JOSEPH HADRIAN BOSCO

DIRECTOR, Karamel Knowledge Ventures

XLRI 2015
1

BANKING PRODUCT
DESIGN: WHAT GOES INTO
THE CONSTRUCTION

 Our economy has been evolving, and continues to

evolve.
So is the banking system.

More so in the developing countries

 We started as an agrarian society we extracted raw materials from the earth

began to make products from the materials so
extracted
further evolved into delivering services.

 We still do all of those things !

But they are all becoming increasingly commoditized.
Including banking products and services.

HOW DO YOU DIFFERENTIATE YOUR BRAND

FROM YOUR MANY COMPETITORS?
Interest rates
Fees
Product features
Speed of services
Add on features ???

 Banks recognize good design to be a critical element

for success of retail banking products and services.
Traditionally, banks were providers of services: they
impose and enforce terms and conditions.

Focus on :
Customers needs
In the past, whether product suited their customers or
not did not exist.
Customers were expected to :
- fall in line and accept products as they were and
- had to adjust to their rigidities and limitations.

Current trend
Boom in the global financial markets and merits of
best practices changed these attitudes everywhere
including India:

Client focus

more proactive stance,

with offerings that make it easier for clients to:
- stick to good behaviour and
- achieve their personal financial goals.

10

Today, due to limited target audience and

disproportionately large number of players banks go the
extra mile to:

woo, entice, nurture and permanently marry

their clientele till death-do-us-part

keeping the customer at the centre of the

canvas, and

developing products around this core,

11

 Banks are constantly innovating in the area of

product design to accurately cater to the way users
can, do, or want to use them.
This flies in the face of the traditional approach of
compelling people to alter their behavior and forcing
them to learn how to use it as per the bank or service
providers requirements.
The change has compelled banks to take a fresh look
at how people really deal with their money.
12

ENTER RETAIL BANKING

It rethinks banking from the customers point of view

and pays close attention to everyday behaviour than
to rates and rewards.
Outcome :
- development of products and services designed to
address :
- real-time and real-world needs
- service delivery handled through aesthetically,
tastefully designed branches and offices.
13

Bank products today look at the real-world behaviour of

bank customers,
- Are tailored to match the clients needs.
- No longer is it one size fits all.
Banks bet big on new products, technologies,
Premium services that are rolled out often fail
dismally, for reasons that are hard to figure out.
Often consumers who devour the latest technological
innovations in mobile phones, cars, shopping, and
entertainment are often wary of experimenting with
new ways of managing their money.
14

Retail banking is unlike other services.

It is often a much underrated segment of banking
(when compared to the more exotic profiles of
investment banking, merchant banking, trade finance,
treasury, M&A or wealth management),

15

 The difference between a product or service that

succeeds and one that fails: the ability to win the
customers trust.
All new programmes, updated processes, and new
products :
Must inspire a sense of TRUST
for consumers to even consider bringing it into their
financial lives.
16

Bank Customers
For handling their own money, even the savviest of
people often tend to be resistant to change.
Look for user-centric designs in a product with
significant details that a new service can be trusted
and will not let them down.

17

 A proper market survey of client requirements and a

perspective based on :
demographic characteristics,
lifestyle patterns and
behaviors and buying patterns
help develop effective deposit, loans and advances and
ancillary fee based banking strategies based on the true
drivers of growth including:

18

 Wallet share by segment and product

Household segmentation mix and penetration
Product propensity analysis
Franchise and branch-level product penetration and
gap breakdowns
Prioritization of key retention segments.
19

 Consumers have many options for banking services.

Attracting their business or the contents of their
wallets, requires smart, personalized marketing.
Critical for a bank to know which of its products
consumers are more likely to use, or which segments
represent the strongest growth potential for the bank.

20

 It is here that suitable market penetration and

product propensity analysis of existing customers
gives answers to:
Target the high-growth consumer segments
Position more relevant messages and product offers
Create new innovative product offerings

21

 By doing so, a bank can recalibrate its approach in

appropriate positioning of its products and services to
retain valuable customers.
It would need to assess:
- Offers Customers are most likely to buy
- New products and services that meet their needs
- Benefits of personalized service and marketing
messages

22

 A PwC survey indicates that customers perceive

financial services institutions to be too impersonal,
but are not willing to pay more for personalization
by a wide margin.
They expect personalization as part of the base
offering.

23

Hence:
Product development with a focus on needs of target
segments
Alignment of the product and service to the customers'
needs
Degree of personal care in banker relationship
Customization of product to client portfolio

24

Experiencing
Being able to stage memorable experiences, large or
small, elevates your brand to a level far beyond the
discussions of product features and price.
Staging experiences allow you to connect with people
emotionally..surprisingly, a good number of people
decide with emotion and justify with fact,
including the affluent.
Being able to guide customers through a
transformation is the highest evolution, and financial
services companies are uniquely positioned to be able
to do that.
25

QUESTION: HOW DO YOU BECOME THE

BANK YOUR CLIENTS CANT LIVE WITHOUT?

No shortage of financial providers willing to help

clients borrow, save, manage and move money.
How can you add value beyond these utilities?
Issue for product managers : typically steeped in
competitive rate shops and price elasticity curves, but
winning affluent clients in this new era requires some
broader thinking about products and about value
propositions suited to such clients.
26

Marketing Myopia
Theodore Levitt's1960 treatise:
"The railroads did not stop growing because the need for
passenger and freight transportation declined. That grew.
The railroads are in trouble today not because that need
was filled by others (cars, trucks, airplanes, and even
telephones) but because it was filled by the railroads
themselves. They let others take customers away from
them because they assumed themselves to be in the
railroad business rather than in the transportation
business. The reason they defined their industry
incorrectly was that they were railroad oriented instead of
transportation oriented; they were product oriented instead
of customer oriented."
27

 So what business are banks in if they are not in the

banking business?
-They are in the business of helping people achieve their
financial and life goals, and the best brands differentiate
themselves by re-imagining the definition of product
beyond a typical set of tangible attributes.

28

MAKE THE COMPLEX SIMPLE

Affluent clients are usually extremely busy people
If your bank could solve all their problems, not just
advise on investment decisions: imagine how
attractive a proposition that would be.
Financial advisors strive to be trusted advisors, but
most are not prepared when their clients wants and
needs go beyond the balance sheet.

29

MAKE THE COMPLEX SIMPLE

Focus on Engagement:
Dont simply provide a list of potential benefits or
services and leave your clients to discover them on
their own. Even the best-designed programs can
remain a secret to many of your clients without your
proactive efforts to promote the value you are creating
for them.
Your goal should be to create extremely targeted and
relevant communications about products, offers and
experiences that cut through the clutter and meet
your clients real needs and desires.
30

Create Experiences:
There are four key elements that should be addressed
when creating an experience that will generate
engagement with clients:
1. Use analytics to ensure the offer is targeted and
relevant
2. Create an emotional connection
3. Bring it to life with awareness and promotion
4. Create a frictionless fulfillment process
31

Industry leadership will be attained by those

institutions most adept at harnessing product, service
and process innovation to anticipate and meet customer
needs. Ultimately, to deliver on these imperatives,
banks will have to focus on their core strengthsthose
activities in which they exceland partner with bestin-class specialists for every thing else: achieving more
by doing less.
-The paradox of Banking 2015, Achieving more by doing
less by the IBM Institute for Business Value

32

FUNCTIONS OF FINANCIAL
MARKETS
1.

Facilitate accumulation of capital and higher

productivity, thus promoting economic development.

2.

Allocate savings by way of investments in businesses and

public enterprises which create the optimal expected
returns (presumption of the risk averse investor).

3.

Provide price formation mechanisms and set

benchmarks for value in the economy.

4.

Promote efficiencies in businesses and public enterprise

(presumption of the rational manager who is aware of his
cost of capital).
33

FUNCTIONS OF FINANCIAL
MARKETS
Thus, Financial Markets facilitate:
The raising of capital ( in the capital markets)
The transfer of risks ( in the derivatives markets)
Price discovery
Global transactions with integration of financial
markets
The transfer of liquidity

Markets and their products are used to match those who

want capital to those who have it.
34

COMPONENTS OF FINANCIAL
MARKETS
1. Securities Market
a) Regulations
b) Organized trading platforms:
Equity markets
Derivatives
Equity
Commodities
Currencies
c) Bonds
d) Clearing Corporation

35

COMPONENTS OF FINANCIAL
MARKETS
e) Depositories
f) Spot Markets
g) Capital Market services:
Investment Banking / Merchant banking
Portfolio Management
Custodial services
Fund houses
2. Banks

36

MARKETS AND BANKS

Banks and Markets exhibit three types of interaction:

Competition,

Complementarity, and

Co-evolution.

37

MARKETS AND BANKS

A borrower chooses its financing source from the
following :
1. direct capital market financing;
2. securitization in which the bank screens and
certifies its creditworthiness first and then
obtains capital market financing; and
3. a direct loan from the bank based on his
relationship.
And so does a depositor or an investor : bankers and
capital market intermediaries will fight for a larger
piece of a customers wallet.
38

FINANCIAL SYSTEMS
A good financial system is the one in which the
payment mechanism is:
Fast
Swift
Smooth and
Safe

39

FINANCIAL SYSTEMS
Comprise of :

Banks, with their numerous product offerings

and Markets along with all their associated arms like
the Depository organizations, Clearing House,
Custodians
AND

Appropriate Regulations, Rules and proper

Market administration enable a robust Payment
Mechanism.

40

SECURITIES MARKETS
A Securities Market is characterized by:
Appropriate legislation establishing a Regulator and
empowering it.
Licensing stock and derivatives Exchanges, clearing
corporations, Depositories, etc
Enabling appropriate Regulations , Rules, bye laws,
directives etc on every facet of the markets functions
Ensuring proper technology is used
41

SECURITIES MARKETS
Facilities to constantly collect data and constantly
analyzing them.
Ensuring uninterrupted and regular flow of information to
all categories of investors without any bias.
Ensuring escalated supervision on errant participants and
initiating action where required.
Regularly update and upgrade the legal frame work.
Important : Investor protection, transparency and
reduction of systemic risk.
42

SECURITIES MARKETS
Financial Services Markets are deeply integrated
Regulations, Rules and guidelines in a Securities Market
are subject to stringent supervision and oversight.
All aimed at :
9 the protection of investors,
9 ensuring efficiency and transparency in the markets;
and
9 the reduction of systemic risk
(IOSCO 1998)

43

SECURITIES MARKETS
In the last two decades, fundamental changes have taken
place in the Securities Markets:
Advent of technology ( has the market been enslaved by
IT)
Capability of harnessing information in the minutest
form
Securities Market regulators progressively moving away
from merit based regimes to disclosure based regimes
Their Role : to insure that markets are given fully, timely and
accurate information.
44

SECURITIES MARKETS
The conventional face of the Securities industry has changed :
traditional boundaries between banking, Securities and
Insurance has blurred.
loss of control or confusion among Supervisors
products offered slipping through cracks in the
regulations.
Result :
failure of markets to meet the three core supervisory
principles.
( reference : financial market debacle of 2008)

45

SECURITIES MARKETS
Leading to :
9 forceful acceptance that financial Markets are deeply
integrated;
AND
9 strong suggestion towards a corresponding integrated
regulatory approach.

46

1933 & 1999

Dismantling of the 1933 Glass - Steagall Act
Introduction of Gramm- Leach Bliley Act in 1999.
Major impact on the Financial world.

47

THANK YOU

Mr. Joseph Hadrian Bosco

www.karamelknowledgeventures.com
josephbosco@gmail.com

JOSEPH HADRIAN BOSCO

DIRECTOR, Karamel Knowledge Ventures
XLRI 2015
1

BASEL FRAMEWORK ON
BANK CAPITAL
REGULATION

This session would deal with the major developments in

the efforts towards harmonisation of bank capital
standards by the Basel Committee on Banking
Supervision( BCBS):

the Basel Accord of 1988,

the1996 amendment to the Basel Accord,
the Basel II framework and
the subsequent refinements

 Capital regulation in the banking sphere had existed

in some form or the other even before the signing of
Basel Accord in1988.
The Accord marked a watershed in the efforts towards
harmonisation of bank capital regulation across
nations.
More than 100 countries adopted the Basel I
regulatory requirement of capital at eight percent of
risk - weighted assets.
4

BIRTH OF BASEL NORMS

The failure of the German Bank Herstatt in 1974.
The 1970s saw banks operating on wafer-thin capital
base.
International banks, especially the Japanese banks,
tried to get short-term competitive advantage.

 The definition of regulatory capital differed from

country to country
The central banks of the G-10 countries addressed
the issue of under-capitalized banks and nonstandardized banking regulations.
Basel Committee on Banking Supervision was
formed under the Bank of International
Settlements (BIS) in 1974.

 In July 1988, the Basel Committee came out with a

set of recommendations popularly known as Basel I
norms.
In 1988 Basel Accord 1 was created & it enforced by
law in G-10 countries in 1992

OBJECTIVES

Strengthen the stability of international banking

system.
Set up a fair and a consistent international banking
system in order to decrease competitive inequality
among international banks.

BASEL I NORMS

Maintain capital of at least 8 per cent of their riskweighted loan exposures.

Exposures to Govt. 0%
Banks 20%
Corporate-100%

BASEL I NORMS
Capital was categorized as
Tier I capital - Permanent capital like equity.
Tier II capital - Supplementary capital like
subordinate debt etc

10

COMPONENTS OF TIER I CAPITAL

Tier I capital is core capital,
This includes equity capital and disclosed reserves.
Equity capital includes instruments that can't be
redeemed at the option of the holder.

11

COMPONENTS OF TIER II CAPITAL

1. Undisclosed Reserves
Undisclosed reserves are not common
Are accepted by some regulators where a bank has made a
profit but this has not appeared in normal retained profits
or in general reserves of the bank.
They must be accepted by the bank's supervisory
authorities.

Many countries do not accept this as an accounting

concept or a legitimate form of capital.
12

COMPONENTS OF TIER II CAPITAL

2. Revaluation reserve :
is a reserve created when a company has an asset revalued
and an increase in value is brought to account.
A simple example may be where a bank owns the land and
building of its head-offices and bought them for Rs.10Cr a
century ago.
A current revaluation is very likely to show a large
increase in value.
The increase would be added to a revaluation reserve.
13

REVALUATION RESERVES
The reserve may arise out of a formal revaluation carried
through to the bank's balance sheet or a notional addition
due to holding securities in the balance sheet valued at
historic cost.
If taken into Tier II , Basel II requires that the difference
between the historic cost and the actual value be
discounted by 55%.

14

COMPONENTS OF TIER II CAPITAL

3. A general provision
is created against losses which have not yet been
identified.
They qualify for inclusion in Tier 2 capital as long as
they are not created against a known deterioration in
value.
They are limited to
- 1.25% of RWA (Risk-weighted assets) for banks
using the
standardized approach
- 0.6% of credit risk-weighted assets for banks using the Internal rating
Based (IRB) approach (Under the Basel II guidelines, banks are allowed to use
their own estimated risk parameters for the purpose of calculating regulatory
capital).

15

COMPONENTS OF TIER II CAPITAL

4. HYBRID INSTRUMENTS
Hybrids are instruments that have some
characteristics of both debt and equity.
Provided these are close to equity in nature, in that
they are able to take losses on the face value without
triggering a liquidation of the bank, they may be
counted as capital.

Perpetual preferred stocks carrying a cumulative

fixed charge are hybrid instruments.
16

COMPONENTS OF TIER II CAPITAL

Perpetual preferred stocks: A type of preferred stock
that has no maturity date. The issuers of perpetual
preferred stock will always have redemption privileges
on such shares. Issued perpetual preferred stock will
continue paying dividends indefinitely.
A cumulative version is one that accumulates
dividends from one period to the next.
Cumulative perpetual preferred stocks are excluded
from Tier 1.
17

COMPONENTS OF TIER II CAPITAL

5. SUBORDINATED TERM DEBT
Is a debt that ranks lower than ordinary depositors of
the bank.
Only those with a minimum original term to maturity
of five years can be included in the calculation of this
form of capital;
They must be subject to proper amortization
arrangements.
18

WEAKNESS IN BASEL 1
The one-size-fits-all approach
Thought that capital requirement would take care of
operational risk
Did not distinguish between high and low quality
assets in the same class.
Not compatible with developing services like
derivatives and securitisation, as they could as
manipulative tools.
19

 The high pace of financial innovations brought into

light the deficiencies of Basel I framework
The need for a more flexible and more risk-sensitive
capital standards.
After years of intense consultations and modifications,
the revised capital frame work, popularly known as
Basel II was released by the BCBS in June 2004.

20

BASEL II - THE NEW CAPITAL

ADEQUACY FRAMEWORK
Recognizing the need for a more comprehensive, broad
based and flexible framework ,Basel committee proposed
an improved version in 1999, which provides for better
alignment of regulatory capital with underlying risk and
also addresses the risk arising from financial innovation
there by contributing to enhanced risk management and
control.
This sophisticated and superior framework was formally
endorsed by central bank governors and heads of banking
supervisory authorities of various countries on June 26,
2004 under the name International Convergence of
Capital Measurement and Capital Standards popularly
known as Basel II or New Basel Capital Accord.
21

BASEL II - THE NEW CAPITAL

ADEQUACY FRAMEWORK
This new set of international standards requires
banks to maintain minimum level of capital, to ensure
that they can meet their obligations, cover unexpected
losses and improve public confidence.

Basel II captures the risk on a consolidated basis for

internationally active banks and attempts to ensure
that capital recognized, set aside in capital adequacy
measures and provide adequate protection to
depositors.
22

BASEL II - THE NEW CAPITAL

ADEQUACY FRAMEWORK
It brings in to focus the contemporary risk
management techniques and it seeks to establish a
more risk responsive linkage between the bank
operations and their capital requirements.
It also provides strong incentive to banks to upgrade
their standards.
The accord is a cornerstone of the current
international financial architecture.

23

BASEL II - THE NEW CAPITAL

ADEQUACY FRAMEWORK
Its overriding goal is to promote safety and soundness
in the international financial system.
The provisioning of adequate capital cushion is central
to this goal and the committee ensures that new
framework maintains the over all level of capital
currently in the banking system.

24

BASEL II
The advocates of Basel II believe that creating such an
international standard can help to protect the
international financial system from various types of
financial and operational risks that banks may
encounter.
It also attempts to set up such rigorous risk and
capital management requirements to ensure that
banks hold sufficient capital reserves appropriate to
the risk the bank exposes itself through its lending
and investment activities.
25

OBJECTIVES
The objectives of the Basel II accord as enunciated by
BIS are fivefold:
Promoting safety and soundness of financial system
Enhance competitive equality
Greater sensitivity to the degree of risk involved in
banking positions ,activities
Constitute amore comprehensive approach to
addressing risk and
Focus on internationally active banks, with capability
of being applicable the banks with varying level of
complexity and supervision.
26

THREE PILLARS OF BASEL II

Three Pillars of BASEL II
Pillar 1 : Minimum Capital Requirement
Banks should have capital appropriate for their
risk taking activities.
Pillar 2 : Supervisory review process
Banks should be able to properly assess the risk
they are taking and supervisors should be able to
evaluate the soundness of these assessments.
Pillar 3 : Market Discipline
Banks should be disclosing pertinent information
necessary to enable market mechanism to
complement the supervisory oversight function.
27

 Refinements in the Basel II framework mooted to

ensure that the banking sector serves its traditional
role as a shock absorber to the financial system:
rather than an amplifier of risk between the financial
sector and the real economy

28

THE SUPERVISORY REVIEW

REQUIREMENT
Banks should have a process for assessing their
overall capital adequacy in relation to their risk
profile and a strategy for maintaining their capital
levels;
Supervisors should review and evaluate banks
internal capital adequacy assessments and strategies,
as well as their ability to monitor and ensure their
compliance with regulatory capital ratios. Supervisors
should take appropriate supervisory action if they are
not satisfied with the result of this process;
29

THE SUPERVISORY REVIEW

REQUIREMENT
Supervisors should expect banks to operate above the
minimum regulatory capital ratios and should have
the ability to require banks to hold capital in excess of
the minimum;

Supervisors should seek to intervene at an early

stage to prevent capital from falling below the
minimum levels required to support the risk
characteristics of a particular bank and should require
rapid remedial action if capital is not maintained or
restored.
30

MARKET DISCIPLINE

Proposes an extensive list of bank disclosure

requirements
Recognizes that markets contain disciplinary
mechanisms that reward banks that manage risk
effectively and penalize those whose risk
management is inept or imprudent

31

DISCLOSURES
Broad classification of required disclosures:
1. Scope of application
2. Capital structure
3. Capital adequacy
4. Credit risk exposure and assessment
5. Credit risk mitigation
32

DISCLOSURES
6. Market risk exposure and assessment
7. Operational risk exposure and assessment
8. Equity exposure and assessment
9. Securitization exposure and assessment
10. Exposures to interest rate risk in the banking book

33

The issues being re-examined include:

Strengthening the risk capture on trading book and
off-balance sheet exposures,
Dampening procyclicality,
Strengthening framework to assess liquidity at
banks and
Globally coordinated supervisory follow-up exercises

34

 Regulators around the world and the banks

themselves have fast-tracked the implementation of
Basel 3 as a safeguard against another financial crisis,
raising the capital levels that banks must hold.

35

ENTER BASEL III

Post crisis, the global initiatives to strengthen the
financial regulatory system are driven by the
leadership of G 20 under the auspices of Financial
Stability Board (FSB) and the Basel Committee on
Banking Supervision (BCBS) .
Immediately after the crisis, the Basel Committee , in
July 2009 came out with certain measures also called
enhancement to Basel II or Basel II.5 to plug the
loopholes in its capital rules ,which were exploited to
arbitrage capital by parking certain banking book
positions in the trading book which required less
capital .
36

BASEL III
The Basel committee published its Basel III rules in
December 2010.
Main Objective:
to minimize the probability of recurrence of a crisis of
such magnitude.
to improve the shock absorbing capacity of each and
every individual bank as the first order of defence and
in the worst case scenario, if it is inevitable that one
or a few banks to fail .
It includes measures to ensure that the banking
system as a whole does not crumble and
its spill-over impact on the real economy is minimized
37

Basel III framework

Sets out higher and better quality capital,
enhanced risk coverage,
the introduction of a leverage ratio as a back-stop to
the risk-based requirement,
Introduces measures to promote the buildup of capital
that can be drawn down in times of stress and
the introduction of compliance to global liquidity
standards.

38

The key elements in Basel III include :

the definition of capital made more stringent,

capital buffers introduced,
loss absorptive capacity of Tier I and Tier II
capital instrument of internationally active
banks proposed to be enhanced,

forward looking provisioning prescribed

modifications made in counterparty credit risk

weights

new parameter of leverage ratio introduced

global liquidity standard prescribed

39

Conclussion

India had always set an example in implementing these

standards,
but requirements were imposed gradually and easy paced, so as
not to disrupt the banking system.
The compliance levels were relaxed from time to time to
accommodate even the weakest link in the banking chain.
The idea was to enable the entire system to adapt these
standards over a fixed time line so that the overall investor
response and the capital market in the economy is ready for the
huge resource mobilization requirements posed by these
compliances on Indian banks .
The real issue is whether the banks would be able to raise funds
from the capital market when the investors are rather wary
about the performance and returns from the banks /industries in
general in the context of a general slowdown in industries
coupled with inflation prevailing in the economy.
40

Conclussion
Before the onslaught of the global financial crisis
originating from the west, even the US and Europe
jurisdictions were not seriously concerned about
compliance with Basel norms.
Following the debacle of new and innovative
instruments, RBI is undertaking an exercise of
assimilating and watching than exerting pressure on
all the Indian Banks to comply with Basel III
standards in hurry ,even before the full compliance
with Basel II by some weak banks in the Indian
economy.
41

Conclussion
More than four years after the financial crisis began, it
is so widely accepted that many of the worlds banks are
burying /hiding losses and overstating their asset values
The lack of transparency, credibility in banks balance
sheet fuels a vicious circle.
When investors cannot trust the books, lenders cant
raise capital and
may have to fall back on their home countries
governments for help.
This further pressures sovereign finances, which in
turn, weaken the banks even more.
42

Conclussion
The new as well as the large private sector banks, with
their
high capital adequacy ratios,
enhanced proportion of common equity
better IT facilities and
other modern financial skills of the personnel,
are well placed to comply with Basel III norms in
general.
PSU banks although dominant participants in the
Indian financial system may take more time and face
challenges in following the Basel III guidelines.
43

Basel 4 ?
Recent developments are likely to result in three
changes that might form the basis of Basel 4:
Requiring banks to meet a higher minimum leverage
ratio;
Restricting the advantages to banks of using internal
models to calculate their capital requirements; and
Greater disclosure by banks.
44

THANK YOU

Mr. Joseph Hadrian Bosco

www.karamelknowledgeventures.com
josephbosco@gmail.com

JOSEPH HADRIAN BOSCO

DIRECTOR, Karamel Knowledge Ventures
XLRI 2015

COMPLIANCE

COMPLIANCE

Adhering to the requirements of laws, industry and

organizational standards and codes, principles of good
governance and accepted community and ethical
standards"

Is it really the role of Compliance to act as the

conscience of the organisation and police moral
standards that are not reflected in legal or regulatory
requirements?

YES

Especially so when there are a number of laws - such as

the obligation to "do all things necessary to ensure that
the financial services covered by the license are
provided:
efficiently,
honestly and fairly and
not to engage in misleading and deceptive conduct
that elevate standards of good behaviour into legal
requirements

COMPLIANCE IS THE ACT OF

FOLLOWING THE RULES
These rules are often external requirements and they
are many and varied.
Compliance also involves following the organizations:

Internal rules
Policies
Procedures
Acting in accordance with ethical practices.

BASEL COMMITTEE DEFINITION

OF COMPLIANCE:

An independent function that identifies, assesses,

advises on, monitors and reports on the banks
compliance risk, that is, the risk of legal or regulatory
sanctions, financial loss, or loss to reputation a bank
may suffer as a result of its failure to comply with all
applicable laws, regulations, codes of conduct and
standards of good practice.

BASEL COMMITTEE ON
COMPLIANCE
Compliance is an internal risk control function which
works closely with the in house legal function and which
is responsible for:
developing and administering systems and procedures
to comply with legal and regulatory requirements
assisting line personnel with day to day legal and
regulatory issues as they arise

BASEL
developing and administering monitoring and
surveillance systems to detect potential breaches of
legal and regulatory requirements
investigating, rectifying and reporting on breaches of
legal and regulatory requirements (including client
complaints)
filing various notices and returns with regulators
liaising with regulators in relation to regulatory
matters etc

COMPLIANCE MANAGEMENT
Compliance Management is the means by which
organizations can assure compliance in accordance
with the rules, regulations, laws, and other
requirements to which the organization is subject.
It involves oversight, assessment, reporting,
educating, and noting needs for remediation.
The element of assurance comes from reliable
evidence of compliance.

 Compliance is frequently misunderstood.

Focus is generally on the compliance mandates
related to Sarbanes-Oxley Act (SOx) requirements:
but organizations have learned that compliance
management is a complex responsibility requiring
measurement and reporting against a dynamic and
seemingly endless array of rules, agreements,
standards, regulations, and legislation.

 Each area of compliance comes with its own

requirements, and in many cases requires extensive
knowledge of esoteric technical subject matter and a
detailed data base for the elements of compliance
requirements, measurement, and reporting.
In many organizations, compliance management has
developed and remained as a series of siloseach
meets its own needs but they are not coordinated
across organizational levels.

 This tendency to silo often results in duplication of

planning effort, redundant reporting systems,
misplaced priorities and can waste the scarcest
resource in business : management attention.

An important distinction must be made between

Compliance Management and compliance itself
because there are two types of compliance activities:

Those done for

good business
reasons regardless
of regulations

Those done only

because of
regulations

 Many organizations only refer to activities required

by regulations as compliance,
but Compliance Management must encompass the
assessment, monitoring and control of activities in
BOTH categories

CULTURE OF COMPLIANCE

Best of breed organizations understand the

advantages of clearly defining,
communicating, measuring, and reporting
strategic objectives.

ATTRIBUTES OF A CULTURE OF
COMPLIANCE
A positive Culture of Compliance includes strategic
vision and relates to larger strategic goals.
It is:

Established by top management

Characterized by senior management example
Embedded in activities such as education
Reinforced by incentive systems

Given force through the treatment of transgressors

Integral to information systems and their use and management
Inseparable from the organizations structure, processes, and
management style

CULTURE OF COMPLIANCE
A positive Culture of Compliance also:
Encompasses enterprise risk management
Addresses the risks that arise in each strategic area
Establishes control points for the risk elements
Ensures controls are well documented for internal
and external purposes
Identifies the specific people responsible for managing
each compliance element

ATTRIBUTES OF A CULTURE OF
COMPLIANCE

Without a commitment to compliance,

even the best policies and
procedures will be useless

THE THREE Cs OF COMPLIANCE

Compliance has, as its basis, three essential and

continuous elements:
Communication
Confirmation
Correction

THE THREE Cs OF COMPLIANCE

The Three Cs of Compliance relate to internal
objectives and response to external requirements.
They establish the tone for how each individual
employee regards his or her role in compliance.
They allow compliance to be a benefit rather than a
burden.

THE THREE Cs OF COMPLIANCE

With communication, confirmation, and correction at
the center of the organizations compliance focus, it
can then radiate outward via compliance
management (policies, procedures, processes, systems,
and strategies) for all areas of compliance facing the
organization from the market, industry, and
regulations.

COMMUNICATION

Compliance communication begins at the top.

An organizations leaders establish its ethical tone

and state its values, then communicate these clearly
to all personnel, ensuring that constant reminders
are in place and are integral to such actions as
compensation, rewards, promotions, etc.

COMMUNICATION
Employees must receive a clear and consistent message:

This organization meets its obligations. We comply

with external requirements and provide sound
evidence of compliance. Our customers and
business partners know they can rely on us. We not
only produce the required reports of compliance,
we use them to measure our opportunities to
improve and our progress toward meeting
objectives.

CONFIRMATION
Automated business systems will do what we tell
them to doright or wrong.
A commitment to compliance includes building checks
and balances into systems so they will reveal the
evidence if they have been told to do something
wrong.
Authorization and authentication controls specify who
is allowed to do what, and provide evidence of what
they did.

CONFIRMATION
The history of corporate scandals includes numerous
examples of individuals abusing their authority and
systems that did not maintain evidence or support
the reporting of such abuse.
Confirmation includes the process for escalating
notification for any significant event or exception to
the level of management responsible for ensuring its
appropriate resolution.

CONFIRMATION
Includes reporting on the results of resolution
including confirmation of remediation.
Confirmation also includes the proper balance of
preventive, detective, and corrective controls, all with
summary reporting supported by recorded detailed
evidence

CORRECTION
Involves effective handling of incidents.
Must also include identifying and addressing the root
cause of each problem not merely the symptoms.

How foolish it would be to respond to hackers and

viruses only after they have been detected in your
systems.

CORRECTION
Also involves noting those changes in business
objectives, the market, the business environment,
technology, and the regulatory and compliance
environments that signal a need for corrective action
at the strategic, tactical and operational levels.

CULTURE OF CONFIDENCE

Compliance Management has evolved rather quickly

as a business best practice.
Until recently, compliance management may have
resided within Quality, Environmental, or Legal
departments.

CULTURE OF CONFIDENCE

However, firms that embraced quality management

concepts across the entire organization were the first
to see benefits from regular assessments and audits.
As compliance became the established focus of
process management, compliance management
systems similarly evolved to take in the expanding
array of processes and activities subject to
compliance.

CULTURE OF CONFIDENCE
Recent decisions of different Regulators against old and
well established enterprises ( irrespective of their
pedigree) highlights:

the importance of heightened supervisory and

internal controls and

the extent or degree to which regulated enterprises

will be held accountable for misconduct within their
firms itself, let alone across the markets or
environment.

OLD PRACTICES !!

To quote a Wall Street observation:

Just because a certain way of doing things is second
nature to you, and appears to be standard operating
procedures on the Street, doesnt mean that its the
correct way of doing things.. And as you have
witnessed, when conflicts are exposed, the costs to the
enterprise are enormous in dollars, in reputation and in
investor confidence and trust.

Compliance : what does it bring in

Continuance in business is of paramount importance
Not exposing senior management to run around
lawyers and to regulatory hearings is a huge savings
in terms of their time that could be used to grow the
business.
Protecting the image and reputation of the enterprise
is the next important aspect of any business.
Expansion of business, profits and wealth creation
will automatically follow to the satisfaction of the
shareholders.
This will instill a sense of pride and belonging among
the employees and lower the employee attrition rate.

OBJECTIVES OF A COMPLIANCE
PROGRAM
The objectives of a compliance program in any enterprise
shall be to put in place the following:

Prevention
Detection
Resolution
Reconstruction and
Heightened Supervision

 Every enterprise is in the business of creating wealth

and affording good meaning to its various stake
holders: investors, managers, employees and clients.
Businesses are compelled to address the GRC
requirements so as to avoid the legal consequences
and risks arising out of noncompliance.

The consequences of noncompliance by an enterprise

to the accepted principles, rules, regulations and any
of the applicable laws include references to financial,
civil, and criminal penalties.

 However, the first and the fiercest hit will be on the

enterprises reputation in the eyes of its customers and
shareholders and its ability to access the resources it
needs to succeed.
In many ways, the financial and legal consequences
are not as compelling and are more remote than the
real cost of diminished brand reputation.

CONSEQUENCES OF
NONCOMPLIANCE
The consequences of noncompliance vary from one
regulatory jurisdiction or space to another, but they
surely include:
Loss of reputation, customer and business partner
trust
Loss of market share in the back drop of
others/competitors complying
Loss of focus of top management from business goals
and objectives to answering all and sundry on why the
enterprise did not comply

CONSEQUENCES OF
NONCOMPLIANCE
Significant fines (both personal and organizational)
Personal legal liability and even incarceration for
extreme offenses
Litigation from shareholders and other parties
Limited access to capital markets and possible loss of
listing status on the stock markets.

CONSEQUENCES OF
NONCOMPLIANCE
Diminishing enterprise valuation and credit rating
Limited ability to do business in specific jurisdictions
Increased regulatory oversight
Possibility of exodus of directors from the company
board and consequent inability to attract new and
capable directors.

CONSEQUENCES OF
NONCOMPLIANCE
Inability to attract appropriate talents to carry
forward existing business and to diversify to newer
green field areas.
Inability to retain experience and talents within the
enterprise
The threat of one or more of these potential
consequences is usually sufficient to compel an
enterprise and its executives to manage compliance
effectively and proactively.

 Some men worship rank, some worship

heroes, some worship power, some
worship God, and over these ideals they
dispute and cannot unite ----- but they all
worship money
- Mark Twains Note book

CONSEQUENCES OF WILFUL NON

COMPLIANCE

THANK YOU

Mr. Joseph Hadrian Bosco

www.karamelknowledgeventures.com
josephbosco@gmail.com

Karamel Knowledge Ventures Pvt Ltd

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Financial Market Architecture

Joseph H Bosco
2105

Functions of Financial Markets

1.

Facilitate accumulation of capital and higher productivity, thus

promoting economic development.

2.

Allocate savings by way of investments in businesses and public

enterprises which create the optimal expected returns
(presumption of the risk averse investor).

3.

Provide price formation mechanisms and set benchmarks for value

in the economy.

4.

Promote efficiencies in businesses and public enterprise

(presumption of the rational manager who is aware of his cost of
capital).
2

Functions of Financial Markets

(contd.)
Thus, Financial Markets facilitate:
The raising of capital ( in the capital markets)
The transfer of risks ( in the derivatives markets)
(Various transformation services)
Price discovery
Global transactions with integration of financial markets
The transfer of liquidity

Markets and their products are used to match those who want capital to those who have
it.

Components of Financial Markets

1. Securities Market
a) Regulations
b) Organized trading platforms:
Equity markets
Derivatives
Equity
Commodities
Currencies
c) Bonds
d) Clearing Corporation
e) Depositories
f) Spot Markets
g) Capital Market services:
Investment Banking / Merchant banking
Portfolio Management
Custodial services
Fund houses

2. Banks

Banks and Markets

There is a great variety of financial systems across different
countries.
Most countries have both financial markets and banks but
the relative importance of these two differs.
At one extreme, countries like the United States have
market-based financial systems where financial markets
play an important role and banks are less significant.
At the other extreme, countries like Germany have bankbased systems where banks dominate credit allocation
and financial markets are not very important.

Markets and Banks

Both of them are concerned the most efficient way
to transfer capital from savers to investors.
Should the emphasis then be on markets or on
banks?
Financial system development positively affects
growth but there is there is no consensus on
whether the effect comes from banks or market
development

Does it really matter to the REAL SECTOR?

Markets and Banks historical

perspective
Why do different countries have such different financial systems?
Do their economies have different needs, resources, and technologies
that require different financial systems?
Are different financial systems performing different functions or do they
constitute different ways of doing the same thing? Can we say that one
system is better than another?
It is often suggested that the current trend is toward market-based
systems.

Why do different countries have such different

financial systems?
Do their economies have different needs,
resources, and technologies that require

Markets and Banks historical

perspective
As a matter of policy, France has deliberately chosen to
increase the importance of financial markets since the mid1980s.
Japan is undertaking a Big Bang reform of its financial
system to make it more efficient and enable the Tokyo
markets to complete with those in New York and London.
The European Union has moved toward a single European
market, which will increase competitiveness and exposure
to financial markets.

Markets and Banks historical

perspective
Historical origins of the bank-based financial systems in Germany and
Japan and the market-based financial system in the US. Can be
attributed to timing of industrialization (TOI).
Variation in the current structure of financial systems can be explained
by differences in the timing of the take-off phase of industrialization.
Regulations came in later on.
Differences in financial regimes dependent not only upon the narrow
issue of financial regulation but also on the nature of the regulation of
labour, including welfare regimes.

Markets and Banks historical

perspective
A crucial aspect of the industrialization process is the
development of an autonomous financial system, that is,
a set of specialized organizations and institutions dealing
with the transfer of payments and mediating the flow of savings
and investment.
While all industrial societies have such a specialized financial
system,
In bank-based systems, the bulk of financial assets and liabilities consist
of bank deposits and direct loans.
tradable in financial markets are the dominant form of financial asset.
Bank- based systems appear to have an advantage in terms of providing a long-term stable financial framework for companies.
re tradable in financial markets are the dominant form of financial asset. system,

that is, a set of specialized organizations and institutions dealing with the transfer of payments and mediating the flow of savings and investment.

Markets and Banks: distinction

In market-based systems, securities that are tradable in
financial markets are the dominant form of financial asset.
Bank- based systems appear to have an advantage in terms
of providing a long-term stable financial framework for
companies

Markets and Banks

A second key distinction is the degree to which the
state is involved in the allocation of credit.
State involvement in credit allocation can turn the
financial system into a powerful national resource
for overcoming market failure problems and
achieving collective economic and social goals.
However, financial targeting also runs the danger
of resource misallocation due to inadequate
reading of market trends or "clientelism"

Markets and Banks

A quantitative comparison of Japan, Germany, and the
United States in the mid-1990s along the first (banks versus
markets) dimension indicates a major distinction between
the first two countries on the one hand and the United
States on the other
The banking systems in Japan and Germany account for the
majority of financial-system assets (64 and 74 percent,
respectively),
whereas banks in the United States (with about one-quarter
of total financial-system assets)
And are only one of a multiple types of financial
institutions.

Markets and Banks

Over half of the combined assets of the non-financial sector
(assets of the financial, household, company, government,
and foreign sectors combined) in the United States are
securitized versus only 23 percent in Japan and 32 percent
in Germany.
Particularly striking is the relatively small proportion of
securitized company liabilities in Japan and Germany in
comparison with the United States
(15.4 % and 21.1% v/s 61.0 % in the US).

Markets and Banks

TOI theory draws on both the German and Japanese cases
to back up its claim that bank-based systems were necessary
for late industrializers to catch up with more developed
countries.
Germany is the premier example of a developmental bankbased system. In the second half of the nineteenth century,
particularly after 1870, joint-stock banks active in both
lending and underwriting activities were established.
These "mixed" banks enjoyed a close relationship with many
of their industrial customers.

Markets and Banks

In addition to getting the lion's share of financial services
business, these banks often held substantial stock in and
appointed directors to the supervisory boards of these
companies.
Banks played an essential role in the rapid industrialization
of Germany, not only through organizing large sums of
capital un-obtainable in nascent capital markets but also
through providing entrepreneurial guidance.

Markets and Banks

What explains these considerable differences in the financial
systems of the three countries?
TOI
In countries where this process started early like in the
United Kingdom, firms were able to finance new
investment gradually from internally generated funds or
from securities issues in relatively developed financial
markets.

Markets and Banks

Firms in countries in which industrialization started later,, faced a double
disadvantage relative to their advanced competitors in early
industrializing countries.
First, internally generated finance was inadequate or, non-existent
relative to the large sums needed for investments in "catch-up"
technologies and infrastructure.
Second, market finance was difficult to raise: securities markets were
underdeveloped and investors were more inclined to invest in safer
assets such as government bonds.
Thus, only banks could gather the large sums of capital required, take
the risks involved in such pioneering ventures, and adequately monitor
their investments.

Markets and Banks

Once established, bank-based systems have a strong survival
capacity. This interpretation of history provides support
for the recommendation that developing countries follow
the model of bank- based development.

Markets and Banks

The advantage of markets based financial system is that it
allow people with similar views to join together to
finance projects.
This will be optimal provided the costs necessary for each
investor to form an opinion before investment decisions
are made are sufficiently low.
Finance to a project can be provided by the market even
when there is great diversity of opinion among investors:
through Intermediation.

Markets and Banks

Intermediation in finance involves delegating the financing
decision to a manager or an agent who expends/ meets the
cost necessary to form an opinion.
This type of delegation turns out to be optimal when the
costs of forming an opinion are high and there is likely to be
considerable agreement in any case.
Most analysis suggest that market-based systems lead to
more innovation and economic growth than bank-based
systems.

Markets and Banks

Banks and Markets exhibit three types of interaction:

Competition,

Complementarity, and

Co-evolution.
A borrower chooses its financing source from the following :
I. direct capital market financing;
II. securitization in which the bank screens and certifies its
creditworthiness first and then obtains capital market financing;
and
III. a direct loan from the bank based on his relationship.

Financial Systems
A good financial system is the one in which the payment mechanism is:

Fast
Swift
Smooth and
Safe

Banks, with their numerous product offerings and Markets along with all
their associated arms like the Depository organizations, Clearing House,
Custodians, rating organisations.
AND
Appropriate Regulations, Rules and proper Market administration enable a
robust Payment Mechanism.

Securities Markets
A Securities Market is characterized by:

Appropriate legislation establishing a Regulator and empowering it.

Licensing stock and derivatives Exchanges, clearing corporations, Depositories, etc
Enabling appropriate Regulations , Rules, bye laws, directives etc on every facet of the
markets functions
Ensuring proper technology is used
Ensuring risk management systems are appropriate
Facilities to constantly collect data and constantly analyzing them.
Ensuring uninterrupted and regular flow of information to all categories of investors
without any bias.
Ensuring escalated supervision on errant participants and initiating action where
required.
Regularly update and upgrade the legal frame work.

Important : Investor protection, transparency and reduction of systemic risk.

Securities Markets
Financial Services Markets are deeply integrated
Regulations, Rules and guidelines in a Securities Market are subject to
stringent supervision and oversight.
All aimed at :
the protection of investors,
ensuring efficiency and transparency in the markets; and
the reduction of systemic risk

(IOSCO 1998)

Securities Markets
In the last two decades, fundamental changes have taken
place in the Securities Markets:
Advent of technology ( has the market been enslaved by IT)
Capability of harnessing information in the minutest form
Securities Market regulators progressively moving away from
merit based regimes to disclosure based regimes

Their Role : to insure that markets are given fully, timely

and accurate information.

Securities Markets
The conventional face of the Securities industry has changed :
traditional boundaries between banking, Securities and Insurance has
blurred.
loss of control or confusion among Supervisors products offered
slipping through cracks in the regulations.

Result :

failure of markets to meet the three core supervisory principles.

the protection of investors,

ensuring efficiency and transparency in the markets; and
the reduction of systemic risk (IOSCO 1998)
( reference : financial market debacle of 2008)

Leading to :
forceful acceptance that financial Markets are deeply integrated;
AND
strong suggestion towards a corresponding integrated regulatory approach.

1933 & 1999

Dismantling of Glass - Steagall Act ( 1933)
Introduction of Gramm- Leach Bliley Act
of 1999.

Major impact on the Financial world.

INTERACTION

Karamel Knowledge Ventures Pvt Ltd

Joseph Hadrian Bosco

Director
1

XLRI 2015

FINANCIAL SYSTEMS

Financial Systems

Specialised
Non specialised institutions
Organised
Unorganised financial markets
Financial instruments
Financial services which facilitate transfer of funds
Procedures
Practices
Inter-relationship

Financial system implies.

Set of complex and closely connected or
inter related
Institutions
Agents
Practices
Markets
Transactions
Claims &
Liabilities
4

Financial system is concerned about

Money - Medium of Exchange or means of
payment
Credit - Money taken to be returned i.e. a debt (with
interest)
Finance - Monetary resources comprising of debt and
ownership funds of a state/company/individuals

Business organisations
Financial systems are business organizations
which act as
mobilisers of savings
purveyors/suppliers of credit/ finance

Provide various financial services

Banking and Non Banking institutions

Banking and Non-Banking institution distinguished
by their character i.e.,
Banking companies participate in the economys
payment mechanism i.e. they provide transaction
services.

Their deposit liabilities constitute nations money supply

can advance credit by creating liabilities on themselves
subject to legal reserve requirements

Non Banking Companies

can lend only out of the money collected from the savers.
7

Banking And Non Banking System

Banking system
Commercial Banks
Co op Banks

Non Banking
Development Financial institutions like
IDBI/IFCI
LIC
UTI
8

Financial institutions
Financial institutions
Intermediaries (between savers & investors)
Non intermediaries

Financial System.
Include:
Centres that provide facilities to buy and sell financial
claims /services.
Organised or unorganised
Direct or through brokers/dealers who are on either
side of the demands & supply sides.
Interlinked
by
laws,
communication network.

contracts,

covenants,
10

Financial Markets
Money Markets
Capital Markets
What is the difference?
Essentially nil..
Conventionally - Yes

Money Markets
Capital Markets

Short term claims

large duration

Money markets e.g.: Treasury bills market, call money

market, commercial bill market etc.
Capital Markets e.g.: Stock Market, Govt. Bonds market etc

11

Financial markets
Organised and unorganised
Official and Parallel,
Formal and informal
Domestic and Foreign

12

Financial Assets and Securities:

Primary (Ultimate investors to ultimate savers)
Secondary (By intermediaries to ultimate servers)

13

Financial Systems
Financial
Institutions

Financial
Markets

Regulatory Intermed
iaries

NonIntermediaries

Others

Organised
Banking

Financial
Instruments
(Claims, Assets,
Securities)

Primary

Short Term

Capital
Markets

Secondary

Unorganised

Non-Banking

Primary

Financial
Services

Secondary

Money
Markets

Medium
Term

Long Term

Basis of Financial instruments difference

Interdependent and inter related investment
characteristics.
Liquidity
Marketability
reversibility
transferability
transaction cost
risk of default/income uncertainty
Maturity period
tax status
options movable (callback/buyback)
volatility in prices
15

Financial sector functions:

Perform different transformation services
a. Accept deposits (and issue claims to depositors)
b. lend money(a& b lead to liability -asset transformation)
c. applying economies of scale
lower transaction cost
lower risk on portfolio
d. create large lending baskets by clubbing smaller deposit
units i.e. size transformation
e. diversify and reduce risk for savers (eg: mutual funds): Risk
transformation
f. offer Savers alternative forms of deposits according to
liquidity preference
g. similarly to borrowers with loans of requisite maturities (f
& g known as maturity transformation)
16

Financial System
An effective Financial System is one where:
Transactions effected safely, swiftly, fast and on an
ongoing basis.
Create confidence amongst buyers and sellers that
instruments will be honored - i.e. efficient payment
mechanisms.

17

Functions of Financial Markets

Functions of Financial Markets
Enabling economic units to exercise the time preferences
Separation, distribution, diversification and reduction of risk.
Efficient operation of payment mechanism
Transmutation or transformation of financial claims to suit
preferences of savers and borrowers.
Enhancing liquidity of claims through securities trading.
Portfolio management.

18

 Equilibrium in financial markets:

Perfect Competition
Supply
demand
Perfect Market when
large numbers of savers and borrowers
All are rational
All well informed
Information is free
No transaction cost
Financial assets are infinitely divisible
Participants have homogenous expectations
No taxes
19

EFFECTS OF FINANCIAL SYSTEMS

Effects of Financial systems on savings and
investments
Crucial inputs in production activities
men, material and money

Money, credit and finance

lifeblood of economic system

Capital formation
is augmented by a good financial system
but timing , quantity and terms of finance are also crucial.
A good financial system should achieve these 3 requirements
20

Importance of financial systems

Importance of financial systems in economic
development.
Impact on savings and investment process
4 important theories
The classical prior savings theory
Credit creation/forced savings/inflationary
financing theory
Financial repression theory
Financial liberation theory.
21

CRITERIA TO EVALUATE FINANCIAL SECTOR

According to Richard Erb, former DyMD, IMF
Do institutions find the most productive investments
Do institutions revalue their assets and liabilities in response to
changed circumstances
Do investors and financial institutions expect to be bailed out of
mistakes and at what price
Do institutions facilitate the management of risk by making
available the means to insure, hedge and diversify risks
Do institutions effectively monitor the performances of their users
and discipline those not making proper and effectiveness of their
resources
How effective is the legal, regulatory, supervisory and judicial
structure in the country
Do financial institutions publish consistent and transparent
information
22

Above criteria do not cover social and ethical aspects of

finance : critical to evaluate performance of Financial
systems.

23

Relevant normative criteria, organising principles, and

value premises
..which should guide the functioning of the financial system are:
Finance is not the most critical factor in development
Financial reforms are not merely a question of credit limits,
they encompass issues involved in limits of credit.
State intervention is not the best way to achieve a faire
distribution of credit.
Financial institutions must evolve from below rather than be
imposed from above. Financial development ought to take place
at a slow and steady pace rather than in spurts and in
programmed or (time) encapsulated manner.
There should be replacement of large scale by small scale,
wholesale by retail and class by mass banking.

24

Relevant normative criteria, organising principles, and

value premises contd

The sufficing principle rather than the maximising one should

power the financial system. The functioning of different financial
institutions must be on the basis of a communitarian spirit, not
competition and profit motive alone.
The financing of investment which results in the displacement or
retrenchment of labour should be discouraged.
The scope for financing various sectors is ultimately constrained
by domestic saving. The substantial increases in the total saving
in India is now visible.
The working on the Indian financial systems should not be
corporate sector centric.

25

Relevant normative criteria, organising principles, and

value premises contd

The only legitimate role of financial markets is infrastructural:

hence they should not exist to provide opportunities to make
quick, disproportionate pecuniary gains.
It is the primary markets activity of supporting new,
economically and socially productive real investment, trade and
flows of goods and services which is of foremost importance. The
enthusiasm, hyperactivity and preoccupation with the secondary
markets ought to be secondary.

26

Mr. Joseph Hadrian Bosco

www.karamelknowledgeventures.com
josephbosco@gmail.com

JOSEPH HADRIAN BOSCO

DIRECTOR, Karamel Knowledge Ventures
XLRI 2015

COMPLIANCE

COMPLIANCE

Adhering to the requirements of laws, industry and

organizational standards and codes, principles of good
governance and accepted community and ethical
standards"

Is it really the role of Compliance to act as the

conscience of the organisation and police moral
standards that are not reflected in legal or regulatory
requirements?

YES

Especially so when there are a number of laws - such as

the obligation to "do all things necessary to ensure that
the financial services covered by the license are
provided:
efficiently,
honestly and fairly and
not to engage in misleading and deceptive conduct
that elevate standards of good behaviour into legal
requirements

COMPLIANCE IS THE ACT OF

FOLLOWING THE RULES
These rules are often external requirements and they
are many and varied.
Compliance also involves following the organizations:

Internal rules
Policies
Procedures
Acting in accordance with ethical practices.

BASEL COMMITTEE DEFINITION

OF COMPLIANCE:

An independent function that identifies, assesses,

advises on, monitors and reports on the banks
compliance risk, that is, the risk of legal or regulatory
sanctions, financial loss, or loss to reputation a bank
may suffer as a result of its failure to comply with all
applicable laws, regulations, codes of conduct and
standards of good practice.

BASEL COMMITTEE ON
COMPLIANCE
Compliance is an internal risk control function which
works closely with the in house legal function and which
is responsible for:
developing and administering systems and procedures
to comply with legal and regulatory requirements
assisting line personnel with day to day legal and
regulatory issues as they arise

COMPLIANCE MANAGEMENT
Compliance Management is the means by which
organizations can assure compliance in accordance
with the rules, regulations, laws, and other
requirements to which the organization is subject.
It involves oversight, assessment, reporting,
educating, and noting needs for remediation.
The element of assurance comes from reliable
evidence of compliance.

 Compliance is frequently misunderstood.

Focus is generally on the compliance mandates
related to Sarbanes-Oxley Act (SOx) requirements:
but organizations have learned that compliance
management is a complex responsibility requiring
measurement and reporting against a dynamic and
seemingly endless array of rules, agreements,
standards, regulations, and legislation.

10

 Each area of compliance comes with its own

requirements, and in many cases requires extensive
knowledge of esoteric technical subject matter and a
detailed data base for the elements of compliance
requirements, measurement, and reporting.
In many organizations, compliance management has
developed and remained as a series of siloseach
meets its own needs but they are not coordinated
across organizational levels.

11

 This tendency to silo often results in duplication of

planning effort, redundant reporting systems,
misplaced priorities and can waste the scarcest
resource in business : management attention.

12

An important distinction must be made between

Compliance Management and compliance itself
because there are two types of compliance activities:

Those done for

good business
reasons regardless
of regulations

Those done only

because of
regulations

13

 Many organizations only refer to activities required

by regulations as compliance,
but Compliance Management must encompass the
assessment, monitoring and control of activities in
BOTH categories

14

CULTURE OF COMPLIANCE

Best of breed organizations understand the

advantages of clearly defining,
communicating, measuring, and reporting
strategic objectives.

15

ATTRIBUTES OF A CULTURE OF
COMPLIANCE
A positive Culture of Compliance includes strategic
vision and relates to larger strategic goals.
It is:

Established by top management

Characterized by senior management example
Embedded in activities such as education
Reinforced by incentive systems

Given force through the treatment of transgressors

Integral to information systems and their use and management
Inseparable from the organizations structure, processes, and
management style

16

ATTRIBUTES OF A CULTURE OF
COMPLIANCE

Without a commitment to compliance,

even the best policies and
procedures will be useless

17

THE THREE Cs OF COMPLIANCE

Compliance has, as its basis, three essential and

continuous elements:
Communication
Confirmation
Correction

18

THE THREE Cs OF COMPLIANCE

The Three Cs of Compliance relate to internal
objectives and response to external requirements.
They establish the tone for how each individual
employee regards his or her role in compliance.
They allow compliance to be a benefit rather than a
burden.

19

THE THREE Cs OF COMPLIANCE

With communication, confirmation, and correction at
the center of the organizations compliance focus, it
can then radiate outward via compliance
management (policies, procedures, processes, systems,
and strategies) for all areas of compliance facing the
organization from the market, industry, and
regulations.

20

COMMUNICATION

Compliance communication begins at the top.

An organizations leaders establish its ethical tone

and state its values, then communicate these clearly
to all personnel, ensuring that constant reminders
are in place and are integral to such actions as
compensation, rewards, promotions, etc.

21

CONFIRMATION
Automated business systems will do what we tell
them to doright or wrong.
A commitment to compliance includes building checks
and balances into systems so they will reveal the
evidence if they have been told to do something
wrong.
Authorization and authentication controls specify who
is allowed to do what, and provide evidence of what
they did.
22

CONFIRMATION
The history of corporate scandals includes numerous
examples of individuals abusing their authority and
systems that did not maintain evidence or support
the reporting of such abuse.
Confirmation includes the process for escalating
notification for any significant event or exception to
the level of management responsible for ensuring its
appropriate resolution.

23

CORRECTION
Involves effective handling of incidents.
Must also include identifying and addressing the root
cause of each problem not merely the symptoms.

How foolish it would be to respond to hackers and

viruses only after they have been detected in your
systems.

24

CORRECTION
Also involves noting those changes in business
objectives, the market, the business environment,
technology, and the regulatory and compliance
environments that signal a need for corrective action
at the strategic, tactical and operational levels.

25

OLD PRACTICES !!

To quote a Wall Street observation:

Just because a certain way of doing things is second
nature to you, and appears to be standard operating
procedures on the Street, doesnt mean that its the
correct way of doing things.. And as you have
witnessed, when conflicts are exposed, the costs to the
enterprise are enormous in dollars, in reputation and in
investor confidence and trust.

26

Compliance : what does it bring in

Continuance in business is of paramount importance
Not exposing senior management to run around
lawyers and to regulatory hearings is a huge savings
in terms of their time that could be used to grow the
business.
Protecting the image and reputation of the enterprise
is the next important aspect of any business.
Expansion of business, profits and wealth creation
will automatically follow to the satisfaction of the
shareholders.
This will instill a sense of pride and belonging among
the employees and lower the employee attrition rate.
27

OBJECTIVES OF A COMPLIANCE
PROGRAM
The objectives of a compliance program in any enterprise
shall be to put in place the following:

Prevention
Detection
Resolution
Reconstruction and
Heightened Supervision

28

CONSEQUENCES OF
NONCOMPLIANCE
The consequences of noncompliance vary from one
regulatory jurisdiction or space to another, but they
surely include:
Loss of reputation, customer and business partner
trust
Loss of market share in the back drop of
others/competitors complying
Loss of focus of top management from business goals
and objectives to answering all and sundry on why the
enterprise did not comply
29

CONSEQUENCES OF
NONCOMPLIANCE
Significant fines (both personal and organizational)
Personal legal liability and even incarceration for
extreme offenses
Litigation from shareholders and other parties
Limited access to capital markets and possible loss of
listing status on the stock markets.

30

CONSEQUENCES OF
NONCOMPLIANCE
Diminishing enterprise valuation and credit rating
Limited ability to do business in specific jurisdictions
Increased regulatory oversight
Possibility of exodus of directors from the company
board and consequent inability to attract new and
capable directors.

31

CONSEQUENCES OF
NONCOMPLIANCE
Inability to attract appropriate talents to carry
forward existing business and to diversify to newer
green field areas.
Inability to retain experience and talents within the
enterprise
The threat of one or more of these potential
consequences is usually sufficient to compel an
enterprise and its executives to manage compliance
effectively and proactively.
32

 Some men worship rank, some worship

heroes, some worship power, some
worship God, and over these ideals they
dispute and cannot unite ----- but they all
worship money
- Mark Twains Note book

33

CONSEQUENCES OF WILFUL NON

COMPLIANCE

34

THANK YOU

Mr. Joseph Hadrian Bosco

www.karamelknowledgeventures.com
josephbosco@gmail.com

KARAMEL KNOWLEDGE VENTURES PVT LTD

Presented by
Joseph Hadrian Bosco
Director
1

SHARIA FINANCE
About three decades ago, the concept of Islamic finance
was considered wishful thinking;
Today, more than one thousand Islamic financial
institutions are operating worldwide;
Standards & Poor estimates the value of Sharia
investments as at 2011 to be around US$ 1.2 Trillion.

SHARIA FINANCE
Investing clientele not confined only to citizens of Muslim
countries, but are spread over Europe, the United States
of America and the Far East.
Muslims now have the opportunity to invest their
financial resources in accordance with the ethics and
philosophy of Islam.

SHARIA FINANCE
As the industry matures, Sharia - compliant instruments are
becoming specific asset classes in their own right.
Scores of new entrants signal the growing sophistication in
the market;

Paving the way for the coming of age of a truly global

Islamic finance industry.

Introduction to Islamic Law (Sharia`)

The Sharia that is Islamic Law is the code of conduct ordained by
Prophet Mohammed (PBUH) for his followers.
It is much wider in scope than the concept of law as understood in a
western context.
Every aspect of a Muslims life is subject to the lens of Sharia scrutiny.
The Sharia regards commercial activities as a part of ones religious
life.
That is why we find a large majority of the Muslims engaged in
business and commerce rather than employment.

Introduction to Islamic Law (Sharia`)

In Islam, doing legitimate business and earning a decent return is not
only highly encouraged but is also regarded as an act of worship.

However, the Sharia requires that the creation of wealth should not
be at the expense of moral standards, values and public interest.

CONTRACTS THE ESSENCE OF ALL FINANCIAL ACTIVITY

Introduction to Islamic Law (Sharia`)

Under Islam, proper governance of financial activities is a priority issue.
The longest verse in the Quaran (verse 2:282) discusses in detail matters
relating to debt and its documentation, witnessing the debt etc.
A prerequisite that all commercial contracts be conducted in a manner
compliant with the principles of Sharia.
Such financial governance is done through a division of the Sharia known as
Fiqh Muamalat ie, Islamic jurisprudence.
It lays down the types of contracts that are permissible or valid and those
that are not.

What is Islamic Finance?

Islamic finance aims to promote and develop the
application of Islamic principles, law and traditions to
transactions of financial banking and related business affairs
investment companies to be engaged in such business
activities that are acceptable and consistent within Sharia
precept.
Prohibition of RIBA is the central tenet of Islamic
finance.

RIBA
Riba (Interest) is any return/reward or compensation charged on a
loan contract as well as charged in rescheduling debts.
Riba literally means:
increase, addition, expansion or growth.
In Sharia, Riba technically refers to the premium that must be paid
on a financial transaction without any consideration.
It is the addition of premium paid to the lender in return for the
waiting period as a condition for the loan.
Riba has the same meaning and import as interest in accordance with
the consensus of all jurists and is haram or an act that is forbidden.
9

PROHIBITION OF RIBA
The prohibition of riba based on the arguments of:
social justice,
equality and
property rights.

Islam encourages the earning of profits but forbids the charging of interest
because:

Profits: determined ex-post, symbolize successful entrepreneurship and

creation of additional wealth
whereas :
interest: determined ex-ante,
is a cost that is accrued irrespective of the outcome of business
operations, and
may not create wealth if there are business losses.
10

PROHIBITION OF RIBA
Thus, charging interest on loans is considered unjust since money is
considered to be a simply an intermediary between goods.
To make money from money is forbidden:
wealth can only be generated through legitimate trade and
investment in assets.
Money must be used in a productive way.
The principal means of Islamic finance are based on trading and it is
essential that risk be involved in any trading activity.

11

PROHIBITION OF RIBA
Any gains relating to the trading are shared between the person
providing the capital and the person providing the expertise,
that borrowers and lenders share rewards as well as losses in an
equitable manner and
that the process of wealth accumulation and distribution in the
economy be fair and representative of true productivity.
Islamic finance also prohibits any transaction that involves excessive
uncertainty and speculation such as gambling: referred to as
Gharrar
12

Prohibitions
Includes Games of Chance: prize bonds/ lotteries, provisions of
inducements or incentives on the happening or non-happening of an
unknown event: all repugnant to injunctions of Islam.
The scope of uncertainty that transforms commercial gains into
unlawful Gharar is one of imminent concern to Sharia scholars;
Parties to a contract must have actual knowledge of the subject
matter of the contract and its implications to avoid uncertainty.
Any investment made must be in ethical sectors, i.e. Sharia approved
activities. In other words, profits cannot be made from prohibited
activities such as alcohol, production, gambling, pornography etc.

13

Islam and debt

Regards conventional debt as a recipe for exploitation;
Capitalism facilitates
monopolization of resources
greed : unbridled pursuit of wealth
Leaving masses to misfortune
money created out of nothing strengthening exploitation mechanism
widening gap between haves & have-nots

14

Islam and debt

Resultant economic scenario leading to:

human behaviour guided only by self-interest

no discipline in the creation of high-powered money, leading to
unjust and exploitative payment systems and illegitimate control over
the resources of weaker individuals and nations;
contradictory policies - leaving the crucial functions of providing
health. education and the basic needs of the masses to a market
characterized by forces like "self interest", liberalization and
deregulation, under the banner of alleviating poverty and increasing
literacy levels , etc. is clearly contradictory;

15

Islam and debt

no or dubious concern for human dignity and rights;
no care for the weak and the oppressed classes;
no concern for justice, fair play and equity;
the influential and the elite exploiting the weak- leading to a
phenomenal concentration of wealth together with large-scale
hunger and poverty ;
unhindered unethical practices like deceitful advertisements to allure
consumers . leading to hefty salary packages for the marketing
"experts" and leaving the real contributors to national and global
production and the consumers at the mercy of market forces.

16

Islam and debt

This grim situation not limited to the poor or the least developed
countries .
Inequity has become the hallmark and the most serious problem
facing mankind in all societies.
Masses in almost all emerging/developing, and industrialized
economies are facing the same fate.
Interest-based financial system is a major hurdle in achieving
distributive justice.
It is creating un-repayable debt situation - making a class of
people richer and leaving others poorer and oppressed.

17

Islam and debt

Islam views such excessive debt and its servicing are the striking
features of the interest-based mechanism
yesterday 's debt can be repaid by taking out more debt today.
not only stifling economic growth but also crippling the efforts
made by the World Bank, IMF and other donors to reduce
poverty in poor countries .
also distorts the payments systems, on account of which the
concern for just and fair incomes and earnings is being accorded
the least consideration.

18

Islam and debt

No one cares who is going to pay the debt: which future
generations and from where?
This kind of behaviour - avoiding the payment of currently owed
debt - is not acceptable under Islam.
In Islamic Sharia, debt liability is subject to strict accountability
on the Day of Judgement.

19

Islam and debt

The remarks of Keynes about harmony between private and
social interests aptly sum up the actual situation in the world and
lend support to the above view:
"The world is not so governed from above that private and
social interests always coincide . It is not so managed here
below that in practice they coincide . It is not a correct deduction
from the principles of economics that enlightened self-interest
always operates in the public interest. Nor is it true that selfinterest generally is enlightened: more often individuals acting
separately to promote their own ends are too ignorant or too
weak to attain even these.''

20

INSURANCE
Need of business and individuals to mitigate risks and losses
Lessen impact of catastrophes on lives and wealth.
Insurance is today critical aspect of any Financial system;
In 1970, conventional insurance considered to be against
tenets of Sharia due to involvement of Riba, Gharar and
gambling.

21

INSURANCE

Muslim societies generally avoid conventional Insurance on two grounds:

i. considered unnecessary: members of a Muslim society are required to help
each other, particularly victims of misfortune;
ii. Prohibitions linked to Riba, Gharar and gambling indicate non permissibility
of conventional insurance;
(the possibility of insurance companies being involved with forbidden business like
alcohol, pork, indecent entertainment and hotels with clubs that carry on prohibited
activities are yet another reason)

Evolution of Takaful

22

Takaful
In Islam the conventional INSURANCE is not permitted. In its place
another form of insurance titled Takaful is practiced:
a co-operative system of reimbursement or repayment in case of
loss, paid to people and companies concerned about hazards,
compensated out of a fund to which they agree to donate in
small regular contributions managed on behalf by a Takaful
operator,
defined as an Islamic insurance concept which is grounded in
Islamic muamalat (Islamic banking),
observing the rules and regulations of Islamic law.
this concept has been practiced in various forms since 622 AD.
Muslim jurists acknowledge the basis of shared responsibility and
laid the foundation of mutual insurance.
23

Takaful
In 1970s an alternative to conventional insurance was popularised as
due to the involvement of Riba, Gharar and gambling which was
inherent in the conventional concept.
Muslim societies are required to help each other, particularly victims of
any misfortune.
Many believe that there is no need to cover against death or losses
things will happen as destined by the will of God.

24

Takaful
Riba is involved both directly and indirectly:

an excess on one side of exchange between premium

and the sum insured involves Riba.

investment of funds in interest based business refers

to the indirect involvement of the policy holder

loss of premium in case of cancellation of life policy

Gharar refers to the uncertainty , price and rights and liabilities of
parties
One of the parties gains at the cost of the other.
The hope of chance profit or a gain motivates the taking of risk.. a
critical feature in a conventional insurance policy.
25

Takaful
Embodies elements of shared responsibility, common benefit and mutual
solidarity.
Every policy holder pays subscription to assist those among them who
needs assistance.
Concept of Tabarru (donation) is an important ingredient of the
contract.
A policy holder agrees to forgo a certain portion of his Takaful
contribution that he agrees to pay as his obligation to help his fellow
participants.

26

Valid Contract
Investing in interest (riba) based financial products are also not allowed.
In Islam there are four (4) conditions required to effect a valid contract:
i.

a price that is agreed mutually and not under duress;

ii.

between parties that are sane and have the legal capacity to
understand the implications of their actions;

iii. at the time of contracting, the subject matter of the contract

should be in existence and able to be delivered without
uncertainty or deception;
iv. must be suitable for transactions according to Sharia
27

Basic Contracts in Islamic Finance

Islamic markets offer various types of contracts to satisfy providers and

users of funds in variety of ways i.e.
sales,
trade financing and
investment
which serves as the basic building blocks for developing a wide array
of more complex financial instruments.

28

Islamic contracts
The major Islamic contracts are as follows:
Ijarah (Leasing) (al-Ajr meaning compensation, substitute,
consideration, return or counter value: hiring or renting to benefit
from its usufruct)
Ijarah is a popular contract in financing vehicles, machinery, equipment,
and aircraft. It is very similar to the conventional lease. Ijarah is
defined as a sale of a right to utilize the goods for a specific period.
A conventional lease is a contractual arrangement calling for the
lessee (user) to pay the lessor (owner) for use of an asset.
A lease agreement is a contract between two parties, the lessor and
the lessee. The lessor is the legal owner of the asset, the lessee obtains
the right to use the asset in return for rental payments.

29

Islamic contracts
Mudharaba (Trust Financing/Profit Sharing)
Mudharaba is a form of partnership in which one partner provides
the capital required for funding a project (Rabul-amal), while the
other party (known as a Mudarib), manages the investment using his
expertise.
Similar to a partnership, but does not require a company/entity to be
created, so long as the profits can be determined separately.
Profits arising from the investments are distributed according to a
fixed, pre-determined ratio.
The loss is carried by the capital-provider unless it was due to the
negligence, misconduct or violation of the conditions pre-agreed
upon by the Mudarib.
30

Islamic contracts
Musharaka (Partnership Financing)
A Musharaka contract is very similar to the conventional sense of a
partnership arrangement where each party contributes capital in their
specific capacity and each partner has management rights in
proportion of their investment.
However, the share of profit for each partner is determined as a
proportion of the final total profit rather than a ratio of capital
invested ie, , profits are shared between partners on a pre-agreed
ratio.
In the event of a loss, each partner is obliged to lose only the
amount invested in the project.

31

Islamic contracts
Murabahah (Cost-plus Financing)
Murabahah is the most popular form of Islamic financing techniques.
Within Murabahah contract, the Bank agrees to fund the purchase of
a given asset or goods from a third party at the request of its client,
and then resell the assets or goods to its client with a mark-up profit.
The client purchases the goods either against immediate payment or
for a deferred payment.
This financing technique is sometimes considered to be akin to
conventional, interest-based finance. However, in practice, the markup profit is quite different in many respects.
32

Islamic contracts
Istisna (Commissioned manufacturing/ order to manufacture)
Istisna is a new concept in modern Islamic finance that offers a
number of future structuring possibilities for trading and financing. In
this contract one party buys the goods and the other party
undertakes to manufacture the goods, according to agreed
specifications : sale of a commodity before it come into existence.
It is a contract where the buyer of an item funds upfront the
production of goods.

33

Islamic contracts
Salam (Advanced Purchase) / Bai us Salam
The concept of Salam refers to a sale whereby the Seller undertakes
to supply a specific commodity to the Buyer at a future date in return
for an advanced price, paid in full on the spot.
Hence, the price is cash but the supply of the purchased goods is
deferred.
It is also defined as forward purchase of specified goods for full
forward payment.
The attraction for the Buyer of Salam contract is that the advance
payment is usually less than the amount that would have to be paid
if the Buyer deferred his purchase and bought the same commodity
spot in one or three months time.
34

Islamic Banking
Conventional banks deal in Money:
receive deposits from the public and pay them interest
extend advances/ credit to needy people/ firms in the form of
money and charge them interest
goods may be a subject matter but banks have no concern with
the goods or assets.
Main concern : financing the purchase of the goods , may also
deal with documents to facilitate trading of goods.
Hence, the old quote : Banks deal with documents and money

not in goods

35

Islamic Banking
On the other hand, Islamic banks:
deal in goods and documents and not in MONEY
money is used only as a medium of exchange to purchase goods to
be leased out or selling onward
earn income or profit (and not interest)
may use documents for executing sale and lease contracts
money itself has no intrinsic value.
The economic implication is that money is considered as a medium
of exchange effectively created to be sought not in itself but for other
commodities.
36

Islamic Banking
Thus, Islamic banks
intermediate between savers/ investors and users of funds
involving certain goods and assets or documents representing
ownership of assets
in Salam or Murabaha, banks deal in certain commodities and not
money. Banks take on ownership of such assets and the risks as well.
In Istisna, the manufacturers manufacture the asset and deliver them
(along with the risks) to the bank or in terms of their direction.
37

Islamic Banking
Sells them at cost-plus just like a trader and transfers risk to the client
In Salam, banks receive the goods for which they have effected
prepayments: risk of the goods as well as the price is therefore
transferred to the Bank. (there can be a back to back deal with a
third party)
In Ijarah, banks have to deal with the physical assets: purchase the
assets for lease to the Client : ownership and all risk of the assets is
that of the Bank.
In Musharakha and Mudarabha
based investments the Banks
earnings depend on the result of economic activity undertaken by the
client: they share the profits as earlier agreed to.
38

Islamic Banking
Islamic Banks may provide other services against Service Charges or
Management fees: cannot receive any fee on lending activities as cost of
Funds.
Any penalty charged in case of default by clients in meeting their
obligations will not be credited to the banks P&L sharing statements..
placed for charity.

39

Sharia Certification : Fatwa

Shariah advice on structures of Islamic financial products and on

compliance of such products with the Islamic law are a necessary
pre-requisite and a regulatory requirement for financial
institutions in many jurisdictions;
Financial Fatwas play an integral part in the development of
Islamic financial products;
without an explicit endorsement from a Shariah viewpoint such
products cannot be successfully marketed and represented as
being Sharia compliant.

40

Sharia Certification : Fatwa

A Fatwa is a religious opinion by a qualified Sharia scholar on :

structure of an Islamic financial product, like a mortgage, lease

etc;
the conduct of the issuers management, like a fund manager;
operative parts of the product;
presence or absence of prohibited aspects of Islamic finance and
other characteristics and
operations of an Islamic financial institution, like an Islamic
bank;

determining their compliance or otherwise with the Islamic law.

41

Sharia Certification : Fatwa

Every financial product stated to be Sharia Compliant needs to

be certified as Sharia Compliant;
Certification is compulsory in every jurisdiction;
Certification is issued by scholars or jurists who are themselves
accredited as Sharia Scholars;
Fatwa, if issued by an individual scholar or jurist, is non-binding
and therefore, its utility is rather limited in this sense. (unless
the market regulations agree for a single Scholar)
However, if a collective body of scholars issues a Fatwa under an
enforcement regime, like a government, Market or another such
authority, it could be made binding on the market participants.
Consequently, Shariah costs are included in the transaction costs
associated with Islamic financial products.
42

PARITES TO AN ISLAMIC PRODUCT

Lead arranger
Lawyers
Originator
Issuer (SPV)/ Trustee
Scholars for certification
Primary investors
Service provider(s)
Secondary investors
Credit enhancers
Rating agency
Auditors
Regulators
43

International Islamic Institutions

Accounting and Auditing Organization for Islamic

Financial Institutions (AAOIFI) - established in 1991
The need to develop accounting standards that adequately and
appropriately reflect the nature of Islamic financial transactions
was an important step to enhance the reliability, consistency and
clarity of financial reporting by Islamic financial institutions
which would also enhance investor confidence in Islamic finance.
Sharia compliant transactions may not have parallels in
conventional financing and therefore, there may be significant
accounting implications.

44

AAOIFI

The objective of the organization is to:

- prepare and develop:
- accounting, auditing, governance and ethical standards
- relating to the activities of Islamic financial institutions,
- taking into consideration international standards and practices and
- the need to comply with Sharia rules.
- make efforts to harmonize concepts and application among the different
Sharia Supervisory Boards of Islamic financial institutions in different
jurisdictions
- through the preparation, issuance and interpretations of Sharia standards for
Istisna ,Musharakah, Mudharaba, Salam, Ijarah and Murabaha.

45

Liquidity Management Centre (LMC)

As Islamic financial transactions increasingly become global in

nature,:
concerns over the sufficiency of supply of appropriate
instruments to address the global liquidity management needs of
Islamic financial institutions.
LMC was established in Bahrain to facilitate the creation of an
Islamic interbank money market that would enable Islamic
financial institutions to manage their liquidity effectively.
LMC plays an important part in creating the International
Islamic Financial Market (IIFM).

46

Liquidity Management Centre (LMC)

facilitates the pooling of assets acquired from governments,

financial institutions and corporations which will be securitized
through the issuance of tradable instruments or sukuks for
Islamic financial services institutions to invest their surplus
liquidity.
by creating a secondary market for the trading of these
instruments, the LMC provides competitive returns on shortterm, liquidity investment opportunities for Islamic financial
services institutions.

47

International Islamic Financial Market (IIFM)

Established in Nov 2001 to facilitate:

the establishment of cooperative framework among the existing

over 265 Islamic banks and other financial institutions
worldwide to encourage product development and the trading of
Sharia compliant products in the secondary market.

enhancing cross-border acceptance of Islamic financial products,

to provide independent Sharia advice and guidelines for the

issuance of new Islamic financial products.

48

Islamic Financial Service Board (IFSB)

is based in Kuala Lumpur

serves as an international standard setting body of regulatory
and supervisory agencies to ensuring the soundness and stability
of the Islamic financial services industry, which include banking,
capital market and insurance;
promote the development of a prudent and transparent Islamic
financial services industry by introducing new or adapting
existing international standards consistent with Sharia
principles, and recommend them for adoption.
Its work complements that of the Basel Committee on Banking
Supervision (BCBS), International Organization of Securities
Commissions (IOSCO) and the International Association of
Insurance Supervisors (IAS).
49

International Islamic Rating Agency (IIRA)

Established in Bahrain (October 2002) to:
rate, evaluate and provide independent assessments and
opinions on the likelihood of any future loss by Islamic financial
institutions as well as their products and services.
assess the Sharia compliance aspects of Islamic financial
institutions and Islamic financial products.
introduce a set of rating products and services, including Sharia
transparency, for both financial products and their issuers.

50

Mr. Joseph Hadrian Bosco

www.karamelknowledgeventures.com
josephbosco@gmail.com

JOSEPH HADRIAN BOSCO

DIRECTOR, Karamel Knowledge Ventures
XLRI 2015

SECURITISATION OF
FINANCIAL ASSETS

Securitization
Securitization istheprocessofpoolingvarioustypesofcontractualdebtsuch
as
residentialmortgages,
commercialmortgages,
autoloans,or
creditcarddebtobligations,
timeshare
aircraftandboatloansandleases
studentloans
airlinetickets,
telecommunicationsreceivables,
tollroadreceiptsand
sellingthesaidconsolidateddebtaspay/passthroughsecurities,or
collateralizedmortgageobligation(CMOs)tovariousinvestors.
3

Virtuallyallformsofdebtobligationsandreceivablescanbe
securitized

Althoughthebasicconcepts,manybasedupontaxand
accountingeffectsanddesiredresults,areessentiallythe
same:
eachassetclasspresentsuniquestructuringconsiderations,
and
theplayersareconstantlylookingforwaystoimprove
structurestoachievehigherratings(andthuslowercosts)and
reducedexpenses.
SecuritizationsoutsidetheU.S.havebeenmorelimitedbecause
ofcertainlegalimpediments
5

SECURITISATION OF FINANCIAL ASSETS

Why Securitisation:
1.
2.
3.

A convenient mechanism to suit changing needs of

borrowers and lenders
Matches supply of funds with demand demands for funds
through floating negotiable securities
Shifts the source of repayment from earning to a pool of
assets

SECURITISATION OF FINANCIAL ASSETS

GenesisandGrowth:
1. Severe financial crisis faced by certain states in US during
1969-70
2. Federal government restriction on inter-state lending and
borrowing
3. Raised funds from surplus states by issuing instruments
backed by mortgaged properties

ElementsofSecuritisation:
1.
2.

Conversion of existing illiquid assets like loans, advances

and receivables into tradable security
Reconverting them into fresh assets through capital market
operations

BenefitsofSecuritisation:
1.
2.
3.

Separates the credit risk of the assets from the credit risk of
the Originator
Lower the cost of borrowing for Originator as the security is
independent of the rating of the corporate securitising these
assets
Illiquid assets converted into marketable securities and thus
provide alternate funding source

Benefits of Securitisation : (contd)

4.
5.
6.
7.

Remove assets from balance sheet and thus improve capital

adequacy
Operations in a particular portfolio of assets can be
increased without increasing total exposure
Creates a highly diversified portfolio in terms of assets and
geography.
Dependability of cash flows from the assets as signified by
the ageing of the portfolio

10

The Players and their Role:

1.
2.

Originator: An entity making loans to borrowers or having

receivables from customers
Special Purpose Vehicle: The entity which buys assets from
Originator and packages them into security for further sale
a.
b.

3.

Bankruptcy remote
Separates the risk of assets from the credit risk of the seller

Credit Enhancer: To reduce the overall credit risk of a

security issue by providing senior subordinate structure,
over-collateralization or a cash collateral

11

The Players and their Role: (contd)

4.
5.

Credit Rating Agency: To provide value addition to security

Insurance Company / Underwriters: To provide cover
against redemption risk to investor and / or undersubscription
6. Custodians
7. Depositories
8. Brokers
9. Banks
10. Investor: The party to whom securities are sold
12

Requirements for Eligible Collaterals:

Assets to be securitised to be homogeneous in terms of:
1.
2.
3.

Underlying assets
Maturity period
Cash flow profile

13

Eligible Collaterals:
1.
2.
3.
4.
5.
6.

Housing finance
Term loan finance
Car loan
Credit card receivables
Export credit
Any other eligible asset

14

Structure of Securitisation:

1. Pass Through Certificates:

Sale of asset to SPV
Investors purchase interest in the assets of SPV
Cash flow (interest and principal) passed through
as and when occurred without any reinvestment
or reconfiguration
Payments made are most often on monthly basis
Reinvestment risk carried by investor
15

Structure of Securitisation:
2. PayThroughCertificates:

SaleofassetstoSPV
SPVissuesadebtsecuritycollateralizedbyassetcash
flows
Cashflows(interestandprincipal)reconfiguredtosuit
therequirementsoftheinvestorsi.e.basedonthe
maturityperiodofthesecurity
ReinvestmentriskcarriedbySPV
Eachtrenchisredeemedoneatatime
Paymentswouldbeatdifferenttimeintervalsthanthe
flowsfromtheunderlyingassets
16

Instruments:
Depending on the structure of securitisation, the
instrument would be Pay/pass-through certificate (PTC),
a promissory note, a bond or debenture.
1.
2.

The PTC passes the cash flows from borrowers in the same
form to investors. (However, in a pass through certificate
negotiability is restricted)
Promissory note / bonds / debentures make available
different tenor maturities and yield to different investors

17