COMMERCIAL BANKING/BANK MANAGEMENT QUESTION BANK

Answers to Question No. 1 to 10 may be given in 50 to 100 words. Each question from No. 1 to 10 carries 2 marks. Q 1. How would economic transactions between suppliers of funds and ultimate users of funds occur in a world without FIs ? Explain with the help of a diagram. Q 2. Give three major reasons that suppliers of funds would not like to directly purchase securities issued by ultimate users of funds ? Q 3. Explain, with the help of a diagram, the financial intermediation process/role performed by an FI ? Q 4. What are the various kinds of financial intermediation roles performed by an FI ? Q 5. How can an FI reduce/overcome those problems faced by primary savers/suppliers of funds in direct transfer of funds to ultimate users of funds ? (4 marks) Q 6. What is meant by Maturity intermediation ? Q 7. What is meant by Denomination intermediation ? Q 8. What are the core/primary activities of a Commercial Bank ? Q 9. What are the differences between the Balance Sheets of a Depository Institution like a Commercial Bank and a Non-financial Firm like a Manufacturing Company ? Q 10. It is said that Commercial Banks are highly leveraged entities. Comment. Q 11. Mention the different items that appear in a Banks Balance Sheet in India.

Q 12. Q 11. Mention the different items that appear in a Banks Income Statement (Profit & Loss Account) in India. Q 13. Classify the following accounts into one of the following categories : (a) assets (b) liabilities (c) equity (d) revenue (e) expense (f) Off-Balance Sheet (OBS) activity. (1) Retail Deposits (2) Paid-up-capital (3) Loan Commitments (4) Consumer loans (5) Interest on Investment securities (6) Interest on Savings Bank Deposits (7) Current Deposits (8) Letter of Credit (9) Retained earnings (10) Provision on NPA Loans Q 14. Define Net Interest Income (NII) and Net Interest Margin (NIM). Q 15. Define Operating Profit and Net Profit/Net Income in a Banks Income Statement. Q 16. It is said that Banks Profitability Management boils down to two components : Spread Management ( or Management of NIM) and Burden or Overhead Management. Comment on the statement by explaining terms like Spread, NIM and Burden and the strategies to improve profitability of a Bank. Q 17. Its often said that Banks must rely less on Net Interest Income/ Core Income and more on the Non-Interest Income/Other Income. Comment on the statement defining the terms like Core Income and explaining (a) the various sources of Non-interest Income and (b) the sources and strategies to control the Non-interest expenses. Q 18. What is meant by an Off-Balance Sheet (OBS) activity ? What are some of the forces responsible for them ? Q 19. How does one distinguish between an off-balance sheet asset and an off-balance sheet liability ? Q 20. What are the main off-balance sheet activities undertaken by commercial banks ?

Q 21. Banks typically differentiate between interest and non-interest income and expense. What are the primary components of each ? Define Net Interest Income (NIM) and burden. What does a banks efficiency ratio measure ? Q 22. A banks efficiency ratio (ER) is defined as the ratio of Non-interest expense to the total of Net interest income and Non-interest income. Should the efficiency ratio be low or high for increasing banks profitability ? Q 23. Arrange the following items into an income statement. Label each item, place it in the appropriate category and determine the banks bottomline net income. a. b. c. d. e. f. g. h. i. j. k. l. m. n. o. Interest paid on Term deposits Rs.100,000/Interest paid on Certificate of deposits Rs.101,000/Interest received on GOI Securities Rs.44,500/Fees received on selling of insurance and mutual funds Rs.23,000/Dividends paid to Shareholders of Rs.0.50 per share for 5,000 shares Provision for loan losses/NPA provision Rs.18,000/Interest and discount on loans Rs.1,89,700/Interest paid on SB accounts Rs.33,500/Interest received on Corporate/PSU bonds Rs.60,000/Employees salary and benefits Rs.1,45,000/Purchase of a new Computer system Rs.50,000/- (Depreciation for the current year Rs.10,000/-) Service charge/commission receipts from customer accounts Rs.41,000/Occupancy expenses for the bank building Rs.22,000/Taxes of 34% of taxable income are paid Safe Deposit Locker rent receipt Rs.15,000/-

Q 24. M/s XYZ Bank Ltd. has the following Balance Sheet & Income Statement. (Figures are in Rs. Crores)

Balance Sheet

Liabilities & Equity Assets Assets Demand Deposits 47,000 Cash & Bal. with RBI 9,000 Term Deposits 89,000 Bal. with Banks/Money at call & short notice 42,000 Debentures 19,000 Investment securities 23,000 Total Liabilities 155,000 Paid up Equity Capital 12,000 Loans & advances 90,000 Share Premium 4,000 Fixed assets 15,000 Retained Earnings 12,000 Other assets 4,000 Total Liabilities & Equity 183,000 Total assets 183,000

Income Statement Interest & discount on Loans Interest on Investment securities Interest on Money Market Securities Interest on deposits in banks Total Interest Income Interest on Deposits Interest on debentures Total Interest Expense Net Interest Income Non-interest/Other Income 9,000 4,000 6,000 1,000 20,000 9,000 2,000 11,000 9,000 2,000

Non-interest/Other Expense Operating Profit Provision for loan losses/NPA Provision Profit before tax Tax paid Net Income/Net Profit (Profit after tax) For XYZ Bank, calculate : a. b. c. d. e. f. ROE ROA EM (Equity Multiplier) ER (Efficiency Ratio) AU PM

1,000 10,000 2,000 8,000 3,000 5,000

Q 25. What is the difference between firm-specific credit risk and systematic credit risk ? How can a Bank alleviate firm specific credit risk ? Q 26. What is the process of asset transformation performed by a Bank ? Why does this process often lead to the creation of interest rate risk ? What is interest rate risk ? Q 27. What is refinancing risk ? How is refinancing risk part of interest rate risk ? If an FI funds long-term assets with short-term liabilities, what will be the impact on earnings of an increase in the rate of interest ? A decrease in the rate of interest ? Q 28. What is reinvestment risk ? How is reinvestment risk part of interest rate risk ? If an FI funds short-term assets with long-term liabilities, what will be the impact on earnings of a decrease in the rate of interest ? An increase in the rate of interest ? Give Answer to Question Nos. 1 to 30 in a couple of words. Each question carries 1 mark.

Q 1. What is the process of pooling small amounts of savings from individuals to be given as loans known as------ ? Q 2. What is the process of borrowing of relatively short-term funds from savers, who often cannot commit their funds over long periods, and making long-term loans to borrowers who require a long-term commitment to funds known as ? Q 3. What is the limit/amount of deposit insurance available to a single individual depositor per bank ? Q 4. All scheduled commercial banks are required to deposit a certain percentage of their Net Demand and Time Liabilities in the form of cash with RBI. What is the name of this and the current rate ?

Q 5. Expand SWIFT ? Q 6. Expand RTGS ? Q 7. Name two non-fund based credit facilities commonly provided by a commercial bank ? Q 8. Name the right of a banker to combine/adjust two accounts of a customer, one with a credit balance and the other with a debit balance ? Q 9. Name the right of the Banker to retain possession of the goods & securities owned by the debtor (borrower) until the debt due from the latter is paid ? Q 10. Name the bill finance facility under which Buyers Bank discounts the bill for the account of the Buyer and remit the amount to the Drawer/Seller of the Bill and Buyers Bank recovers the amount paid on the bill along with interest and other charges, if any from the Buyer (his Customer) on the due date of the bill. This is a working capital facility to the buyer as an alternative to the Cash Credit facility against stocks.

Q 11. What is the name of a bill which is payable after a specified period of time ? Q 12. Name a credit facility which is a substitute of a Term loan and also a non-fund based credit facility ? Q 13. In countries like USA and Japan, issue of bank guarantee is prohibited, instead the banks there issue a specific type of Letter of Credit for this purpose. Name this Letter of Credit ? Q 14. Write the expression for Working Capital Gap (WCG) ? Q 15. Write the expression for Tangible Net Worth (TNW) ? Q 16. Current ratio is 1, find out the Net Working Capital (NWC) ? Q 17. THIS IS A SIMPLE METHOD OF WORKING CAPITAL ASSESSMENT WHERE THE WORKING CAPITAL REQUIREMENT OF THE BUSINESS UNIT TO BE ASSESSED AT 25% OF THE PROJECTED ANNUAL GROSS SALES FOR THE NEXT YEAR. NAME THIS METHOD ? Q 18. Define Margin of Safety (MoS) in relative form which is used as tool in Term loan appraisal. Q 19. In loan syndication, a borrower is liable to pay a charge which is certain percentage on the undrawn/unutilized portion of the loan. Name this charge ? Q 20. In a loan transaction, very often borrower has got better information than the banker. This situation is known as ------ ? Q 21. After loan is availed by the borrower, very often borrower indulges in irresponsible or problematic behavior which may lead to negative outcome. This situation is known as ------------- ? Q 22. Define Net NPA to Net Credit Ratio ? Q 23. What is the NPA provision rate f2or Loss Loan Asset ?

Q 24. What is the maximum default period beyond which a loan account will be classified as NPA in the books of the bank ? Q 25. Name the new risk recognized in Basel II ? Q 26. What is the minimum Capital adequacy ratio (CAR) for Banks in India as per Basel II ? Q 27. Sub-ordinated debt is a part of Tier I or Tier II capital ? Q 28. BCBS defines one risk as the risk of direct or indirect loss resulting from inadequate or failed internal processes, people and systems or from external events. This risk is called as --------- ? Q 29. When the asset of a bank is short funded (borrowing short, lending long), this gives rise to a risk which is a particular form of interest rate risk. Name this risk ------ ? refinance position Q 30. Name the ratio used for assessing the repayment capacity of a borrower in case of a Term Loan ?
Q 31. If a Bank funds long-term assets with short-term liabilities, what will be the impact on earnings of an increase in the rate of interest ?

this gives rise to a risk which is a particular form of interest rate risk. Name this risk ------ ?
Q 32. When the asset of a bank is long funded (borrowing long, lending short), Q 33. If a Bank funds short-term assets with long-term liabilities, what will be the impact on earnings of a decrease in the rate of interest ? +++++++++++++++++++++++++

Q 34. Who decides interest rate on Savings Bank account ? Q 35. What is the current interest rate on Savings Bank account ? Q 36. What is the interest rate payable on Current Deposit account ? Q 37. Who decides interest rate on Term Deposit account ?

Q 38. What is the full form of BPLR ? Q 39. Who decides the BPLR of a Bank ? Q 40. Define the Rate Sensitivity Gap (RSG) also known as Re-pricing Gap or Funding Gap ? Q 41. What are the three pillars of Basel II new capital accord ? Q 42. What is the new risk introduced as per Basel II ? Q 43. Define Capital Adequacy Ratio (CAR), also known as Capital to risk-weighted asset ratio (CRAR). Q 44. What are the two reasons for Which banks need liquidity ? Q 45. What two methods do Banks/Financial Institutions use to manage the liquidity needs ? Q 46. Calculate the re-pricing gap and impact on net interest income (NII) of a 1% increase in interest rates for the following position : RSA = 100 crore, RSL = 50 crore Q 47. Calculate the re-pricing gap and impact on net interest income (NII) of a 1% increase in interest rates for the following position : RSA = 50 crore, RSL = 150 crore

Question Nos. 1 to 6 carry 5 marks each.

Q 1. Mention the different items that appear in a Banks Income Statement (Profit & Loss Account) in India. Show step by step calculation to derive Operating Profit and Net Profit after tax (Net Income).

Question Nos. 7 to 9 carry 10 marks each.

Q 7. What are three pillars of Basel II new Capital accord ? What is the new risk introduced as per Basel II ? Define Capital Adequacy Ratio, also known as Capital to risk-weighted asset ratio (CAR or CRAR). What is the minimum Capital adequacy ratio requirement for Banks in India ?

Q 8. What is Credit Default Swap (CDS) ? Explain with the help of a diagram.

: : 2 : :
Q 9. M/s XYZ Bank Ltd. has the following Balance Sheet & Income Statement.

Balance Sheet
Liabilities & Equity Assets Demand Deposits 57,000 Term Deposits 99,000 Debentures 29,000 Total Liabilities 185,000 Paid up Equity Capital 22,000 Share Premium 14,000 Retained Earnings 12,000 Total Liabilities & Equity 233,000

(Figures are in Rs. Crores) Assets Cash & Bal. with RBI 19,000 Bal. with Banks/Money at call & short notice 52,000 Investment securities 33,000 Loans & advances Fixed assets Other assets Total assets 110,000 15,000 4,000 233,000

* Average earning assets = 200,000

Income Statement
Interest & discount on Loans Interest on Investment securities Interest on Money Market Securities Interest earned on deposits in banks Total Interest Income Interest paid on Deposits Interest paid on debentures Total Interest Expense Non-interest/Other Income Non-interest/Other Expense Operating Profit Provision for loan losses/NPA Provision Profit before tax Tax paid Net Income/Net Profit (Profit after tax) For XYZ Bank, calculate : a. b. c. d. e. NIM ROE ROA EM (Equity Multiplier) AU 19,000 5,000 6,000 1,000 31,000 10,000 3,000 13,000 4,000 6,000 16,000 3,000 13,000 3,000 10,000

f.

PM

Q 10. Explain the Letter of Credit (LC) Mechanism by means of a diagram.

-----------------End of Question Paper--------------

Q 4. Why banks need liquidity ? What two methods do Banks/Financial Institutions use to manage the liquidity needs ? Q 5. Calculate the re-pricing gap and impact on net interest income (NII) of a 1% increase in interest rates for the following positions : a. RSA = 100 crore, RSL = 50 crore b. RSA = 50 crore, RSL = 150 crore c. RSA = 75 crore, RSL = 70 crore d. What conclusions can you draw about the re-pricing model from the above results ?

: : 2 : :

Question Nos. 9 & 10 carry 10 marks each.

Q 10. (a) As per the duration gap model of interest rate risk management, the change in the Market Value of the Equity (MVE) of an FI is given as under :

E = - DGAP x A x

(Where the symbols have usual meanings as under

Change in E = - Adjusted duration gap x Asset size x Interest rate shock) Derive the above formula and explain the effect of the above three factors on the market value of the FIs equity due to interest rate volatility. (b) If the market values of assets and liabilities are Rs.2,400/- Crore and Rs.2,100/- Crore respectively, compute the change in the market values of equity given the following information :

Duration of Assets Duration of Assets Interest rate Change in Interest rate

5 years 4 years 11%

1%

Suggested Solution :
(a) As per the duration gap model of interest rate risk management, the change in the Market Value of the Equity (MVE) of an FI is given as under :

E = - DGAP x A x
(Where the symbols have usual meanings as under Change in E = - Adjusted duration gap x Asset size x Interest rate shock) Derive the above formula and explain the effect of the above three factors on the market value of the FIs equity due to interest rate volatility. [2.5 + 1.5 = 4 marks] (b) If the market values of assets and liabilities are Rs.2,400/- Crore and Rs.2,100/- Crore respectively, compute the change in the market values of equity given the following information : Duration of Assets Duration of Liabilities Interest rate Change in Interest rate 5 years 4 years 11% + 1% [4 marks] [Total 8 marks] Start with E = A L and finally arrive at E = - DGAP x A x

(Desirable time limit 15 minutes)

; where DGAP = (DA k DL ), where k=L/A

K=L/A=0.875, E = - DGAP x A x

= - (5 0.875x4)x2,400x(+ 0.01/1.11) = - 32.43 Cr.

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Question Nos. 1 to 6 carry 2 marks each.

Q 7. The following information relates to the assets of a bank :

Nature of Asset Standard Asset Sub-Standard Asset : Secured Exposure Unsecured Exposure Doubtful Asset : up to 1 year 1 3 years above 3 years Loss Asset

Amount (Rs. in Crore) 5,600 2,150 1,000 1,200 480 220 150

Additional information : (i) Standard asset carries a provision of 0.40% (ii) The proportion of security available for the doubtful assets is 65%, 40% and 25% for the three categories respectively. Calculate the provisioning requirement of the bank based on the above information.

: : 2 : :

Question Nos. 7 to 15 carry 3 marks each.

Q 9. Classify the following accounts into one of the following categories : (a) assets (b) liabilities (c) equity (d) revenue (e) expense (f) Off-Balance Sheet (OBS) activity. (1) Retail Deposits (2) Paid-up-capital (3) Loan Commitments (4) Consumer loans (5) Interest on Investment securities (6) Interest on Savings Bank Deposits (7) Current Deposits (8) Letter of Credit (9) Retained earnings (10) Provision on NPA Loans

Question Nos. 16 to 18 carry 5 marks each.

Q 16. What is refinancing risk ? How is refinancing risk part of interest rate risk ? If an FI funds long-term assets with short-term liabilities, what will be the impact on earnings of an increase in the rate of interest ? A decrease in the rate of interest ? Q 17. What is reinvestment risk ? How is reinvestment risk part of interest rate risk ? If an FI funds short-term assets with long-term liabilities, what will be the impact on earnings of a decrease in the rate of interest ? An increase in the rate of interest ?

Q 18. Arrange the following items into an income statement. Label each item, place it in the appropriate category as per the Banks Income Statement (P & L A/c) format and determine the banks bottom-line net income. p. Interest paid on Term deposits Rs.100,000/q. Interest paid on Certificate of deposits Rs.101,000/r. Interest received on GOI Securities Rs.44,500/s. Fees received on selling of insurance and mutual funds Rs.23,000/t. Dividends paid to Shareholders of Rs.0.50 per share for 5,000 shares u. Provision for loan losses/NPA provision Rs.18,000/v. Interest and discount on loans Rs.1,89,700/w. Interest paid on SB accounts Rs.33,500/x. Interest received on Corporate/PSU bonds Rs.60,000/y. Employees salary and benefits Rs.1,45,000/z. Purchase of a new Computer system Rs.50,000/- (Depreciation for the current year Rs.10,000/-) aa. Service charge/commission receipts from customer accounts Rs.41,000/bb. Occupancy expenses for the bank building Rs.22,000/cc. Taxes of 34% of taxable income are paid dd. Safe Deposit Locker rent receipt Rs.15,000/-

Q 8. ABC bank has 11.75% as its average cost of funds. If the transaction cost involved for credit accommodation is 0.5% and if the bank plans to maintain a 3% margin on the same, compute the contractual rate for the loan which is adjusted for loan defaults and losses. Following additional information for the problem : Principal loan amount Rs.1,500/- crore, Probability of repayment 0.9, Recovery rate for the principal and interest component 0.95. Case Study 1 Read the case let carefully and answer the following questions. Each Answer should be specific/to the point and not to exceed 4 to 5 lines.

Axis Bank has to control cost of funds improve bottomline (ET dtd.12.01.09) Q 10. Define Net Interest Income (NII), Net Interest Margin (NIM) and Burden or Overhead. Q 11. What do you mean by CASA deposits ? Why is it so important for a bank ? Q 12. Comment on the statement Falling interest rates affect lending rates rather than the borrowing or deposit rates. Q 13. What are the sources of other income for a bank ? Why its so important for the bank in the present environment ? Q 14. What are the sources of other income for a bank ? Why its so important for the bank in the present environment ? Q 15. Comment on the statement The amount provided under the head of provisions and contingencies fell by 34% Y-o-Y due to reversals of provisions on corporate and government bonds, amounting to Rs.147 crore boosting its profit growth. In fact, this is the most crucial aspect of the results, where the profit growth is more on account of drop in provisions than the growth in net interest income (NII). Q 16. Going forward, the cost of deposits is expected to come down that would ease the pressure on NIM. Explain this statement.

AXIS Bank reported a 63.2% growth in net profit for the quarter ended December 2008 on growing business and a sharp drop in provisions and contingencies. Banks business as measured by the sum of deposits and advances grew by 54.5% year-on-year (Y-o-Y). This was in line with the trend

seen in the first half of the financial year 2009. Net interest margin (NIM) fell by close by close to 79 basis points (bps) to 3-12% for the December quarter, as term deposits posted a growth of 75%, while CASA deposits grew by just 29%. Term deposits attract higher interest than CASA deposits. The bank also reduced interest rates after the RBIs rate cuts. Falling interest rates affect lending rates rather than the borrowing or deposit rates. Therefore, it was expected that banks NIM could be affected, though the change was substantial and it is extremely crucial for Axis Bank to control its rising cost of deposits. Other income rose by 50% Y-o-Y on strong momentum in fee income which grew by 56.7% and trading gains. The amount provided under the head of provisions and contingencies fell by 34% Y-o-Y due to reversals of provisions on corporate and government bonds, amounting to Rs.147 crore boosting its profit growth. In fact, this is the most crucial aspect of the results, where the profit growth is more on account of drop in provisions than the growth in net interest income (NII), which stood at a mere 24.4% against 70.8% during the six months ended September 2008. The positive aspect of the third quarter result is that the bank is still posting a very high growth on its loan book. The performance at the operating level is satisfactory. The key concern is high cost of deposits. The bank has to control its cost of funds, as it may affect its bottomline growth in coming quarters. Going forward, the cost of deposits is expected to come down that would ease the pressure on NIM. And if this happens, the bank would continue to post high growth rates in profit as seen in the first nine months of the financial year 2009.

Case Study 2 Read the case let carefully and answer the following questions. Each Answer should be specific/to the point and not to exceed 4 to 5 lines.

Arcil to float USD600-m fund to invest in NPAs (ET dtd.19.01.09) Q 10. What do you mean by asset quality/credit quality ? How the asset quality of a bank is measured ?

Q 13. Why the banks have voiced concerns over the impact on their asset quality in the present situations ? Q 13. What is the difference between firm-specific credit risk and systematic credit risk ? How can a Bank alleviate firm specific credit risk ? Q 14.
Define loan sales. What is the difference between loans sold with recourse and without recourse from the prospective of both sellers and buyers ?

ARCIL, the countrys first asset reconstruction company, is looking to float a USD600-million fund for investing in distressed bank assets, said managing director & CEO of the Company S Khasnobis. Arcil has proposed to contribute 20% of the fund and the balance would be raised from International and Domestic investors. The company will float the product in next three months and the funds would be raised in phases on the basis of requirement. The fund will be used for cash purchases of NPAs from banks, Mr. Khasnobis said here on Saturday on the sidelines of the 4th international convention of the Association of National Exchange Members of India. With the latest proposal to float a fund, which would be used to finance its cash purchases, Arcil is certainly positioning itself for a better business prospect next fiscal. Given the economic downturn, every top banker has voiced concerns over the impact on their asset quality. They expect NPAs to rise from the current levels. This is an opportunity for Arcil to grow its business. Arcil buys bad loans from banks and expedite recovery of the amounts locked in NPAs. Sectors like exports, textiles, gems and jewellery, logistics have faced severe stress following the slowdown and these sectors are likely to contribute most in the rise of NPAs. As job cuts have also become a regular

affair now, banks may also face rise in NPAs in their housing loans. Arcil has recently started purchasing distressed assets, especially bad home loan assets. However, its main focus continues to be buying the distressed corporate loans from banks.

Case Study 3 Read the case let carefully and answer the following questions. Each Answer should be specific/to the point and not to exceed 4 to 5 lines.

Treasury loss : Rs.1,500 Crore PSU Banks to take a major hit due to rising yields (ET dtd.28.06.08) Q 11. What do you mean by mark-to-market (MTM) ? Q 10. Mention the three categories of investment securities held by banks based on the objectives of investments. Q 13. Out of this which categories of investments are subjected to Markto-market (MTM) accounting ? And what is the frequency of MTM for such categories ? Q 6. Whatare objectives of an investment portfolio of a bank ? Q 13. Banks run into losses on their bond portfolios, when bond yields rise sharply. Thus, in the current circumstances, banks with a larger share of portfolios in the AFS category (non-HTM bucket), and that too, bonds with a longer duration, will be most affected.

The first quarter of 2008-09 could see banks declare losses up to Rs.1,500 Crore on treasury operations. Nationalised banks are more likely to bear the brunt of rising yields compared to their private sector peers since a few large PSU banks have perked as much as 50-60% of their bond portfolios in the available-for-sale (AFS) category. As against this, private sector majors such as ICICI Bank, HDFC Bank and Axis Bank have perked only 15-20% of their bond portfolios in the AFS bucket. As per RBI guidelines, banks have to mark-to-market (MTM) a portion of their G-sec book (i.e., 26-30% of assets owing to high SLR), which is in the non-held-to-maturity (HTM) category. Thus, in the current circumstances, banks with a larger share of portfolios in the AFS category (non-HTM bucket), and that too, bonds with a longer duration, will be most affected. In addition, banks have also to markto-market all their non-G-sec investments (like corporate bonds) every quarter. According to a recent report published by Merrill Lynch, for every 10-basis points rise in yields, banks could incur a loss of up to Rs.250 Crore. It may be recalled that the yield on the benchmark paper, the 8.24% bond maturing in 2018 (residual maturity of 10 years), has moved up from 7.90% in March 2008 to over 8.85% in June 2008. Banks run into losses on their bond portfolios, when bond yields rise sharply. Bond prices fall when yields rise and banks have to mark-to-market the holdings in the AFS category based on the yield prevailing on the last day of the quarter. Recently, the RBI hiked repo rate rate at which banks borrow from RBI and the CRR by 50 bps each. This has caused yields to move up drastically in the past week of this quarter. Given the PSU banks have large SLR requirements, most banks would have huge stocks of the benchmark bond, which alone has witnessed a fall of more than 400 paise rise in barely three months time. SBI, the largest PSU player, seems to be the worst hit, given the significant exposure to varied class of securities. The bank has parked up to 80% of its bond holdings in the HTM category, but faces the risk of incurring a loss of more than Rs.350 Crore this quarter.

Numerical Questions on Loss/NPA Provisioning :

Credit

Risk

and

Loan

Q 1. The following information relates to the loan portfolio of a bank as on 31/03/2010 :

Nature of Loan Asset Standard Asset Sub-Standard Asset : (3,150) Secured Exposure Unsecured Exposure Doubtful Asset : (1,900) up to 1 year 1 3 years above 3 years Loss Asset

Amount (Rs. in Crore) Provision 55,600 2,150 1,000

before

1,200 480 220 150

Additional information : (i) Standard asset carries a provision of 0.40% (ii) The proportion of security available for the doubtful assets is 65%, 40% and 25% for the three categories respectively. Based on the above information, answer the following questions : (i) Calculate the provisioning requirement of the bank as on 31/03/2010. (ii) Calculate the Gross NPA/Gross Credit ratio. (iii) Calculate the Net NPA/Net Credit ratio.

Suggested Solution : (i) Calculation of Provisioning Requirement : Asset Class/Amount Standard Asset/55,600 Sub-Standard Asset/3,150 Secured Exposure/2,150 Unsecured Exposure/1,000 Doubtful Asset/1,900 Up to 1 year/1,200 1 3 years/480 Provisioning Rate 0.40% 10% 20% Unsecured Portion/100% Secured Portion/20% Secured Portion/30% Provisioning Requirement 222.40 215 200 415 1200(0.35*1+0.65*0.20) = 576 480(0.60*1+0.40*0.30) = 345.60 220(0.75*1+0.25*1) = 220

Above 3 years/220

Secured Portion/100%

Loss Asset/150 Total Provision Required Out of which NPA Provision

100%

1,141.60 150 1,929

1,706.60

(ii) Calculate the Gross NPA/Gross Credit ratio : Gross NPA = SS + DA + LA = 3,150 + 1,900 + 150 = 5,200 Gross Credit or Loans = 5,200 + 55,600 = 60,800 So Gross NPA/Gross Credit Ratio = 5,200/60,800 = 0.0855 or 8.55%

(iii) Calculate the Net NPA/Net Credit ratio. Net NPA = Gross NPA NPA Provision = 5,200 1,706.60 = 3,493.40 Net Credit = Gross Credit NPA Provision = 60,800 1,706.60 = 59,093.40 So Net NPA/Net Credit Ratio = 3,493.40/59,093.40 = 0.0591 or 5.91%

Q 2. The loan portfolio of a bank as on 30/06/2010 is as follows : Nature of loan asset Standard Sub-Standard : (540) Secured Exposure Unsecured Exposure Doubtful asset : (700) - Up to 1 year - 1-3 years - More than 3 years Loss Amount (Rs./Lakhs) before Provision 1,450 240 300 210 400 90 45

Additional information : (i) Standard asset carries a provision of 0.25% to the extent of Rs.400, 1% to the extent of Rs.450 and the balance carries @ 0.40%.

(ii) The proportion of security available for the doubtful assets is 70%, 60% and 50%
for the three categories respectively. Based on the above information, answer the following questions : (i) Calculate the provisioning requirement of the bank as on 30/06/2010. (ii) Calculate the Gross NPA/Gross Credit ratio. (iii) Calculate the Net NPA/Net Credit ratio.

Q 3. Consider the following loan portfolio data of a private bank as on 31/03/2010 : i. Total Outstanding credit in the books of the bank : Rs. 4,580 Cr. ii. Total Outstanding balances in NPA accounts : Rs. 620 Cr. iii. Total Provisions made on NPA accounts : Rs. 145 Cr. iv. PAT of the bank : Rs. 280 Cr. v. Tax Rate : 40% You are required to calculate a. Net NPA/Net Credit Ratio b. Amount of Credit reflected on the assets side of the balance sheet Q 4. The following relates to the loan assets of a bank as on 31/03/2010. Nature of loan asset Standard Sub-Standard : (1,300) Secured Exposure Unsecured Exposure Doubtful Loss asset (secured) : (950) Up to 1 year 1-3 years More than 3 years Amount (Rs. in Crores) before Provision 4,125 900 400 600 250 100 125

Additional information : (iii) Standard asset carries a provision of 0.25% to the extent of Rs.1,000, 1% to the extent of Rs.500 and the balance carries @ 0.40%.

(iv) The proportion of security available for the doubtful assets is 70%, 60% and 50%
for the three categories respectively. Based on the above information, answer the following questions : (iv) Calculate the provisioning requirement of the bank as on 31/03/2010. (v) Calculate the Gross NPA/Gross Credit ratio. (vi) Calculate the Net NPA/Net Credit ratio.

Q 5. Consider the following data of a private bank i. Total Outstanding Credit in the books of the bank : Rs. 2,780 Cr. ii. Total Outstanding balances in NPA accounts : Rs. 320 Cr. iii. Provisions made on NPA accounts : Rs. 60 Cr. iv. PAT of the bank : Rs. 130 Cr. v. Tax Rate : 40% You are required to calculate a. Net NPA/Net Credit Ratio b. Amount of Credit reflected on the assets side of the balance sheet

Numerical Questions on Capital Adequacy Requirements (CAR/CRAR) :

Q 1. Risk Weighted assets of The Assam Bank as on March, 2010 are Rs. 3,520 Cr. Tier I capital of the bank is Rs. 120 Cr. Whereas the revaluation reserves and the subordinated debt of the bank with a maturity over 4 years, but within 5 years are Rs. 54 Cr. and Rs.. 67 Cr. respectively. Assess whether the bank satisfies the capital adequacy requirements or not, as per current RBI norm. Risk weighted assets of a bank are Rs.3,250 Cr. Tier I capital of the bank stands at Rs.119 Cr. Revaluation reserves and general provisions and loss reserves stood at Rs.74 Cr. and Rs.49 Cr. respectively. The bank wants to find out whether it meets the capital adequacy requirements of 9% or not. If not, to meet the capital adequacy requirement, the bank is contemplating on raising equity
Q 2.

and subordinated debt. Suggest a suitable alternative to the bank while stating the regulations that have to be followed.

Q 3. The present level of capital adequacy of Bank of Bombay is at 9% and the total assets of the bank stood at Rs.4,500 Cr. The Bank proposed to increase the risk-weighted assets by Rs.1,000 Cr. out of the increase of Rs.1,500 Cr. in the subsequent year. The present capital structure is as under : Rs. in Crores Equity 200 Reserves 50 Revaluation reserves 145 Total 395 a. What is the additional capital required to maintain the existing level of capital adequacy? b. If the retained earnings constitute 1% of total assets, what is the additional capital to be raised from market? c. What is the maximum amount of Tier II capital that can be raised? Q 4. The risk weighted assets of a bank are Rs.10,800 Cr. as against the total assets of Rs.15,500 Cr. The capital structure of the bank is given below: Rs. in Crores Equity 225 Free Reserves 415 Subordinated debt (remaining maturity 2 years) 265 Revaluation reserves 405
a. Verify whether the bank has achieved the capital adequacy level of 10%.

b. If the bank expects to increase the total funds during the year by 15% and proposes to deploy the funds at an average risk weight of 50%, compute the requirement of capital to maintain CAR of 10%.

Q 5. The risk-weighted assets of a bank are Rs.12,450 Cr. as against the total assets of Rs.16,600 Cr. The capital structure of the bank is given below Rs. in Crores Equity 280 Free Reserves 465 Subordinated debt (remaining maturity 3.5 325 years)$ Revaluation reserves 428 $ Subordinated debt to be reckoned @ 40% discount for CAR purposes a. Verify whether the bank has achieved the capital adequacy level of 9 %. b. If the bank expects to increase the total funds during the year by 15% and proposes to deploy the funds at an average risk weight of 64%, compute the requirement of capital to maintain CAR of 9%.

Suggested Solution : a. Verify whether the bank has achieved the capital adequacy level of 9%
Elements of Capital/Amount Equity Capital/Tier 1/280 Free Reserves/Tier 1/465 Subordinated Debt/Tier 2 bonds (Remaining maturity 3.5 years) Reckoning Rate for Capital Fund Calculation 100% 100% 60% Contribution to Capital Fund 280 465 195

@ 40% discount/325 FA Revaluation Reserves/428 @ 55% discount (Tier 2) Total Capital Fund Available (CF)/(Tier 1 + Tier 2) Capital

45%

192.60 1,132.60

Total Risk-Weighted Assets (TRWA) = 12,450 Cr.

CAR or CRAR = CF/TRWA = 1,132.60/12,450 = 9.10%

b. If the bank expects to increase the total funds during the year by 15% and proposes to deploy the funds at an average risk weight of 64%, compute the requirement of capital to maintain CAR of 9%. Total Funds now = 16,600, Increase in funds @ 15% = 16,600*0.15 = 2,490 Addition to risk weights = 2,490 * 0.64 = 1,593.60 Total Risk-weighted assets = 12,450 + 1,593.60 = 14,043.60 Capital Fund required @ 9% CAR = 14,043.60 * 0.09 = 1,263.92 Capital Fund available now = 1,132.60 Additional Capital Fund Required = 1,263.92 1,132.60 = Rs.131.32 Cr.

Q 6. The current capital structure of a bank is as under : Equity capital Rs.180 Cr.

Reserves and surplus Subordinated debt with a remaining maturity of 3 years$ Investment in subsidiaries Capital adequacy ratio Average risk weight

Rs.520 Cr. Rs.200 Cr. Rs.40 Cr. 13.40% 48%

If the return on assets is going to be 1.8%, compute the increase in the risk weighted assets that can be supported without raising additional capital. Q 7. The risk weighted assets of a public sector bank stands at Rs.5,000 Cr. for the year ended March31, 2010. According to the latest balance sheet equity capital and free reserves stood at Rs.180 Cr. and Rs. 45 Cr. It has a revaluation reserve of Rs.65 Cr. and General Provision and Losses Reserves (GPLR) of Rs.70 Cr. It has also subordinate debt of Rs.45 Cr. and Rs.36 Cr. of maturities between 2 to 3 years and 4 to 5 years respectively. The present capital adequacy requirement of bank is 9%. To meet the capital adequacy requirement, the bank is contemplating on raising equity and subordinate debt. The risk weighted assets of the bank will grow by 10% in the current year. You are required to find out the capital adequacy level for the current year ended and the amount of equity and subordinated debt that can be raised by the bank stating the regulations that have to be complied with. Q 8. Royal Bank Ltd. has risk weighted assets to the tune of Rs.4,200 Cr. Tier-1 capital of the bank is Rs.123 Cr. Banks revaluation reserves stood at Rs.170 Cr. and General Provisions and Losses Reserves (GPLR) at Rs.56 Cr. The bank is expected to maintain a capital adequacy requirement of 9% as per MOU entered with RBI. The bank proposes to issue a subordinated debt to ensure the capital adequacy norms. You are required to determine the additional capital required and the maximum amount of subordinated debt that can be raised considering the regulations that have to be followed. Numerical Questions on Home Loan Appraisal :

Q 1. Mr. X, a salaried person, approaches HDFC Ltd. for sanction of a Home Loan. The all inclusive cost (including stamp duty & registration etc.) of a new ready flat, he wants to buy, is Rs.40,00,000/-. HDFC stipulates a maximum

loan to value ratio (LTV) of 85%, i.e., Minimum Borrowers Margin required is 15% of the cost of the house. Borrowers age at the time of application is 50 years and his retirement age is 60 years. Borrowers current gross monthly salary is Rs.60,000/-. HDFC has a policy of maximum loan instalment to (gross) income ratio (IIR) 50% and maximum loan term of 20 years including the maximum initial moratorium or loan holiday period of 18 months, wherever applicable. In case of ready made house or flat, HDFC do not grant any repayment holiday. HDFC has a policy of granting maximum loan duration to an applicant matching with his retirement age, but not beyond.

The applicant, Mr. X, wants to avail maximum possible loan amount and maximum permissible loan repayment term. Mr. X wants to avail the fixed rate home loan which is currently 12% p.a. Interest on home loan is charged/ compounded monthly.

You are the Home Loan Appraisal Manager in HDFC. Calculate the maximum home loan amount (to nearest thousand) that can be granted to Mr. X based on the above information.

Suggested Solution :

#1. Parameter 1 based on cost & margin,i.e., LTV : Property Cost is Rs.40,00,000/-. Maximum LTV ratio as per HDFC norm is : 85%. So maximum possible loan amount is : Rs.40,00,000/- * 0.85 = Rs.34,00,000/-.

#2.

Parameter

based

on

Repayment

capacity,

i.e.,

Maximum

permissible EMI & Maximum possible loan repayment term :

Maximum possible EMI is : Maximum IIR * Gross Monthly Income = 0.50 * Rs.60,000/- = Rs.30,000/-.

Normal maximum home loan term is 20 years including the repayment holiday period, if any. Borrowers age at the time of application is 50 years and retirement age is 60 years, by which loan should be fully repaid as per HDFC policy. Borrower wants to avail maximum possible loan term and loan amount. So the maximum permissible loan term is : 60 50 = 10 years or 120 months. Loan carries an int. rate of 12% p.a. compounded monthly, i.e., int. rate per month is 1%. Based on the maximum EMI of Rs.30,000/- (annuity = A or PMT), maximum loan term of 120 months and int. p.m. of 1%, we can calculate the maximum loan that can be granted based on repayment capacity. That is the PV of the annuity, PVAn = (PMT or A) * PVIFA (1%, 120) = 30,000 * 69.7005 = Rs.20,91,000/- (approximately).

Maximum Eligible loan limit : Lower of parameter 1 or parameter 2.

So the maximum eligible loan amount is (as per parameter 2) Rs.20,91,000/-. Numerical Questions on Working Capital Assessment : Q 1. The following information has been summarized after due analysis by a Credit Appraisal Officer of a Commercial Bank in respect of a loan applicant. You have joined the bank as a Trainee Loan Manager. You are asked to assess the Working Capital needs of the borrower and answer the following questions. N.B. If the available NWC is
Amount in Rs. Lakhs Accepted Projected Gross Sales for the next Year 48.00 Raw Materials Purchased and Consumed P.a. 28.80 Cost of Production and Sales p.a. 38.40 Stores and Spares consumed p.a. 1.80 Other Current Assets 1.30 Available NWC 5.00 Holding Periods In months Raw Materials 2.00 Work in Progress 0.50 Finished Goods 1.00

more than the minimum NWC required, take the available NWC.

Receivables Stores and Spares Credit Purchase

1.50 6.00 1.50

Based on the above information, answer the following three questions :

(Desirable time limit 15 minutes) [2 + 2 + 6 = 10 marks]

(i)

Calculate the Permissible Bank Finance (PBF) for the borrower assessed under the Turnover method (Nayak Committee).

(ii) Calculate the Working Capital Gap.

(iii) Calculate the Working Capital Requirement (aka Maximum Permissible Bank Finance or MPBF) for the borrower under Tandon II method of lending (aka Holding Period Method).

Suggested Solutions : For detailed answer, pls refer to caselet/case exercise discussed in the class.
(i) Calculate the Permissible Bank Finance (PBF) for the borrower assessed under the Turnover method (Nayak Committee).

Ans. 7
(ii) Calculate the Working Capital Gap.

Ans. 14.20
(iii) Calculate the Working Capital Requirement (aka Maximum Permissible Bank Finance or MPBF) for the borrower under Tandon II method of lending (aka Holding Period Method).

Ans. 9.20
Q 2. An unemployed Engineer wants to start a washing soap manufacturing unit at a very small scale. The following information has been summarized from his project report after due analysis by a Credit Appraisal Officer of a Commercial Bank. You have joined the bank as a Trainee Credit Analyst. You are asked to assess the Working Capital needs of the borrower and answer the following questions. N.B. If the

available/proposed NWC is more than the minimum NWC required, take the available/proposed NWC.
Amount in Rs. Lakhs

Accepted Projected Gross Sales for the next Year Raw Materials Purchased and Consumed P.a. Cost of Production and Sales p.a.

66.00 18.00 30.00

Other Current Assets Available/Proposed NWC Holding Periods Raw Materials Work in Progress Finished Goods Receivables Credit Purchase

1.50 2.00 In months 2.00 0.50 3.00 3.00 2.50

Based on the above information, answer the following three questions :

(Desirable time limit 15 minutes) (j) [2 + 2 + 6 = 10 marks] Calculate the Permissible Bank Finance (PBF) for the borrower assessed under the Turnover method (Nayak Committee).

Sl. # a. b. c. d. e. f. g.

h.

Items of Working Capital Accepted Projected Gross Sales for next FY 25% of the accepted Projected Sales as Working Capital Gap (a * 0.25) 5% of the accepted projected Sales as minimum borrowers margin or minimum NWC required (a *0.05) Available NWC in the System b - c b - d Permissible Bank Finance (PBF) (b c) or (b d) to be decided in consultation with the borrower In this case as per question, PBF is (b d)

Amount/Rs. in lakhs 66.00 16.50 3.30 9.00 13.20 7.50

7.50

(iv) Calculate the Working Capital Gap as per holding period method.

Working (1)

Capital

Components

Holding Period in months (2) 2.00 0.50 3.00 3.00 -----

Cost per month/ Rs. in lakhs (3) 1.50 2.50 2.50 5.50 -----

Raw Materials (RM) Work-in-progress (WIP) Finished Goods (FG) Receivables Stores & Spares/ Consumables Other Current Assets (OCA) Total Current Assets (TCA) Less : Other Current Liabilities (OCL)/ 1. Creditors for Purchases

Total investment/ Rs. in lakhs (4 = 2 * 3) 3.00 1.25 7.50 16.50 --1.50 29.75 3.75

2.50

1.50

3.75

(Trade Creditors) 2. Creditors for Expenses (Other Creditors) Working Capital Gap (WCG)
(v)

---

---

---

26.00

Calculate the Working Capital Requirement (aka Maximum Permissible Bank Finance or MPBF) for the borrower under Tandon II method of lending (aka Holding Period Method).

Working Capital Gap (WCG) Margin or NWC / Minimum Required (25% of TCA as per Tandon or MPBF II method) Available in the System : Whichever is higher : 7.44

26.00 9.00

9.00 9.00

Maximum Permissible Bank Finance (MPBF) = WCG NWC

17.00

Numerical Questions on Term Loan Assessment :

for the bank. Year Sales Total Variable Costs Total Fixed Costs Net Profit or PAT Term Loan Instalment Term Loan Interest Depreciation

Q 1. Here is the extract of the Projected Profitability Statement of M/s

1st Year 1.50 0.70 0.59 0.21 0.12 0.14 0.30 2nd Year 1.80 0.80 0.49 0.51 0.24 0.11 0.23 3rd Year 2.10 0.92 0.39 0.79 0.24 0.07 0.17

Amar Xerox, a Term Loan applicant (Figures in Rs. lakhs) 4th Year 5th year 2.10 2.10 0.95 0.98 0.36 0.29 0.79 0.83 0.24 0.16 0.04 0.01 0.13 0.09

Based on the above information, answer the following three questions :

(Desirable time limit 15 minutes) [2 + 2 + 6 = 10 marks]

(i)

Calculate the Break Even Point (BEP) in terms of Sales Revenue for the year 3.

(ii) Calculate the Margin of Safety ratio for the year 3.

(iii) Calculate the Debt Service Coverage Ratio (DSCR) for the loan proposal for years 3, 4 and 5.

Suggested Solutions : For detailed answer, pls refer to caselet/case exercise discussed in the class.

(i)

Calculate the Break Even Point (BEP) in terms of Sales Revenue for the year 3.

Ans. Rs.69,407/= or Rs.0.69407 lakh

(ii) Calculate the Margin of Safety ratio for the year 3.

Ans. 0.669
(iii) Calculate the Debt Service Coverage Ratio (DSCR) for the loan proposal for years 3, 4 and 5.

Ans. (DSCR)3 = (DSCR)5 = 5.47

3.32,

(DSCR)4

3.43,

Q 2.

Here is the extract of the Projected Profitability Statement of M/s Finecast Pvt Ltd., a Term Loan

applicant for the bank.

(Figures in Rs. 000s)

Year Projected Sales Total Variable Costs Total Fixed Costs Net Profit or PAT Term Loan Instalment Term Loan Interest

1st Year 22500 17250 6180 - 930 1000 750

2nd Year 27000 20745 5372 883 1000 600

3rd Year 31500 24258 4871 1442 1000 450

4th Year 36000 27960 4661 2027 1000 300

5th year 36000 28042 4345 2168 1000 150

Depreciation Preliminary Exp. Written off

2520 100

1672 100

1131 100

781 100

551 100

Based on the above information, answer the following three questions :

(Desirable time limit 15 minutes) (i) [2 + 2 + 6 = 10 marks] Calculate the Break Even Point (BEP) in terms of Sales Revenue for the year 4. Rs.20,870,000/(ii) Calculate the Margin of Safety ratio for the year 4. 42% (iii) Calculate the Debt Service Coverage Ratio (DSCR) for the loan proposal for years 3, 4 and 5.

(DSCR)Yr. 3 = 2.15, (DSCR)Yr. 4 = 2.47, (DSCR)Yr. 5 = 2.58