BANKING IN INDIA Banks are perbaps the most important financial intermediary. In the nineteenth century, banks mainly lent nioney to firms to help finance their inventories — which were held as colateral- in the cases of defaulters banks seized them. Gradual, bantes expanded their lending activites — to finance houses and commercial real estates — bolding the buildings as collateral. Emergence of the information technology has presented special problems to these traditional forms of finance ~ if the idea does not pan out, the firm ‘may go bankrupt, but there is no collateral — there is little of value that the creditor can stize.* Financial Sector Reforms » Introduction > > Bank & Non-Bank Institutions» Banking Sector Reform > Non-Banking Financial » New Rules for Opening Banks Companies (NBFCs) > The Menace of NPAs » Reserve Bank of India » Capital Adequacy Ratio » Base Rate f » Why to maintain CAR? i sation an » Non-Resi > Sm bi ‘esident Indian Deposits > coc sgseise ualizane Gre wast tronemics: WH Marton New Tk USA, ‘ath Edition, 2006, P. 205. Scanned with CamScannershe term ; The sense in which we today use banking has its origin in the western world to Which India was introduced by the British rulers, way back in the 17° water has flown and today Indian banks are century. Since then, enough considered among the best banks in the developing world and its attempts to emerge among the best in the world is going on as the Union Budget 2007-08 said ‘ BANK & NON-BANK INSTITUTIONS A financial institution which accepts differ forms of deposits and lends them to the prospective borrowers as well as allows the depositors to withdraw their money from the 1k: If the financial institution has all the same accounts by cheque is a functions but does not allow depositors to issue d withdraw their money from deposits chequ then it is a non-bank institution. NON-BANKING FINANCIAL COMPANIES (NBFCs) A non-banking financial company (NBFC) is a company! registered under the Compani Act, 1956 and is engaged in the business of loans and advances, acquisition of shares/stock/ bonds/debentures/securities issued by government ot local authority or other securities ofllike marketable nature, leasing, hire-purchase, insurance business, chit business, but does not include any institution whose principal business ‘ndian hav of ageiculture activity, incase) that of ag te i Fpurchase/COnsteuction OF imp, i, sale/f My property A non-ba and which aking institution which ig, its principal business of ny scheme oF atangemeny pe lending in any manner 8) a company (esiduy RNBO) te deposits wnder a8 other manner, ¢ non-banking financia banking company 4. NBFCs are doing functions akin toy panks, however there are a few differeneg, « {) An NBFC cannot accept demand dg {which are payable on demand) ie savings andl current accounts {@ Ie is not a part of the paymegy settlement system and as such cng cheques to its customers; and Deposit insurance facility is not aya for NBFC depositors unlike in cag y banks (It means the public deposits yj, them are ‘unsecured’. In case a Nip defaults in repayment of deposit, 4, depositor can approach Company [yy Board or Consumer Forum ot file a cig suit to recover the deposits). Under the RBI Act, 1934, the NBECs hi to get registered with RBI. However, to obvigg dual regulation, certain category of NBR which are regulated by other regulators ax exempted from the requirement of registatia with RBI such as: @ venture capital fund, merchant banking companies, stock broking companies register with Sebi; @i insurance company holding a valid certificate of registration issued by IRDA; i) nidbi companies under the Companies Ad, 1956; Gi) The discussion here is based on the updated informations released by the RBI, May 11, 2012. Scanned with CamScannering in india — — > chit companies under the Chit Funds Act © Vos ) housing finance companies regulated b © peional Housing Bank (of the RB), zr , company incorporated under the | Gompanies Acts 1956 and desirous of | rnencing business of the NBEC should haye Misnun net owned fund (NOB) of Rs 25 lakh ‘i edto Rs 2 crore from April 21, 1999). NBECs ; werd with RBI have been reclassified (since 06) as ~ the Asset Finance Company (ARC); vestment Company (IC); and the Loan C). Provisions for accepting To There is ceiling on acceptance of public deposits an NBFC maintaining requited NOF and CRAR and complying with the prudential norms can accept public deposits maximum upto 4 times of NOF; «Can offer the maximum 11% rate of interests Minimum investment grade credit rating (MIGR) is essential (may get itself rated by any of the four rating agencies namely, CRISIL, CARE, ICRA and FITCH Ratings India Pvt. Ltd); * Are allowed to accept/renew public deposits for a minimum period of 12 months and maximum period of 60 months; and «Effective from April 2004, cannot accept deposits from NRIs except deposits by debit to NRO account of NRIs provided such amount do not represent inward remittance or transfer from NRE/FCNR (B) account, however, the existing NRI deposits can be renewed (Note: diferent foreign aarrengy accounts the Indian bankes have been given as the (. 123 There is no ceiling on raising of deposits by RNBCs but every RNBC has to ensure that the amounts deposited and investments made by the company are not less than the aggregate amount of liabilities to the depositors. To secure the interest of depositors, such compares are required to invest in a portfolio comprising of highly liquid and secured instruments viz. Central/State Government securities, fixed deposit of scheduled commercial banks (SCB), Cettificate of deposits of SCB/FIs, units of Mutual Funds, etc. The amount payable by way of interest, premium, bonus or other advantage, by whatever name called by them in respect of deposits received shall not be less than the amount calculated at the rate of 5% (to be compounded annually) on the amount deposited in lump sum or at monthly or longer intervals; and at the rate of 3.5% (to be compounded annually) on the amount deposited under daily deposit scheme. Further, an RNBC can accept deposits for a minimum period of 12 months and maximum period of 84 months from the date of receipt of such deposit. Like the NBFCs they cannot accept deposits repayable on demand (it means they, too can not open saving and current accounts). | Reserve BANK OF INDIA ‘The Reserve Bank of India (RBI) was set up in 1935 (by the RBI Aa, 1934) as a private bank with two extra functions—regulation and control of the banks in India and being the banker of the Government. After nationalisation in 1949, it emerged as the central banking body of India and it did not remain a ‘bank’ in the technical sense. Since then, the governments have been ‘Scanned with CamScanner124 eee RBI handing over different functions* to the which stand today as given below: () Itis the issuing agency of the currency coins other than rupee one currency and coin (which are issued by the Ministry of Finance itself with the signature of the Revenue Secretary on the note) Distributing agent for the currency and coins issued by the Government. and @ Gii) Banker of the Government (iv) Bank of the banks/Bank of the last res0F% (w) Amhounees the credit and monetary policy for the economy: Stabilising the rate of inflation. wi) (vii) Stabilising the exchange rate of rupee. (sii) Keeper of the foreign currency reserve’ in the [Agent of the Government of India IMF Performing a variety of developmental and promotional functions under which it did Set up institutions like IDBI, SIDBI, NABARD, NEB, etc. Credit and Monetary Policy ‘The policy by which the desired level of money flow and its demand is regulated is known as the credit and monetary policy. All over the ‘world itis announced by the central banking body of the country—as the RBI announces itin India. Tn India there has been a tradition of announcing jt twice in a financial year—before the starting of the busy and the slack seasons. But in the reform period, this tradition has been broken. Now the RBI keeps modifying this as per the requirement of the economy, though the practice of the two policy announcements a year still continues. In India, a debate regarding autonomy to the RBI regarding announcement of the policy Narasimham Com en the started when recommended OF these lines. As the Ge, RBI it was Bimal Jalan who vocal eee * officially but it is believed ig wernment i ae given almost working auton this area. In most ‘of the developed econ | pieiceatab bane fonction with autonoms| powers in this area (bifurcation of politig | Pee economics). Though we lack such veécially open autonomy for the RBI and are better arnt enough by How le: ny tools by w ‘There are ma regulates the desired required kind of nei monetary policy —CRR, SLR, Repo rate, Reverse Repo fate, PLR, Exim rate, Small Saving Schemes’ inter jnterest changes for the instruments of Market, ete. est ra cRR The cash reserve ratio (CRR) is them} (fixed by the RBD of the total deposits ofa in India which is kept with the RBI in cai ‘This was fixed to be in the mange of 3@ cent.’ A recent Amendment (2007) ! the 3 per cent floor and provided a free bast the RBI in fixing the CRR. At present it is 4 per cent and 2 1p change in it today affects the econom ~96,000 crore*—an increase sucks this from the economy while a decrease i amount into the economy. Following the recommendations 7 Narasimham Committee on the Fi (1991) the Government started 1% changes concerning the CRR: 2, Based on the RBI Notonaliszation Act, 1949 and further announcements ofthe Government of n# MS 3. RBI Act, 1934, sub-section (1) of Section 42. 4. ‘Annual Policy Statement 2013-14, RB, May 3, 2013, N. Delhi Scanned with CamScannergonininindia — meee 6. reducing the ORR w: Q Set as the medium. term objective and itwas reduced gradually from its peak of 15 per cent in 1992 tg 4.5 per cent by June 20035, * After the RBI (Amendment) Act has been qacted in June 2006, the RBI can now preseribe ERR for scheduled banks without any floor o ailing ate thereby removing the sta prinimu CRR limit of 3 per cent fi) Payment of interest by the RBI on the CRR money to the scheduled banks started in financial year 1999-2000 (in the wake of banking slow down). Though the RBI discontinued interest payments from mid- 2007. tutory SLR ‘The statutory liquidity ratio (SLR) is the ratio (Gxed by the RBI) of the total deposits of a bank which is to be maintained by the bank with itself jnnon-cash form prescribed by the Government to be in the range of 25 to 40 per cent* ‘The ratio was cut to 25 per cent (done in October, 1997 after CFS suggestions)’. It used to be as high as 38.5 per cent. The CES has recommended the Government not to use this y by handing G-Secs to the banks. Inits place amarket-based interest on it should be paid by the Government it was being advised. However, there has been no follow up in this regard by the governments, The Government of India has removed the 25 per cent floor for the SLR by an Amendment (2007) providing the RBI a free hand in fixing it. By July 2013 it at 23 per cent. Bank Rate ‘The interest rate which the RBI charges on its long-term lendings is known as the Bank Rate: The clients who borrow through this route are the Gol, State governments, Banks, Financial Institutions, Co-operative Banks, NBFCs, etc. The fate has direct impact on the long-term lending activities of the concerned lending bodies operating in the Indian financial system. Tha rate was realigned " with the MSF (Marginal Standing Facility) by the RBI in February, 2012 Repo Rate The rate of interest the RBI charges from its clients on their short-term borrowing is the repo rate in India which is at present 7.25 per cent: Basically, this is abbreviated form of the ‘rate of repurchase’ and in western economies it is known as the ‘rate of discount’."> In practice itis not called an interest rate but considered a discount on the dated Government Securities which are deposited by the institution to borrow for the short term. When they get their securities released from the RBI, the value of the securities is lost by the amount of the current repo rate. This rate functions as the benchmark rate for the inter-bank short-term market (.e. Call Money Market) in India. Banks usually use this route for one-day borrowing to falfill their short-term liquidity crunch. Higher the repo rate costlier the loans banks forward and vice versa. It has direct impact on the nominal interest rates of the bank's lending. The repo rate was introduced in December 199: 5. Economic Survey, 2006-07, Mof, Gol, N. Delhi 6, RBI (Amendment) Act, 2006, Gol, N. Delhi 7. Credit and Monetary Policy, April 1, 2007, op. cit. and Banking Regulation Act, 1949 Section 24. 11 System (CFS) headed by the then RBI Deputy Governor M, Narasimhan, 1991 .cement on 15th Feb. 2012. ‘Statement 2013-14, RBI, 3rd May, 2013, N.Delhi ies, op. cit, P. 629-630. Scanned with CamScanner126 Reverse Repo Rate cher 8 th 3 of interest the RBI pays t0 its ents who offer short term loan to it. Atpresent Guly 2013) the rate is at 6,25 percent It is rev se of the repo rate and this was Started in November 1996 as part of Liquidity Adjustment Facility (LAF) by the RBI. In practice, financial instituions operating in India park theit surplus funds with the RBI for short-term period. and earn money. It has a direct bearing on the interest rates charged by the banks and the financial institutions on thei different forms of loans, This tool was utilised by the RBI in the wake of over money supply with the Indian banks and lower loan disbursal to serve twin purposes « cutting down banks losses and the prevailin interest rate". Ithas emerged as a very importan tool in direction of following cheap interest regime—the general policy of the RBI since reform process started, Marginal Standing Facility (MSF) ** MSF is a new scheme announced by the RBI in its Monetary Policy, 2011-12 which came into effect from 9th May 2011. Under this scheme, banks can borrow overnight upto 1 per cent of their net demand and time liabilities (NDTL) from the RBI, at the interest rate 1 per cent (100 basis points) higher than the current repo rate. In an attempt to strengthen rupee and checking its falling exchange rate, the RBI has increased the gap between ‘repo’ and MSF to 3 percent (late July 2013) and now it stands at 10.25 percent, ‘The MSF would be the last resort for banks once they exhaust ali borrowing options including the liquidity adjustment facility by pledging through government securities, which has lower rate (Le. repo rate) of interest in comparison with the MSE. The MSF would be a penal rate for banks and the banks can borrow funds by pledging ‘Survey 2001-02, Mo, Gol, N. Delhi s the Fed) Washington, DC, USA Indian at securities within the in, Tiquidity ratio. The scheme stanutory teal , srtroduced by RBI with the main aim gf hy overnight lending ‘volatility inthe overi 8 ae i Penk market and t enable smooth N i the financial system, governme ye ~ Tag transmission if = Banks can borrow through Mgp orking days excePt Saturdays, between 38 130 pm in Mumbai where Rp jy headquarters. The minimum amoung yet pe vaccessed through MSF is Rs crops) multiples of Rs:1 crore MSE represents the upper bang gp est corridor and reverse repo (7.25 pe ee ‘ sine lower band and the repo rate inthe B To balance the liquidity, RBI would use ie independent policy £ate which is the rey a and the MSF rate automatically adjuss te cent above the repo rate. Similar to India’s MSF the ECB (By Central Bank) also offers standing facilites marginal lending facilities (MILF) and the F Reserve (the US Central Bank) has discount ig systems (DWS). Like the MSF, the secondary facility made available by the Federal Reserey the depository institutions in USA is npigg overnight credit on a very short term bag g rates above the primary credit rate In an attempt to strengthen rupee a checking its falling exchange rate, the RBIs increased the gap between ‘repo’ and MSF is} percent (late July 2013) and now it standsat 0 per cent. The effectiveness of standing fais in reducing volatility have been examined fy many scholars and certain studies have point out that in the Federal Reserve System inte United States, the design of the facility decrexs abank’s incentive to participate actively inintrat market (ie. India’s Call Money Market) due® the perceived stigma from using such facility Ths in turn reduces the effectiveness of stundit facility in reducing interest rate volatiit: pis based on - the RBIs Credit & Monetary Policy, 2011-12 in which the Seheme was nosed Central Bonk, Frankfurt, Germany and Federal Reserve Syitem (also known as the Feder! Rese Scanned with CamScanner‘The RBI on February 15, 2012 increased the Rate by 350 basis points from 6 per cen 19.50 per cent and realigned the Bank Rate wits ginal Standing Facility (MSF) rate, which, in islinked to the policy repo rate”. Hencefeath grever there is an adjustment of the MSF rate, fe RBI will consider and align the Bank Rate “vith the revised MSF rate. Being the discount rate, the Bank Rate should ly be higher than the policy repo rate. ¢ Bank Rate has, however, been kept changed at 6 per cent since April 2003, This mainly for the reason that monetary policy was done through modulations in the verse repo rate and the repo rate till May 3, “ppt, and the policy repo rate under the revised fing procedure of monetary policy from 3, 2011 onwards. oreover, under the revised operating iP Rate. At present, the repo tate #5 8.50 per per cent and MSF 9.50 js the rate at which banks funds from the RBI and reverse rep Base Rate is the interest rate below tach Scheduled Commercial Baniks (Sis) wi lend es mocans 0 hike Prime Lending Rate (PLR) 20d the Benchemare Prime lending Rate (BPLR) of the past and s basically 2 floor rate of interest. It replaced™ the no loans to its customers existing idea of BPLK on Juby 1, 2010. “The BPLR system (while the exieting #77 was of PLR), introduced in 2003, fe short of its original objective of bran lending rates. This was mainly because under thes system, banks could lend below BPLR Tras made 2 bargaining by the borrower with bank ulimately one borrorwer getting cheaper loan thas the other, and blurred the atiempts of bangme in transparency in the lending business. Fox the same reason, it was also difficult to assess the transmission of policy rates (Le repo rate, reverse repo rate, bank rate) of the Reserve Bank t0 lending rates of banks. The Base Rate system aimed at enhancing transparency in lending rates of banks and enabling better assessment of transmission of monetary To took snto this matter the RBI constinsted 2 Working Group on Benchmark Prime Lending Rate (chaired Deepak Mobanty) to review the present benchmark prime lending cate (BPLR) system and suggest changes to make credit pricing one t- report in October 2009 ccordingly the idea of Base rate was ted all categories of loans are priced with the Base Rare only, except the (2 and a Now, reference to ‘Scanned with CamScanneray Base Rate will be the minimum rate for all loans, = ATE Not permitted to resort to any tending below this te- accordingly, the provision of is below the BPLR to a customer by banks # the loan amount is mot less than Re? lak has been withdrawn. It is expected that the above deregulation of lending rate will increase the credit fow to small borrowers at reasonable rate and direct bank finance will provide effective Competition to other forms of high cost credit. For export credit, RBI announces the floor rate S