1. How
banks can avoid borrowings from money market at a very high interest? Explain
ur answer.
2. Describe the various core
principles of insurance companies on which they operate?
3. In
the event of bank failures, can adequate capital really contribute to prevent
it? Explain in brief the tolls available for managing credit risks.
4. What
is the investment bank? Explain how investment banks take part in share
issuance and underwriting of a company?
5. What
is the core liability of a commercial bank? How can a commercial banks judged
through CAMELS rating?
6.
Discuss the differences between Bank and Non-Bank Financial Institution (NBFI).
What r the sources and uses of funds of NBFI?
7. Is
liability management and capital adequacy management crucial for the smooth
functioning of a Financial institution? Discuss briefly.
Basic Insurance Principles
Insurance
is based on two principles: risk transference and the law of large
numbers.
Risk transference,
sometimes called ‘pooling’, involves the transfer of risk from the individual
to a pool of the insurance company’s policyholders. The insurance company
charges a fee, the premium (or part thereof), for accepting the risk and
‘pools’ the premiums from a group of policyholders into a general fund to fund
the death benefits under contract.
The law of large numbers
basically relies on the principle that the larger the pool, the more
predictable the amount of losses will be in a given period. Since not all members
of the pool are the same age or in the same health condition, we can assume not
all of them will be making a claim at the same time.
Understanding Principles of Insurance
The main objective of every insurance contract is
to give financial security and protection to the insured from any future
uncertainties. Insured must never ever try to misuse this safe financial cover.
Seven Principles
of Insurance With Examples
The seven principles of insurance are :-
- Principle of Uberrimae fidei (Utmost Good Faith),
- Principle of Insurable Interest,
- Principle of Indemnity,
- Principle of Contribution,
- Principle of Subrogation,
- Principle of Loss Minimization, and
- Principle of Causa Proxima (Nearest Cause).
1. Principle of
Uberrimae fidei (Utmost Good Faith)
Principle of Uberrimae fidei (a Latin
phrase), or in simple english words, the Principle of Utmost Good Faith,
is a very basic and first primary principle of insurance. According to this
principle, the insurance contract must be signed by both parties (i.e insurer
and insured) in an absolute good faith or belief or trust.
The person getting insured must willingly
disclose and surrender to the insurer his complete true information regarding
the subject matter of insurance. The insurer's liability gets void (i.e legally
revoked or cancelled) if any facts, about the subject matter of insurance are
either omitted, hidden, falsified or presented in a wrong manner by the
insured.
The principle of Uberrimae fidei
applies to all types of insurance contracts.
2. Principle of
Insurable Interest
The principle of insurable interest states that
the person getting insured must have insurable interest in the object of
insurance. A person has an insurable interest when the physical existence of
the insured object gives him some gain but its non-existence will give him a
loss. In simple words, the insured person must suffer some financial loss by
the damage of the insured object.
For example :- The owner of a taxicab has
insurable interest in the taxicab because he is getting income from it. But, if
he sells it, he will not have an insurable interest left in that taxicab.
From above example, we can conclude that,
ownership plays a very crucial role in evaluating insurable interest. Every
person has an insurable interest in his own life. A merchant has insurable
interest in his business of trading. Similarly, a creditor has insurable
interest in his debtor.
3. Principle of
Indemnity
Indemnity means security, protection and
compensation given against damage, loss or injury.
According to the principle of indemnity, an
insurance contract is signed only for getting protection against unpredicted
financial losses arising due to future uncertainties. Insurance contract is not
made for making profit else its sole purpose is to give compensation in case of
any damage or loss.
In an insurance contract, the amount of
compensations paid is in proportion to the incurred losses. The amount of
compensations is limited to the amount assured or the actual losses, whichever
is less. The compensation must not be less or more than the actual damage.
Compensation is not paid if the specified loss does not happen due to a
particular reason during a specific time period. Thus, insurance is only for
giving protection against losses and not for making profit.
However, in case of life insurance,
the principle of indemnity does not apply because the value of human life
cannot be measured in terms of money.
4. Principle of
Contribution
Principle of Contribution is a corollary of the
principle of indemnity. It applies to all contracts of indemnity, if the
insured has taken out more than one policy on the same subject matter.
According to this principle, the insured can claim the compensation only to the
extent of actual loss either from all insurers or from any one insurer. If one
insurer pays full compensation then that insurer can claim proportionate claim
from the other insurers.
For example :- Mr. John insures his property
worth $ 100,000 with two insurers "AIG Ltd." for $ 90,000 and
"MetLife Ltd." for $ 60,000. John's actual property destroyed is
worth $ 60,000, then Mr. John can claim the full loss of $ 60,000 either from
AIG Ltd. or MetLife Ltd., or he can claim $ 36,000 from AIG Ltd. and $ 24,000
from Metlife Ltd.
So, if the insured claims full amount of
compensation from one insurer then he cannot claim the same compensation from
other insurer and make a profit. Secondly, if one insurance company pays the
full compensation then it can recover the proportionate contribution from the
other insurance company.
5. Principle of
Subrogation
Subrogation means substituting one creditor for
another.
Principle of Subrogation is an extension and
another corollary of the principle of indemnity. It also applies to all
contracts of indemnity.
According to the principle of subrogation, when
the insured is compensated for the losses due to damage to his insured
property, then the ownership right of such property shifts to the insurer.
This principle is applicable only when the
damaged property has any value after the event causing the damage. The insurer
can benefit out of subrogation rights only to the extent of the amount he has
paid to the insured as compensation.
For example :- Mr. John insures his house
for $ 1 million. The house is totally destroyed by the negligence of his
neighbour Mr.Tom. The insurance company shall settle the claim of Mr. John for
$ 1 million. At the same time, it can file a law suit against Mr.Tom for $ 1.2
million, the market value of the house. If insurance company wins the case and
collects $ 1.2 million from Mr. Tom, then the insurance company will retain $ 1
million (which it has already paid to Mr. John) plus other expenses such as
court fees. The balance amount, if any will be given to Mr. John, the insured.
6. Principle of
Loss Minimization
According to the Principle of Loss Minimization,
insured must always try his level best to minimize the loss of his insured
property, in case of uncertain events like a fire outbreak or blast, etc. The
insured must take all possible measures and necessary steps to control and
reduce the losses in such a scenario. The insured must not neglect and behave
irresponsibly during such events just because the property is insured. Hence it
is a responsibility of the insured to protect his insured property and avoid
further losses.
For example :- Assume, Mr. John's house is
set on fire due to an electric short-circuit. In this tragic scenario, Mr. John
must try his level best to stop fire by all possible means, like first calling
nearest fire department office, asking neighbours for emergency fire
extinguishers, etc. He must not remain inactive and watch his house burning
hoping, "Why should I worry? I've insured my house."
7. Principle of
Causa Proxima (Nearest Cause)
Principle of Causa Proxima (a Latin
phrase), or in simple english words, the Principle of Proximate (i.e Nearest)
Cause, means when a loss is caused by more than one causes, the proximate or
the nearest or the closest cause should be taken into consideration to decide
the liability of the insurer.
The principle states that to find out whether the
insurer is liable for the loss or not, the proximate (closest) and not the
remote (farest) must be looked into.
For example :- A cargo ship's base was
punctured due to rats and so sea water entered and cargo was damaged. Here
there are two causes for the damage of the cargo ship - (i) The cargo ship
getting punctured beacuse of rats, and (ii) The sea water entering ship through
puncture. The risk of sea water is insured but the first cause is not. The
nearest cause of damage is sea water which is insured and therefore the insurer
must pay the compensation.
However, in case of life insurance, the principle
of Causa Proxima does not apply. Whatever may be the reason of
death (whether a natural death or an unnatural death) the insurer is liable to
pay the amount of insurance.
Definition of 'Investment Bank - IB'
A financial intermediary that
performs a variety of services. Investment banks specialize in large and
complex financial transactions such as underwriting, acting as an intermediary
between a securities issuer and the investing public, facilitating mergers and
other corporate reorganizations, and acting as a broker and/or financial
adviser for institutional clients. Major investment banks include Barclays,
BofA Merrill Lynch, Warburgs, Goldman Sachs, Deutsche Bank, JP Morgan, Morgan
Stanley, Salomon Brothers, UBS, Credit Suisse, Citibank and Lazard. Some
investment banks specialize in particular industry sectors. Many investment
banks also have retail operations that serve small, individual customers.
Bank and
NBFI
A Bank is an organization that accepts customer
cash deposits and then provides financial services like bank accounts, loans,
share trading account, mutual funds, etc.
A NBFC (Non Banking Financial Company) is an organization that does not accept customer cash deposits but provides all financial services except bank accounts.
a) A bank interacts directly with customers while an NBFI interacts with banks and governments
(b) A bank indulges in a number of activities relating to finance with a range of customers, while an NBFI is mainly concerned with the term loan needs of large enterprises
(c) A bank deals with both internal and international customers while an NBFI is mainly concerned with the finances of foreign companies
(d) A bank's man interest is to help in business transactions and savings/ investment activities while an
NBFI's main interest is in the stabilization of the currency
A NBFC (Non Banking Financial Company) is an organization that does not accept customer cash deposits but provides all financial services except bank accounts.
a) A bank interacts directly with customers while an NBFI interacts with banks and governments
(b) A bank indulges in a number of activities relating to finance with a range of customers, while an NBFI is mainly concerned with the term loan needs of large enterprises
(c) A bank deals with both internal and international customers while an NBFI is mainly concerned with the finances of foreign companies
(d) A bank's man interest is to help in business transactions and savings/ investment activities while an
NBFI's main interest is in the stabilization of the currency
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