Banking Term 2|Polarisedutech

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Systemically Important Financial Institutions

Defnition : Systemically Important Financial Institution can be

defned as some o the key banking companies, insurance

companies or a fnancial institutions whose ailure can become athreat to the existing fnancial system and may trigger a grave

fnancial crisis which may have an adverse impact on the

economy as a whole.

Explanation : The act that these fnancial institutions are

designated as systematically fnancial institutions can be

attributed to their signifcant sie, lack o substitutability,

complexity in operations, cross!"urisdictional activities and

interconnectedness. #uring the global fnancial crisis o $%%&when some o the ma"or fnancial institutions came under

signifcant pressure, the 'overnment had to intervene to restore

stability in the market and normal unctioning o the fnancial

system. In the backdrop o this fnancial crisis, the (asel

)ommittee on (anking Supervision released a ramework which

aims to identiy systemically important banks at the international

level. The Financial Stability (oard which coordinates between

fnancial authorities at the international level mandated thatmember states need to adopt a ramework which will minimie

the risk within such important fnancial institutions.

Example : The *eserve (ank o India +*(I in line with

recommendations made by the Financial Stability (oard released

a ramework in which it described the methodology that the

)entral (ank will adopt to identiy such #omestic Systemically

Important (anks. *(I will frst assess the banks on various

indicators like sie and interconnectedness and then give a scoreon the basis o relative systemic importance. (anks having a

score greater than the cut!o- score will be termed as #omestic

Systemically Important (anks. The *(I urther added that such

banks will be sub"ect to additional regulatory and supervisory

reuirements.

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indicators #eadin$ and la$$in$

Defnition : /n economic indicator gives an idea about the trend

o a particular macroeconomic parameter that has either

happened in the past or is most likely to happen in the uture. /0eading indicator can be defned as an indicator that points

towards the trend which is most likely to sustain in the uture

while a lagging indicator gives an idea about the trend that has

already taken place in the past.

Explanation : 0eading indicators orecast the event that is likely

to take place in the uture while lagging indicators are all about

those economic activities that have already taken in the past.

(oth leading indicators and lagging indicators have their own seto advantages and disadvantages. 1hile a leading indicator is

used or short term predictions and allows organiations to make

necessary ad"ustments in accordance with the results such

indicators may pose challenges in terms o data capturing and

may at times have no historical data. 0agging indicators on the

other hand is comparatively easy to identiy and capture but does

not in any way re2ect the current activity levels and has no

estimation or orecasting traits as such.

Example : /n example o a leading indicator is the 0eading

3conomic Index o 4S/ which is published by the )onerence

(oard. This indicator gauges the level o economic activity that is

most likely to sustain within the 4.S. economy in the short to

medium term. Indicators like 'ross #omestic 5roduct, Index o

Industrial 5roduction and )onsumer 5rice In2ation on the other

hand can be taken as examples o lagging indicators.

Fixed income o%li$ations to income ratio &FOI'(

Defnition : Fixed Income obligation to income ratio +F6I* which

is also known as the debt service ratio or debt!to!income ratio is a


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critical aspect that banks and other fnancial institutions need to

take into account while sanctioning a loan. This ratio is generally

expressed in terms o percentage and helps to determine the loan

eligibility o the borrower.

Explanation : (eore lending money to the borrower, the bank

tries to ascertain whether the concerned borrower has the ability

to pay euated monthly instalments +37Is in time and repay the

principal amount. To ascertain the credit worthiness o the

borrower the bank looks into the personal credit history o the

borrower and other fnancial details and calculates the F6I*. The

ratio shows the proportion o the total monthly income that the

borrower is using at present to pay his debt obligations. 8owever,

F6I* does not take into account statutory deductions rom his

monthly income which may be provident und, proessional tax

and deductions or investments made or insurance or a recurring

deposit. Say or example the monthly income o a borrower is *s.

9%,%%% and he has a car loan o *s. :9,%%%. Then the F6I* o the

borrower comes out to be :9,%%%%;9%,%%%. / bank will preer to give a loan to borrower whose F6I* is

low. This is because i a borrower?s F6I* is high then it implies

that the credit risk o the lender is also high as the disposable

income available to the borrower ater paying his 37Is is low.

Thus the ability o the borrower to repay the loan is also low.

Example : Suppose the monthly income o an individual is *s.

9%,%%% and the bank F6I* is 9%>. Thus the individual can avail

loans rom the bank whose total 37Is is to the extent o *s.

$9,%%%. @ow i the individual is already paying a car loan 37I o

*s. :9,%%% and he wants to take a home loan as well then takinginto account the above F6I* criteria the individual can avail a

home loan rom the bank provided that the 37I does not exceed

*s. :%,%%%.

Macroeconomic Vulnera%ility Index


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Defnition : 7acroeconomic Aulnerability Index +7AI is

constituted by adding up the rate o in2ation, )urrent /ccount

#efcit and Fiscal #efcit o a country +all obtained rom the latest

1orld 3conomic 6utlook o the International 7onetary Fund.

Fiscal #efcit and )urrent /ccount #efcit are measured aspercentages o '#5 while in2ation is calculated as the year!on!

year change in the relevant price index. Thus 7AI together

indicates three key areas where macroeconomic imbalances are

most likely to occur! fscal management, external account and

domestic prices.

Explanation : 4sually it is reviewed that the index should have a

level o :$! consisting o B> in2ation, $> )/# and C> Fiscal

#efcit. 8igher the level o 7AI, higher is the macroeconomic

imbalance and more vulnerable is the economy. The index is used

to make comparison across countries and across time.

In $%:$!:=, India witnessed a vulnerability index with a value o

$$.B, comprising a :%.$> in2ation rate, a (udget #efcit o D.9>

and a )urrent /ccount #efcit o B.D> o '#5, which was well

above other countries. This put the domestic economy at the top

o the Fragile Five pack +India, (rail, Indonesia, South /rica, and

Turkey. In the conseuent years, 7AI witnessed an improvement

and in $%:=!:B, it stood at :&.:. In $%:B!:9, 7AI has been

pro"ected at :9.$.

Example : )hange in 7AI must be interpreted cautiously as

increase in the index does not add to macroeconomic risk in the

same way. For instance, a $> rise in in2ation with a $> rise in

)/# cannot be compared at the same level. In both cases, the

7AI increases by $, but in the latter case 7AI is more risky,because it can rapidly lead to a currency crisis, while the ormer

represents only a mild deviation rom the range o in2ation.

In)ation Expectations


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Defnition : *ate o in2ation that might prevail in the uture can

be termed as in2ation expectations. #epending on in2ation

expectations, the )entral (ank and other market participants can

set their uture strategies

Explanation : In2ation expectations play a crucial role in

determining the )entral (ank?s policy measures. I the )entral

(ank expects a high level o in2ation then it would preer to raise

the rate o interest and i in2ation expectations remain low then

the )entral (ank would reduce the interest rate.

To measure the in2ation expectations in India, the *(I conducts

in2ation expectations surveys o households o nearly 9,%%%

people across :C cities. The survey helps produce both ualitative

and uantitative responses on in2ation expectations over the

near term +three months and long term +one year periods. These

samples are then used to calculate median and mean in2ation

expectations or the coming three!month and one!year periods.

Example : In2ation expectation can be used as a key parameter

to determine the policy measures. It can also be used by the

wage earners to determine wages. For example i the in2ation

expectation is high, labour orce may ask or higher wages, whichin turn will push up costs.

*ic+ Sie

Defnition : Tick sie can be defned as the minimum price

movement that is allowed on stocks and derivatives which are

traded on stock exchanges. In other words, tick sie is the

minimum amount by which the value o a security can change.

Explanation :Tick sie depends on the nature o the underlying

security and the stock exchange on which the security is currently

trading. #i-erent stocks have di-erent market prices and as a

result, tick sie o one stock varies rom that o another. / stock


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with a high market price can have a higher tick sie while a stock

with a comparatively low market price can have a low tick sie.

Theoretically, tick sie has a bearing on the liuidity o a security

and trading volumes. / security that has low liuidity in the

market has a wide bid!ask spread. In such case, a high tick siecan improve the liuidity and trading o the stock as the

possibility o proft making on such stock increases accordingly.

8owever, a low tick sie limits the number o orders placed on the

trading platorm as price points o such orders may be very close

to each other. Thus trading volumes are a-ected and as a result,

low tick sie a-ects stocks with relatively smaller market

capitaliation. I the tick sie varies widely across the stock

exchanges, it may create room or arbitrage on a stock that islisted on more than one exchange.

Example : For example, let us consider that the tick sie or a

stock is *e.%.%9. This implies that i the market price o the stock

is *s. :%%.C%, then the closest price or the next buy order or the

next sell order can be placed at is *s. :%%.C9 or *s. :%%.99,

respectively.

Fiscal rudence

Defnition : Fiscal prudence can be defned as the manner in

which the 'overnment manages its fnances. Fiscal prudence

implies that the 'overnment adheres to strict discipline in the

management o its fnances. 8owever, i the 'overnment is not

fscally prudent, then it may end up spending more than its

means and thereby incur a huge debt burden and subseuently

run higher levels o defcit.

Explanation : It is imperative that the Indian 'overnment

maintains fscal prudence in the management o its fnances. For

that the 'overnment may bring down its populist spending and

allocate unds towards productive and developmental activities

that help in the growth and development o the economy. 8igher


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'overnment borrowing may lead to increased demand or unds

in the bond market, which in turn will increase the cost o money,

leading to a scenario o higher interest rates. 8igh interest rates

will adversely impact investments and thereby derail growth o

the economy. 6n the other hand, i the 'overnment borrows less,its outgo on interest payments will be less. Thus the 'overnment

will be in a position to allocate unds towards productive and

developmental economic activities.

Example : The 4nion 7inister o Finance till recently has

advocated or strong fscal prudence. The Finance 7inister opined

that there is a need or fscal consolidation and the 'overnment

needs to spend within its means.

De%t O.er"an$

Defnition : /ccording to 5aul Erugman, debt overhang can be

defned as a situation in which a company or a country has

inherited such high levels o debt that the creditors themselves do

not have the confdence that the concerned company or country

will be able to ully repay the debt.

Explanation : #ebt overhang results due to high levels o debt. Ithas an adverse e-ect on the prospects and the values o the

country or the company as the case may be. This is because o

the act that there is no incentive to increase economic activity

within the country or the company as the benefts o it are likely

to go to the creditors rather than to its stakeholders. Thus even

when there is a surge in economic activity, the concerned entity

under debt overhang stands to gain little. )ountries with debt

overhang are thus unable to allocate asset in key areas such aseducation, healthcare and inrastructure. The only way by which a

country can overcome the debt overhang is when the creditors

decide to orgive a part o the debt or the most o it or when the

country itsel fles or bankruptcy.

/ross 0 romotion


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Interactive 7edia

Defnition : Interactive media is a method o communication

widely used in present times. It is the integration o digital media

including combination o electronic text, graphics, movingimages, and sound, into a structured digital computeried

environment which provides an alternative mode o

communication. It is a method o two!way communication

whereby ideas or eedbacks can be exchanged at a aster pace.

Explanation : Interactive media is used or various purposes

such as training, education, inormation presentation, corporate

presentation etc. Social networking sites are examples o

interactive media as these sites allow users to share inormation,video, photo etc using graphics and text. It is a useul tool or

business houses to interact with potential clients. 7arketers use

the platorm o interactive media to showcase their o-ering to the

prospective customers.

Interacti.e Mar+etin$

Defnition : It is an developing trend in current marketing

practices, where the marketing e-ort has moved rom traditionalsystem to a conversation!based one. In the current scenario,

companies closely track the eedback o customers in various

online platorms like social networking and e!commerce sites,

which in turn are used to customie product o-erings or the

targeted segment. The process mainly involves understanding

what customers want and the products are o-ered accordingly.

Explanation : This orm o marketing has made customer

segmentation easier and has allowed the marketer to closely

analyse what the customers want. The ability to react to the

actions o customers and prospects are oten more e-ective than

normal marketing practice. For example, a popular website invites

its registered users to write reviews on restaurants they have

visited recently. They are also asked to rate the restaurant based


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on certain parameters like ood uality, service, overall ambience

etc. The restaurant management tracks such reviews regularly

and alters their o-erings based on the eedback received.

1ensen Alp"aDefnition :ensenGs /lpha, commonly known as H/lpha?, is used

to measure the risk!ad"usted perormance o a security or

portolio in relation to the expected market return.

Explanation : The ensen /lpha ormula was frst used by

7ichael ) ensen in :&C. The ratio helps in gauging the und

managerGs ability to generate additional returns over the risk!

ad"usted returns delivered by the corresponding benchmark

index. Investors can get an idea o how much value the und

manager has added +subtracted to +rom the und through his

stock!selection ability. Stock selection can be a combination o

sound undamental and market timing. / high value or alpha

implies that the und has perormed better than expected.

/ positive alpha o : means the und has outperormed its

benchmark index by :>. Similarly, a negative alpha o : signifes

an underperormance o :>. The higher the ratio, the better the

risk!ad"usted returns.

1ensens2 Alp"a3 ort4olio 'eturn - 5enc"mar+ ort4olio

'eturn

1hereJ

5enc"mar+ 'eturn 3 'is+ Free 'ate o4 'eturn 6 5eta

&'eturn o4 Mar+et - 'is+-Free 'ate o4 'eturn( Source:

In.estopedia

Investors usually "udge a und manager by the return he provides,

never by the risk he took to provide that return. The primary ideabehind is that the und manager should never be analyed solely

on the basis o returns. The risk component associated with the

investment should also be considered so to get the correct

picture.


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Moody2s

Defnition : 7oody?s, also reerred to as 7oody?s )orporation, is

the parent company or the holding company o 7oodyGs Investors

Service and 7oodyGs /nalytics. 7oodyGs Investors Service is ama"or global credit rating agency that undertakes extensive

research and analysis and covers debt instrument and securities.

7oody?s /nalytics provides fnancial sotware and advisory

services or economic analysis and fnancial risk management.

Explanation : 7oody?s is a very essential and crucial part o

global capital markets that contribute signifcantly in maintaining

transparency, accountability and integrity in fnancial markets

across the globe. 7oody?s Investors Service tracks debtinstruments that cover as much as :=% sovereign nations, $:,%%%

public fnance issuers, DC,%%% structured fnance obligations and

::,%%% corporate issuers in several market segments and rates

them accordingly. 7oody?s Investors Service allocates di-erent

ratings to debt instruments ranging rom /// to ). 1hile ///

signifes the highest uality with the lowest level o credit risk, )

indicates an instrument that is likely to deault and there is a very

little chance o recovery o principal or interest. 7oody?s/nalytics, on the other hand, o-ers uniue tools and best

practices or managing and mitigating risk by undertaking

economic research, credit analysis and fnancial risk

management.

Example : 7oodyGs *atings revised IndiaGs sovereign rating

outlook to KpositiveL rom LstableL as the credit rating agency

expects that actions by policymakers will enhance the countryGs

economic strength in the medium term.

Mar+et Se$mentation

Defnition : 7arket segmentation is a process or strategy by

which the entire market can be divided into various groups or

small units consisting o people who have relatively similar


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product needs or demand characteristics.

Explanation : There are several advantages o market

segmentation as it helps a company identiy a particular product

or a particular segment. This also helps to build itscompetitiveness or a particular market segment, improving its

core competency. (y using segmentation analysis, customer

retention can be encouraged and proftability can be improved.

7arket segmentation can be done in various ways, some o which

are discussed belowJ

:. 7eo$rap"ical se$mentation: It is based on variables such

as region, climate, population density and population growth.

For example, woollen garments can be promoted all through

the year in polar countries but in tropical countries, it can be

promoted only in winter.

$. Demo$rap"ic Se$ment: 8ere segmentations are done

based on age, gender, amily sie, income, occupation,

nationality, religion etc. For example, there are various mutual

und products that cater to people o di-erent age groups. /n

aggressive euity scheme may appeal to young investors butaged investors may opt or a debt scheme.

=. syc"o$rap"ic Se$mentation: This is based on

consumers? liestyle as well as values and belies. For

example, a luxury club membership may appeal to those who

belong to the high!income segment and need to develop

network with people to boost business.

B. 5e"a.ioural Se$mentation: It is based on variables suchas usage rate, patterns, price sensitivity, brand loyalty etc. For

example, a consumer may preer to use the service o a

certain telecom service provider as his usage rate matches

with the price o-ering o that particular company.


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S"oroomin$

Defnition : Showrooming is the practice o visiting retail stores

to examine a product or merchandise and subseuently

purchasing the same rom online retailers at a cheaper rate.Explanation : 1ith the growing popularity o online retail

shopping sites, showrooming is gaining prominence among tech!

savvy consumers. / section o such consumers preer to visit a

retail shop;store to physically examine a product;merchandise

they preer to purchase. /ter getting a look and eel o the

product, they purchase the same at a cheaper rate rom online

retailers. The online price may be lower compared to the retail

shopping centers;stores as it involves lower overhead costs.7eanwhile, online retailers o-er ree shipping i the purchase

exceeds a certain threshold amount.

In order to combat the challenges aced by physical retailers due

to showrooming, a number o retail stores are using tactics such

as o-ering in!store pickup or online purchases, thereby avoiding

shipping charges and o-ering select products exclusively in

physical stores.

Explanation : / customer comes to know about the launch o a

smart phone. 8e goes to a retail mobile store to get the look and

eel o the product. /ter being satisfed with the eatures, he does

research on the best available prices and fnalises an online retail

store. /ccordingly, he purchases the smart phone rom that online

store.

'ecession

Defnition : *ecession reers to a phase in which signifcant

decline in economic activity is witnessed and it gets spread across

the economy. It is generally considered to be less severe than

depression. 8owever, i a recession continues or a long period o

time, it may lead to depression.


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Explanation : *ecession generally sets in "ust ater the economy

reaches a peak o activity and ends as the economy reaches its

trough. (etween trough and peak there is a phase o expansion.

#ecline in real '#5, real income, employment, industrial

production, investment, consumption are some o the keyattributes o recession. The e-ects o recession are extensive and

lead to tough times or most companies due to all in overall

consumer spending. 8owever, in order to ensure that recession

does not last long, 'overnment takes necessary actions to boost

the economy. It attempts to pull the economy out o recession

through its monetary and fscal policies.

Explanation : The fnancial crisis o $%%& was one o the worst

economic disasters which the world has witnessed and it exposed

the vulnerability o ma"or global banks. It originated in the 4.S.

through sub!prime crisis and gradually hit di-erent economies

across the globe.

'eal 7D

Defnition : *eal 'ross #omestic 5roduct +'#5 can be defnedas a macroeconomic indicator, which measures the value o

economic output within the concerned economy. It takes into

consideration the necessary ad"ustments or price changes due to

in2ation or de2ation.

Explanation : '#5 is the monetary value o all goods and

services produced within the economy during a specifc year. '#5

o an economy can be expressed in real terms as well as in

nominal terms. @ominal '#5 or '#5 at current prices can present

a misleading growth picture o an economy. This is because

in2ationary pressures are ignored by nominal '#5, which can

have a signifcant bearing on the perormance o the economy.

8owever, real '#5 provides the real picture o actual growth o

the economy. *eal '#5 considers a specifc year as base year and


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calculates the growth rate o the economy in the current year with

respect to that o the base year. *eal '#5 does not take into

account taxes and subsidies in its calculation. To measure the

impact o price changes on the economy, a new indicator called

'#5 de2ator is arrived by dividing nominal '#5 by real '#5. Sincereal '#5 is calculated by making necessary ad"ustments or

in2ation, it can be used to depict the purchasing power o an

individual by dividing the real '#5 by the population sie.

oni Sc"eme

Defnition : 5oni scheme is a raudulent scheme, designed to

dupe investors with the promise o very high rate o return rom

investments. Such schemes deliver returns to older investors byadding new ones. 5oni schemes generally deliver promised

returns to earlier investors as long as new investors invest in the

scheme. 1hen the 2ow o new investments dries up, such

schemes collapse and as a result investors lose their money.

Explanation : 5oni scheme derives its name rom )harles 5oni,

who started an arbitrage scheme in :$% in (oston and used the

ploy o paying o- early investors with the money o new

investors. 8e promised to double investors? money in % days by

buying and reselling international postal!reply coupons. 8e

mopped up over M& million rom around =%,%%% investors in a

span o "ust seven months, beore the scheme busted. Aarious

money!raising schemes use similar tactics like 5oni. They raise

money rom unsuspecting investors in the name o investing in

real estate, agriculture and other lines o pro"ects and businesses.

In reality, very ew such businesses exist and do not generate any

signifcant revenue. (esides o-ering very high returns to investorscompared to banks and other regulated channels, poni schemes

also give huge commissions to agents and feld workers. 5oni

schemes 2ourish due to lack o awareness among investors and

the greed to earn unrealistically high returns.


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Explanation : Sanchaita Investments in the mid!seventies used

to o-er sky!high rates o around B&> returns. The raud was

detected in :D when many depositors complained about non!

payment o dues. Subseuently, the company was wound up in

early eighties. In recent times, the scam o Saradha, *ose Aalley,75S, I!)ore and other poni schemes came into picture ater they

started deaulting in making payments to depositors. The

investors must stay away rom such schemes which promise

unrealistically high returns.

Fair Value

Defnition : In accounting and economics, air value is a rational

and unbiased estimate o the potential market price o a good,service, or asset.

Explanation : Fair value is an exit price. /n exit price represents

expectations about the uture cash in2ows and out2ows

associated with an asset or liability rom the perspective o a

market participant. The most common method o determining the

air value o a bond is to calculate the present value o all

expected uture cash 2ows rom the bond. To do so, one typically

needs the time to maturity, the discount rate, the coupon rate

and the par value. In the utures market, air value is the

euilibrium price or a utures contract. This is eual to the spot

price ater taking into account compounded interest +and

dividends lost because the investor owns the utures contract

rather than the physical stocks over a certain period o time.

/"it Fund

Defnition : / chit und can be defned as an arrangement where

a group o people contribute money at periodic intervals in a pre!

defned manner into a corpus or a kitty. )hit unds are uite

popular in rural areas and tier II and tier III towns in India, mainly

due to lack o fnancial inclusion in such areas. 6wing to under!

penetration o banking services in such regions, many people use


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chit unds to raise uick money or to meet sudden liuidity needs

and even a planned expenditure.

Explanation : 4nder the organised route, many companies have

been incorporated to run chit und as a business and aregoverned by state or central laws. /part rom a number o state

chit und acts, there is a central )hit Funds /ct o :&$ to govern

the operations o chit unds. The oNce o registrar o chit unds

monitors operations at the state level. Such chit unds cater to

the cash reuirements o members locally. 8owever, there are

many instances o raudulent activities by chit und companies

where the members have lost their hard!earned money.

Example : 1hile a simple orm o chit und is run to und theneeds o members, it can get complicated i it starts getting

members to und real estate pro"ects, plantation schemes etc.

5eople have lost money in various poni schemes, multi!level

marketing schemes etc and need to be cautious about the

operation o a chit und. )hit unds, that are well operated, can be

an option or people who are outside the ambit o ormal fnancial

channel, but those who have access to bank accounts need not

explore the risky path.


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Banking Term 2|Polarisedutech

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