the Authority are laid down in the IRDAI Act, 1999 and Insurance Act, 1938 to enable the Authority to achieve its objectives. 98 CU IDOL SELF LEARNING MATERIAL (SLM)
2. Section 25 of IRDAI Act 1999 provides for establishment of Insurance Advisory Committee which has Representatives from commerce, industry, transport, agriculture, consume for a, surveyors agents, intermediaries, organizations engaged in safety and loss prevention, research bodies and employees’ association in the Insurance sector are represented. All the rules, regulations, guidelines that are applicable to the industry are hosted on the website of the supervisor and are available in the public domain. 3. Section 14 of the IRDAI Act,1999 specifies the Duties, Powers and functions of the Authority. These include the following: To grant licenses to (re) Insurance companies and Insurance intermediaries To protect interests of policyholders, To regulate investment of funds by Insurance companies, professional organisations connected with the (re)Insurance business; maintenance of margin of solvency; To call for information from, undertaking inspection of, conducting enquiries and investigations of the entities connected with the Insurance business; To specify requisite qualifications, code of conduct and practical training for intermediary or Insurance intermediaries, agents and surveyors and loss assessors To prescribe form and manner in which books of account shall be maintained and statement of accounts shall be rendered by insurers and other Insurance intermediaries; D. PRUDENTIAL APPROACH: REPORTING, RISK MONITORING AND INTERVENTION: 1. Reporting Requirements: Insurers are required to submit various returns like financial statements on an annual basis duly accompanied by the Auditors’ opinion statement on the annual accounts; reports of valuation of assets, valuation of liabilities and solvency margin; actuarial report and abstract and annual valuation returns giving information about the financial condition for life Insurance business; Incurred But Not Reported claims in case of general Insurance business; Reinsurance plans on an annual basis; and monthly statement on underwriting of large risks in case of general Insurance companies; details of capital market exposure on a monthly basis; Investment policy, Quarterly and annual returns on investments. 2. Solvency of Insurers: In order to monitor and control solvency requirements, it has been made mandatory to the insurers to submit solvency report on quarterly basis. In case of any deviation, the 99 CU IDOL SELF LEARNING MATERIAL (SLM)
Supervisor initiates necessary and suitable steps so as to ensure that the Insurer takes immediate corrective action to restore the solvency position at the minimum statutory level. Computation of solvency margin takes into account the inherent risk that respective line of business poses to the insurer. Higher requirements are placed for risky lines of business compared to others posing less risk to the insurers. Even though the insurers are required to maintain a minimum solvency ratio of 150% at all times, the actual solvency margin maintained by insurers are well above the required solvency margin leading to the solvency margin ratio significantly higher than 150% on average. Quarterly solvency ratio reports have to be submitted to the Supervisor, maintaining minimum solvency ratio of 150%. This provides the regular a mechanism to monitor the solvency position periodically over the financial year in order to ensure compliance with the requirements and hence to initiate suitable action in the event of any early warning signal on the Insurer’s financial condition. 3. Asset-Liability Management: Under Asset-Liability Management reporting, Insurer must provide the year wise projected cash flows, in respect of both assets and liabilities. Insurers must maintain mismatching reserves in case of any mismatch between assets and liabilities as a part of the global reserves. Further, Life insurers are required to submit a report on sensitivity and scenario testing exercise in the prescribed format. Non-life insurers must submit a report on ‘Financial Condition’ covering the sensitivity analysis of the financial soundness in meeting the policyholders’ liabilities. The supervisor requires management of investments to be within the insurer’s own organization. In order to ensure a minimum level of security of investments in line with Insurance Act Provisions, the regulations prescribe certain percentages of the funds to be invested in government securities and in approved securities. The regulatory framework lays down the norms for the mix and diversification of investments in terms of Types of Investment, Limits on exposure to Group Company, Insurer’s Promoter Group Company. Investment Regulations lay down the framework for the management of investments. The exposure limits are also prescribed in the Regulations. The Investment Regulations require a proper methodology to be adopted by the insurer for matching of assets and liabilities. 4. Reinsurance: Transfer of risk through Reinsurance is recognized only to the extent specified in the regulations. Due safeguards are built in to ensure that adjustments are made to provide for quality of assets held. No other risk transfer mechanism exists in the current system. In order to minimize the counterparty risk, the re-insurers with whom business is placed must 100 CU IDOL SELF LEARNING MATERIAL (SLM)
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