Ethical Issues in the Banking Industry

Over the years, banks have undergone tremendous growth in many aspects of their operations, starting with the type of customers they deal with to the manner in which information is received, recorded, transformed, and finally used. Ultimately, banks have unraveled the whole mystery of discrimination as to what customers to offer services to or not by categorizing their clients in terms of their income structure. This classifying of customers is meant to assist in the decision making process as to what customer receives what treatment, but it is also meant to assist the banks in understanding the type of customers to offer better services to. Therefore, regulated by their policy of information non-disclosure, banks would obtain very crucial information about various customers (their age, sex, race, employment status, as well as income level) with a notion that they are adhering to the Know Your Customer policy. This information is supposed to be private and confidential. However, on close examination, one would realize that banks need such information to make decisions aimed at enabling them to remain in the global market while at the same time, maintaining their traditional banking principles.

Consequently, the objective of this article is to analyze the various unethical practices the employees of the bank practice, and their relevance to the community at large. Moreover, the unethical practices will be addressed in a manner that relates to ethical dilemma and decisions regarding management. Banks operate in an economy that is very volatile, and they need to ensure that various practices are done in the traditional banking manner, provision of financial services in a legal manner.… Read the rest

Different Types of Risks Faced by Banks Today

All companies which have a profit maximizing objective hold a certain degree of risk whether through microeconomic or macroeconomic factors. Banks also face a number of risks atypical of non financial companies due to the payment and intermediary function which they perform. Recent changes in the banking environment has lead to an increased pressure to maximize shareholder value, this means that banks take on a higher risk in order to gain a higher return. It is due to this increased pressure and market volatility that banking risk needs such effective management to ensure the banks continued solvency. Risk can be defined as an “exposure to uncertainty of outcome” measured by the volatility (standard deviation) of net cash flow within the firm. Banks aim to add equity to the bank by maximizing the risk adjusted return to shareholders highlighting the importance of fully considering the risk and return business equation. Exposure to risk does not always lead to a loss, pure risk only has a downside from the expected outcome but speculative risk can produce either a better or worse result that expected.

Credit risk is the risk that the counterparty will fail to repay the loan in part or full. This includes delayed payments or any default on the loan agreement. It is widely know that credit risk is one of the most damaging risks to banks, for this reason there is usually a separate credit department run around a credit culture of the management’s views. The objective of the credit department will be to maximize shareholder value added through credit risk management.… Read the rest

Reasons for Liquidity Fluctuations in Indian Banking System

Liquidity risk is inherent in bank’s core business because banking organizations employ a significant amount of leverage in their business activities and need to meet contractual obligations in order to maintain the confidence of customers and fund providers. The first step in measuring and managing liquidity risk is the identification of the most important sources of risk.

In the Indian context of banking, unexpected liquidity fluctuations are driven mainly by the following items:

  • Behavior of non-maturity deposits: A large fraction of deposits, in an Indian bank, consists of low-cost current and savings deposits which do not have any contractual maturity. Moreover, the depositor has the option to introduce or withdraw funds at any point of time. This makes the analysis of future cash inflows and outflows quite difficult. However, it is extremely crucial because the main reason for the closure of banks has been the inability to pay depositors on sudden demand. Therefore, the bank needs to know how much of these deposits is volatile, i.e. likely to flow out at short notice and how much is core or stable, i.e. unlikely to leave the bank. In the absence of contractual maturity, the bank needs to analyze the behavioral maturity of these deposits.
  •  Renewal patterns of term deposits: If the actual proportion of renewal is more than what the bank expects, it is left with surplus funds which might have to be reinvested at lower rates. If the actual fraction is less than anticipated, the bank faces a liquidity deficit, which might entail higher financing costs.
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8 Risks Faced by Modern Banks at the Present Competitive Business World

The unanticipated part of the return, that portion resulting from surprises is the true risk of any investment. If we always receive what we expect, than the investment is perfectly predictable and, by definition, risk-free. In other words, the risk of owning an asset comes from surprises-unanticipated events. RISK is a concept that denotes the precise probability of specific eventualities. It is simply the future uncertainty and not only the incidents of predictable outcomes but also the unpredictable favorable outcomes. All the firms or companies whether it is in real or providing service are facing some sort of risk at present competitive business world to run its business. Banks are one of them in these regard and it is facing possibility of risk in terms of money and their achieved reputation. Bank is a financial institution that primarily deals with borrowing and lending money from the people by the people to the people. Besides this core activities now-a-days banks are also dealing with other roles related to economy. A wide range of financial services are offering by modern banks as a result the level and intensity of risk exposure have been expanded as well. So all the policymakers and the managers are now believe that risk management is essential, where they have been identified few core areas to be managed effectively and efficiently are as follows, credit risk, interest-rate risk, exchange-rate risk, environmental risk, money laundering risk, liquidity or funding risk, leverage or capital risk, strategic risk, which needed to discuss broadly.… Read the rest

Loan Against Securities

Considerations of security form an important basis of lending. In fact, they constitute necessary adjunct to financial appraisal. Lending institutions have to examine the loan proposals from the point of view of nature and extent of security offered. Sometimes, there is a greater reliance on security due to inadequate financial appraisal, which in its turn may be due to non-availability of the necessary data. The security cover of the loan should, however, not be regarded as a substitute for an adequate financial assessment.

Security considerations are of particular importance in less developed countries like India where information on the character, integrity and credit-worthiness of the borrowers is not readily available and much ground work has yet to be done in the establishment of credit information bureaus. A prudent term lending institution, therefore, secures its loan by adequate collateral and, where necessary, guarantees. It also embodies in the loan agreement suitable protective and restrictive covenants such as maintenance of certain minimum financial standards, supplying to the lender adequate financial information, earlier repayment of loans under certain conditions, restriction on the payment of dividend and any other payments like managing agency or selling agency commission. Taking of adequate security infuses the necessary responsibility in the borrower. A general tendency exists among term lending institutions in India to depend more on collateral for the repayment of loans than on the integrity and policy of management and the borrowing concern’s past and prospective earnings..

The types of security generally accepted by the term lending institutions are the existing industrial assets as well as those to be acquired out of the granted loans.… Read the rest

Variable Cash Reserve Ratio and Credit Control

Considering the limitations of the bank rate policy and the open market operations, the need to develop a very effective method of credit control was felt. Especially the need was to directly control the power of the commercial banks to create credit, Variable cash reserve ratio was suggested as one more method of quantitative credit control by Keynes. Further this method is considered necessary for promoting the overall liquidity and solvency of the banking system, apart from improving the public confidence on the banking system.

The process of working of this method of credit control can be easily understood with an example. Suppose in an economy there is over expansion of credit which is possible with excessive cash reserves with the commercial banks. To check this, the central bank may raise the cash reserve ratio say from 20% to 25% Then this will bring down the availability of cash reserve with the commercial banks. With lesser cash reserve they can only create lesser credit. Similarly, suppose the central bank wants to expand the credit creation by the commercial banks. Then it will bring down the cash reserve ratio say from 25% to 20%. This will enable the Commercial banks to have more cash reserve with which they can create more credit. It should be noticed that the cash reserve ratio determines the credit multiplier in an economy. An increase in former will contract credit through multiplier effect and reduction in the former will expand credit through multiplier.

In India the variable cash reserve ratio is slightly altered and it is called Statutory Liquidity Ratio (SLR).… Read the rest