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Tuesday, January 12, 2016

Banking & Research - XV : Controlling Syatemic Risk

Banking is the most regulated business all over the globe. The reason is simple: it has a sway on the macro economy of nations. Essentially, Central Banks monitor financial intermediaries to ensure their solvency and thereby elimination of systemic risks. Any instability amongst the intermediaries is potential enough to rock the very financial architecture of a nation. It is to minimize this risk of contagion, Basel I Accord was introduced stipulating a uniform framework of risk-based capital adequacy among the banks. However, during the process of its implementation, it is realized that the uniform framework prescribed for all credit exposures, irrespective of their creditworthiness was ‘credit insensitive’. So, to eliminate this limitation Basel II Accord has come into existence.

As a sequel to this, it has become necessary for Central Banks to monitor financial intermediaries for maintenance of capital adequacy. In the process, Central Banks initiated steps for compliance with certain prudential norms and ensuring transparency in their financial reporting. One obvious mechanism to track the functioning of banks as per the laid down prudential norms is on-site inspection of their books. But, it is pretty expensive. So the next option is the off-site supervision. Now, the moot question is how to monitor offsite? It is in this context that the US Federal Reserve has come out with Financial Institutions Monitoring System risk rank model which is used to estimate the probability of a bank failure in the subsequent two years based on bank’s financial condition.

Taking this as a platform Amit Kulkarni developed an econometric model that enables monetary authority of India to forecast the soundness of banks ‘one-year’ ahead and the same is presented in his article—Modeling ‘Early Warning System’ for Off-site Surveillance of Commercial Banks. There is, of course, a distinct difference between the Fed Reserves model and that of Kulkarni’s: the former predicts the failure of a bank while the model presented in the article aims at predicting ‘one-year ahead capital adequacy ratio’, for no bank in India usually fails or is allowed to fail. The author identified leading indicators of capital adequacy based on the experience of the Indian banks during 2001-2004. The article has tested 15 different banking ratios for their predictive ability of future capital ratios. It identified the following as the most important leading indicators of the future capital adequacy: credit deposit ratio, priority sector advances to total advances, net profit to total assets, burden to total income, debt equity ratio, and the ratio of contingent liabilities to total liabilities. The model developed by the author can provide a timely signal about impending capital inadequacy to the Reserve Bank of India. This study also throws open a new avenue for further research: Why the ratio of Net NPAs to Net Advances and total income to total expenditure are behaving erratically while predicting future capital ratios?

Commonsensically, we all know how important commercial banking is for the smooth functioning of the real sector of the economy. Taking a lead from this assertion, the authors, Tokunbo Simbowale Osinubi and Akin-Olusoji Akinyele, made an attempt to study the impact of commercial banks’ lending rates on performance of the real sector of the Nigerian economy during the period of 1970 to 2003, and presented their findings in the article—Commercial Bank Lending Rates and the Real Sector of the Nigerian Economy. The findings revealed that the “activities of real sector as well as its performance predominantly dependent on foreign intermediate input instead of resources within the local economy”. The other inference is that the “impact of commercial bank lending rates on the real sector of the Nigerian economy has been insignificant and negative”. Based on these findings, the authors have made certain recommendations for the smooth functioning and better performance of the real sector, for the government to practice.

In the wake of financial reforms, many private banks have come into existence in India and indeed they have been taking a dominant role in providing certain services. The fight between the new generation private banks and the existing public sector banks for winning the confidence of customers and thereby garner more business has generated public interest in their respective strengths and weaknesses. Against this backdrop, the authors B S Bodla and Richa Verma made an attempt to evaluate the performance of top two banks from the public and private sector, namely, State Bank of India and ICICI Bank in the first five years of 21st century using CAMEL Model and presented their findings in the article Evaluating Performance of Banks through CAMEL Model: A Case Study of SBI and ICICI. It is interesting to note that the ICICI outsmarted SBI in terms of business per employee, profit per employee and net interest income to total income. Though SBI has outperformed ICICI bank in terms of G-Secs to total investments; spread to total assets; interest income to total income, liquid assets to total assets and G-Secs to total assets, in the overall analysis, ICICI bank proved to have performed better than the SBI. These findings throw open a new field of research: What is the role of IT in enhancing per employee business and per employee profit?

In the changing world of today’s banking where consumer became the king of business, banks of all hues have started wooing the customers with all kinds of personalized-services. In the recent past, mobile banking has become one such tool. The authors, Abhay Jain and B S Hundal, examined the barriers if any in offering mobile banking services effectively, and presented their findings in the article Barriers in Mobile Banking Adoption in India. The study observed that the competency of service quality does not reach an adequate level inflicting consumer dissatisfaction. They have, in fact, observed that there is a functional impediment in the mobile phone as a delivery medium for banking services. The authors have also suggested certain remedial measures to overcome these hurdles.

When competition is intensifying and margins are becoming thinner and thinner, funds management has become the linchpin of profit making. The authors, Fulbag Singh and Balwinder Singh, have studied the criticality of funds management in improving financial margin of Central Cooperative Banks in Punjab and presented their findings in their article—Funds Management in the Central Cooperative Banks of Punjab—An Analysis of Financial Margin. The findings are obvious: more reliance on own funds and reduction in overdues are the major contributors towards profit maximization.


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