The relationship between a customer and banker is that of debtor and creditor which is contractual in nature. The contract law is applicable and affects the circumstantial and business relationship between the two. Banker honors the cheques drawn by the customer on his account. Cheque is a bill of exchange by definition and function, therefore the law of negotiable instrument is applicable. Banker provides the service of lockers, safe deposit, and safe custody where the relationship is defined by contract law as “Bailor” and “Bailee”. 

Banker accepts money for the purpose of lending and investment. To create a charge and legally receive the right and interest in property and collateral securities, all the above laws are applicable and followed while executing documentation. The banker takes on the role of Pawnee or Mortgagee and the customer becomes “Pawner” or “Mortgagor”. The rights and obligations under these contractual are defined and interpreted under these laws. The following laws and Acts may be applicable in the banking business on case to case and the nature of the relationship between banker and customer. 

• Contract law
• Anti Money Laundering Law and FATF recommendations
• Bank Secrecy Act
• Negotiable Instrument Act
• Banking Law
• Company Law
• Partnership Act
• Trust Act
• Mercantile law
• Evidence Law
• Limitation Law
• Advances Recovery Law

1.      Maintain foreign currency accounts 

Foreign Exchange has become the lifeblood of any economy. Countries have liberalized their economy for the free transfer of capital, foreign investment, and foreign trade.  Banks have been allowed to maintain foreign currency accounts in major currencies viz, US Dollars, Pounds Sterling, EURO, and Japanese Yen. Foreign exchange is surrendered to Central Bank for accounting towards exchange reserves and local currencies are paid in exchange. However, the account holders are paid in any currency (subject to local laws) of their choice applying the subject exchange rates. Deposits may be accepted in Current and Savings accounts, Fixed Deposits of 3, 6, 12, 24, and 36 months maturities.

Accounts are free from all foreign exchange restrictions (subject to local laws) and balances in the accounts and income therefrom are exempt from the levy of Wealth Tax, Income Tax and any compulsory deductions with the purpose to encourage foreign exchange reserves. Clearing facilities for transfer among accounts and banks is provided by the central bank.

Loan Amount 

The credit Officer/ BDO must be competent enough to identify the genuine need of the business/ borrower. He is conversant with the kind of business and borrower. The credit officer has already sufficient research in the industry and market intelligence that he can ascertain the need of the borrower. Excess/ less credit amount than the actual requirement is fraught with the risk of misuse and /or default. 

Loan Securities 

Loan security is no less important than any other factor in the processing of a credit proposal. This is the source of repayment in case of a normal course of default and a deterrent to willful default on the part of the borrower. The security may be evaluated on the following test/ grounds; 

1. Liquidity
2. Securities offered are marketable and there is an active market available.
3. The securities are transferable by ownership.
4. The securities are durable in nature and not obsolete or out of fashion.
5. The securities are free of any prior charge.
6. Controllability
7. Creation of charges in favor of the bank

The credit officer of the bank should discuss and identify the genuine need of the borrower. The period of the loan as to whether it is for working capital, asset purchase, or debt refinancing. The amount required, and the benefit of the fund to the business. The credit officer should understand the business segment in which the loan amount would be deployed and the resultant increase in cash flow/income from the use of funds. The credit officer should discuss with the borrower about the amount of contribution that would be made to the business by additional assets that would be purchased and deployed and its contribution towards repayment of the loan amount. The purpose should be in line with the Bank's policy of preference if any, diversification motive and comply with the directives of the central bank. It should align with the economic policy of the state i.e. Employment, the promotion of economic activities in a particular sector or geographic area of the state, province, or district.

Credit policy should spell out the techniques of analysis used in the process of credit proposal. It is important to understand the borrower his business and performance. The fundamental point in avoiding default is the risk to know the applicant. It is generally said that seeds of fraud are sown at the time of opening an account. This aphorism can also hold good in credit that seeds of bad loans are sown at the time of allowing credit. A normal bad loan can be cured but there may be no remedy for abinitio bad selection of borrowers. It does not just know the name and address but besides the bio-data of the borrower, the bank should know the personal character, business character, dealings, reputation in the market, meeting his obligation, credibility, honesty, and trustworthiness. The second point is capital which refers to the ability to pay, his credit worthiness, resources, and wealth. The third point is capacity which means the management efficiency, legal status, and sustainability of the business. The fourth point is the collateral which is the fallback available to the bank in case a loan is approved. That collateral offered is marketable, stable in price, transferable, and free of any prior charge or encumbrance. The fifth point in the process of analysis is the conditions in which the business operates. Conditions also refer to the environment, the industry, the market for the product/ services, the production process, distribution and marketing, the business cycle, market demand, and market acceptability/ response to the business of the applicant. It may be summarized as;

1. Identify the strong points about the business of the borrower.
2. Ascertain the weaknesses in the business of the borrower.
3. Identify the success factors in the business of the borrower.
4. Market reputation and creditworthiness of the borrower.
5. Business health and growth prospect of the business of the borrower.

Loan repayment is the primary concern of a bank. As bank asset creation is backed by purchased debt of the deposit of depositors, therefore payback is important for the bank for income, reputation, and sustainability. To identify the repayment sources and capacity of the borrower, the credit department of the bank should use techniques of analysis of the business of the borrower. These techniques include; 

1.    Measure the ability of the borrower to pay i.e. financial statement analysis; three basic statements that tell the story as to how the business is performing financially. The balance sheet shows the company's financial position at a given point in time. An income Statement or Profit and loss indicates how much profit the company earned during a period of time. The cash flow statement tells how cash is generated during the period and where it has been used (cash inflow and cash outflow).

a.  Liquidity through; through Current ratio, Acid test Ratio, Working capital ratio.

Current Ratio = Current Assets divided by Current liabilities; this ratio indicates how sound the company is. How much dollar is available to pay each dollar of liability? The higher the ratio the better it is but not always and not everywhere.

Acid Test/ Quick Ratio= current assets less inventory divided by current liabilities; again this ratio indicates the health of the company in its most liquid state.

b.  Profitability Ratios; Gross Profit margin = Gross profit divided by net sales; It indicates much each dollar of revenue is gross profit. What %age of profit is included in revenues.

Operating Profit Margin= EBIT divided by sales; it indicates % age of operating expense in revenues.

c.   Efficiency Ratios;

ROE = Net income divided by paid-up capital plus reserves indicates the income rate earned on owner's investment.

ROCE = Net income divided by capital plus long-term debt showing how effectively the capital is being used.

ROA = Net income divided by total assets will indicate how well the investment has been made.

d.  Leverage Ratios; Interest coverage, Debt to Equity, and debt to total equity. 

Ratios alone do not give any meaningful results and guidance unless there is a benchmark for comparison. The result should be compared with industry standards or other companies of the same nature. 

2.       Repayment is ensured by;

a.   Cash flow; using techniques to ascertain the cash inflow and outflow of the borrower and identify the cushion for loan repayment.

b.  Asset conversion; Borrower balance sheet contains assets that can easily without loss be converted into cash to arrange for repayment.

c.  Refinancing from other banks/sources; Borrower has the ability to arrange finance from other banks for refinancing the loan or transferring the loan to other banks.

A major portion of the bank’s fund is employed by way of loans and advances.  lending thus constitutes the main banking business. The business of lending nevertheless is not without certain inherent risks. Largely depending on the borrowed funds, a Banker cannot afford to take undue risks in lending. While so operating a Banker follows certain policy and conduct his business based on well-known principles of sound lending to minimize the risks. In doing so the banker hedges his risk with security and follows the following principles 

• Ideal Security
• Adequate margin
• Proper charge on securities offered
• Proper documentation 

Security has been defined as an encumbrance vested in the creditor over the property of his debtor for securing the recovery of the debt. Anything offered as security to the creditor normally never changes its ownership. It remains in the ownership of the debtor unless some event happens to deprive him of it. An owner of a property offers security as all the legal rights of ownership of that security. When a property is offered as security the debtor transfers certain rights and interests out of his absolute ownership to the creditor. This may include any of the following; 

• Property interest
• Possession
• Neither possession nor ownership but a charge or claim on the property. 

To avail the benefit of ideal security and recourse to law, the bank ensures perfect documentation. Executing any loan involves perfecting the bank security interest in the collateral. A security interest is a legal claim on a property that secures payment on debt or performance of an obligation. Bank interest is said to be perfected where the bank's claim is superior to that of other creditors and borrowers. Documentation means the process of acquiring rights/interests through documents.  It also provides evidence or proof of contract, covenants, rights, and interest. In banks, documentation forms conclusive proof of dealing with the debtor and terms and conditions agreed to by the debtor and creditor. Correct and proper documentation is the most essential factor that enables the banker to avail the benefits of Ideal security accepted by him and the charge created thereon according to the law of the land. Documentation forms a permanent record of the rights and obligations among the parties i.e. the bank, the borrower, and the guarantor if any.  In case of the borrower’s death or the death of the guarantor or co-obligate if any, their legal heirs and successors hold the assets left by him, subject to any charge or liability that they may have created thereon. Nothing is better proof in this regard than the documents that the deceased had executed. it is therefore not only desirable but also essential that the bank officials should be fully conversant with the law and practice on the subject. If at any time the filing of a lawsuit against the borrower and the guarantor becomes necessary, the court may not pass a decree if the documents are defective or fractious and Bank may lose the case. 

Selection of proper document 

The terms and conditions of the advance and covenants between the borrower and the bank are contained in the documents. Each term and condition agreed upon must therefore be clearly defined and unambiguous. The documents must be drafted in a technical language commonly adopted for the purpose. Many technical terms have specific judicial interpretations and the Bank treads on safe ground while using such terms instead of its own which might be interpreted in a sense different from what was intended. Bank may have developed a variety of standard forms and agreements for documentation purposes. 

Authority

The executants of documents must be competent to contract as per law.  A minor, a lunatic, or an insolvent has no contractual capacity. A company cannot transgress or overstep the powers which it may have under its memorandum of association. All acts done by the company beyond its powers would be ultra-virus and the company is not legally binding. In case documents are executed by an attorney on behalf of his principal, the original power of attorney needs to the examined to ensure that it has been properly executed and that it confers the requisite powers on the attorney to execute the documents and bind the principal. The powers to execute the document may not be accompanied by the powers to borrow or pledge securities. Such power should be specifically contained in the power of attorney. In the case of companies, a resolution authorizing the directors to borrow and authorizing them to executive documents are two separate things as borrowing may not include the execution of documents. The documents executed by the companies must bear the official seal of the company.  In the case of firms document must be signed by all partners and also in their individual/personal capacity. 

Stamp duty 

After having decided on the documents which have to be executed by the borrower, the bank should ensure that they bear the correct stamps where applicable. in case of doubt in Bank legal advisor/counsel should be consulted. An instrument not duly stamped will be inadmissible as evidence. It must be remembered that an unstamped or insufficiently stamped is an invalid document abinitio and cannot be admitted as evidence even on payment of duty and penalty. A lawsuit based on such documents will therefore fail in law. 

Covenants and contents of documents 

The contents of the documents must contain the correct particulars of parties, proper recitals, a detailed description of security, if any, to be charged the consideration, amounts, terms of repayment, and positive and negative covenants. 

Witnessing 

Some documents are required to be compulsorily witnessed others do not. A mortgage deed,  a gift deed, and a sales deed of immovable property or a will are required to be attested by two witnesses. Attestation must follow execution, and not precedes it. 

Registration 

Under the law some documents are required to be registered other do not. Documents that require registration must be got registered to make documents enforceable and conclusive proof of perfection.

These loans are generally availed by builders of a residential and commercial buildings. These loans can be of two types; 

1.  Bridge finance of stop-gap loan; In this category of loans the builder while negotiating a long-term loan with a bank or a group of banks, request a loan for the intervening period from a bank which is usually of short-term/temporary nature. When the long-term loan is approved this short-term loan is adjusted with the proceeds of the long-term loan.

2.  It may be a long-term loan from a bank requested by the builder against the pledge of land and collection of proceeds of the sale of units.

Review of loans is an important function of credit management that saves the bank from the risk of default. The review involves monitoring the current loans and taking care of bad loans. Banks may segregate the duties. One is the monitoring of the current loan by reviewing the documentation, perfection of charge on securities, pricing of the loan, and covenants of agreement that are being complied with. The business of the borrower is performing as per expectation and the return and principal is being paid regularly. No early warning signs have been noted. The business is a going concern and meets its obligations.  Bank may create a separate division for tackling bad/ problem loans. It is termed as Special Asset Management Division (SAM). The loan usually turns out to be bad due to poor selection of risk, improper loan structuring, incomplete credit information, technical incompetency, over-lending, emphasis on income, and unforeseen changes in economic conditions. Experts in this division are different in approach to the borrower while negotiating rescheduling, call-off, Asset/ security liquidation, or recommending a legal course for recovery.  SAM may suggest the borrower for infusion of capital, and renegotiate the terms of credit. Bank may let the borrower gain time to reinvigorate his business and pay the loan amount. rescheduling.

Countries with agricultural land in particular and those with little agricultural land, in general, are supported by bank credits. Owners, Farmers, and contractors need funds for production, farm development, and working capital for non-farm sectors. Farmers need seeds, pesticides, and fertilizers. Credit is needed for farm development like Tractors, tube wells, Stores and cold storages, land improvement, irrigation supplements, waterways, canal lining, etc. Working capital for a nonfarm sector like Livestock, poultry farming, dairy farming, fisheries, honey bees, forestry, etc. Finance for nonfarm development is required in the field of milk storage and processing, livestock clinics, laboratories, Sericulture and delivery vans, etc. 

Period 

1. Seasonal until harvesting of crop
2. Short-term up to three years
3. Long-term up to seven years 

Securities 

1. Stock and produce
2. Marketable securities
3. Gold ornaments and bullion
4. Farm machinery/ residential property
5. Land

Consumer loan as the term connotes is for the final use. A consumer loan is extended for the purpose of the purchase of durable household goods. Since consumer loan entails consumption however these may be obtained by the borrower for meeting the need for medical care, education, and other expenses of domestic chores. The consumer may also be extended as bridge finance in case of a mortgage.  These loans carry fixed interest rates. Banks are exposed to interest rate risk during the rising interest trend in the market. Therefore banks usually charge a higher rate as compared to rates charged on another form of lending. These loans are categorized into installment (bullet payment) or non-installment (balloon Payment). Consumer loans are generally availed by fixed-income individuals. The repayment schedule, amount, and period is negotiated with the borrower. Over the years consumer loans have become very attractive and banks are competing for achieving a good market share in this area of credit. Almost every bank has a credit card facility which has become a lucrative source of consumer financing and built a vast clientele base.

 Period

Consumer loans are extended from a period of one year to 7 years.

 Securities 

1. Lien on salary for deduction of installment amount regularly.
2. Personal Guarantee
3. Lien on Asset financed 

Repayment 

It may be a regular monthly installment plan, non-installment, or credit card rollover plan.

Commercial loans constitute a big chunk of the loan portfolio. Banks compete for a commercial loans in the industry. These loans are extended to commercial enterprises for meeting their need for working capital, expansion of the business, business modernization, and renovation. Banks extend large amounts of credit to manufacturing companies, brokers, farmers, security dealers, service industries, and other financial institutions.  

 Period of the loan

The borrower determines the period and amount of loan required. Banks match credit terms with the borrower's specific needs. It is extended for a period of one year to three years and may be short-term or medium-term. 

Securities

1.  Marketable Securities
2. Certificate of deposits
3. Trade Receivables
4. Paid-up Shares
5. Plant and Machinery
6. Immovable  properties 

Repayment 

As per the contract, the repayment may be a bullet or balloon. However it is negotiated between the bank and borrower and keeping in view the cash flow of the project, the repayment period can be mutually agreed. It may be a checking account like an overdraft and the return is charged only on the outstanding balance or it may be a quarterly, half-yearly schedule of installments.

 Creation of Charge over securities;  Charge shall depend on the nature of the security being obtained. 

1. Marketable Securities; these can be discharged in favor of the bank.
2. Certificate of deposits; these can be discharged in favor of the bank.
3. Trade Receivables; These can be pledged by registering with the Security Exchange Commission or such other institution.
4. Paid-up Shares; By transfer letter in favor of the bank and registered with the CDC in favor of the bank or any other arrangement of registration of charge as per law in vogue.
5. Plant and Machinery; Charge is created by registering with Security and Exchange Commission or such other institution.
6. Immovable properties; such security is mortgaged with the bank in a form mutually agreed.

Performance evaluation or measurement is to measure how well an entity is doing in relation to its strategic objectives. An entity may be manufacturing and producing tangible goods or a service entity providing services. Banking is a service industry that sells its services to its customers. Performance evaluation of a service industry is comparatively challenging as compared to manufacturing concerns. In manufacturing concerns value analysis, marketing, target market, and pricing strategies lead to product quality and sales improvement, but in the case of the services industry the service provided by the bank is perishable, services cannot be owned, it cannot be transferred and it cannot be measured and stored. Therefore performance evaluation of a service industry is necessary not only in terms of financial indicators but also very important to evaluate the performance in terms of non-financial factors of the bank. The non-financial factors include customer footfall, repeat customer business (customer loyalty), customer list, delivery channels, and time factor in the provision of services. Experts have developed methods and standards to evaluate the financial and non-financial indicators of a service entity like bank insurance companies, education institutions, health, and community welfare, etc.

CAMELS RATINGS

Interested parties and various stakeholders like employees, customers, tax authorities, creditors, auditors, trade unions, investors, and the press usually evaluate the bank's performance. Employees of the bank are interested in salary and allowances, auditors are solicited for evaluation and reporting, investors for investment, and others with different intentions of their own. But the Central bank also evaluates regularly the performance and financial health of each bank in the industry as a duty to ensure that best business practices and sound principles are being pursued for the protection of customers and the financial industry. Most of the regulators use the procedure and method called CAMELS RATINGS. The regulators numerically rate each bank ranging from 1-5. The best category of rating is “1” and the worst is “5”. The acronym is used to denote the following; 

1.       “C” stands for Capital of the bank

2.       “A” stands for the Assets

3.       “M” stands for management

4.       “E” stands for earnings

5.       “L” stands for liquidity

6.       “S” stands for Sensitivity

Each alphabet letter refers to a specific category of the financial statements and nonfinancial indicators of the bank. “C” denotes capital which takes into account the capital adequacy of the bank.  A bank is insolvent when it has a negative net worth or shareholders' equity. Net worth shows the difference between the market value of assets and liabilities of the bank. If a bank in such a situation is liquidated it would not able to pay the creditors and would be considered bankrupt. It is believed that a bank with a 12 % of capital adequacy ratio is considered stable and would be able to withstand the loss due to a fall in the market value of its assets. For the purpose of capital adequacy, the capital is divided into tiers based of risk-adjusted assets. 

“A” represents the asset quality. Assets quality is adjudged on the basis of the risk involved and the quality of securities and fallback that is available to the bank. Bank assets comprise Loans and investments and contra commitments. These loans are issued for different purposes against various classes of securities. These securities and loans carry different risks. Likewise, investments are having different grades. Investments in govt. securities carry no risk whereas investments in the stock market have no guarantees and involve risk of the underlying issuer of the stock. Again gilt-edged securities carry comparatively little risk.  Total assets adjusted for risks based on a well-defined rating system are calculated and compared to the total book value of assets on the balance sheet. The higher the value of assets so compared to the total value, the better the quality of assets. 

Management category rates the ability of the senior management and those charged with directing and controlling the bank, to identify, assess, measure, control, and monitor the risks involved in the operations, systems, human, internal, and external. Management is expected to put in place policies and procedures to manage the risks and run the bank by applying best business practices. 

Earnings represent the earning quantity and quality. Earning depends on the capital adequacy to withstand hard times, and the quality of assets which may lead to sustainability and management efficiency to enhance the value of shareholders pursuing the strategic objectives of the bank. The liquidity of a bank is the ability to meet its obligation when due. It refers to the bank’s current and prospective sources of funds. Finally, the sensitivity is taking into account the sensitivity to the market. It refers to risks of changes in interest rates, foreign exchange rates, market forces, and cyclical changes. 

The above factors see the bank’s performance through a different lens, however, to reach the final decision and rate a bank according to this rating system, the regulators use the tools of financial and non-financial analysis.

Financial evaluation

Analysis and interpretation of bank accounts will give an indication of the bank’s performance. They would usually involve;

Analysis and interpretation of bank accounts will give an indication of the bank’s performance. The would usually involve; 

1.  Ratio analysis

a.       Profitability; to evaluate as to how well the bank performed.

Gross profit Margin = Gross profit* 100/ Revenue

Operating Profit= EBIT *100/Revenue

Net Profit= Net profit*100/ Revenue

b.      Liquidity analysis; to identify the short-term financial health of the bank.

Current Ratio= Current Assets/ Current Liabilities

Quick Ratio = Current Assets (less inventory)/ Current Liabilities

c.       Leverage analysis; to identify and measure the risk.

Gearing Ratio= Debt*100/ Equity

2.   Trend analysis; to evaluate the growth or performance trend over the period.

Taking ratios of different periods and comparing for appreciation or deterioration.

3.  Cash flow; identify and ascertain the positive or negative cash generation over the period. It analyzes the deficit/ surplus of cash generated by Operating activities, investing activities, and financing activities.

4.   Evaluate the off-balance sheet item to identify contingent assets and liabilities. 

Non-financial evaluation

Balanced Scorecard Approach

Kaplan and Norton in their book “The balanced Scorecard” have described the framework for performance measurement for a service industry. The balance scorecard approach consists of a variety of indicators both financial and non-financial. The method focuses on four different perspectives and aims to establish goals for each together with measures that can be used to evaluate whether these goals have been achieved. These are;

1. Financial perspective; this is a financial measurement as mentioned above.
2. Internal business perspective; what and where the bank must excel at
3. Customer perspective; how customers see us, customer perspective about the bank
4. Innovation and Learning perspective: Can we continue to improve and create value.

 Building Blocks Model

Moon and Fitzgerald in their model propound that a performance measurement system in a service entity can be analyzed as a combination of three building blocks.

1. Dimensions of performance; These are determinants and include profit, Competitiveness, Quality, Resource allocation, Flexibility, and innovations.
2. Standards: these are the targets of performance i.e. Ownership, Achievability, Equity
3. Rewards; these are the rewards system for achievers and include Clarity, Motivation, Controllability

Solvency is associated with the overall health of the bank. No single factor or act or event may be regarded as responsible for the solvency or insolvency of a bank. Credit risk may contribute to insolvency in the form of bad loans, defaults, writing-offs, and late payments. Liquidity risk may contribute to solvency as negative cash flow, withdrawal runs on the bank, loss on assets conversions, and lack of refinancing from other banks. The reputational and legal risks may contribute to the blacklisting of activities, and cancellation of licenses. Market risk and operational risk may cause insolvency in the form of low activities, high competition, noncommercial location, etc.

 The solvency of a bank greatly depends upon a robust capital base, Strong control and use of the latest technology and delivery channels, creation of quality assets backed by long-term liabilities, and qualified and trained human resources. Insolvency may be caused by the following factor where the net worth of the bank becomes negative at any given point in time;

•  Lack of cash flow and cash equivalents
• Over borrowing
• Major debt repayment due
• Low capital
• High level of gearing
• Negative cash flow to meet the operating expense
• A legal decision against the bank
• Deterioration of assets
• Long-term assets against short-term liabilities
• High administrative & intermediation cost

Market risk is associated with interest rate fluctuation and foreign exchange rate fluctuation. Market risk originates from the mismatch of the assets and liabilities mix of the bank. Since it directly affects the income which in turn affects the value of shareholders. When the market is volatile and interest rates are not stable, the income from assets and payment on liabilities varies. Banks need to take into account the assets mix and liabilities backing those assets. The effect will different under different scenarios. When interest rate is rising and the asset and liabilities are booked on fixed rates and shall be re-priced at equal intervals there will be no effect on net income. When the interest rate is rising and the asset and liabilities are booked on floating rates and the assets and liabilities are supposed to be re-priced at an equal interval, there will be no effect on net income. When the interest rate is falling and the asset and liabilities are booked on fixed rates and the assets and liabilities will be re-priced at an equal interval, with no change in net income. When the interest rate is falling and the asset and liabilities are booked on floating rates and the assets and liabilities will be re-priced at equal intervals, with no change in net income.

 The risk arises when the interest rate is rising and the assets are re-priced in the short term and liabilities are re-priced in the longer term. In this situation, income will rise positively. But when the interest rate is rising and the assets are re-priced at the long term and liabilities are re-priced at the short term, the income will fall.

 Foreign exchange rate risk is involved when banks maintain assets and liabilities in foreign currencies. The foreign exchange rate can be transactional as well as translations. Foreign currency assets and liabilities holdings will be affected positively/ negatively by the changes in the daily rate of exchange and by the translation of foreign currencies assets and liabilities at the year's end when preparing accounts.

Legal and reputation risks co-exist. Factors that cause legal risk also lead to reputational complications. For example, an annoyed employee due to redundancy or any other complaint may put up a Legal case against the bank. Whatever the nature of the case may be a little or big, simple or complicated, the bank has to hire a lawyer with a heavy fee which is a financial loss to the bank. Other employees feel insecure and send a feeling of resentment against the institution among the employees. An employee may indulge in misappropriation in the customer account. The matter is unearthed by the account holder or the auditors, making the whole unit unreliable and skeptical. If divulged to the press, the news may create a huge legal and reputation loss to the bank. An unscrupulous employee may connive with culprits and involve himself and the bank in the laundering of illicit money for the holder may cause legal, financial, and reputational risk for the bank. A borrower may stop paying back the Loan amount willfully. Bank may initiate a recovery lawsuit against the defaulting borrower. 

Fraud not only causes monetary loss to a bank, but it also negatively affects the reputation of the bank. Negative publicity in the press bears a huge loss to the bank. Fraud is an intentional act by one or more individuals among management, those charged with governance, and employees of the bank or third parties. Fraud and misappropriation (the theft of a company’s assets such as cash) are not limited to theft. It may be parallel banking or an unauthorized transaction in customer accounts, misappropriation of assets, divulging customer information, etc. are causing a long-term effect on the bank's reputation. Unscrupulous employees may indulge in illegal activities like AML and blow a reputational risk for the bank.

Legal repercussions in the banking business are multifarious, and banks generally maintain a full-fledged legal department for legal services.  

Operating risk is associated with the operations of the bank. Operations include human resources, technologies, applications, and management information systems. All these entail expenses. If operating expenses are high, profit will be low. Big banks have large operating expenses. Human resources need to be properly screened, selected, and trained to avoid fraud. Technologies should be the latest to provide efficient and cost-effective services. The computer application used by banks should support service delivery and an in-built control system. Management information systems should facilitate effective and timely decision-making. Operating cost is high with banks where technology and systems are compromised. Bank must devise a system to calculate per-employee assets and expense/profit and compare the same with industry standards to evaluate operating risk. Operating risk is difficult to identify and assess, however, the facts mentioned above may help reduce such costs and increase profit.

 Liquidity refers to the ability to meet due obligations. It is the conversion of assets into cash within a year. Banks are highly leveraged institutions. When the bank is unable to liquidate its assets in case of need, it is running a liquidity risk. The liquid asset of a bank balance sheet comprises the following;

Core deposits; constitute the demand liabilities, savings accounts, and money market borrowings. The greater the volume of core deposits, the lower the unexpected withdrawal.

Treasury bills; are considered the most secured and readily saleable current assets on the bank balance sheet. Bank purchase short-term securities both for income and to achieve liquidity requirements.

Trading securities and securities available for sale; gilt edge securities on the balance sheet of a bank provide a robust fallback in a case of liquidity crunch.

Repurchase agreements; these agreements are secured low-risk marketable securities that strengthen the liquidity position of banks.

Current due from borrowers; principal and interest receivables support liquidity.

Bank liquidity is the state of affairs where the bank cannot convert its assets into cash with no or minimal losses.  The liquidity risk arises when the bank is either unable to liquidate its current assets or unable to raise new borrowings from the market. Liquidity turns out to be the greatest risk when banks cannot anticipate the new loan demand in the market or expected withdrawal by the depositors. The liquidity position is worsened when banks have no access to new sources of cash.