MONEY AND BANKING 5 Flashcards
Transmission of Repo Rate into Lending Rate
If repo high, lending rate high, lower aggregate demand and inflation. Vice versa also. Thus, monetary policy transmission involves two stages:
In the first stage, monetary policy changes are transmitted through the money market
to other markets, i.e., the bond market and the bank loan market. The second stage involves the propagation of monetary policy impulses from the financial market to the real economy - by influencing spending decisions of individuals and firms.
Real economy and financial economy
The “real economy” refers to the part of the economy that is concerned with actually producing goods and services, as opposed to the part of the economy that deals with buying and selling on the financial markets.
Base Rate:
The base rate is the minimum interest rate set by a bank below which it cannot lend, except for certain specified loans. Calculated on the basis of-1)AVERAGE Cost of deposits (interest rate that bank offers to its depositors) 2)Cost of maintaining CRR and SLR 3)Operational Costs of Banks 4)Return/profit on Net worth (investment)
MCLR Marginal Cost of Funds-Based Lending Rate (MCLR)
Introduced by RBI in 2016. The MCLR is the benchmark interest rate set by banks below which they cannot lend, except for some specified categories. It is calculated based on the 1)MARGINAL cost of funds 2)Cost of maintaining CRR and SLR 3)operating costs, and the tenor premium. It ensures that the lending rates are more responsive to changes in the policy rates set by the Reserve Bank of India (RBI) because a. is recalibrated regularly (e.g., monthly) based on the bank’s current cost of funds b.MCLR is based on the marginal cost of funds, which includes the latest interest rates, deposit rates, and borrowing costs.
Positives of Base Rate and MCLR
1.Transparency and Fairness: ensures all customers are treated equally, preventing discriminatory lending practices.
2.Financial Stability: Helps banks cover costs and remain profitable, protecting their long-term viability.
3.Market Discipline: Prevents excessive undercutting among banks, maintaining sector stability.
4.Sustainable Lending Practices: Discourages unsustainable borrowing, reducing the risk of higher default rates and financial instability.
Tenor premium
refers to the extra interest charged by a bank for loans with longer durations, reflecting the higher risk and uncertainty associated with lending money for a longer period.
Are MCLR and Base rates set by banks themselves?
MCLR (or Base Rate) is an “internal benchmark” which varies from bank to bank. Banks link their lending rate with MCLR.
Has MCLR been effective in india?
1)But, the transmission of policy (repo) rate changes to the lending rate of banks under the MCLR framework has not been satisfactory due the various reasons like:
Banks fearing that they will lose depositors/customers if they will reduce the deposit
rate first, and since deposit rate was not reduced, MCLR (or base rate) was also not
coming down.
2)Government offering higher interest rates on its own small savings schemes
What has RBI done to overcome the poor response wrt the internal benchmarks?
RBI has made it mandatory for banks to link all new floating rate PERSONAL/RETAIL loans and floating rate loans to MSMEs to an external benchmark effective October 1, 2019 to have faster transmission of monetary policy.
Banks can choose one of the four external benchmarks – repo rate, three-month treasury bill yield, six-month treasury bill yield or any other benchmark interest rate published by Financial Benchmarks India Pvt. Ltd which will be reset once in 3 months. Banks are NOT mandated to link their DEPOSIT rates with an external benchmark rate.
Has the RBI mandated the NBFCs to link their lending rates with anchor rates?
Nothing yet
Govt is doing recapitalization of PSBs how?
1.putting capital into the PSBs from budgetary resources
2.Through recapitalization bonds in which Govt. issues bonds to PSBs and gets cash from the PSBs and then this cash Govt. again puts into the PSBs as equity capital (a technical process)
BASEL norms and India
are international banking regulations issued by the Basel Committee on Banking Supervision (BCBS) to promote stability and soundness in the financial system. They provide a framework for managing risks and ensuring banks have adequate capital to withstand financial stress. Capital Adequacy: Banks must maintain a minimum level of capital relative to their risk-weighted assets to absorb potential losses. Higher the capital to risk weighted asset ratio (CRAR), higher is the safety of bank deposits. In India RBI has kept Capital Adequacy Requirement of 11.5% (including 2.5% capital conservation buffer). Scheduled Commercial Banks have achieved the minimum Basel III capital requirement.
Prompt Corrective Action (PCA)
Way through which RBI monitors banks and their financial health. 3 parameters- Capital Adequacy, Asset quality, and leverage( total assets/equity). Once banks reach a certain threshold, RBI can take discretionary action-restrictions on expansion, stop lending, increase provisioning, new management board etc.
For all Scheduled commercial banks except RRBs, Small Finance and Payment Banks and for all NBFCs.
For Urban cooperative banks- SAF- “Supervisory Action Framework”
NABARD for Regional Rural Banks (RRBs) and Rural Cooperative Banks has SAF.
Systemically Important Financial Institutions and in India?
Crucial for financial structure due to size and interconnection, “Too Big to Fail”. These institutions are also subjected to additional regulatory/supervisory measures like capital requirements.
Banks are regulated by RBI and NBFCs are regulated by RBI/SEBI/IRDA. So, all these
regulatory bodies declare Systemically Important Institutions
1.RBI designates BANKS with assets over 2% of GDP as Domestically Systemically Important Banks (DSIB), currently including SBI, HDFC, and ICICI. NBFCs with assets over Rs. 500 crores are declared Domestic Systemically Important NBFCs.
2.IRDAI (Insurance Regulatory and Development Authority of India) identifies Domestic Systemically Important INSURERS (D-SII) like LIC, GIC, and NIAC for 2020-21.
3.SEBI declares Domestically Systemically Important FINANCIAL MARKET INFRASTRUCTURE (FMI) like MCX and NCDEX.
Foreign Investment and types
Any investment made by a ‘person’ resident outside India in CAPITAL INSTRUMENTS of an Indian company. Person means foreign individuals, NRIs, companies etc. i.e. equity shares, debentures, preference shares and share warrants.
equity shares, debentures, preference shares and share warrants.
Equity shares: Equity shares represent ownership of the company and voting rights
Preference shares: They have preferential rights over dividend and to repayment of the capital in the case of a winding-up of the company. They must be converted into (common) equity shares after some time.
Debentures-They are like bonds but must be converted into equity shares after some time:
Share Warrants: Share warrant is a document issued by the company to the investor that gives the warrant holder (investor) a right to subscribe to equity shares of the company at a predetermined price on or after a pre-determined time period. The warrant holder is given a right but not an obligation to subscribe equity shares.
Foreign investment classification
FDI and FPI
Foreign Direct Investment (FDI) is the investment through ‘capital instruments’ by a person resident outside India: In an unlisted Indian company; or In 10 percent or more of the equity capital of a listed Indian company
Foreign Portfolio Investment (FPI) is any investment made by a person resident outside India in ‘capital instruments’ where such investment is less than 10 percent of the equity capital of a listed Indian company.
Foreign Direct Investment routes
can come through two routes viz. automatic and government approval route. More than 95% of the FDI comes in India through the “Automatic Route” where no government approval is required and are subject to only sectoral laws. Certain sectors that are still under “Government approval route” are scrutinised and cleared. The Department for Promotion of Industry and Internal Trade (DPIIT), Ministry of Commerce and Industry sets the rules
