India’s Banking Sector and Monetary Policy

India’s Banking Sector and Monetary Policy

PRIMARY FUNCTION

• It is a Measure of Value.
• It is a Medium of Exchange
• It is a unit of account

SECONDARY FUNCTION

• Store of Value.
• Transfer of Value.
• It can help in making deferred payments

CONTINGENT FUNCTION

• Basis of Credit System.
• Distribution of national income.
• Liquidity of Money

• Transaction Motive– to carry out transactions.
• Speculative Motive –when holding money is perceived to be less risky than lending the money or investing.
• Precautionary Motive – to meet the unforeseen circumstances in future. E.g. a car accident, home repairs etc.

• It refers to the amount of money in circulation at a given point in the economy.
• The measures of money supply in India are classified into four categories M1, M2, M3 and M4 along with M0
• Reserve Money (M0) – Currency in circulation + Bankers’ Deposits with the RBI + ‘Other’ deposits with the RBI.
• High – Powered Money: The total liability of the monetary authority of the country, RBI, is called the monetary base or high powered money.

M0 = Currency in Circulation + Bankers’ Deposits with RBI + Other deposits with RBI

Narrow Money: M1 is called narrow money as it is highly liquid and banks cannot run their lending programmes with this money.

M1 = Currency with the Public + Demand Deposits with the Banking System + ‘Other’ deposits with the RBI.

• M2 = M1 + Savings deposits of post office savings banks
• Broad Money (M3) = M1 + Time deposits with the banking system. It is also known as Aggregate Monetary Resources. It is the stock of total money.
• M4 = M3 + All deposits with post office savings banks.
• The liquidity in descending order is – M1>M2>M3>M4

• Only a fraction of bank deposits are backed by actual cash on hand and available for withdrawal and in the process creating money.

• It measures the amount of money the banks are able to create in the form of deposits with every unit of money it keeps as reserves.
• It is Broad money (M3) ÷ Reserve Money (M0).
• When Reserve money increases, Broad money will also increase.
• Example – If the money multiplier is 6, it means that It signifies that for every unit of money kept as cash reserves, banks are able to create 6 units of money.

• Minimum rate at which the RBI provides loan to commercial banks

• Rate at which the RBI lends to the commercial banks to manage short term needs of liquidity with an agreement to repurchase the same government securities at a predetermined date and rate is called Repo Rate.

• Interest rate at which the Reserve Bank absorbs liquidity, on an overnight basis, from banks against the collateral of eligible government securities under the LAF.
• It is lower than the repo rate.

• It is a tool under which the RBI provides 1 – 3 year money to banks at the prevailing repo rate, accepting government securities with matching or higher tenure as the collateral.
• LTRO scheme will be in addition to the existing Liquidity Adjustment Facility (LAF) and the Marginal Standing Facility (MSF) operations

• CRR is decided by RBI’s Monetary Policy Committee.
• Banks are required to maintain with the Reserve Banka certain percent of its Net demand and time liabilities (NDTL) as specified by RBI.
• Banks do not get any interest on the money that is with the RBI under the CRR requirements

Liquidity Adjustment Facility

• LAF allows commercial banks and primary dealers to borrow money through repurchasing agreements or repos/reverse repos.
• It is used to aid banks in adjusting the daily fluctuations in liquidity.
• It allows banks to park their excess money with the RBI in case of excess liquidity or to avail liquidity from the RBI at the time of deficit on an overnight basis against the collateral of government securities.

• It is the purchase and sale of securities by the RBI.

• It is a penal rate at which scheduled banks can borrow money from the RBI over and above what they can borrow from the RBI under the LAF window.
• It is always fixed at a higher rate than the Repo rate.
• Aim– reduce volatility in the overnight lending rates in the interbank market.

• SLR is that % of the deposits which the banks have to hold with themselves in highly liquid government securities.
• To ensure that banks don’t lend away all their funds and always have enough liquidity.

• It is the difference between the current value of the security offered for a loan (called collateral) and the value of the loan granted.
• Higher the Margin, Lesser will be the loan granted.
• Example, If the RBI feels that more credit should be allocated to priority sectors, then it will reduce the margin.

• Central Bank fixes a limit on the credit amount to be granted by each commercial bank. Helps in lowering banks credit exposure to unwanted sectors.

• Issue Directives, meetings, Persuasion and pressure, Inspections and frequent follow ups.

• Impose fines, ban non cooperating banks, refuse rediscounting of their bills, refuse credit supply.

• MSS securities are issued to suck out excess liquidity from the market through issue of securities like Treasury Bills, Dated Securities etc. on behalf of the government.
• The amount raised under the MSS is maintained with the RBI.

• It is the minimum rate set by the Reserve Bank of India below which banks are not allowed to lend to its customers.
• The main components of base rate system are:

1. Cost of funds (interest rates offered by banks on deposits)

2. Cost of maintaining CRR.

3. Profit margin.

4. Operating expenses to run the bank.

• It does not consider ‘repo rate’ in their calculations. Effective Monetary Transmission was not happening.

MCLR – Marginal Cost Of Funds Based Lending Rates

• It replaced Base rate to determine the lending rates for commercial banks.
• It is the minimum interest rate that a bank can lend at.
• It is a tenor – linked internal benchmark, meaning the rate is determined internally by the bank depending on the period left for the repayment of a loan.
• MCLR is closely linked to the actual deposit rates and is calculated based on four components:

1. Marginal cost of funds

2. Tenor premium

3. Operating costs

4. Negative carry on account of cash reserve ratio

• It is the difference between the sum of demand and time liabilities (deposits) of a bank (with the public or the other bank) and the deposits in the form of assets held by the other banks.

• It is a tradable instrument issued by the central government or state governments.
• Short term G-secs (with original maturities of less than one year) are called Treasury Bills.
• Long term G-secs (with original maturities of more than one year) or long term are called Government Bonds or Dated Securities.
• Treasury Bills are not issued by State Governments while Government Bonds or Dated securities are issues both by State and Central Governments

• refers to the ‘aggregate of gross additions to fixed assets (that is fixed capital formation) plus change in stocks during the counting period.’

• It is an online image-based cheque clearing system undertaken by the RBI for faster clearing of cheques.
• It eliminates the associated cost of movement of physical cheques.

• APPOINTMENT– Appointed after the proposal made by the Financial Sector Regulatory Appointments Search Committee (FSRASC), headed by the Cabinet Secretary.
• TERM – According to Section 8 (4) of the RBI Act, the Governor and Deputy Governors shall hold office for such term not exceeding 3 years as the Central Government may fix when appointing them.
• RE-APPOINTMENT – They are eligible for re-appointment
• QUALIFICATION – The RBI Act does not provide for any specific qualification for the governor.
• REMOVAL – The governor can be removed by the central government.

• With a minimum value of government-held gold of ₹200 crores (₹115 cr rupee should be in the form of Gold or gold bullion and rest ₹85 cr should be in the form of foreign currencies) and the remaining is backed by the government securities issued and held by RBI.

2. Bharatiya Reserve Bank Note Mudran Private Limited (BRBNMPL)

3. Reserve Bank Information Technology Private Ltd. (ReBIT)

4. Indian Financial Technology And Allied Services (IFTAS)

• Returns from foreign currency assets
• Interest on rupee-denominated government bonds
• Interest on overnight lending to commercial banks
• Management commission on handling the borrowings of central and state governments.

• Printing of currency
• Staff expenditure
• Commission given to commercial banks
• Commission to primary dealers

• Currency held by Public
• Vault cash held by commercial banks
• Government securities
• Other liabilities

• Foreign currency assets
• Bill purchases and discounts
• Collaterals by commercial banks
• Loan and advances
• Rupee securities
• Gold coin bullion

2. Financial stability report- Half yearly

3. Monetary policy report- Half yearly

4. Report on foreign exchange reserves- Half yearly

5. Bi-monthly Policy Statement

6. Industrial Outlook Survey of the Manufacturing Sector (Quarterly)

7. Consumer Confidence Survey (Quarterly)

8. Report on Financial Review

Scheduled Bank

• SBs are eligible for loans from the Reserve Bank of India at bank rate.

• Required to deposit CRR with RBI.

• Types are – Commercial Banks and Cooperative Banks.

Non – Scheduled Bank

• Depends on RBI discretion

• Can maintain CRR with themselves, not with RBI

• Many co-operative banks are non – scheduled

• Private Sector Banks-most of the capital is in private hands.

• Foreign Banks

• State

• Multi – State

• Payments Banks.

• Regional Rural Banks.

Development Bank

• SIDBI

• EXIM

• NHB

• IFCI

• IFCI was the first specialized financial institution set up in 1948 to provide term finance to large industries in India, under the Industrial Finance Corporation Act of 1948.

• National Bank for Agriculture and Rural Development (NABARD) is an apex development financial institution in India to provide finance for agriculture and rural development.
• Established in 1982 on the recommendations of B. Sivaraman Committee.
• It is a statutory body established in 1982 under Parliamentary act – NABARD Act, 1981.
• Its headquarter is located in Mumbai.
• NABARD today is fully owned by the Government of India. The authorized share capital is about Rs.30,000 crore.
• It is responsible for the development of the small industries, cottage industries, and any other such village or rural projects.
• NABARD operates Rural Infra. Development fund (RIDF) from PSL shortfalls from SCBs.
• NABARD is also known for its “SHG Bank Linkage Programme” (1992) which encourages India’s banks to lend to SHGs. 

FUNCTIONS: Undertakes monitoring and evaluation of projects refinanced by it + Regulates the cooperative banks and the RRBs + Refinances the financial institutions which finance the rural sector + Provides training facilities to the institutions working in the field of rural upliftment. 

REFINANCE FACILITY BY NABARD IS AVAILABLE TO:

1. State co-operative agriculture and rural development banks (SCARDBs),

2. State co-operative banks (SCBs),

3. Regional rural banks (RRBs),

4. Commercial banks (CBs) and

5. Other financial institutions approved by RBI.

• Small Industries Development Bank of India (SIDBI) is a statutory body set up on 2nd April 1990 under an Act of Indian Parliament, acts as the Principal Financial Institution for Promotion, Financing and Development of the Micro, Small and Medium Enterprise (MSME) sector as well as for co-ordination of functions of institutions engaged in similar activities.
• Schemes like Pradhan Mantri MUDRA Yojana, credit linked capital subsidy scheme are implemented by it.

• It is a wholly owned Govt. of India entity established in 1982.
• Aim– financing, facilitating and promoting foreign trade of India

• Created in 1988 under National Housing Bank Act (1987).
• It regulates and re-finances social housing programs and other activities like research etc.

• Introduced in India in the year 1996 based on Budget-1996 by the then Finance Minister, Dr. Manmohan Singh.
• Unlike RRBs, they’re not set up by Union or State governments or by any special act of the parliament, but by private entities, simply applying to RBI under Banking Regulation Act.
• Each Local Area bank is registered as a public limited company under the Companies Act, 1956. However, they are licensed under the Banking Regulation Act, 1949.
• Earning profit is the main objective of Local Area Banks
• They are Non-Sch. Banks – CRR, SLR, PSL applicable.

• NBFC cannot accept demand deposits;
• Cannot issue cheques drawn on itself;
• Deposit insurance facility of DIGCG is not available to depositors of NBFCs;
• Norm of Public Sector Lending does not apply to NBFCs;
• Cash Reserve Requirement also does not apply to NBFCs;
• Regulated by multiple regulators

2. RESTRUCTURING – Strategic Debt Restructuring, Scheme for Sustainable Structuring of Stressed Assets (S4A), Joint Lenders Forum.

3. RECOVERY – SARFAESI ACT, 2002 and Insolvency and Bankruptcy Code, 2016 

NOTE: Reserve Bank of India (RBI) has set up a committee headed by K.V. Kamath on restructuring of loans impacted by the Covid-19 pandemic.

SUSTAINABLE STRUCTURING OF STRESSED ASSETS (S4A)

• It is an optional framework for the resolution of largely stressed accounts and a tool for financial restructuring.
• PROCESS: bank hires an independent agency à it will evaluate how much of the stressed asset is sustainable and how much is unsustainable à it will convert the unsustainable debt into equity à no change of ownership of the company, unlike in strategic debt restructuring à helps in financial restructuring.

• A bad bank is a set up to buy the bad loans and other illiquid holdings of another financial institution and do the loan restructuring and absorb losses.
• Economic Survey 2016 – 17suggested public sector asset rehabilitation agency(PARA)to resolve the twin problems of ‘balance sheet syndrome’ (of the banks as well as the corporate sector),
• PARA is a proposed Bad Bank that will buy bad loans from public sector banks.

• The PCA framework considers banks as risky if they fall below certain norms on three parameters — capital ratios, asset quality and profitability.
• Certain restrictions such as halting branch expansion and stopping dividend payment, restrictions in branch expansion, higher provisions etc are put in place.

• Narasimham Committee (1998) recommended setting up an ARC. It is a specialized financial institution that buys the NPAs or bad assets from banks and financial institutions so that the latter can clean up their balance sheets.

• It provides the legal basis for the setting up ARCs in India to tackle wilful defaulters.
• Under this, a lender can take possession of the property or mortgaged assets after giving the borrower a 60 – day notice.
• It is not applicable to unsecured creditors.
• Not applicable on Farm Loans.

• Lenders can recover their dues by approaching a DRT and get a recovery certificate. It allows lenders to take possession of properties of borrowers anywhere in the country and sell them to recover dues.
• Appeals against orders passed by DRTs lie before Debts Recovery Appellate Tribunal (DRAT).
• It can go beyond the Civil procedure Code.

• To enable online auction by banks of attached assets transparently and cleanly for the improved realization of value, eBkry is launched.
• It has property search features and contains navigational links to all PSBs e – auction sites.
• eBkry also contains photographs and videos of the properties uploaded on the platform.

• CAR/Capital to Risk Weighted Assets Ratio (CRAR) is the ratio of a bank’s capital to its risk.
• The higher the CRAR of a bank the better capitalized it is.

• It is the primary funding source of the bank.
• Tier 1 capital consists of shareholders’ equity and retained earnings.

• Tier 2 capital includes revaluation reserves, hybrid capital instruments and subordinated term debt, general loan – loss reserves, and undisclosed reserves.
• Tier 2 capital is considered less reliable than Tier 1 capital because it is more difficult to accurately calculate and more difficult to liquidate

• It is a form of bank guarantee under which a bank can allow its customer to raise money from another Indian bank’s foreign branch in the form of a short term credit.

• Maintained by Indian banks in foreign countries where they have operations for facilitating easy clearing of their transactions.

• The account maintained by foreign banks in India with their corresponding banks is called vostro accounts.

• It is a messaging network used by banks to securely send and receive information, such as money transfer instructions.

• Are part of the financial system where credit activities remain outside the regular banking system.
• They are those institutions that do not collect deposits but still provide loans.
• Liabilities of the shadow banks are uninsured.

• Based on the recommendation of Naresh Chandra Committee on corporate governance
• SFIO is a fraud investigating agency in India under the Ministry of Corporate Affairs
• investigates white – collar crimes

• It is the bank’s own deposits that are used to rescue the bank or reduce its liabilities.

• Involves the rescue of a financial institution by external parties, typically governments using taxpayer’s money.

• A wilful defaulter is an entity or a person that has not paid the loan back despite the ability to repay it.

• Fixed deposits, Cumulative/ recurring deposits, Staff security deposit etc.
• Banks are legally not required to pay customers before maturity but may pay after deducting penalty/ interest.

• Current Account, Savings Account, Demand Draft
• Overdue balance in Fixed Deposits
• Unclaimed deposits

• Core Banking Solutions (CBS) or Centralised Banking Solutions is the process which is completed in a centralized environment i.e. under which the information relating to the customer’s account (i.e. financial dealings, profession, income, family members etc.) is stored in the Central Server of the bank (that is available to all the networked branches) instead of the branch server.

Selective Credit Control

• Selective credit control refers to a qualitative method of credit control by the central bank. The method aims, unlike general or quantitative methods, at the regulation of credit taken for specific purposes or branches of economic activity.
• It aims at encouraging good credit, i.e., development credit while at the same time discouraging bad credit, i.e., speculative credit.

• Increased efficiency of banks
• Better Monitoring
• Better Capital Adequacy of the Consolidated Banks.
• Merger helps reduce Cost of operation.
• Helps improve the professionalism and competency of banks.

• Bad Loans of the Associate bank can drag down the good bank’s performance.
• Larger Banks are more vulnerable to economic crisis
• Difficult to manage people and different attitudes
• Merger destroys the idea of Decentralisation
• Many Bank Branches have been closed after mergers – affecting financial inclusion.

• Insolvency is a state where the liabilities of an individual or an organization exceeds its asset and that entity is unable to raise enough cash to meet its obligations or debts as they become due for payment.

• When an individual is unable to pay off his liabilities and debts then he generally files for bankruptcy. Here he asks for help from the government to pay off his debts to his creditors.
• Bankruptcy could have two types, namely, reorganization bankruptcy and liquidation bankruptcy. Usually people tend to restructure the repayment plans to pay them easily under reorganization bankruptcy. And under liquidation bankruptcy, the debtor tends to sell off certain of their assets to pay off their debts for their creditors.

• Nidhis are included in the definition of NBFCs.
• They are companies registered under the Companies Act, 1956 and are regulated by the Ministry of Corporate Affairs.
• Created for cultivating the habit of thrift and savings amongst its members.
• It receives deposits from, and lends to its members only, for their mutual benefit.
• It works on the principle of mutual benefits that are regulated by the Ministry of Corporate Affairs.

• It is a type of saving scheme where a specified number of subscribers contribute payments in installments over a defined period.
• Concurrent List
• RBI does not regulate the chit fund business and SEBI Act specifically excludes chit funds.
• Chit fund business is regulated under the Central Chit Funds Act, 1982 and the rules framed under this Act by the various state governments for this purpose.

• These schemes promise high returns with little or no risk.
• The Ponzi scheme generates returns for older investors by acquiring new investors. example – Saradha Scam.

• Owned, managed and installed by banks.

Brown label ATMs

• Owned by a third party (a nonbanking firm).
• The concerned banks only handle part of the process that is ‘cash handling’ and ‘back – end server’ connectivity.
• They carry ‘logo’ of the bank which outsources their service

• ‘Owned’ and ‘operated’ by a third party (a non – banking firm).
• They do not bear the ‘logo’ of the banks they serve (that is why such a name).
• In place, they carry the logo of the firm which owns them.

• Greater use of Aadhaar and mobile numbers for making digital payments as easy as cash.
• Inter – operable payments between bank and non – banks as well as within non – banks.
• Proposed to make digital payment regulation independent from the RBI.

• NPCI, an umbrella organisation for operating retail payments and settlement systems in India,
• It is an initiative of RBI and Indian Banks’ Association (IBA) under the provisions of the Payment and Settlement Systems Act, 2007, for creating a robust Payment & Settlement Infrastructure in India.
• It is a “Not for Profit” Company under the provisions of Section 25 of Companies Act 1956 (now Section 8 of Companies Act, 2013).
• Various NPCL operated systems are-
• Bharat Interface for Money-Unified Payments Interface (BHIM-UPI):
• BHIM is based on Unified Payment Interface (UPI) to facilitate e-payments directly through banks. It is an app. This is a system that powers multiple bank accounts into a single mobile application. It also caters to the “Peer to Peer” collect request which can be scheduled and paid as per requirement and convenience.
• Aadhaar enabled Payment System (AePS): It allows people to carry out financial transactions on a Micro-ATM by furnishing just their Aadhaar number and verifying it with the help of their fingerprint/iris scan.
• National Electronic Toll Collection (NETC): It helps in electronic toll collection at toll plazas using FASTag.
• National Automated Clearing House (NACH): It is a service offered by NPCI to banks which aims at facilitating interbank high volume, low value debit/credit transactions, which are repetitive and electronic in nature.
• Immediate Payment Service (IMPS): It offers an instant 24×7 interbank electronic fund transfer service through mobile phones.
• Bharat Bill Payment System (BBPS): Under BBPS, the Bharat Bill Payment Operating Units (BBPOUs) function as entities facilitating collection of repetitive payments for everyday utility services, such as, electricity, water, gas, telephone and Direct-to-Home (DTH).
• Rupay: The name, derived from the words ‘Rupee and ‘Payment’, emphasizes that it is India’s very own initiative for Card payments. It is an indigenously developed Payment System. It supports the issuance of debit, credit and prepaid cards by banks in India.

• It is an indigenously developed Payment System. It supports the issuance of debit, credit and prepaid cards by banks in India.