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    List of sectors in india stock market?1)Metals

    2) Auto

    3) Banking

    4)Breweries and distilleries





    9)Computers10) IT


    12) FMCG

    13) Electronics


    15) Entertainment/Media

    16)Finance and Investments

    17) Hotel

    18) Food processing

    19) Healtcare

    20) Pharma

    21) Paint

    22) paper

    23) Petrochemicals

    24) Plastic

    25) Refineries

    26) Sugar

    27) Tea

    28) Airlines

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    A comparison of these rankings with other information developed by the money

    manager provides a powerful tool in selection of specific equities for inclusion in the

    portfolio or the elimination of existing holdings.


    DefinitionA distinct subset of a market, society, industry, or economy, whose components share

    similar characteristics. Stocks are often grouped into different sectors depending upon

    the company's business. Standard & Poor's breaks the market into 11 sectors. Two of

    these sectors, utilities and consumer staples, are said to be defensive sectors, while therest tend to be more cyclical in nature. The other nine sectors are: transportation,

    technology, health care, financial, energy, consumer cyclicals, basic materials, capital

    goods, and communications services. Other groups break up the market into different

    sector categorizations, and sometimes break them down further into subsectors.

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    Banking Sector in India is one of the growing sectors with great dynamics. There are

    various factors which affect the share prices of Banking Companies. This report is all

    about how various factors (Internal and External) affect the Banking Sector Share

    Prices. In this report a detailed analysis of the factors affecting the share prices is

    carried on and a model is developed to study the effect of various factors on the share

    prices. Here, various internal factors (Banks Profitability, Income, Expenses, and News

    about the Bank.) and external factors (Government policies, CRR, Repo Rate, Reverse

    Repo Rate, Rules and Regulations.) are considered which affect the prices of theshares of Bank. Datas are collected for all the quantifiable factors and for the rest

    factors a theoretical explanation is given in detail. Using SPSS a model is developed

    which shows the regression and correlation co-efficient between the share prices and

    various factors affecting the same.

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    STOCK MARKET IN INDIA The Indian security market has become one

    of the most dynamic and efficient security markets in Asia today. The

    Indian market now conforms to International Standards in terms of

    operating efficiency. During the latter half of 19th century, shares of

    companies used to be floated in India occasionally. There were share

    brokers in Bombay who assisted in the floatation of shares of companies. Asmall group of stock brokers in Bombay joined together in 1875 to form an

    association called Native Share & Stockbrokers Association. The

    association drew up codes of conduct for brokerage business and

    mobilizes private funds for investment in the corporate sector. It was this

    association which later became the Bombay Stock Exchange, Mumbai or

    BSE Later on in 1894 the brokers of Ahmedabad formed the Ahmedabad

    Stock Exchange, the second stock exchange of the country. During the

    1900s Kolkata became another major center of share trading and as a

    result Kolkata Stock Exchange was formed in 1908. Later on Chennai

    Stock Exchange was started in 1920. However, by 1923, it ceased to exist.

    Then the Madras Stock Exchange was started in 1937. Three more stock

    exchanges were established before independence, at Indore in 1930, at

    Hyderabad in 1943 and at Delhi in 1947.

    Thus along with the increase in number of stock exchanges, the number of

    listed companies and the capital of listed companies grown tremendously

    after 1985 which results into growth and development of stock market inIndia.

    ABOUT BSE SENSEXBSE SENSEX or Bombay Stock Exchange Sensitive Index is a value-weighted index composed of 30 stocks started in 01 of January, 1986. Itconsists of the 30 largest and most actively traded stocks, representative of

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    various sectors, on the Bombay Stock Exchange. These companiesaccount for around one-fifth of the market capitalization of the BSE. Thebase value of the SENSEX is 100 on April 1, 1979, and the base year ofBSE-SENSEX is 1978-79. At irregular intervals, the Bombay StockExchange (BSE) authorities review and modify its composition to makesure it reflects current market conditions. The index is calculated based ona free-float capitalization method; a variation of the market cap method.Instead of using a company's outstanding shares it uses its float, or sharesthat are readily available for trading. The free-float method, therefore, doesnot include restricted stocks, such as those held by company insiders.The index has increased by over ten times from June 1990 to the present.Using information from April 1979 onwards, the long-run rate of return onthe BSE SENSEX works out to be 18.6% per annum, which translates toroughly 9% per annum after compensating for inflation. There are five

    major indices in BSE, thirteen sector specific indices and a BSE DollexIndex for dollar prices and movements.

    ABOUT NSE AND NIFTY 50The National Stock Exchange of India Limited (NSE) is a Mumbai-basedstock exchange. It is the largest stock exchange in India in terms of dailyturnover and number of trades, for both equities and derivative trading.Though a number of other exchanges exist, NSE and the Bombay StockExchange are the two most significant stock exchanges in India and

    between them are responsible for the vast majority of share transactions.The NSE's key index is the S&P CNX Nifty, known as the Nifty, an index offifty major stocks weighted by market capitalization.NSE is mutually-owned by a set of leading financial institutions, banks,insurance companies and other financial intermediaries in India but itsownership and management operate as separate entities. There are atleast 2 foreign investors NYSE Euro next and Goldman Sachs who havetaken a stake in the NSE. As of 2006, the NSE VSAT terminals, 2799 intotal, cover more than 1500 cities across India. In October 2007, the equitymarket capitalization of the companies listed on the NSE was US$ 1.46

    trillion, making it the second largest stock exchange in South Asia. NSE isthe third largest Stock Exchange in the world in terms of the number oftrades in equities. It is the second fastest growing stock exchange in theworld with a recorded growth of 16.6%

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    The Standard & Poor's CRISIL NSE Index 50 or S&P CNX Nifty nicknamed

    Nifty 50 or simply Nifty, is the leading index for large companies on the

    National Stock Exchange of India. The Nifty is a well diversified 50 stock

    index accounting for 22 sectors of the economy. It is used for a variety of

    purposes such as benchmarking fund portfolios, index based derivativesand index funds. There are seven major Indices in NSE and fifteen sector

    specific Indices. CNX BANK INDEX or BANK NIFTY is the index which has

    17 banks listed on it and is a separate index to look upon price movements

    of banks share prices. A brief account of the same is given below.

    CNX Bank Index The Indian banking Industry has been undergoing

    major changes, reflecting a number of underlying developments.

    Advancement in communication and information technology has facilitated

    growth in internet-banking, ATM Network, Electronic transfer of funds and

    quick dissemination of information. Structural reforms in the banking sector

    have improved the health of the banking sector. The reforms recently

    introduced include the enactment of the Securitization Act to step up loan

    recoveries, establishment of asset reconstruction companies, initiatives on

    improving recoveries from Non-performing Assets (NPAs) and change in

    the basis of income recognition has raised transparency and efficiency in

    the banking system. Spurt in treasury income and improvement in loan

    recoveries has helped Indian Banks to record better profitability. In order to

    have a good benchmark of the Indian banking sector, India Index Service

    and Product Limited (IISL) has developed the CNX Bank Index. CNX Bank

    Index is an index comprised of the most liquid and large capitalized Indian

    Banking stocks. It provides investors and market intermediaries with a

    benchmark that captures the capital market performance of Indian Banks.The index will have 12 stocks from the banking sector which trade on the

    National Stock Exchange. The average total traded value for the last six

    months of CNX Bank Index stocks is approximately 95.85% of the traded

    value of the banking sector. CNX Bank Index stocks represent about

    86.06% of the total market capitalization of the banking sector as on

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    January 30, 2009. The average total traded value for the last six months of

    all the CNX Bank Index constituents is approximately 14.86% of the traded

    value of all stocks on the NSE. CNX Bank Index constituents represent

    about 8.63% of the total market capitalization on January 30, 2009.

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    The objective of the project is to identify, understand and analyze the impact of various

    factors that affect the Indian Equity Market (BANKING SECTOR). The main focus will

    be on understanding, analyzing and providing a valid explanation both theoretically and

    technically, that how various factors affect the share prices of BNAKING SECTOR. By

    undertaking this study I would like to keep my first step in the field of research. This

    project will help me in enhancing my analytical skills and will give me a better

    understanding of how things move on and are to be studied. At the same time with this

    study I will be providing the organization a list of factors that affect the market, so that

    they can keep a watch on the same and use the same for the benefit of clients and

    company and also increase their accuracy and profits. This will be my contribution tothis huge company


    The PURPOSE of the report is to analyze how various factors affect the prices of abanks share. The share prices are highly affected by various internal and externalfactors. It is of great importance to understand, learn and analyze the same. Thus, this

    report is a move in path of understanding those factors and analyzing the impact of thesame.Banks are a major part of any economic system. They provide a strong base to Indian

    economy too. Even in share markets, the performance of bank shares is of great

    importance. This is justified by the proof that in both BSE and NSE we haveseparate

    index for Banking Sector Shares. But for our study we have taken only Bank Nifty which

    is a part of NSE. Thus, the performance of share market, the rise Page | and the fall of

    market is greatly affected by the performance of Banking Sector Shares and this report

    revolves around all those factors, their understanding and a theoretical and technical

    analysis of the same.

    SCOPE OF STUDYIt gave me an opportunity to study the banking sector in a detailed manner.

    I got knowledge of prevailing Market Scenario.

    It helped me in learning the market dynamics, study the movement of share prices andto give a proper justification for the same, theoretically and technically.

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    It helped me in understanding and learning the corporate culture And above all, theconcerned organization can get some valuable recommendations, which can definitelyimprove the performance of the organization.


    Though the resources seem sufficient enough to achieve high standard for thisresearch, still we foresee the following limitations of study.The Sectoris very vast and it was not possible to cover every nook and corner of this sector.

    The variability and availability of data was also a limitation.

    The data were linear and possessed multi collinearity, so each and every data was notconsidered for analysis.

    The objective which we want to fulfill in this project is really good, but the major demeritto our study is the availability of time for our search and analysis, but then also, I havetried my level best to show a glimpse of my Research in tune with the objectives.

    11.. wwhhaatt iiss BBaannkkiinngg

    Section 5(b) defines banking Accepting for the purpose of lending or investmentof deposits or money repayable on demand or otherwise and withdrawable bycheque, draft, order or otherwise

    BBaannkkss ggeett aaffffeecctteedd bbyyy Actions of Central Banksy Actions of the Governmenty Domestic and International Disturbancesy Inflation


    y Banks are now operating in a fairly deregulated environment and arerequired to determine on their own, interest rates on deposits andadvances

    y Intense competition for business involving both the assets and liabilities

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    together with increasing volatility in the interest rates has brought pressureon the management of banks to maintain a good balance among spreads

    RRiisskkss FFaacceedd bbyy BBaannkkss

    y Credit Risky Market Risk

    o Liquidity Risko Interest Rate Risk

    y Operational Risk

    EEffffeeccttss ooffRRiisskk FFaaccttoorrss

    y Loss of Market Valuey Loss of Reservesy Loss of stakeholders confidence


    y Indian banks, the dominant financial intermediaries in India, have made goodprogress over the last five years, as is evident from several parameters, includingannual credit growth, profitability, and trend in gross non-performing assets(NPAs). While the annual rate of credit growth clocked 23% during the last five

    years, profitability (average Return on Net Worth) was maintained at around 15%during the same period, and gross NPAs fell from 3.3% as ony March 31, 2006 to 2.3% as on March 31, 2011. Good internal capital generation,

    reasonably active capital markets, and governmental support ensured goodcapitalisation for most banks during the period under study, with overall capitaladequacy touching 14% as on March 31, 2011. At the same time, high levels ofpublic deposit ensured most banks had a comfortable liquidity profile.

    yy While banks have benefited from an overall good economic growth over the last

    decade, implementation of SARFAESI1, setting up of credit information bureaus,internal improvements such as upgrade of technology infrastructure, tightening of

    the appraisal and monitoring processes, and strengthening of the riskmanagement platform have also contributed to the improvement. Significantly,the improvement in performance has been achieved despite several hurdlesappearing on the way, such as temporary slowdown in economic activity (in thesecond half of 2008-09), a tightening liquidity situation, increases in wagesfollowing revision, and changes in regulations by the Reserve Bank of India(RBI), some of which prescribed higher credit provisions

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    y or higher capital allocations. Currently, Indian banks face several challenges,such as increase in interest rates on saving deposits, possible deregulation ofinterest rates on saving deposits, a tighter monetary policy, a large governmentdeficit, increased stress

    y in some sectors (such as, State utilities, airlines, and microfinance), restructured

    loan accounts, unamortised pension/gratuity liabilities, increasing infrastructureloans, and implementation of Basel III.yy 1 The Securitisation and Reconstruction of Financial Assets and Enforcementy of Security Interest Act, 2002y ICRA Researcbbbbby bbbbbby


    undyy ba


    The Indian financial sector (including banks, non-banking financial companies, or

    NBFCs, and housing finance companies, or HFCs) reported a compounded annualgrowth rate (CAGR) of 19% over thelast three years and their credit portfolio stood atclose to Rs. 49 trillion (around 62% of 2010-11 GDP) as on March 31, 2011. Banksaccounted for nearly 86% of the total credit, NBFCs for around 10%, and HFCs foraround 4%. Within banks, public sector banks (PSBs), on the strength of their country-wide presence, continued to be the leader, accounting for around 76% of the total creditportfolio, while within the NBFC sector, large infrastructure financing institutions2accounted for more than half the total NBFC credit portfolio; NBFCs that are into retail

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    financing took up the rest. While the Indian banking sector features a large number ofplayers competing against each other, the top 10 banks accounted for a significant 57%share of the total credit as on March 31, 2011

    Key Players In Banking Sector

    Strong growth in infrastructure creditdrives creditgrowth in 2010-11; pace ofdepositgrowth slows

    Total banking credit4 stood at close to Rs. 39 trillion as on March 25, 2011 and reporteda strong 21.4% growth in 2010-11, led by credit to the infrastructure sector and toNBFCs. In 2011-12, although the pace of credit growth has been subdued in the firsttwomonths (up just 0.2% from March 2011 levels), it is in line with the pattern noticed in theprevious years (0.1% in 2010-11 and 0.4% in 2009-10). According to ICRAsestimates, private banks reported a higheroverall credit growth of around 26% in2010-11 (10% in previous year) as compared with PSBs, which achieved around 22% (20%in previous year). Historically, the banking sectors credit portfolio has been growing at

    Name ofBank

    CreditPortfolioasin March2011 (Rs.billion)



    Tier ICapital% as inMarch2011

    Returnon NetWorth(2010-11)

    GrossNPA %as inMarch2011

    State Bankof India

    7,567 18% 2.9% 7.8% 13% 3.3%


    2,421 6% 3.5% 8.4% 24% 1.8%

    Bank ofBaroda

    2,287 5% 2.8% 10.0% 24% 1.4%

    ICICI Bank 2,164 5% 2.3% 13.2% 10% 4.5%Bank ofIndia

    2,131 5% 2.5% 8.3% 17% 2.2%


    2,125 5% 2.6% 10.9% 26% 1.5%


    1,600 4% 4.2% 12.2% 17% 1.1%

    IDBI Bank 1,571 4% 1.8% 8.1% 16% 1.8%Axis Bank 1,424 3% 3.1% 9.4% 19% 1.1%CentralBank ofIndia

    1,297 3% 2.7% 6.4% 18% 2.2%


    42,874 100% 2.9% 9.7% 17% 2.3%

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    over 20% per annum over the last several years (except in 2009-10, when the growthrate moderated to 17% mainly because of the decline in ICICI Banks credit portfolio).Over the years, credit growth has outpaced deposits growth; the credit portfolio reporteda CAGR of 24% over the last eight years, while deposits achieved a CAGR of 19% andthe investment portfolio of 14% over the same period. The higher growth in credit could

    be achieved because of the slower growth in investments and the increase in capital. In 2010-11, while deposits growth for SCBs slowed down to 17%, credit growth wasmaintained at 21% with the growth in investments being just 13%. The higher creditgrowth versus deposits growth led to an increase in the credit deposits ratio (CD ratio)from 72.2% as in March 2010 to 75.7% as in March 2011, although the CD ratiomoderated to 74.2% as on May 27, 2011, largely because of the slow credit growth incomparison with deposits duringthe first two months of 2011-12.

    During 2010-11, the infrastructure sector, particularly power, and NBFCs were the keydrivers of the credit growth achieved by the banking sector. Credit to the power sector

    reported a growth of 43%, while other infrastructure credit grew by 34% during 2010-11,against an overall credit growth of 21%. As in March 2011, the infrastructure sector(including power) accounted for 14% of the total credit portfolio of banks.

    Within the power sector, historically banks have been taking exposure to State powerutilities as well asindependent power producers (IPPs). Going forward, with many banksapproaching the exposure cap on lending to the power sector and given the concernshovering over the prospects of the sector itself, the pace of growth of credit to this

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    segment could slow down. However, in the short to medium term, the undisbursedsanctions to power projects are likely to provide for a moderate growth.

    As for bank credit to NBFCs, the same increased by 55% in 2010-11 and accounted foraround 5% of the banks total credit portfolio as in March 2011. Moreover, around half

    of this went to infrastructure relatedentities, and the rest mainly to NBFCs engaged inretail financing. Most of the NBFCs are focused on secured assets classes, havereported low NPA percentages, and are well-capitalised. As for banks retail lending,this continued to lag overall credit growth during 2010-11. Retail credit grew by 17% in2010-11 against the overall credit growth of 21%, although the 17% figure marked asignificant increase over the 4.1% reported in 2009-10. Credit to commercial real estatealso increased in 2010-11, reporting a 21% growth that year as against nil in 2009-10.

    Large governmentborrowings may allow for just17-18% creditgrowth in 2011-


    Since March 2010, the RBI has raised the repo rate by 275 basis points (bps), which inturn has been transmitted by the banking system via increases in the base and primelending rates, besides deposit rates. Going forward, while the RBIs tight monetarystance may exert a downward pressure on the demand for credit, considering theanticipated GDP growth (around 8%), investments in infrastructure and lower funds flowfrom the capital markets, credit demand could still remain high. However, bankscapacity to meet credit demand could get constrained by the volume of deposits theyare able to mobilise and by the large amount of funds they would need to keep aside tofund the government deficit. In case the government deficit is in line with the Budget

    numbers, the net borrowing of the Government of India (GOI) and the Stategovernments via bonds would reach an estimated Rs. 4.7 trillion in 2011-12 (Rs.4.1trillion in 2010-11). As banks fund around 40% of these bonds, they would need to setaside Rs. 1.9 trillion for the purpose. If deposits were to grow by 17%, the balance funds(incremental deposits + internal capital generation + fresh external capital increase ininvestments in government bonds) would supportonly 17-18% credit growth. Any highergrowth would require intervention from the RBI. Further, in case the government deficitis higher because of lower tax collection and underprovided fuel & food subsidies, themaximum possible credit growth would be still lower. At the same time, a higher-than-expected deposit growth could allow banks expand their credit base.

    On assetquality, PSBs reportsome deterioration while private banks showImprovement

    The Gross NPA percentage of SCBs did not increase by the extent that the stress in theIndian market during 2008-09 would warrant because of large loan restructuring overlast 2-3 years (4-5% of total advances); Gross NPAs declined marginally from 2.4% as

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    in March 2010 to 2.3% as in March 2011.However, higher provisioning led to areduction in Net NPAs from 1.1% as in March 2010 to 0.9% as inMarch 20

    Higher interest rates could ensure better deposits growth in 2011-12

    Higher interest rates could ensure better deposits growth in 2011-12

    In the banking system,historically, there has

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    been a positive correlation between growth in deposits base and increase in interestrates; periods with high interest rates have seen relatively high deposits growth, as inhigh interest rate regime bank fixed depositsbecome more attractive than many other instruments. At present, it appears that giventhe outlook on interest rates, banks may be able to mobilise retail deposits at a higher

    pace in 2011-12 than in the previous year. In 2010-11, according to ICRA In 2010-11,according to ICRAs estimates, the overall deposits of private banks increased by 22%,while that of PSBs increased by 18%. Within deposits, low cost deposits (CASA, currentand saving accounts) increased by 27% for private sector banks, and by 15% for PSBs.CASA deposits represented 41% of the total deposits for private banks, and for a lower33% for PSBs. For banks, having significant low cost deposits (CASA) as a proportionof total deposits could help them keep their cost of funds under control even in ascenario of rising interest rates in the system.

    High proportion of certificates of deposits could impactNIM and liquiditynegatively

    ICRAs analysis of the current liquidity situation shows that Indian banks have beenraising bulk funds in the form of certificates of deposit (CDs) and high-cost depositsfrom corporate entities mostly for short tenures. The share of CDs outstandingincreased to 8.2% as in March 2011 from 7.2% as in September 2010 and 7.6% as inMarch 2010, with the total CDs outstanding increasing from Rs. 3.4 trillion to Rs. 4.2trillion during this period. The high proportion of CDs (instead of retail deposits) couldadversely impact the liquidity profile of banks and their NIMs in a scenario of risinginterest rates.

    Mostbanks may not require significantcapital now

    During 2010-11, the GOI infused Rs. 165 billion in PSBs to improve their Tier I capital to8% and take up its stake in the PSBs to at least 58%. After this, the Tier I capital ofmost of the PSBs has improved. Therefore, these banks (apart from SBI) may notrequire significant Tier I capital in the short term. The GOI has budgeted for Rs. 60billion capital for PSBs in 2011-12. As for SBI, it plans to raise significant capital througha rights issue, and therefore, under the current regulations and market valuations, theGOI may need to infuse substantial capital into it to maintain its stake in the bank at58%. As for private banks, these are well capitalised, although some may need equity to

    fund their growth plans.Some banks may require capitalto meetBasel III norms

    As can be seen in table 4 below, banks will need to maintain higher regulatory capitalunder BASEL-IIInorms versus the existing RBI norms.

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    Starting off with the project, in the initial phase of SIP, I learnt the basics of the stockmarket. As I had to work here in this market for 3.5 months this was the basic necessity.In that phase I had a nice exposure of how to deal with clients, how to handle the

    queries of the investors, it was a practical exposure to learn the working of the market,how the market moves and all about the corporate culture. Also I had learnt what factorsbasically affect the equity market. Then I decided to limit my project to just BankingSector, because it is one of the most dynamic sector and also availability of time wasnot permitting me to go beyond this.

    There are N number of factors which affect the share prices. They can be broadlyclassified into two:



    INTERNAL FACTORS:As the name suggests, Internal Factors are those whichaffect the share prices internally, i.e. they are internal to the company or morespecifically bank. Some of the major internal factors that affect the share prices of abank are as follows:

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    EARNINGS OF THE COMPANY:How much Profit a company earns acts as a significant factor in price movements. If the

    quarterly results are good for a bank, then the price goes up, and if the results are not

    good, the investors show no interest in such banks share and thus price

    falls. Investors invest money in the companies who earn well and in turn give goodreturn on investment. Thus, a wealthy and a profitable company have gooinvestors and

    thus have positive price movements. Price/Earnings Ratio also gives us idea about the


    MARKET CAPITALIZATION: Generally we commit one mistake that we guess the

    companys worth from the price of its stock. It is the market capitalization of the

    company, rather than the stock price, that is more important when it comes to

    determining the worth of the company. We need to multiply the stock price with the total

    number of outstanding stocks in the market to get the market capitalization of a

    company and that is the worth of the company. Thus, a company or bank with high

    Market Capitalization turns out to be more popular among investors. For example,

    HDFC BANK, ICICI BANK and SBI are more popular among investors than other banks

    because they have huge market share and market capitalization. As market

    capitalization increases, the share price tends to increase and as market capitalization

    decreases, the share price tends to decrease

    PRICE/EARNINGS RATIO: Price/Earnings ratio or the P/E ratio gives us a fairidea of how a company's share price compares to its earnings. If the price of the shareis too much lower than the earning of the company, the stock is undervalued and it hasthe potential to rise in the near future. On the other hand, if the price is way too muchhigher than the actual earning of the company and then the stock is said to overvaluedand the price can fall at any point. The earnings also have a direct relation with pricewhich is already explained above.

    INTERNAL AFFAIRS OF THE COMPANY:Any happening inside the company or any internal news does affect its share price. For

    example any key person moving out of the company, acquisition or takeover or mergernews, share split, employee strike and any other thing internal to the affairsof the bank

    affects the share price. A positive note from the internal affairs takes the price to new

    highs and a negative does vice versa.

    INTERST RATES: Interest rates play a major role in determining stock markettrends. Bull markets (those in an upward market) are usually associated with low

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    interest rates and high Capital Gains, and bear markets (those in a downward trend)

    with high interest rates and low Capital gains. Interest rates are determined by the

    demand for capital pushes them up and normally indicates that the economy is

    thriving and that shares probably expensive. Low interest indicate low demand for

    capital, thus liquidity builds up on the economy, driving share price down. Otherinterest rates like that of on Deposits and Borrowings also have impact on share prices.

    OTHER FACTORS: Other factors like Growth of the company, figures of deposits,

    advances, balance sheet, Profit and Loss Account, etc.. also affect the share prices

    drastically. A discussion for the same is done in later part of the report

    EXTERNAL FACTORS:After studying the internal factors, lets take a lookat some External Factors which affect the Share Prices.

    SENTIMENTS:Investor sentiment is almost impossible to predict and can be infuriating if, for example,

    you have bought shares in a company that you think is a good buy but the price

    remains flat. Investor sentiment is influenced by a wide variety of factors. Share prices

    can, for example, be flat during the summer simply because so manmajor investors are

    on holiday or attending major sporting events such as Royal Ascot and Wimbledon,

    hence the adage sell in May and go away. Investor sentiment can lead to irrational

    buying or selling of shares and result in bull and bear markets. A bull market is when

    share prices rise while a bear market is when they fall. In the technology boom of thelate 1990s, for example, investors paid extremely high prices for shares and ignored

    traditional valuation measures, such as P/E ratios. This carried on until 2000 when

    investors belatedly realized these shares has risen too far and resulted in a three year

    bear market in shares. Thus, Sentiments of investors affect the share prices a lot and

    this is something unpredictable and immeasurable factor, but still the most important


    COMPANY NEWS and OTHER NEWS: The way investors interpret newscoming out of companies is also a major influence on share prices. If, for example, acompany puts out a warning that business conditions are tough, shares will often dropin value. If, however, a director buys shares in the firm, it may be a signal that thecompanys prospects are improving. Companies put out a great deal of news and mostof the major announcements are covered by the financial press. But someannouncements not regarded as so important and sometimes, particularly amongsmaller firms that are monitored less by investors and financial journalists, indicators of

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    the companys health can be missed. Takeovers or even rumors of takeovers alsohave a big influence on prices. This is because investors expect the bidder to pay apremium to shareholders. Also any other news or speculation about factors like changein Repo Rate, Cash Reserve Ratio, Reverse Repo Rate, any change or likely change inthe policies of government or RBI or SEBI, any new guidelines issued by the concerned

    authority, etc. affect the price of the share. A positive news in any of these respectsleads to a rise in must always remember that often times, despite amazingly good news,a stock can show least movement. It is the overall performance of the company that

    matters more than news. It is always wise to take a wait and watch policy in avolatile market or when there is mixed reaction about a particular stock.

    DEMAND AND SUPPLY: This fundamental rule of economics holds good for theequity market as well. The price is directly affected by the trend of stock market trading.When more people are buying a certain stock, the price of that stock increases andwhen more people are selling the stock, the price of that particular stock falls. Now it isdifficult to predict the trend. Thus, we should be very careful while dealing in stocks as

    buying or selling pressure may lead to steep rise or fall in price of the shares.Thus, news in any respect is undoubtedly a huge factor when it comes to stock price.

    Positive news about a company can increase buying interest in the market while a

    negative press release can ruin the prospect of a stock. Having said that, we

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    SummaryCapital adequacy ratios are a measure of the amount of a bank's capital expressed as apercentage of its risk weighted credit exposures. An international standard whichrecommends minimum capital adequacy ratios has been developed to ensure banks canabsorb a reasonable level of losses before becoming insolvent.

    Applying minimum capital adequacy ratios serves to protect depositors and promote thestability and efficiency of the financial system.

    Two types of capital are measured - tier one capital which can absorb losses without a bankbeing required to cease trading, e.g. ordinary share capital, and tier two capital which canabsorb losses in the event of a winding-up and so provides a lesser degree of protection to

    depositors, e.g. subordinated debt.

    Measuring credit exposures requires adjustments to be made to the amount of assets shownon a bank's balance sheet. The loans a bank has made are weighted, in a broad brush manner,according to their degree of riskiness, e.g. loans to Governments are given a 0 percentweighting whereas loans to individuals are weighted at 100 percent.

    Off-balance sheet contracts, such as guarantees and foreign exchange contracts, also carrycredit risks. These exposures are converted to credit equivalent amounts which are alsoweighted in the same way as on-balance sheet credit exposures. On-balance sheet andoffbalance sheet credit exposures are added to get total risk weighted credit exposures.

    The minimum capital adequacy ratios that apply are:y tier one capital to total risk weighted credit exposures to be not less than 4 percent;y total capital (tier one plus tier two less certain deductions) to total risk weighted

    creditexposures to be not less than 8 percent.

    IntroductionBanks registered in Our country are required to publish quarterly disclosure statements whichinclude a range of financial and prudential information. (For an explanation of the disclosurearrangements, see the Reserve Bank Bulletin of March 1996). A key part of these statementsis the disclosure of the banks' "capital adequacy ratios". These ratios are a measure of theamount of a bank's capital in relation to the amount of its credit exposures. They are usually

    expressed as a percentage, e.g. a capital adequacy ratio of 8 percent means that a bank'scapital is 8 percent of the size of its credit exposures. Capital and credit exposures are bothdefined and measured in a specific manner which is explained in this article.

    An international standard has been developed which recommends minimum capital adequacyratios for international banks. The purpose of having minimum capital adequacy ratios is toensure that banks can absorb a reasonable level of losses before becoming insolvent, andbefore depositors funds are lost.

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    Applying minimum capital adequacy ratios serves to promote the stability and efficiency ofthe financial system by reducing the likelihood of banks becoming insolvent. When a bankbecomes insolvent this may lead to a loss of confidence in the financial system, causingfinancial problems for other banks and perhaps threatening the smooth functioning offinancial markets. Accordingly applying minimum capital adequacy ratios in Banks assists in

    maintaining a sound and efficient financial system.

    It also gives some protection to depositors. In the event of a winding-up, depositors' fundsrank in priority before capital, so depositors would only lose money if the bank makes a losswhich exceeds the amount of capital it has. The higher the capital adequacy ratio, the higherthe level of protection available to depositors.

    This article provides an explanation of the capital adequacy ratios applied by the ReserveBank and a guide to their calculation. For more detail, the Reserve Bank policy documentCapital Adequacy Framework, issued in January 1996, available from the Reserve BankLibrary, should be consulted.Development of Minimum Capital Adequacy Ratios

    The "Basle Committee" (centred in the Bank for International Settlements), which wasoriginally established in 1974, is a committee that represents central banks and financialsupervisory authorities of the major industrialised countries (the G10 countries). Thecommittee concerns itself with ensuring the effective supervision of banks on a global basisby setting and promoting international standards. Its principal interest has been in the area ofcapital adequacy ratios. In 1988 the committee issued a statement of principles dealing withcapital adequacy ratios. This statement is known as the "Basle Capital Accord". It contains arecommended approach for calculating capital adequacy ratios and recommended minimumcapital adequacy ratios for international banks. The Accord was developed in order toimprove capital adequacy ratios (which were considered to be too low in some banks) and tohelp standardise international regulatory practice. It has been adopted by the OECD countries

    and many developing countries. The Reserve Bank applies the principles of the Basle CapitalAccord in Our country.

    CapitalThe calculation of capital (for use in capital adequacy ratios) requires some adjustments tobe made to the amount of capital shown on the balance sheet. Two types of capital aremeasured in Our country - called tier one capital and tier two capital. Tier one capital iscapital which is permanently and freely available to absorb losses without the bank beingobliged to cease trading. An example of tier one capital is the ordinary share capital of thebank. Tier one capital is important because it safeguards both the survival of the bank andthe stability of the financial system.

    Tier two capital is capital which generally absorbs losses only in the event of a winding-up ofa bank, and so provides a lower level of protection for depositors and other creditors. Itcomes into play in absorbing losses after tier one capital has been lost by the bank. Tier twocapital is sub-divided into upper and lower tier two capital. Upper tier two capital has nofixed maturity, while lower tier two capital has a limited life span, which makes it lesseffective in providing a buffer against losses by the bank. An example of tier two capital issubordinated debt. This is debt which ranks in priority behind all creditors except

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    shareholders. In the event of a winding-up, subordinated debt holders will only be repaid if allother creditors (including depositors) have already been repaid.

    The Basle Capital Accord also defines a third type of capital, referred to as tier three capital.Tier three capital consists of short term subordinated debt. It can be used to provide a bufferagainst losses caused by market risks if tier one and tier two capital are insufficient for this.

    Market risks are risks of losses on foreign exchange and interest rate contracts caused bychanges in foreign exchange rates and interest rates. The Reserve Bank does not requirecapital to be held against market risk, so does not have any requirements for the holding oftier three capital. The composition and calculation of capital are illustrated by the first stepof the capital adequacy ratio calculation example shown later in this article.

    Credit ExposuresCredit exposures arise when a bank lends money to a customer, or buys a financial asset (e.g.a commercial bill issued by a company or another bank), or has any other arrangement withanother party that requires that party to pay money to the bank (e.g. under a foreignexchange contract). A credit risk is a risk that the bank will not be able to recover the moneyit is owed. The risks inherent in a credit exposure are affected by the financial strength of

    the party owing money to the bank. The greater this is, the more likely it is that the debt willbe paid or that the bank can, if necessary, enforce repayment.

    Credit risk is also affected by market factors that impact on the value or cash flow of assetsthat are used as security for loans. For example, if a bank has made a loan to a person to buya house, and taken a mortgage on the house as security, movements in the property markethave an influence on the likelihood of the bank recovering all money owed to it. Even forunsecured loans or contracts, market factors which affect the debtor's ability to pay the bankcan impact on credit risk.

    The calculation of credit exposures recognises and adjusts for two factors:

    y On-balance sheet credit exposures differ in their degree of riskiness (e.g.Government Stock compared to personal loans). Capital adequacy ratiocalculations recognise these differences by requiring more capital to be heldagainst more risky exposures. This is done by weighting credit exposures accordingto their degree of riskiness. Abroad brush approach is taken to defining degrees ofriskiness. The type of debtor and the type of credit exposures serve as proxies fordegree of riskiness (e.g. Governments are assumed to be more creditworthy thanindividuals, and residential mortgages are assumed to be less risky than loans tocompanies). The Reserve Bank defines seven credit exposure categories into whichcredit exposures must be assigned for capital adequacy ratio calculation purposes.

    y Off-balance sheet contracts (e.g. guarantees, foreign exchange and interest ratecontracts) also carry credit risks. As the amount at risk is not always equal to thenominal principal amount of the contract, off-balance sheet credit exposures arefirst converted to a "credit equivalent amount". This is done by multiplying thenominal principal amount by a factor which recognises the amount of risk inherentin particular types of off-balance sheet credit exposures. After deriving creditequivalent amounts for off-balance sheet credit exposures, these are weightedaccording to the riskiness of the counterparty, in the same way as on-balancesheet credit exposures. Nine credit exposure categories are defined to cover alltypes of off-balance sheet credit exposures. The credit exposure categories and

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    the risk weighting process are illustrated by the second step of the calculationexample.

    Minimum Capital Adequacy RatiosThe Basle Capital Accord sets minimum capital adequacy ratios that supervisoryauthorities

    are encouraged to apply. These are:y tier one capital to total risk weighted credit exposures to be not less than 4 percent;y total capital (i.e. tier one plus tier two less certain deductions) to total risk weighted

    credit exposures to be not less than 8 percent;

    There are some further standards applicable to tier two capital:

    y tier two capital may not exceed 100 percent of tier one capital;y lower tier two capital may not exceed 50 percent of tier one capital;y lower tier two capital is amortised on a straight line basis over the last five years

    of its life.

    The Reserve Bank will not register banks in Our country that do not meet these standards- and maintaining the minimum standards is always made a condition of registration.

    y If the registered bank is incorporated in Our country, then the minimum standardsapply to the financial reporting group of the bank.

    y If the registered bank is a branch of an overseas bank, then it is the capitaladequacy ratios of the whole overseas bank (and not the branch) which arerelevant. Overseas banks which operate as branches are registered in Our countryon the condition that they comply with the capital adequacy ratio requirementsimposed by the financial authorities in their home country and that theserequirements are no less than those recommended by the Basle Capital Accord.

    When a registered bank falls below the minimum requirements it must present a plan to

    the ReserveBank (which is publicly disclosed) aimed at restoring capital adequacy ratiosto at least the minimum level required.

    Even though a bank may have capital adequacy ratios above the minimum levelsrecommended by the Basle Capital Accord, this is no guarantee that the bank is "safe".Capital adequacy ratios are concerned primarily with credit risks. There are also othertypes of risks which are not recognised by capital adequacy ratios e.g.. inadequateinternal control systems could lead to large losses by fraud, or losses could be made onthe trading of foreign exchange and other types of financial instruments. Also capitaladequacy ratios are only as good as the information on which they are based, e.g. ifinadequate provisions have been made against problem loans, then the capital adequacyratios will overstate the amount of losses that the bank is able to absorb. Capital

    adequacy ratios should not be interpreted as the only indicators necessary to judge abank's financial soundness.

    Calculation ExampleBecause off-balance sheet credit exposures are included in calculations, capital adequacyratios cannot be calculated by reference to the balance sheet alone. Even the calculation ofcapital adequacy ratios to cover on-balance sheet credit exposures usually cannot be done byusing published balance sheets, as these will probably not provide sufficient detail about whothe bank has lent to, or the issuers of securities held by the bank. However, the disclosure

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    statements of the bank should contain the information necessary to confirm the bank's capitaladequacy ratio calculations. To illustrate the process a bank goes through in calculating itscapital adequacy ratios, a simple worked example is contained in Figures 1 to 5. The steps inthe calculation are explained below. The balance sheet information and the off-balance sheetcredit exposures on which the calculations are based are set out in Figures 1 and 2.

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    First Step - Calculation ofCapital

    The composition of the categories of capital is as follows:

    Tier One Capital

    In general, this comprises:y the ordinary share capital (or equity) of the bank; andy audited revenue reserves e.g.. retained earnings; lessy current year's losses;y future tax benefits; and

    y intangible assets, e.g. goodwill.

    Upper Tier Two Capital

    In general, this comprises:

    y unaudited retained earnings;y

    revaluation reserves;y general provisions for bad debts;y perpetual cumulative preference shares (i.e. preference shares with no maturity date

    whose dividends accrue for future payment even if the bank's financial condition doesnot support immediate payment);

    y perpetual subordinated debt (i.e. debt with no maturity date which ranks in prioritybehind all creditors except shareholders).

    Lower Tier Two Capital

    In general, this comprises:

    y subordinated debt with a term of at least 5 years;

    y redeemable preference shares which may not be redeemed for at least 5 years.

    Total CapitalThis is the sum of tier 1 and tier 2 capital less the following deductions:

    y equity investments in subsidiaries;y shareholdings in other banks that exceed 10 percent of that bank's capital;y unrealised revaluation losses on securities holdings.

    Figure 3 shows an example of a calculation of capital.

    Figure 3

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    Second Step - Calculation of Credit Exposures

    On-Balance Sheet Exposures

    The categories into which all credit exposures are assigned for capital adequacy ratiopurposes, and the percentages the balance sheet numbers are weighted by, are as follows:

    Off-Balance Sheet Credit Exposures

    (1) Calculation of Credit Equivalents

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    Listed below are the categories of credit exposures, and their associated "credit conversionfactor". The nominal principal amounts in each category are multiplied by the creditconversion factor to get a "credit equivalent amount":

    The final category of off-balance sheet credit exposures, market related contracts (i.e.interest rate and foreign exchange rate contracts), is treated differently from the othercategories. Credit equivalent amounts are calculated by adding the following:

    (a)current exposure - this is the market value of a contract i.e.. the amount the bank

    could get by selling its rights under the contract to another party (counted as zero forcontracts with a negative value); and

    (b)potential exposure i.e.. an allowance for further changes in the market value, which iscalculated as a percentage of the nominal principal amount as follows:

    Although the nominal principal amount of market related contracts may be large, the creditequivalent amounts are usually small, and so may add very little to the amount of creditexposures to be risk weighted.

    (2) Calculation of Risk Weighted Credit Exposures

    The credit equivalent amounts of all off-balance sheet exposures are multiplied by the samerisk weightings that apply to on-balance sheet exposures (i.e. the weighting used depends on

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    the type of counterparty), except that market related contracts that would otherwise beweighted at 100 percent are weighted at 50 percent.

    Figure 4 shows an example of a calculation of risk weighted assets.

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    Figure 4 (Contd.)

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    Third Step - Calculation of Capital Adequacy Ratios

    Capital adequacy ratios are calculated by dividing tier one capital and total capital by riskweighted credit exposures.Figure 5 shows an example of a calculation of capital adequacy ratios.


    Capital adequacy ratios measure the amount of a bank's capital in relation to the amount of

    its risk weighted credit exposures. The risk weighting process takes into account, in a stylisedway, the relative riskiness of various types of credit exposures that banks have, andincorporates the effect of off-balance sheet contracts on credit risk. The higher the capitaladequacy ratios a bank has, the greater the level of unexpected losses it can absorb beforebecoming insolvent.

    The Basle Capital Accord is an international standard for the calculation of capital adequacyratios. The Accord recommends minimum capital adequacy ratios that banks should meet.

    The Reserve Bank applies the minimum standards specified in the Accord to banks registeredin Our country. This helps to promote stability and efficiency in the financial system, andensures that Our country banks comply with generally accepted international standards.

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