REGULATORY FRAMEWORK

Banks Credit Policy can be implemented provided Banks enjoy adequate level of liquidity. On the other hand Central Bank of the Country is required to control and regulate macroeconomic parameters e.g. Funds/Cash flow in the economy, interest rates, inflation etc. As such Central Bank (RBI in the Indian Context) is vested with the powers of laying down regulations that ultimately determine the levels of liquidity. One of the most widely adopted and frequently used by most Central Banks are Reserve requirements. All such reserves that are to be maintained as a legal requirements are referred to as Primary Reserves. In the Indian context these legal requirements fall in two categories: Cash Reserve Ratio (CRR) & Statutory Liquidity Ratio

(SLR). These two monetary policy of RBI ensure adequate liquidity and balanced monetary position at the macro level. CRR and SLR are required to be maintained by all the Commercial Banks, Only SLR is required to be maintained by Non-Banking Finance Companies, whereas neither CRR nor SLR is maintained by Development Financial Institutions (DFIs). CRR and SLR is required to be maintained by Banks as a percentage of their Net Demand and Time Liabilities. The % of CRR & SLR required to be maintained is prescribed by RBI from time to time depending upon prevailing macroeconomic variables existing at that time. As per RBI Act, minimum and maximum CRR, RBI

Can prescribe ranges between 3% and 15% of NDTL, whereas minimum and maximum in case of SLR can range between 25% and 40%. Constituents of Cash Reserves: CRR: With regard to CRR, Reserve can be in the form of cash balance (i) in an account for the purpose with RBI (ii) Cash balances kept in the Currency chest of the Bank Branch SLR: With regard to SLR, Reserve can be kept by the bank in the form of (i) cash balance with RBI (ii) Net balances in the current accounts maintained with the nationalised banks (iii) unencumbered approved securities for the purpose

The approved securities will generally include all securities issued by the Central/State Govt., bodies that have the guarantee of the Government and all such securities which have the approval of the RBI to be categorised as approved security for SLR purpose.(iv) Gold NET DEMAND & TIME LIABILITIES(NDTL) Liabilities of the Bank can be (i) Internal Liabilities e.g. Equity, Provisions (ii) External Liabilities i.e. Liabilities to outsiders Net Demand & Time Liabilities take into account liabilities to outsiders only. Further, NDTL = Net Inter Bank Liabilities (NIBL) + Liabilities to Others

 Net Inter Bank Liabilities= Liabilities to Banking

system Assets With Banking System Banking System includes all commercial banks, co-operative banks, DFHI, PNB/SBI Gilts, ICICI Securities Finance Company Ltd.& any other institution notified by Central Government Banking System does not include RBI, IDBI, EXIM Bank, NABARD, IRBI, SIDBI etc. basically FIs. Assets with Banking System: Deposits with Banking System Call & Short Notice money to Banking system

 Any other Loans made available to the Banking System Any other amount due from the banking system. Demand & Time Liabilities that are to be included for NDTL Computation: - Current Account & SB Deposits - Balances in Fixed Deposits - Margins held against L/cs & BGs - Unclaimed deposits - Credit balances in the Cash-Credit Account - Outstanding DDs/TTs/MTs - Deposits held as security for advances

- Interest accrued on deposits, Bills payable, unpaid dividends - Credit balance in suspense a/c - Net Credit balance in inter-branch adjustment a/c - Outstanding Balance in Block accounts - Gold borrowed from abroad by banks. While calculating Inter Bank Liabilities, All the assets with other Banks are netted against the Inter-bank liabilities. However, in case if interbank assets are > Inter Bank liabilities, the negative balance can not be taken into account for computation of NDTL.

 The portfolio of ABC Bank Ltd. include Rs.360 cr as liabilities to others. Consider the following positions of Inter-bank liabilities & assets and compute NDTL. (Rs./Crs) Liabilities (i) (ii) (iii) 90 80 50 Assets 40 80 60

 (i) NIBL = 90 40 = 50 NDTL = 360 + 50 = 410 (ii) NIBL = 80 80 = 0 NDTL = 360 + 0 = 360 (iii) NIBL = 50 60 = -10 NDTL = 360 + 0 = 360 Liabilities not to be included in NDTL computation: -Any Loan or refinance from RBI, Exim Bank, NHB NABARD, SIDBI etc. -Amount received from DICGC, ECGC, Insurance Company pending adjustment etc.

 Reporting Friday and period of maintenance: Every alternate Friday is considered as Reporting Day on which primary reserves are calculated and are maintained for a period of 14 days from Saturday onwards. In case if reporting Friday is a holiday, then reserves are calculated as on the balances of previous working day. From the level of NDTL, all the liabilities that are exempted from the maintenance of statutory liabilities are deducted to arrive at Reservable Liabilities (RL) on which the rate of prevailing CRR or SLR is applied. However, there may be certain liabilities on which differential rate as

Prescribed by RBI are applied. Total Reserve=Reserve computed on common rate + Reserve computed on differential rate CRR: CRR is maintained as higher of (a) 3% of NDTL or (b) Prevailing % on RL as announced by RBI from time to time

 Concept of Reporting Friday: Prior to 6/11/1999, banks had to maintain cash reserves for a fortnight, which commences on the day that immediately follows the reporting friday i.e. if reporting Friday is say 23rd October then maintenance period is 24th October to 6th November. But by following this criteria banks used to face lot of difficulty in calculating NDTL & RL expeditiously on the close of business on Friday and then immediately maintaining the Reserve requirement from the next day. Often banks used to default on the maintenance of Reserve requirements for first few days since

 Actual calculations used to be available only after few days. The estimations made by the banks regarding NDTL & RL on the reporting Friday often used to lend the banks in maintaing erroneous reserves, pressures on the last days of fortnight or loss of investment opportunities. On account of above problems, RBI revised the concept of reporting Friday w.e.f.06/11/1999 and directed banks to maintain reserves for the fortnight based on the NDTL & RL of previous reporting Friday i.e. if reserves are to be maintained during the fortnight 24th October to 06th November, it will based on the NDTL & RL of previous reporting Friday i.e. 09/10/ and not

23/10/. This allowed time lag of two weeks, thereby accurate calculations. Yields & Penalities on CRR Yields RBI allows 4% interest on the reserves required to be maintained by the banks over and above minimum 3% of NDTL.

Penalties: There can be default on maintenance of CRR on two counts: (a) When daily balance of 85% is not maintained during the first 13 days of the fortnight Penalty: No interest will be paid by RBI for the days minimum 85% of CRR is not maintained. (b) When bank fails to meet the total reserve requirement for the fortnight. Penalty @25% p.a. of the shortfall and also lose interest on the amount of shortfall.

 SLR: HIGHER of 25% on NDTL or prevailing % on RL as announced by RBI from time to time. Yields and penalties: SLR do earn better returns than CRR due to assets that comprises such reserves. While the cash in current account balances of RBI/Banks will not fetch any returns but investments in Gold and approved securities will earn higher returns. Moreover, unlike CRR balances, higher investment for SLR purpose in approved securities and Gold will also fetch

 Returns. Unlike CRR, 100% of calculated SLR is required to be maintained on daily basis. RBI will levy a penal interest for the day default occurs at the rate of 3% p.a. above the Bank rate on the shortfall and if default continues for the next working day, it will be increased to 5% p.a. above the Bank rate on the shortfall of all the defaulted days.