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Banking & Financial Awareness

Banking Terminology

Loss Given Default-

  • The loss given default (LGD) is an important calculation for financial institutions projecting out their expected losses due to borrowers defaulting on loans.
  • The expected loss of a given loan is calculated as the LGD * probability of default * exposure at default.
  • An important figure for any financial institution is the cumulative amount of expected losses on all outstanding loans.

 Repossession-

  • Repossession is the term used to describe the taking back of property after a borrower has defaulted on payments. The lender either repossesses the collateral or pays a third-party service to do so.

 Tier I Capital-

  • Tier 1 capital is used to describe the capital adequacy of a bank and refers to core capital that includes equity capital and disclosed reserves. Equity capital is inclusive of instruments that cannot be redeemed at the option of the holder.
  • Tier 1 capital is essentially the most perfect form of a bank’s capital—the money the bank has stored to keep it functioning through all the risky transactions it performs, such as trading/investing and lending.

Tier II Capital-

  • Tier 2 capital is the secondary component of bank capital, in addition to Tier 1 capital, that makes up a bank’s required reserves. Tier 2 Capital is designated as supplementary capital and is composed of items such as revaluation reserves, undisclosed reserves, hybrid instruments, and subordinated term debt.
  • Tier 2 Capital is considered less reliable than Tier 1 capital because it is more difficult to accurately calculate and is composed of assets that are more difficult to liquidate.

 Revaluation Reserves-

  • Revaluation reserve is an accounting term used when a company creates a line item on its balance sheet for the purpose of maintaining a reserve account tied to certain assets. This line item can be used when a revaluation assessment finds that the carrying value of the asset has changed.
  • Revaluation reserves are most often used when an asset’s market value greatly fluctuates or is volatile due to currency relationships.

 Leverage-

  • Leverage results from using borrowed capital as a funding source when investing to expand the firm’s asset base and generate returns on risk capital.
  • Leverage is an investment strategy of using borrowed money specifically, the use of various financial instruments or borrowed capital to increase the potential return of an investment.
  • Leverage can also refer to the amount of debt a firm uses to finance assets. When one refers to a company, property or investment as “highly leveraged,” it means that item has more debt than equity.

 Capital Reserves-

  • Capital reserve is an account on the balance sheet to prepare the company for any unforeseen events like inflation, instability, need to expand the business, or to get into a new and urgent project.
  • A capital reserve is created out of capital profits, which are always non-operational in nature.
  • It is useful for long term purposes.

 Deferred Tax Assets-

  • A deferred tax asset is an asset on a company’s balance sheet that may be used to reduce its taxable income.
  • It can refer to a situation where a business has overpaid taxes or taxes paid in advance on its balance sheet.
  • These taxes are eventually returned to the business in the form of tax relief, and the over-payment is, therefore, an asset for the company.

 Hybrid Debt Capital Instruments-

  • A hybrid debt instrument is a loan agreement which is treated, for the purposes of the Act, as being an equity arrangement as opposed to a normal loan arrangement.
  • When a company owes debt and pays interest on it, the company can ordinarily deduct from its taxable income, the interest payable on the loan. The creditor receiving the interest receives income on which tax is payable.

Market Stabilization scheme (MSS)-

  • Market Stabilization scheme (MSS) is a monetary policy intervention by the RBI to withdraw excess liquidity (or money supply) by selling government securities in the economy.
  • The MSS was introduced in April 2004. Main thing about MSS is that it is used to withdraw excess liquidity or money from the system by selling government bonds.
  • The MSS was launched to withdraw the excess liquidity in the system that was generated as a result of the RBI’s purchase of foreign currencies in the foreign exchange market.