Para Banking & Financial Services by Banks - Detailed Study | MODULE D: FINANCIAL PRODUCTS AND SERVICES

Guidelines on Para Banking & Financial Services Provided by Banks

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Introduction

Para Banking refers to the services that banks provide apart from their core banking operations (like accepting deposits and lending). These include a variety of financial services such as insurance, asset management, and advisory services. The Reserve Bank of India (RBI) has laid down specific guidelines that banks must adhere to when engaging in para banking activities.

Guidelines on Para Banking & Financial Services

The RBI issues strict norms to ensure that para banking activities do not compromise the financial health of banks. Some key guidelines include:

• Banks must obtain prior approval from RBI before undertaking certain para banking activities.
• Investment in subsidiaries, joint ventures, or strategic investments should not exceed 20% of a bank’s paid-up share capital and reserves without RBI’s approval.
• Separate accounting and disclosure for para banking income.
• Risk Management Systems must be strengthened when engaging in these activities.

Types of Para Banking and Financial Services Provided by Banks

Common types of para banking services provided by banks include:

• Insurance Agency/Distribution (both Life and General Insurance)
• Mutual Fund Distribution
• Asset Management Services
• Investment Banking
• Portfolio Management Services (PMS)
• Credit Card Issuance
• Wealth Management Services

Organisation of Para Banking and Financial Services Activities by a Bank

Banks may organize para banking services through:

1. Direct Mode: Providing services directly under the bank’s brand.
2. Subsidiary Mode: Creating a separate legal entity (subsidiary company) to provide services.
3. Joint Venture: Partnering with another company to offer para banking services.
4. Strategic Investment: Investing in other companies offering financial services, with certain ownership limitations.

Para-Banking and Financial Services Undertaken by a Bank

Services undertaken by banks under para banking include:

• Retailing of Government Bonds and Mutual Funds.
• Underwriting of corporate shares and bonds.
• Distribution of pension products like NPS (National Pension System).
• Providing advisory services such as mergers, acquisitions, and other corporate finance services.
• Referral services for loans, credit cards, and insurance products.

Disclosure of Commissions/Remunerations Earned from Para Banking and Financial Services Activities

Banks are required to:

• Clearly disclose in their financial statements the commissions, fees, and other income earned through para banking activities.
• Disclose any associated risks involved in such activities separately.
• Ensure that the income from para banking activities is reported separately from traditional banking income to maintain transparency and inform stakeholders accurately.

Advanced Mathematical Example: Commission Income Calculation

Suppose a bank distributes mutual funds and earns a commission at a rate of 1.25% of the total investments mobilized. If the bank mobilized ₹500 crore worth of investments in a year, calculate the total commission income, and analyze its impact on profitability given that the operational cost for para banking activities was ₹2 crore.

Step-by-Step Calculation:

Given:

• Commission Rate (r) = 1.25% = 0.0125
• Total Investment Mobilized (I) = ₹500 crore = ₹500 × 10⁷
• Operational Cost (C) = ₹2 crore = ₹2 × 10⁷

Commission Income (CI) = r × I

Thus,

CI = 0.0125 × 500 × 10⁷ = 6.25 × 10⁷ = ₹6.25 crore

Net Profit (NP) from Para Banking Activity = CI - C

NP = ₹6.25 crore - ₹2 crore = ₹4.25 crore

Profitability Analysis:

The profitability percentage (PP) from para banking services can be calculated as:

PP = (NP / C) × 100
= (4.25 / 2) × 100
= 212.5%

Conclusion: The para banking activity in this case yields a high profitability of 212.5%, significantly enhancing the bank's non-interest income stream.

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Previous Chapter Pension Funds (include APY, NPS)

Next Chapter Real Estate Investment Funds / Infrastructure Investment Fund (concept)

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Chapter List: MODULE D: FINANCIAL PRODUCTS AND SERVICES

• Overview of Financial Markets
• Money Markets and Capital Markets
• Fixed Income Markets - Debt / Bond Markets
• Forex Markets
• Interconnection of various markets/Market Dynamics
• Merchant Banking Services
• Derivatives Market including Credit Default Swaps
• Factoring, forfaiting & Trade Receivables Discounting System (TReDS)
• Venture capital
• Leasing and Hire Purchase
• Credit Rating agencies & their functions
• Mutual Funds
• Insurance Products
• Pension Funds (include APY, NPS)
• Guidelines on Para Banking & Financial Services provided by Banks
• Real Estate Investment Funds / Infrastructure Investment Fund (concept)