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[Banking] Monetary Policy: Quantitative & Qualitative
Tools, applications & limitations MSF, LAF, Repo,
OMO, CRR, SLR, Revisited before upcoming Urjit
Article
1. Prologue
2. What is monetary policy?
3. Quantitative Tools
1. #1: Reserve Ratios (SLR and CRR)
2. #2: Open Market Operation (OMO)
3. #3: Policy Rate
4. Bank Rate
1. Liquidity Adjustment facility (LAF)
2. LAF Repo Rate
3. Marginal Standing facility (MSF)
4. Reverse repo Rate
5. Repo Rate in recent years:
4. Monetary Policy: limitations
5. Qualitative Tools
1. #1: Margin Requirements/ LTV
2. #2: Consumer credit regulation
3. #3: Selective credit control
4. #4: Moral Suasion
6. Monetary policy tools: Quantiative vs Qualitative
7. Appendix
1. #1: Why High SLR and High CRR are bad?
2. #2: Narsimhan (I) Committee 1991
3. #3: Narsimhan (II) Committee 1998
8. Mock Questions
Prologue
Next article is about RBI appointed Urjit Patel Committee on Monetary policy framework.
But before dwelling into that, we must recap the basic concepts of what is monetary policy:
its tools and limitations. Otherwise Urjit wont make much sense.
Hence in a way, this whole article is a prologue to next article.
Why RBI and Why Monetary policy?
Initially people used barter system for trading. But the barter system had many problems ( click
me). Therefore, people switched to money system.
Financial intermediates = middlemen who help in the circular flow of money between
households and business firms.
There are two types of financial intermediaries: banking institution and non-banking
financial institutions.
RBI controls (all) banks and (some) non-banking financial institutions.
RBIs main job is to control Money supply in this game, and thereby fight inflation and
deflation.
Inflation = price rise = bad for economy, you know that by common sense.
But Deflation = price decrease = we can buy things at a lower price. Isnt that good? Why is
deflation bad for economy?
Ans. Every business has fixed cost of production say minimum light bill, phone bill, office
rent, staff salary etc. So, if prices keep falling and falling (say of Nano car), then car
marker will suffer losses. He has no motivation to expand business. He wants to cut down
his production costs, by firing some of the employees= less new jobs created=
unemployment = social unrest.
If prices of everything fall- then custom duty, VAT, excise duty, service tax- their collection
will also decrease. Then government has less money to spend on education, healthcare,
social sector, defense, law and order = poverty, disease, crime.
by the way
TERM meaning Does RBI want
it?
DEFLATION fall in the prices (and fall IN employment.) No.
DISINFLATION Fall in the prices but without causing unemployment. yes (while
fighting inflation)
STAGFLATION stagnation + inflation
prices and wages rise
but people cant find jobs, companies cant find
customers.
No
REFLATION policy to stop the fall in price levels, but without causing
rise in the price levels (inflation).
yes
What is monetary policy?
Policy made by the central bank.
To control money supply in the economy. (and thereby fight both inflation and deflation).
RBI implements monetary policy using certain tools. Two types
quantitative tool qualitative tools
Lets start from here.
Quantitative Tools
#1: Reserve Ratios (SLR and CRR)
SLR A Bank has to set aside this much money into gold or RBI approved securities. 23%
CRR A Bank has to set aside this much as reserve. Bank cannot lend it to anyone.
Bank earns no interest rate or profit on this.
4%
Reserve ratio: SLR, CRR
Suppose economy is showing inflationary trend. Prices of all goods and services are
increasing day by day.
How can RBI stop it using Reserve ratio as a tool?
In this case, RBI should RAISE the reserve ratios.
Observe:
Right now
People deposited total this much money in SBI (net demand & TIME
liabilities NDTL)
100 cr.
CRR (4%) [SBI has to keep this much cash aside for reserve] -4 cr
SLR (23%) [SBI has to invest this much money in RBI approved securities] -23 cr.
Money left with SBI 100-4-23=73
Cores.
Say RBI raises SRL to 40% and CRR to 15% then?
Originally 100 cr
SLR 40 -40
CRR 15 -15
Money left with SBI 45 cr.
You can see, when Rajan has raised reserve ratio, money with SBI is reduced (from 73 crores to
just 45 crores.)
What will be its implication?
Imagine youre a money lender. Youve 100 crore rupees and you must make Rs.1 crore
profit in a year.
Obviously, you should lend it @1% interest rate. (because 1% of 100 crore = 1 crore.)
But what if youve only 2 crore rupees, and you still want to make Rs.1 croer profit in a
year?
Now you must lend it @50% interest rate. (because 50% of 2 cores = 1 crore.)
Observe that as money decreased (from 100 to 2), loan interest rate increased (from 1% to
50%).
Same happens when SBI is left with less money (after RBI increases reserve ratio).
Lets prepare a flow chart.
Situation: Economy has inflationary trend. Prices of goods and services increasing every day.
Solution: RBI raised reserve ratio (CRR, SLR)
Result: SBI is left with less money to lend.
Consequences:
1. SBI raises its loan interest rate
2. Businessmen borrow less money from SBI
3. Businessmen donot start new business. Donot expand existing business
4. Result=Less jobs. Even existing employees discharged. If anyone remains in the job, he
doesnt get pay raise. He starts cutting down unnecessary expenditure (e.g. buying two
newspapers, getting his shirts ironed, drinking tea @4PM in office and so on. Thus even
paper-wall, dhobi, chai-walla- everyones income reduced.)
5. Result= Less income (Because of above reasons)
6. Result= Less demand of goods and services (because less income).
7. Ultimately shopkeeper will bring down the prices to attract people into buying more things.
Thus inflation is reduced.
You may doubt- what about supply side bottlenecks, what about cost push and demand pull
inflation : Im not going into all that details at the moment, else this article will become longer than
five kilometers.
Lets just prepare a summary table:
Policy dear money cheap money
Tool To fight inflation To fight deflation
Reserve Ratio (CRR, SLR) Increase them. Decrease them.
Moving to the next (Quantitative) tool. Under monetary policy
#2: Open Market Operation (OMO)
Open Market Operation= when RBI starts buying/selling government securities to control
money supply.
Government securities= piece of paper. It says something like this give me Rs.100, Ill
give you 8% interest rate for next ten years and after that Ill repay the principle of Rs.100.
This is how government borrows from others.
Situation: Economy has inflationary trend. Prices of goods and services increasing every
day.
Solution: RBI starts selling government securities in open market.
Result: SBI buys them and thus SBIs lending money is reduced. Wait. How?
Imagine Rajan is selling sabzi (vegetables). If SBIs chairman Arundhati Madam goes to buy
vegetables. Obviously madams money will decrease when she buys vegetables.
Then same as usual:
1. SBI left with less money to lend.
2. SBI raises its loan interest rate (to keep profit margin same)
3. Businessmen borrow less money from SBI.
4. Businessmen donot start new business. Donot expand existing business
5. Less jobs
6. Less income
7. Less demand
During deflation, RBI will do the reverse. (i.e. RBI buys Sabzi from SBI). How will it stop
deflation? Think in your head.
Lets update our table
Open Market Operation (OMO) RBI sell securities RBI buy securities
Mock Question
In 2013, UPSC walla asked a very chillar question from this topic.
In context of Indian Economy, Open Market Operation refers to
1. Borrowing by scheduled banks from RBI
2. Lending by commercial banks to industries and trade
3. Purchase and sale of government securities by the RBI
4. None of Above
Whenever you face a GS/GK type MCQ, Youve three choices
Skip If you dont know the answer, Just leave it instead of risking negative mark.
Attempt Correct answer is Opt C.
Mark n
Review.
It means youve unsure of the answer. 50:50. So you mark the question number (say
45), at the back of your question paper. At the end of exam, if youre left with 10-15
free minutes. You look at the question again, and try to solve it.
So, should you put above question in mark n review?
No.
Because its a definition based question. If you dont know the definition of OMO you
might tick a wrong answer and fail. Most of the sincere players fail in prelims because of
this reason. They push their luck in negative marking to overcome an imaginary cutoff and
thus dig up their own grave. (especially during last 10-15 minutes of the exam.)
Moral of the story: never put fact/definition type MCQs in Mark-n-Review.
Lets solve a bit more complicated MCQ from 2012s CSAT paper.
Q.Which of the following measures would result in an increase in the money supply in economy?
1. Purchase of government securities from public by central bank
2. Deposit of currency in commercial banks by the public
3. Borrowing by government from the central bank.
4. Sale of government securities to the public by central bank.
Answer choice
1. Only 1
2. 2 and 4
3. 1 and 3
4. 2, 3 and 4
Whenever you face such multiple statement type MCQs, always use elimination method. First
find a statement that is definitely right or definitely wrong and eliminate choices accordingly.
Focus on first statement Purchase of government securities from public by central bank:
will it increase money supply in the system?
Imagine Rajan puts an ad in newspaper: bring your Sabzi (vegetables), Ill buy it. Junta
gives him their own veggies, Rajan gives them money. (a classic buy and sell).
Ultimate result: money supply increased in the system- because junta got the money.
Meaning #1 definitely correct.
If you think it on technical terms. Central bank purchases government securities=OMO
(Open market operation), where money shifts hands from RBI to people.
Hence money supply increased. (In reality, money doesnt go to aam admi directly, but
those bankers and non-banking institutions who participate in OMO). Anyways, #1 is right,
Eliminate choices that do not have #1
1. Only 1
2. 2 and 4
3. 1 and 3
4. 2, 3 and 4
Now the final answer depends on whether statement #3 is right or wrong?
Statement #3 says Borrowing by government from the central bank. (So, will it increase
money supply?)
How does Government borrow from Central bank? Does Mohan just callup Rajan and
demand 1 lakh crores? No. Mohan will have to give Rajan that much government
securities (vegetables) and Rajan will give him cash.
Is money supply increased? Yes Mohan sold veggies to Rajan and got Money. Whenever
Rajan buys veggies and pays the money supply is increased. (this is similar to Open
Market operation)
Besides, Mohan can then use money to pay salaries of government staff, pay for rail-road-
bridges and other infrastructure projects, pay for MNREGA and so on. Therefore Answer
C: 1 and 3 correct.
Counter- argument?
What if Rajan subsequently sells those (Mohans) securities to bankers. Then bankers
money reduced. Hence #3 is wrong. Therefore final answer A only 1.
So, whats the final answer: is it A or is it C?
Ultimate judge= UPSCs official answer key uploaded on their site.
In 2012s Question paper Test series A, this is Q77: and its official answer is C. Therefore,
both 1 and 3 are correct.
Anyways, what to do in the exam?
Skip If you dont know the concept better skip.
Attempt This question is attemptable if you dont drag the logic too much in statement #3.
Mark n
Review.
Yes, it can be put under mark and review because this is not an absolute fact/
absolute definition type MCQ. If you apply some concepts, you can eliminate wrong
choices. But still if doubt persists in the mind (e.g whether Statement 3 is right or
not) then its always safe to skip and avoid negative marking.
By the way, What about Statement #2: Deposit of currency in commercial banks by the public.
(Will it increase money supply or not?)
Viewpoint 1: yes. Because bank can used it to expand loanable credit. (as explained in
Money creation topic in Class 12 NCERT Macroeconomics page 39 onwards).
Viewpoint 2: no. (Because Bank will have to put some money aside as CRR- so that much
money is less in the system.)
Either way it doesnt change the answer. Because We know that statement 1 is definitely correct.
And there is no option where (1,2) are given simultaneously.
Anyways, Moving onSo far, RBI has two tools under monetary policy:
1. reserve ratios (SLR, CRR)
2. Open market operation.
Third and the most important quantitative tool is
#3: Policy Rate
Policy rate= in case of India its Repo rate. Before moving further, lets refresh our concepts of
Bank rate, LAF, MSF, Repo and Reverse repo.
Bank Rate
When banks borrow long term funds from RBI. Theyve to pay this much interest rate to
RBI. [Note: different books give different explanation of Bank Rate. I've used NDTV's
definition]
At present, Bank rate= 9%
Collateral: nothing. (Bank can borrow money without pledging government securities to
RBI)
Bank rate is not the main tool to control money supply these days.
Nowadays, RBI uses LAF Repo rate as the main tool, to control money supply.
Ok then Whats the use of Bank rate?
Penal rates are linked with Bank rate. For example, If a bank doesnt maintain CRR, SLR
as per the prescribed limit.
Then RBI can impose penalty interest on such notorious bank.
At present, Penalty rate = Bank rate + 3% (or 5% in some cases)
Meaning if Bank rate = 9% then penalty rate=9+3=12%
Anyways, what if RBI wants to fight inflation using bank rate as a tool?
Obviously they should increase bank rate. That way it becomes harder (more expensive) for
banks to borrow from RBI.=> SBI increases its loan rates (to keep the profit margin same).
Result?
Less people get home loan, bike loan, business loans.
Less business expansion
Less jobs
Less incomes
Less demand
Ultimately shopkeeper will bring down the prices to attract people into buying more things.
Lets update our (stupid) table
Bank rate Increase decrease
Liquidity Adjustment facility (LAF)
Liquidity Adjustment facility
RBI started this in 2000. You can imagine it as a Adda/gambling den/gang-hideout where
RBIs clients gather, consumer desi liquor, play cards, watch item songs and borrow
money from RBI (or lend Money to RBI).
By the way, who are the clients of RBI?= Central and state governments, Banks and non-
banking financial institutions (NBFI). NBFI further includes:
AIFI (all India finance institutions) NABARD, SIDBI, EXIM Bank and National
Housing Bank.
Primary dealers (Morgan Stanley , Goldman Sachs, JP Morgan Chase, Standard
Chartered Bank, HSBC etc.)
Non-Banking financial companies.
Anyways, Under this LAF adda, RBI has two tools:
Repo If client borrows money from RBI (for short term) then client has to pay this much
interest rate to RBI. At present Repo is 8%. (article written on 29th Jan 2014)
Reverse
Repo
If client lends money to RBI (for short term) then RBI has to pay this much interest
rate to client. RBI doesnt like headache. So they made a simple formula: Reverse
repo rate= Repo MINUS 1%=8-1=7%.
Collateral:
Problem with running a adda/gambling-den = sometimes client drinks too much desi
liquor and passes out on floor. Sometimes he even dies because of hooch. Sometimes
police raids the den, and clients run away with cash and register.
If such things happen, Rajan will be at loss. So, he demands government securities as
collataral. So even if client doesnt repay money on time, Rajan can sell those securities (in
open market operations) and recover money.
LAF Repo Rate
Lets get a bit technically correct now. Observe following image
Scenario
SBI chairman Arundhati mam wants to borrow Rs.100 crore (for short term).
She gives her stash of government securities to Rajan.
Rajan gives her Rs.100 crore.
Madam Also signs an agreement
I, Arundhati Bhattacharya, agree to buy same securities from Rajan, at 108 crores after 14
days.
Notice that she has agreed to re-purchase same securities from Rajan. Therefore its
called Repo.
And how much interest rate did she pay on this loan? [108-100]/100=8%. Thats our repo
rate.
Important:
Recall that SBI also has to keep part of her money in RBI approved securities (under
SLR).
So Madam cannot USE those government securities to borrow under Repo Rate from
Rajan.
That leads to a new topic
Marginal Standing facility (MSF)
MSF mechanism is same as repo. But some differences
LAF (Repo) MSF
Rajan says dont come here
unless you want to borrow
minimum Rs.5 crores.
Minimum Rs. 1 crore.
All clients are welcome i.e.
Central and state
governments
Banks be it commercial
bank or RRB or
cooperative bank
Non-banking financial
institutions.
Sorry. Not all clients welcome here.
Only scheduled commercial banks can borrow under
this window. SBI, PNB, BoB, ICICI etc.
This MSF facility is specially created to help them
solve short-term cash mis-match.
You (bankers) cannot pledge
securities from SLR quota to
borrow from this window.
Can use securities from SLR quota.
No limit. You may borrow as
much as you want. (as long as
you have government securities
to pledge to me.)
Maximum 2% of NTDL. To put this in crude words, if SBI
received 100 crores from aam-admi under savings account,
current account, fixed deposit etc. then SBI can borrow only
upto Rs.2 crores from RBI.
Rajan decides Repo rate (8%
right now)
MSF = Repo Rate +1% = 8+1=9%. (earlier this margin of 1%
used to be higher. But nowadays just 1%!)
for those who still have doubt about Repo vs MSF:
for repo borrowing, bank will need to pledge securities to Rajan. But bank cannot use SLR-
reserved securities for this.
so, imagine if a bank is in dire need of cash, but doesnt have spare government securities- then
they can borrow using MSF by pledging those SLR securities. (and under MSF window, Rajan
will demand 1% higher than Repo as one type of punishment for pledging SLR securities.)
Reverse repo Rate
Although self-explanatory. But lets check
Repo = clients borrow from Rajan and pay this much interest rate. (short term loan)
Reverse repo= when Rajan himself borrows from clients, then he has to pay this much
interest rate to clients.
Collateral = yes. What if police raids this gambling-den, and Rajan runs away to Nepal?
Clients can sell Rajans Government securities and recover their money.
Reverse repo = Repo MINUS 1% = 8-1% =7%.
Note: in official parlance, they call percentages in basis points so 1%=100 basis points.
So in that official language, Reverse repo = Repo MINUS 100 basis points.
Enough cheap jokes. What have we learned so far?
That Rajan controls money supply using monetary policy.
Under Monetary policy, Rajan has various weapons (or tools)
1. Reserve ratios (SLR, CRR)
2. OMO: Open market operation
3. Rates: Bank rate, LAF (Repo, Reverse repo), MSF.
We already know how to apply SLR, CRR and OMO to fight inflation (and deflation.) let me paste
the table again.
Reserve Ratio
(CRR, SLR)
Increase them. Decrease them.
Open Market
Operation
(OMO)
RBI sell securities RBI buy securities
Bank Rate increase it decrease it
Repo rate increase it decrease it
Reverse Repo its value is linked with Repo, hence cannot be increased/decreased
independently.
Marginal
Standing
Facility
its value is linked with Repo, hence cannot be increased/decreased
independently. Besides MSF= temporary firefighting, cash mismanagement.
We learned that Rajan doesnt use Bank rate much, to control money supply.
We learned that Rajan doesnt decide Reverse repo and MSF. (theyre automatically -1%
and +1% of Repo rate).
Thus the only thing Rajan has to decide under monetary policy= Repo rate. Therefore,
Repo rate is called the policy rate
Lets revisit out flow chart:
Situation: Economy has inflationary trend. Prices of goods and services increasing every
day.
Solution: Rajan increases Repo rate. (say from 7.75% to 8%).
Result: it becomes expensive for SBI to borrow from Rajan. Theyll increase their own
rates as well.
Wait. How?
Just like how things roll in Onion biz.
If prices of Onion rise in Maharashtras wholesale yard (in Lasangaon), then immediately, retail
veggie @Ahmedabad will also raise their onion prices to keep the profit margin same.
Whatll be the consequences (if repo rate is hiked / increased)?
Consequences:
1. SBI raises its loan interest rate (to keep profit margin same)
2. Businessmen borrow less money from SBI.
3. Businessmen donot start new business. Donot expand existing business.
4. Less jobs
5. Less income
6. Less demand
Policy Rate (Repo Rate) Increase it Decrease it
Repo Rate in recent years:
Lets observe with a graph: how RBI fought inflation/deflation in recent times using Repo rate as
the main-weapon of monetary policy.
From above above graph, you can see RBI has frequently changed its repo rate to combat both
inflationary and deflationary trend. But Youd agree that inflation has not been contained. No
matter what number juggling or statistical interpretations are given- the hardship of common man
has not stopped- be it milk, petrol, onion, LPG anything.
Agreed that prices of onion, sugar, pulses and food are subject to vagaries of monsoon
and black marketeering. Rajan cannot do anything about it.
Agreed that crude oil prices are subject to rupee-Dollar exchange rate, external factors and
governments de-regulation of their prices. Rajan doesnt have much control over this.
But still even in the non-food, non-fuel type commodities- RBIs monetary policies have failed to
curb inflation. WHY? Observe the following image.
Suppose Vijay Mallay got 100 crore loan from State Bank of India. If you trace the source of that
money, itll turnout 60-70 crores came from banks savings account, fixed deposit etc. Rajan
lends money in repo rate yes, but that doesnt mean banks depend only on Rajan to arrange the
cash for its clients.
Suppose Rajan reduces repo rate from 8% to 5%. Banks are not legally required to reduce their
loan interest rates.
The current system is following:
Banks are free to decide their base rate. E.g. SBIs base rate is 10%.
It means SBI wont loan money to anyone at an interest rate lower than 10% (except those
farmers under Interest subvention scheme.)
SBI will link all of its loan products with Base rate. For example
SBI Base rate =10% Calculation Result
Car loan 0.75% above Base rate 10.75%
Two wheeler loan 8.25% above base rate 18.25%
Education loan (upto 4 lakh) 3.5% above base rate 13.5%
Home loan for women (upto 75 lakh) 0.10% above base rate 10.10%
Meaning if SBI changes her Base rate then all of above loan interest rates will change
automatically.
If Rajan changes his repo rate, will SBI change her base rate?
Not always.
Because those common men are the main suppliers of money to SBI.
RBI is not the main supplier of money to SBI.
SBI will only change its base rate, when she feels necessary for its own profit / loss
compared to its competitors.
Does it mean Repo rate system is bogus and ineffective?
Not always.
In developing countries like India, most people park their money in only four things:
savings account, fixed deposit (FD), provident fund and LIC. Weve mutual funds, weve
NPS, weve ULIPs, weve Rajiv Gandhi equity savings scheme
but most people (particularly the older generation) feels insecure in into such new things.
Therefore lot of money flows into Savings accounts and fixed deposits= SBIs main source
of money.
But, In advanced economies, like USA, people dont invest large portion their income in
savings account or FD. Theyve variety of investment options. So, for those American
banks, their own Central bank (US Feds) is a significant money supplier.
Hence US Feds monetary policy shows faster impact on their American Banks, THAN
Rajans monetary policy on Desi banks.
Monetary Policy: limitations
In developing countries, Monetary fails to bring quick results because
1. People dont have many investment alternatives. Commercial banks have large deposits.
Rajan is not the main or even prominent money supplier for these banks. Whatever Rajan
does, its effect will be felt only after 6-8 months but by that time, new factors would cause
another rise in inflation and Rajan will have to start from scratch again.
2. Non-Monetized economy: in rural areas, many transactions are still of barter nature. (E.g.
kiranawalla cum middleman supplies seeds, pesticides, fertilizers- in exchange of share in
farmers produce.)
3. Lack of financial inclusion. Since most people are not in the banking net. They rely on
Shroffs and moneylenders. Many of them circulate the black money of cops and
politicians, and charge 36% interest rate on loans. Rajan has no control over them.
4. Monsoon uncertainty, cyclone, flood, draughts and their effect on food production. Food
inflation =>newspaper walla, washerman, barber, car mechanic everyone will raise their
service fees to accommodate their raised cost of living. Rajan has no control over them.
5. Crude oil and gold import + negative effect when rupee weakens. Rajan can try to bring
1$=Rs.65 to $1=63 Rs. But he has not enough forex reserves to bring $1=Rs.50.
6. Fiscal deficit, illogical schemes. e.g MNREGA worker digs a temporary road. After first
rain, t he road is wiped out= physical infrastructure added to economy no. Wages
raised..yes. = this mismatch leads to more inflation.
7. Subsidy leakage, Black money, underground economy.
8. And most importantly, because Rajan uses Multi-indicator approach, he focuses on WPI
(minus food and fuel). Thats why Urjit Patel recommends him to target CPI. More on that
in next article.
So far, we learned that RBI has two sets of tools/instruments under monetary policy:
Quantitative tool Qualitative tools
1. Reserve ratios
2. OMO
3. Policy rate (Repo Rate)
Well see them in a moment
Qualitative Tools
#1: Margin Requirements/ LTV
Mallya wants to borrow from SBI. He pledges his companys shares worth Rs.100 crores
as collateral.
For such loans, Rajan can prescribe margin, say 65%.
In that case even if Mallya pledges 100 crores worth shares, SBI can give him 100-
65=only 35 Crore rupees as loan.
Using this tool, Rajan can control money supply. e.g. during inflation, he should increase
margin requirement, so Mallya can borrow less=> less job=>less income=>less
demand=>prices reduced.
If Rajan changes repo rate, it is not compulsory for SBI to change her loan interest rates.
(we saw how Alok Nath keeps giving money to SBI, so they are not entirely dependent on
Rajan.)
But if Rajan changes margin requirements, then SBI and all other banks must obey it. In
other words, this tool has direct impact on money supply.
#2: Consumer credit regulation
Suppose Nano car sells @1 lakh and Rajan has made rule that downpayment cannot be
less than 30%.
It means customer must bring Rs.30,000 from his pocket and bank can only give him
maximum 70000 as loan.
How can Rajan fight inflation with this tool?
Increase downpayment from 30%=>50% (meaning bank can give less loan. Customer
himself has to arrange lot of money from his own pocket)
Rajan can make rule banks cannot accept EMI less than 5000 on car loan. Observe:
Case #1: 100 EMIs worth 1000 each = 1,00,000. (ignore interest rates)
Case #2: 20 EMIs worth 5000 each=1,00,000. (ignore interest rates)
In case #2: some of the lower-middleclass families may postpone their decision to purchase nano
car (Because they cant afford higher EMIs.)
Result= less demand=>prices reduced. (indirectly- because car mechanics get less work,
number-plate painters get less orders etc. so they reduce fees to attract new clients and
retain existing clients.)
Thus, Rajan can control money supply by changing downpayment and installment (EMI)
rules.
#3: Selective credit control
Under this, Rajan can specifically instruct bankers not to give loans to traders of certain
commodities e.g. sugar, gur, edible oil etc.
even if the said trader is ready to mortgage his shares/bonds/factory/machine/vehicle
anything.
this prevents speculations/ hoarding of commodities using money borrowed from banks.
#4: Moral Suasion
Here Rajan tries to persuade the bankers to do xyz thing. Example
1. Please reduce giving automobile loans- instead park your money in government securities.
(above the SLR requirements.)
2. Ive reduced my repo rate, now you also reduce your base rate.
Rajan will try to influence those bankers via- direct meetings, conference, giving media
statements, giving speeches @public seminars, university convocations etc. (even where
bankers are not present.) Hell do so, to build a public opinion, media opinion and influence those
bankers by making them feel guilty.
Rationing
of credit
Found in Planned economies/communist nations.
Here central bank will decide upper limit to loans in each sector (heavy
industries, service, agriculture, small-scale etc.)
So once that quota is over. Additional loans cannot be given to that
borrowers from that sector. This also controls money supply.
Direct
action
Means RBI gives punishment to erring banks. Punishment can involve: penal
interest, refuses to lend them money from LAF etc. and in worst case even
cancels their banking license.
Lets recap
Monetary policy tools: Quantiative vs Qualitative
Quantitative Qualitative
1. Reserve ratios (SLR, CRR)
2. Open Market Operation
3. Policy rate (Repo Rate)
1. Margin requirements / LTV
2. Consumer credit regulation
3. Selective credit control
4. Moral Suasion
5. Rationing of Credit
6. Direct Action
Indirect in nature. (Even if Rajan changes repo rate, its
not necessary SBI will immediately change its base rate /
loan interest rates.)
Direct in nature. (e.g. those margin
requirements)
General- they affect money supply in entire economy- be
it housing, automobile, manufacturing- everything.
Selective- can affect money supply
in a specific sector of economy e.g.
automobile.
Lets solve an Official MCQ from UPSC 2012 Question paper
Q. RBI Acts as bankers bank. This would imply which of the following?
1. Other banks retain their deposits with RBI
2. RBI lends funds to commercial banks in the times of need.
3. RBI advises commercial banks on monetary matters.
Correct Statement
1. Only 2 and 3
2. Only 1 and 2
3. Only 1 and 3
4. 1, 2 and 3
Approach:
Whenever you face such 3 statement MCQ or 4 statement MCQ, Always use elimination
method. First you find out a statement that is definitely right or definitely wrong. In above case,
we can see #2 is definitely right. RBI lends funds to banks in the times of need (Repo, MSF)
So lets eliminate choices that dont involve statement #2
1. Only 2 and 3
2. Only 1 and 2
3. Only 1 and 3
4. 1, 2 and 3
This did not help much. We still have three choices left. Observe statement #1: Other
banks retain their deposits with RBI. That is correct with respect to cash reserve ratio. CRR
is one type of deposit that banks make to RBI. (RBI doesnt pay interest on it- thats a
different story).
Meaning #1 is also correct eliminate choices that donot have #1
1. Only 2 and 3
2. Only 1 and 2
3. Only 1 and 3
4. 1, 2 and 3
Only two choices left and the ultimate solution = is statement #3 is correct or not?
Viewpoint #1 Viewpoint #2
The statement says RBI advises commercial banks on
monetary matters.The word advises makes this statement
incorrect. Because RBI doesnt Advice they just order the
banks- be it SLR, CRR, PSL. RBI doesnt advice, RBI gives
orders and direction. Therefore statement #3 is wrong.
RBI does advice those
banks. We saw it under
Moral Suasion. Therefore,
Statement #3 is right.
Even if we accept that RBI advices, still the questions asks
what is implied by RBI as Bankers bank. So, RBI advices
moral suasion that is a monetary policy tool. RBIs not doing
it as a Banker to those banks. Therefore, Statement #3 is
definitely wrong.
Money Banking and finance,
E Narayan Nadar (PHI
publication). He has
specifically listed this
Advice function under
Bankers bank topic.
Answer (B) Answer (D)
So, is it B or is it D? Final judge is UPSC.
They had uploaded CSAt-2012 official answer key on their site.
This question is Test Series A, Question #75 and its official answer is D = meaning all
three statements are correct.
If you face such MCQ in exam, what should be your approach?
Skip Upto you. But if you start skipping all such question (OMO, Money supply, Bankers
bank), because youre completely unaware of those topics=that is not pardonable.it
shows youre underprepared for this exam. You should either change your study
method or change the game- try for some easier exam.
Attempt This question is attemptable, if you dont nitpick over the word advises in third
statement.
Mark n
Review
If youve thoroughly prepared the RBIs monetary tools (both qualitative and
quantitative), you can solve it by applying concepts/principles- particularly the
moral suasion thing. But if youre still doubtful over whether #3 is right or wrong,
then better skip. If you skip because youre doubtful = that is pardonable. But if you
skip because youre completely unaware of this topic= non-bailable offense.
Appendix
These are the topics I wanted to discuss in the article, but they would break the flow of other
topics. Hence writing them @bottom:
#1: Why High SLR and High CRR are bad?
From the discussion so far, you might think why Rajan only focuses on Repo rate to control
money supply. Why not simply raise SLR and CRR requirements.
Lets check the de-merits of high SLR and CRR:
Prior to LPG reforms in 90s, RBI used to keep SLR and CRR very high. Lets take an example
A Bank can two types of deposits
Deposit type examples
Time Deposit Fixed deposit (FD) recurring deposit.
Demand Deposit Savings account, current account
Using this money, bank has to count its Net Demand and Time liabilities (NDTL), every
fortnight. Suppose its 100 crores.
Both CRR and SLR are counted on this figure. In the old times, these reserve ratios used
to be as high as 15% and 40% respectively. Observe the effect:
Net Demand and Time Liabilities (NDTL) +100 cr.
Reserve ratios
CRR (15%) (-) 15 [no profit]
SLR (40%) (-) 40 [some profit]
Money left with bank =45 cr.
From 100 crores, barely 45 crores left with the bank. But adding insult to the injury- even here
RBI mandates Priority sector lending (PSL). Meaning, at least 40% of the loans has to be given
to farmers, small businessmen, students etc. groups.
Lets update the table:
Net Demand and Time Liabilities (NDTL) +100 cr.
Reserve ratios
CRR (15%) (-) 15 [no profit]
SLR (40%) (-) 40 [some profit]
Money left with bank =45
PSL (40%) =45 x 0.4 =18 crore.
Money left for big borrowers (i.e. big businessmen, upper middleclass) =45-18=27 crores.
By the way, PSL is counted on annual basis while SLR, CRR counted on fortnight basis so
above table is technically incorrect but Ive plugged in those numbers only for the sake of
explanation.
before the 90s- Government would even interfere and order public sector banks to give
PSL-loans @cheap interest rates. The local politicians would coerce the branch manager
to give PSL-loans to ineligible people. They default on loans, Branch manager cannot
recover money (because defaulter will goto civil court then taarikh pe taarikh.) So, bank
would have to forget about most of those 18 crores given in PSL loans.
Anyways you can see people deposited 100 crores in the bank yet bank is left with barely
27 crores (over which, bank has Freedom to decide whom they should give the loan.)
What are the consequences for businessmen?
1. High cost of credit (because bank will try to make maximum profit from those 27 crores- so
bank will charge very high interest rate on the business loans- to pay off for the staff
salaries, branch office rents and everything.)
2. Businessman cannot expand his business.
3. Less exports.
4. Less tax income for the government.
So in a way- that was also one of the factors leading to Balance of Payment crisis (and
subsequently LPG reforms.) You can read more about that in NCERT Class 11- chapter 2 and 3.
#2: Narsimhan (I) Committee 1991
Plagued by problems and losses in nationalized banks, Government of India formed this
Committee. Recommendations were:
1. Deregulate interest rates. Let the banks decide their loan interest rates. Accepted.
Gradually, we moved to the Base Rate system.
2. PSL loans should be given at normal interest rates. Accepted (but with exception=>
interest subvention- that we saw under Nachiket articles.)
3. NPA/Loan default matter should be handled by separate body and not civil courts. Result:
Debt recovery tribunal created in 1993. Ultimately SARFAESI Act in 2002.
4. Reduce CRR, SLR. Accepted. Today weve them @4% and 23% respectively.
5. Allow Private banks and foreign banks. RBI invited applications in 1993. ICICI, Axis, HDFC
and many others got license.
6. Liberate Branch expansion policy. Done (Except that 25% rural branching mandate we
saw under Nachiket articles).
7. Prepare NBFC regulatory framework. Accepted.
8. Government should reduce shareholding (and thereby its official influence) in the public
sector banks. Government agreed. Today governments shareholding in SBI =~60%.
#3: Narsimhan (II) Committee 1998
Suggested more reforms.
1. allow VRS in the banks so they can get rid of excessive staff.
2. Suggested additional Legal reforms for loan recovery. => SARFAESI 2002.
3. Computerization, electronic fund transfer, legal framework => Payment and Settlement
Act=>Retail (ECS, NEFT, credit Card) + Wholesale (RTGS)
4. Permit new private /foreign banks. RBI invited license in 2001= Yes Bank and Kotak
Mahindra got licenses. 2013: RBI again invited applications for bank licenses.
[Note: list of recommendations not exhaustive, Ive only highlighted important topics that show
evolution of banking sector in recent times.]
Mock Questions
1. With open market operations, RBI can
1. increase liquidity in the economy, but cannot decrease it
2. decrease liquidity in the economy, but cannot increase it
3. Can increase or decrease liquidity in the economy to control money supply.
4. None of above.
2. By which of the following methods, government can reduce money supply in the
economy?
1. taxation
2. sale of securities to public
3. both A and B
4. neither A nor B
3. During the period of deflation
1. RBI should use dear money policy to combat it
2. Government should reduce its tax rates.
3. both A and B
4. Neither A nor B.
4. IF prices are lowered without causing unemployment, we call it:
1. stagflation
2. reflation
3. disflaction
4. Disinflation.
5. Which of the following contains correct set of quantitative instruments of monetary policy?
1. reserve ratio, bank rate, margin requirements
2. open market operations, margin requirements, regulation of consumer credit
3. cash reserve ratio, bank rate, open market operation
4. None of above
6. Which of the following contains correct set of qualitative instruments of monetary policy?
1. reserve ratio, bank rate, margin requirements
2. credit rationing, margin requirements, regulation of consumer credit
3. cash reserve ratio, bank rate, open market operation
4. None of above
Q7. To counter the effect of deflation, which of the following steps should RBI initiate?
1. decrease reserve ratios
2. buy government securities through open market operation
3. increase policy rate
Answer choices
1. only 1 and 2
2. only 2 and 3
3. only 1 and 3
4. 1, 2 and 3
Q8. To counter inflation, which of the following steps should RBI initiate?
1. Increase reserve ratios
2. sell government securities through open market operation
3. Increase policy rate
Answer choices
1. only 1 and 2
2. only 2 and 3
3. only 1 and 3
4. 1, 2 and 3
Q9. Which of the following may cause deflation in the economy?
1. RBI raises policy rate
2. RBI raises cash reserve ratio
3. RBI sells securities
Choices:
1. only 1 and 2
2. only 2 and 3
3. only 1 and 3
4. all 1,2 and 3
Q10. Money supply in the economy, is affected by
1. Cheap money policy and dear money policy.
2. Open market operation and Moral Suasion.
3. Consumer credit regulation and loan to value ratio.
Choices:
1. only 1 and 2
2. only 2 and 3
3. only 1 and 3
4. all 1, 2 and 3
Q11. An increase in SLR
1. will restrict the expansion of banks credit
2. will increase banks investment in safe securities
3. will ensure solvency of the banks
choices:
1. only 1 and 2
2. only 2 and 3
3. only 1 and 3
4. all 1,2 and 3
Mains/interview type questions- after we check Urjit Patels recommendations on strengthening
monetary policy.
Hints
1. can increase by buying, can decrease by selling
2. both [or only B, depending on how UPSC examiner interprets the effect of taxation on
money supply. In one of the reputed book on Banking and finance, author Narayan
Nadar claimed taxation can affect money supply.]
3. dear money policy during deflation =adds insult to the injury of businessman. If
government reduces tax- then its revenue collection will drastically reduce. So both
incorrect. [OR debatable- depending on how UPSC examiner interprets the effect of
taxation during deflation.]
4. directly given in the article.
5. see the last table in the article
6. see the last table in the article
7. observe the table before the topic repo rate in recent years
8. same as above
9. same as above
10. All correct. (Unless you nitpick and drag the logic too much.)
11. same as above.
Visit Mrunal.org/Economy For more on Money, Banking, Finance, Taxation and Economy.
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mrunal.org http://mrunal.org/2013/02/economy-banking-ombudsman-meaning-functions-appointment-reforms-explained.html
[Economy] Banking Ombudsman: Meaning, functions,
appointment, reforms explained
1. What is Banking Ombudsman (BO)?
2. Appointment & Tenure
3. Jurisdiction
4. Procedure for getting justice?
1. How does BO settle complaint?
2. Punishment
3. Appellate authority for Banking Ombudsman
5. Reforms and Issues
1. #1: Netbanking frauds
2. #2: Need more BOs
6. Location of Offices
7. Mock questions
From UPSC point of view, you dont need to memorize all minute details given in this article
(theyre provided for IBPS/SBI PO exam).
What is Banking Ombudsman (BO)?
He hears customers complaints against banks.
BO was first setup in UK.
In India, RBI started this scheme in 1995.
Appointment & Tenure
Earlier RBI used to appoint reputed persons from banking, finance, management, legal
etc. sectors as Banking Ombudsmen (BO).
But now RBI has reserved this BO post for its own Chief General Managers and General
Managers.
Tenure: 3 years at a time.
Reappointment: yes possible.
Jurisdiction
Banking Ombudsman (BO) Scheme applies to whole of India (including Jammu and
Kashmir).
Banking Ombdusmen have jurisdiction over
1. All commercial banks (scheduled and non scheduled, public and private)
2. Regional rural banks
3. scheduled primary co-operative banks
4. NBFCs (BOs Jurisdiction limited to loan part.)
BO is not a replacement of Consumer forum/courts. He merely supplements them.
BO deals with matters less than or equal to Rs.10 lakhs.
Here are some examples situation where BO can help you:
Regular banking
1. Demand draft, cheques, pay orders etc. not issued on time. (or not paid on time)
2. Credit card related complaints (e.g. bank putting hidden charges. Your credit card was
stolen but bank did not disable it even after you called them.)
3. You asked the bank to close your account / credit card but they are not doing it.
4. Bank refuses to open your account without giving valid reasons.
5. Bank closes down your account without valid reasons.
6. Government / your company deposited salary / pension in your account but the bank is
not releasing it on time.
7. Bank is taking out money from your account in pretext of some flimsy charges.
8. Branch office notice board says 10.30 to 5 but staff refuses to provide you service after
3.30PM.
9. NRIs having bank account in India and facing problems about remittances etc. (e.g. he
deposited money from America, but his parents are not given money on time.)
Loans
1. Your loan application is not processed in time.
2. Your loan application is rejected without valid reasons.
3. You loan application is accepted but money is not released in time. (and still bank is
charging interest on it!)
4. Bank doesnt follow RBI guidelines regarding loan-recovery agents (e.g. bank hires some
criminals to bully and harass you.)
5. Bank doesnt follow RBI guidelines regarding loan interest rates.
Procedure for getting justice?
Youre unhappy with the bank for xyz reason. But you cannot directly approach BO.
First youve to give written complaint to the concerned bank that Ive so and so problem.
and IF the bank doesnt deal with your complaint within one month, then you can
approach BO.
On the other hand, you cannot approach BO if the matter is older than 1 year.
You dont need lawyer to approach BO.
You dont need to pay any fees/ stamp papers for approaching BO.
You cant approach BO in following situations
1. Matter is higher than Rs.10 lakh.
2. If the matter is pending before any other court, tribunal, forum then you cannot approach
BO.
3. If any other court, tribunal, forum has already passed an order on the same matter.
4. You cannot approach BO for frivolous or vexatious complaints (e.g. AC or water cooler
was off when I went to the branch. Someone jumped the queue but security guard did
nothing.)
How does BO settle complaint?
Upon receiving your complaint, first BO will try to solve the matter via settlement
/arbitration (=try to achieve a compromise, conciliation or amicable solution between bank
and its customer.)
This has to be done within one month after receiving complaint.
But if either party (customer/bank) is not accept this (compromise/negotiation/settlement)
then after 1 month, BO will have to pass order.
Now, hell ask both parties to present their case/documents etc. And hell pass the order
accordingly.
Two things can happen
1. He rejects your complaint (=bank is not guilty). OR
2. He finds the bank guilty and orders punishment.
Punishment
BO can order the Bank to compensate the actual money loss OR Rs.10 lakh (whichever is
lower).
In case of Credit card related cases, BO can order the bank to pay additional fines (upto
Rs.1 lakh) for the mental harassment caused to the customer.
Appellate authority for Banking Ombudsman
If either party (Bank / Customer) is unhappy with Ombudsmans order, then they can
approach the Appellate authority (=Deputy Governor of RBI.)
1. If youre the customer, you can directly approach him.
2. But if youre the Bank, then you can approach him only after getting permission from
your Chairman/CMD/MD or CEO. (This ensures Banks lower staff doesnt automatically
go for frivolous appeals against every order).
Reforms and Issues
Banking Ombudsman scheme was originally started in 1995.
But in subsequent years, RBI made many reforms in it, some of them are:
originally After reforms
Reputed persons from law, finance,
banking, Management, administration
etc. can become BO.
Only RBIs own officers can become BO. (=outsiders
not allowed for this post.)
Banks provided Money+Staff for
Ombudsmans office in their area.
RBI itself gives the money and staff to Ombudsman.
He only accepted paper complaints. Accepts Paper + online complaints.
Regional Rural Banks put under jurisdiction of
Ombudsman.
Ombudsman can look into internet-banking related
complaints.
Banks are required to display salient features of the
scheme for common knowledge of public. (e.g.
posters in the branch office.)
#1: Netbanking frauds
According to RBIs scheme, Ombudsman can also look into internet banking related
matters.
But Ombudsmen across the country often wash away their hands and ask the victim to
wait for police investigation to finish.
And on the other hand, Banks donot take responsibility saying net banking frauds as
most of them happen due to customers negligence and cyber-crime.
So ultimately customer has to depend on the police to get justice.
#2: Need more BOs
A Committee formed by RBI has recommended that instead of having only 15 Banking
ombudsman across country, have one BO appointed for every bank.
The upper limit (of Rs.10 lakh) should be increased.
Location of Offices
Banking Ombudsman has total 15 offices throughout India
Those whore preparing for IBPS/SBI PO should prepare this table for MCQs, others need
not worry much.
1. Abad
Gujarat + UT of Diu, Daman, Haveli
2. Banglore
Karnataka.
3. Bhopal
MP+Chattisgarh
4. Bhuvneshwar
Odisha
5. Chandigarh
HP+Punjab+part of Haryana
6. Chennai
TN+Andaman, Nico
7. Guwahati
All north Eastern states minus Sikkim
8. Hyd.
AP
9. Jaipur
Raj
10. Kanpur
UP (some areas excluded though)
11. Kolkata
WB+Sikkim
12. Mumbai
Mah+Goa
13. Delhi
Delhi+J&K+part of UP+Part of Haryana
14. Patna
Bihar+Jharkhand
15. Thiruvanthapuram
Kerala+Lakshdweep+Puducherry
Mock questions
Q1. Which of the following falls under the jurisdiction of Banking Ombudsman
1. Regional Rural Banks
2. Scheduled commercial banks
3. Non Scheduled primary co-operative banks
Answer choice
1. Only 1 and 3
2. Only 2 and 3
3. Only 1 and 2
4. All of them.
Q2. Find correct statements
1. BO is selected and appointed by Finance ministry.
2. BOs staff and office expenditure are charged on the consolidated fund of India.
1. Only 1
2. Only 2
3. Both
4. None
Q3. Find incorrect statement
1. If the promises made by a sales agent, are not kept by the bank, you cannot approach
BO.
2. If the matter involves loss of more than Rs.10 lakhs, you cannot approach BO.
3. The appellate authority for BO is High court of the concerned State.
4. There is one separate BO for Union Territories of India.
Answer choices
1. Only 2
2. 2 and 4
3. 1,3 and 4
4. All of them.
Q4. Which of the following are included in the purview of BO?
1. Net banking
2. Credit cards
3. ATM cards
4. Harassment by Loan recovery agents
Answer choices
1. Only 2 and 3
2. Only 1, 2 and 3
3. Only 2,3 and 4
4. All of them.
[Economy] Special 301 Report, Priority List, Implication on India, Nexvar case,
Compulsory License, Patent Evergreening, IPR protection, USTR explained
[Fed Tapering:Part2 of 2] Measures to immunize Indian Economy against negative
impacts of Fed Tapering, Currency Swap, Dollar Swap, FCNR swap, Brics bank explained
The work o f Mrunal is under the Creative Commons Attribution-Non Commercial-ShareAlike 4.0
License.Permissions beyond the scope of this license may be available at Mrunal.org/contact.
mrunal.org
http://mrunal.org/2013/01/economy-banking-business-correspondents-agents-bca-meaning-functions-financial-inclusion-swabhimaan-
common-service-centres-csc.html
[Economy] Banking Business Correspondents Agents
(BCA): Meaning, functions, Financial Inclusion,
Swabhimaan, Common Service Centres (CSC)
1. What is financial inclusion?
2. Why Business Correspondents system?
3. Who/What is Business correspondent?
4. Who can become Business correspondent for Banks?
5. Functions of Banking Business Correspondents?
6. Swabhimaan
7. Reforms in BC model
1. Common BC
2. NREGA payment
3. Kiosk Banking
8. BCA for Direct Cash Transfer?
9. Mock questions
What is financial inclusion?
Give every poor man a bank account. And help him get a loan from banks.
Financial inclusion involves
1. Give formal banking services to poor people in urban & rural areas.
2. Promote habit of money-savings, insurance, pension-investment among poor-people.
3. Help them get loans at reasonable rates from normal banks. So they dont become victims
in the hands of local moneylender cum thugs.
Three important initiatives taken by RBI for financial inclusion:
1969
Lead banking scheme (LBS).
RBI assigns a district to a particular bank.
That Bank will be responsible for promoting banking services and financial
literacy, in that district.(=financial inclusion).
2005
No frills account.
Poor people can open bank accounts with very low balance e.g. Rs.5 only.
Weve already discussed that in earlier articles: Click me and click ME
2006
Business Correspondents (BC) system. Discussed in this article.
Why Business Correspondents system?
If Financial inclusion means open bank accounts for poor people. Then whats the big
deal, just open a damn account!
Not so easy. India has around 6 lakh villages. Most of them dont have bank branches.
Ok so Why cant banks open branches in every village?
No profit
Because Administrative costs will be high= Building rent, telephone, electricity, staff salary,
security guards.
On the other hand volume of business is very low in village areas=amount of money
deposited, loans taken.
Means there is No profit. Actually itll lead to heavy losses.
Reluctant staff
In many villages, there is no electricity, no good schools/drinking water, naxalite problem=
Bank staff doesnt want to serve there.
Therefore banks dont like to open branches below district HQ or Tehsil level. Now comes
the problem
Hardships faced by poors
A poor man lives in remote village.
This man has deposited some Rs.2000 in a bank @his tehsil.
Now, He wants to take out some money from his bank account.
So Hell have to make a trip for 10-20 kms =travel =time and cost.
He is illiterate so he doesnt know how to fillup bank slips, other paperwork. He needs to
ask for help here and there in the bank office.
And most banks/post-offices dont treat poor people with respect or priority like they do
with regular customers.
So, he may have to wait for many hours, move from this table to that table, before he gets
his money.
= he cannot return to his village and do his daily job/work.
= his one days income is lost.
Same process repeats, when this man wants loan to buy a new cow, pumpset, seeds or
fertilizers.
One the other hand, local money lenders in his village, give money quickly, without asking
many questions or requiring him to fillup two dozen application forms. (but then they
extract 36% compound interest from this poor man, thus making his life a living hell.)
Ultimately
1. Banks
We cant open branches @every village, because its not profitable.
2. poor
people
We cant make trip to nearest town to access banking facilities, because it is
inconvenient.
So, whats the solution?
How about a middleman / agent between banks and the poor people?
Who/What is Business correspondent?
Business correspondents are bank representatives.
They help villagers to open bank accounts.
They help villagers in banking transactions. (deposit money, take money out of savings
account, loans etc.)
The Business Correspondent carries a mobile device.
The villager gives his thumb impression or electronic signature, and get the money.
Business Correspondents get commission from bank for every new account opened,
every transection made via them, every loan-application processed etc.
Who can become Business correspondent for Banks?
1. Non-Governmental
Organisations(NGOs)
2. Self Help Groups (SHGs),
3. Micro Finance Institutions (MFIs)
4. Post Offices
5. Insurance agents
6. Panchayats
7. Civil Society Organisations (CSOs)
8. farmers clubs
9. Community based organisations
10. Cooperatives societies
11. Village Knowledge Centres,
12. Agri Clinics/ Agri Business Centers,
13. Krishi Vigyan Kendras
14. Khadi and Village Industries units
15. corporate entities with IT outlets in rural
parts.
Functions of Banking Business Correspondents?
1. Create awareness about savings.
2. Give advice to villagers, about how to save/invest money and how to arrange/manage
loans.
3. Help the villagers to open bank accounts.
4. Collect loan applications, forward them to bank.
5. Preliminary processing of loan applications for example: verification of persons identity,
home-address etc.
6. Help the Self Help Groups (SHG), to get loans.
7. Help the bank to collect EMIs and recover loan money.
Swabhimaan
Initiative by the Finance Ministry + Indian Banks Association
launched in 2011
To bridge economic gap between rural and urban India.
Objectives
Make banking facilities available to every habitat with a population >2000 (by March
2012.)
Banks will provide basic services like deposits, withdrawal, Kisan Credit Card (KCCs) etc
via Business Correspondents (BCs) also known as Bank Saathi.
Banks will also working together with the Unique Identification Authority of India (UIDAI)
for opening new bank accounts.
Government will send subsidies and social security benefits (pension etc.) directly to
beneficiarys account.
Beneficiary can withdraw the money from the Business Correspondents (BCs) in their
village itself.
Government has provided 500 million rupees to banks for taking these ^initiatives.(e.g.
paying Commissions to Bank Saathi, their training cost, doing paperwork with UID.)
Reforms in BC model
Common BC
Last year Finance ministry came up with this proposal:
India be divided into 20 clusters.
A common BC be appointed for all public sector banks operating in that geography.
Such a move would improve the economics of the BC model. (otherwise so many BCs,
fragmentation=nobody earning decent Commission=nobody improving the service
delivery.)
Reserve Bank of India (RBI) has permitted all business correspondents (BCs) working for
one particular bank, to conduct business for other banks as well.
FINO, Indias largest Business Correspondents company
FINO=Financial Inclusion Network and Operations (FINO).
It is promoted by various Public and Private sector banks and insurance companies like
LIC.
Last year, FINO become the common Business Correspondents company for all public
sector banks operating in Jharkhand.
NREGA payment
Old system New system
1. A villager earns some cash
under MNREGA.
2. Government gives cash to
bank.
3. Bank gives it to B.C.
4. B.C. deposits it into
MNREGA workers
account.
1. All accounts will be maintained by core banking
system.
2. So, cash directly goes from Government > Bank
>MNREGA workers bank account.
3. Villagers will have the freedom to make their
withdrawals from any BC they choose.
Kiosk Banking
The D.I.Y. (Do it yourself) banking services e.g. ATM, internet kiosks = still expensive.
There is also lack of education + awareness in rural areas about such things.
So even if Government /bank installs such automatic ATM, internet kiosks=> most of the
time they just gather dust.
Therefore, technology-based self-service model (e.g ATM, internet kiosks) is not useful at
this stage.
And hence we need Personnel (these Business Correspondents=middlemen). Because
often villagers are illiterate, so they cant even fill up the forms for opening bank accounts
or loan-application or filling the deposit slips etc. Business Correspondents are essential
at this stage.
But again problem: The cost per transaction remains high. (Because Bank has to pay
commission to B.C.agent.)
Therefore, Chindu has suggested following solution for long term:
Migrate from banking correspondent model to Kiosk banking = mobile vans fitted with ATM
machines+ biometric devices.
Theyll provide banking services in remote areas.
BCA for Direct Cash Transfer?
In November 2012, Mohan announced Direct Cash transfer scheme. (will be covered in
detail, later)
Anyways, under Direct Cash transfer scheme, Government will directly deposit payments,
subsidies, scholarships, pensions etc into the beneficiarys bank account.
Sounds well and good? Well, here is the big problem
There are about six lakh villages in India.
And despite all these financial inclusion initiatives (of FINMIN+RBI), still only ~75,000
villages have a bank branch or business correspondent agents (BCA). So for the poor
people in remaining ~525000 villages still face the problems we saw` in MNREGA
payment withdrawl.
So Direct Cash Transfer will be #EPICFAIL unless each and every village is covered
under banking services.
Therefore, recently Chindu asked the banks to have at least one bank branch or business
correspondent agents (BCA) for every village or group of villages with 1,000 to 1,500
households.
In the villages without BCA, Department of Electronics and Information Technology will
install Common Service Centre (CSC).
This CSCs will serve as the BCA.
Right now, CSC will used only for opening new accounts of beneficiaries under the
scheme for direct cash transfer.
Only after banks install the software and complete other technical requirements for cash
transactions, the CSC will allow villagers to withdraw cash from their accounts.
Side note on CSC
Common Services Centers scheme= started in 2006.
Aim= set up of 100,000+ (one lakh) internet enabled centers in rural areas under the
National e-Governance plan (NeGP)
Mock questions
MCQs
Q1. Financial inclusion involves
1. Covering rural poors in banking net.
2. Covering urban poors in banking net.
3. Providing jobs to poor people.
4. Providing vocational training to poor people.
5. Spreading banking awareness among poor people.
Ans.choices
1. Only 1, 3 and 5
2. Only 1,2 and 5
3. Only 3 and 4.
4. All of them
Q2. Find incorrect statements about Swabhimaan scheme
1. It was launched by the Ministry of Social justice in 2009.
2. It aims to provide insurance coverage to laborers in unorganized sector.
3. It aims to provide financial inclusion to people residing in remote areas of India.
Ans
1. Only 3
2. Only 1 and 2
3. Only 2 and 3
4. Only 1 and 3
Q3. Who among the following, is/are eligible to become Business correspondents for banks?
1. Post office
2. Panchayats
3. NGO and Insurance Agents
4. Self Help Groups (SHG)
Ans
1. Only 1 and 2
2. Only 2 and 4
3. Only 2 and 3
4. All of them.
Descriptive Questions
1. Swabhimaan (5m)
2. Swavalamban (5m)
3. Common Services Centers scheme (5m)
4. Write a note on National E-governance Plan (NeGP) (10m)
5. Define Financial inclusion. Discuss the initiatives taken to achieve financial inclusion.
(15m)
Interview
1. Apart from what is already being done, what new initiatives should be taken to achieve
100% financial inclusion?
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mrunal.org http://mrunal.org/2012/12/economy-sarfaesi-asset-reconstruction-company-arc-security-receipt-sr-qib-drt.html
[Economy] SARFAESI Act, Asset Reconstruction
Company (ARC), Security Receipts (SR), QIB, DRT,
Central Registry
1. What is NPA?
2. Debt Recovery tribunals (DRT)?
3. What is the Sarfaesi Act?
1. Appeal structure
2. Bank: Power to Auction
4. What is ARC?
1. What are Security Receipts (SR)?
2. What is Qualified Institutional Buyer (QIB)?
3. Foreign investment in ARC?
4. ARC New Power: convert Debt into equity
5. Anti-arguments: Debt to Equity conversion
6. What is Central Registry?
7. Misc.Amendments
8. Summary
9. Mock Questions CSAT
10. Boring details
11. Committees
What is NPA?
Bank gives loan to a person.
Person fails to make regular payments.
Bank gives him notice to correct his behavior. But he doesnt.
Bank declares that loan as Non-Performing Asset (NPA) (=Bad Loan)
Currently Indian banks have NPAs worth more than Rs. 1 lakh crores.
Debt Recovery tribunals?
Prior to 90s, banks had very hard time recovering bad loans.
Because often, borrowers (loan takers) would file frivolous cases in civil courts, then
taarikh pe taarikh, taarikh pe taarikh.. proceeding would go on for years.
So 1993, Government established Debt Recovery Tribunals to deal with NPA matters.
Now borrower cannot approach civil court, theyve to goto special Debt Recovery Tribunal
(DRT).
This led to some relief, but then DRTs clogged down by truckload of cases. (Even now,
more than 60,000 cases pending with DRTs)
In 2002, Government came up with new Act, named SARFAESI Act.
What is the Sarfaesi Act?
Securitisation
and Reconstruction
of Financial Assets
and Enforcement of Security Interest Act, 2002,
Suppose, Mr.Paraajay has opened factory with Rs.100 crores. He financed this, via mixture of
Debt + equity in following way. (make sure you understand debt vs Equity, if not click me)
Holder Rupees in Cr.
Equity (IPO->Shares) Paraajay and his family 20
Juntaa (public) 30
Debt (loans, Bonds) Business loan from SBI 40
Bonds 10
Total 100
Initially the company runs well and good.
But then Mr.Paraajay doesnt revise his MBA books often, so he forgets the business
concepts. His company starts making losses.
He fails to pay loan EMIs for many months.
SBI gives him notice to correct his behavior.
Still, he doesnt start paying money.
SBI declares this Rs.40 crores loan NPA (Non-Performing Asset).
Once a loan is declared as non-performing asset, SBI can take actions under SARFAESI
act, to recover the loan money.
Bank have following powers under SARFAESI Act
1. Take possession of Mr.Paraajays assets without requiring court order. (Commericial or
residential, fixed or moving assets.)
2. Auction / Sale them.
3. Change the administration/ Management of those assets.
4. If Mr.Paraajay had sold away the mortgaged asset to third party Mr.X, bank can order Mr.X
to surrender that Asset.
5. If Mr.X owes money to Mr.Paraajay, he can be ordered to pay money.
*ARCs explained after a few paragraphs.
SARFAESI applies only to loans above Rs.10 lakhs.
By the way SARFAESI applies only to those assets mortgaged/secured to get the loan.
E.g. if Mr.Paraajay had taken business-loan, SBI would have asked him to sign away his
factory/machinary/vehicles/land etc. specific items as mortgage.
Hence SBI can attach only ^those assets.
But SBI cannot take away Paraajays personal home-furniture, expensive wrist-watch or
his sons bicycle in the name of SARFAESI.
Similarly, Agricultural land is exempted from SARFAESI attachment.
Appeal structure
The borrower (loan taker) has following options:
Get a stay order from Debt Recoverty tribunal (DRT) against the auction/sale of his
properties. (He cannot file case in Civil courts.)
Fight the case in DRT.
If unhappy with DRT verdict, he can appeal to Debt Recovery Appellate Tribunal (DRAT).
But before filing appeal with DRAT, hell have to deposit 50% of his pending loan money.
Bank: Power to Auction
First SBI contacts the experts, gets valuation of Mr.Paraajays assets.
Expert says those assets are worth Rs.50 crores according to present market value of
land/ building/ machinary whatever.
Then SBI will give advertisement in newspapers we are auctioning xyz
land/machinary/building. Minimum bidding amount is Rs.50 crores. Whoever wishes to bid,
send us application along with Rs.50,000 as deposit, and their class 10, 12 mark-sheets
and school leaving certificates, duly attested by a Gazetted officer.
Problem: sometimes, bidders donot take interest in buying such properties, factories etc.
To fix this problem, Amendment bill of 2011, makes a new provision: if noone else comes
to bid in the auction, Bank itself can buy that property.
Here comes the new problem:
Suppose SBI attached a warehouse of Mr.Paraajay.
If the land was in good urban area, SBI could open a new branch office there (or housing
for its employees).
But if plot/factory/house is in some remote area= useless for SBIs personal business.
Under the Banking regulation Act, a bank cannot keep such immovable property beyond 7
years, (max 12 years with RBIs permission).
So ultimately SBI will have to auction it to someone. What if they dont get better price?
Critiques of the bill say, this is not clarified in the bill.
What is ARC?
Asset reconstruction company (ARC).
They buy NPA (Bad loans) from Banks and try to extract maximum money out of it=profit.
Theyve to register with Reserve Bank of India.
Examples:
1. ARCIL (Indias first and largest asset reconstruction company (ARC))
2. Reliance Asset Reconstruction Company Limited by Anil Ambani
In our example, SBI has NPA worth Rs.40 crores.
ARC will buy the NPA file from SBI at a lower rate say 35 crores. (well, SBI is making loss,
yes, but something is better than nothing.)
Besides, banks have hundreads of bad loan cases, they donot have time or manpower to
pursue individual case, sometimes no bidders are interested in auction. All the filework and
donkey labour, In such cases, its better for bank to transfer NPA to ARC.
But that doesnt mean ARC will give 35 crores to the SBI from its own pocket!
Then how will the Asset reconstruction company (ARC) arrange for the money?= via
Security Reciepts.
What are Security Reciepts (SR)?
In above example, ARC needs Rs.35 crores to buy a Non performing asset from SBI.
So ARC will issue security reciepts (SR) worth Rs.35 crores.
Only Qualified Institutional buyers (QIB) can buy these security reciepts (SR).
SR are not bonds, they donot carry fixed interest rate.
ARC will promise to pay money on SR, when it gets money the bad loan.
Although, ARC usually promise 9% profit on security reciepts (SR).
So, three possible situations:
1. Qualified institutional buyers (QIB) buy those security reciepts (SR). So Rs.35 cr cash
goes from QIB -> ARC -> SBI.
2. SBI itself recieves SR worth Rs.35 crores for free. (that means ARC will gradually pay the
money to SBI).
3. combination of both: QIBs buy SR worth 30 crores + SBI recieves free SR worth 5 crores.
What is Qualified Institutional Buyer (QIB)?
These people have the expertise and the financial muscle to evaluate and invest in the capital
markets.
Examples: (click on each to read previous articles on them)
1. Scheduled Commericial Banks
2. Foreign Institutional Investor
3. Mutual Funds
4. Venture Capital Investors
5. Insurance Companies
6. Pension/ Providend Funds
Foreign investment in ARC
ARC =buy bad loans from banks.
ARC =arrange money from QIBs to buy bad loans from banks.
Problem= Indian QIBs do not invest much in ARCs.
Therefore ARCs capacity to buy NPA= very low.
And bank themselves dont have enough expertize or manpower to dispose those NPAs
quickly.
Previously Foreign investors could invest only upto 49% in ARC=minority
shareholder=cannot influence company decisions.
Now, Government also increased foreign investment limit in ARCs. This would attract
more investment in ARCs and help in quicker purchase and disposal of NPAs.
Foreign investment in ARC %
Earlier 49%
Now (December-24-2012) 74%
Anyways, back to the topic, lets recap:
1. SBI had NPA. First solution: auction the property. Did not work out.
2. Second solution: sell it to ARC.
So, ARC purchased the NPA worth Rs.40 crores (at Rs.35 crores).
ARCs aim= extract maximum money out of this investment. But how?
1. Auction the assets fully or partially. (sell the machinary now, rent the building and wait for
land prices to go up for two years and then sell it.)
2. Sell the property in combination with other NPA properties of other defaulters. (similar to
buy one large pizza and get 20% discount on any medium sized pizzas).
3. Restructure the EMIs of Mr.Paraajay. E.g. instead of 1 lakh per month, give us 75,000 per
month.
4. Change the Management of that asset, appoint its own directors/officers.
5. Order Mr.Paraajay to outsource or lease his business to a another company.
^SARFAESI act empowers ARC to do such things. The amendment Bill adds a new power to the
ARC.
ARC New Power: convert Debt into equity
Before reading further, Make sure you know the pros and cons of Debt Vs. Equity (already
discussed in an old article click me)
The new Amendment in SARFAESI, empowers ARC to convert debt into equity.(fully or partially).
Share holding Before:
Shares Rupees Cr. %
Paraajay and his family 20 40%
Juntaa 30 60%
Total shares worth 50 100%
Share holding After
Shares Rupees Cr. Approx. %
Paraajay and his family 20 22%
Juntaa 30 33%
ARC 40* 44%
Total shares worth 90 100%
*that is the paper value of original debt (NPA loan of SBI to Mr.Parajaay), Otherwise ARC
purchased it @Rs.35 crores.
Anyways, This leads to two situations:
1. If company starts making more profit in future, ARC will receive more share from that
profit. (because more profit=more dividend to shareholders.)
2. If price of companys shares go up in the sharemarket, ARC can sell those shares to third
party and make decent profit.
Anti-arguments: Debt to Equity conversion
Critiques says this debt to equityprovision will be abused. This provision is made to help bad
corporates. How so? Well consider following:
Banks loss
SBI gave Rs.40 crores loan to Mr.Parajaay
He refuses to pay loan=bad loan/NPA.
Then SBI sells this bad loan file to an ARC company @Rs.35 crores.
Hence, SBIs loss is 40-35=5 crores. (actually more than 5 crores, if we count the possible
interest rate that he would have paid, if he had not defaulted. And loss figure will be
different if he had paid a few installments earlier. Anyways, lets keep the loss at 5 crore for
the moment.)
ARCs profit
Now ARC owns the NPA assets. (their investment Rs 35 crores)
Paraajay offers Rs.37 crores and ask ARC to sell the assets to his relative, friend or proxy.
Hence, ARCs profit is 37-35=Rs.2 crores.
And yet Mr.Parajaay successfully saved Rs.3 crores (because originally he had to pay
Rs.40 crores to SBI, but he walked away by paying just Rs.37 crores!)
Few years back, CVC had held a meeting with Bank chairmans and CBI officers. They
alleged ^this type of mischief going on, in many loan default cases.
Now under the new provision: if ARC converts its debt into equity (shares), then what will
happen?
1. It is very unlikely that Parajaays company will start making huge profits (otherwise it
wouldnt be in bad loan problem in the first place!)
2. It is very unlikely that share-price of Parajaays company will go up in sharemarket.
(because it has negative publicity due to NPA).
Hence it is very unlikely that ARC will make huge profit out of this Equity.
Then Mr.Parajaay can simply offer them a way out : sell those shares to me, in my
friend,relative,driver or peons name @Rs.37 crores.
And ARC would agree, because 37-35=Rs.2 crores profit!
Side question
How would Mr.Parajaay arrange those Rs.37 crores?
Ans. If Mr.Parajaay is totally awesome then he wouldnt give 37 crores from his own pocket.
Hed just open another company, get new loan from second bank, issue IPOs to get money from
juntaa. Then Iski topi uske sar pe.
^This is (one of the many) reasons why Mr.Ratan Tata said following thing:
Overseas people go bankrupt or companies go bankrupt. Here they never dothey
continue to be sick and still operate. Then they are operating to kill you with destructive
competition (using predatory pricing etc.)
(Airline business) is proliferated by many operators, some of them in financial trouble.
I would hesitate to go into the (airline) sector today in the sense that the chances are that
you would have a great deal of competition which would be unhealthy competition.
Bank Employee unions are also against the Debt to Equity clause of SARFAESI amendment.
(When they had gone on strike to oppose Banking Amendment bill , they also cited this Debt-
equity reason as well.)
Central Registry
Previously, borrowers used to forged property documents and get loans from multiple
banks by giving them duplicate property documents as security.
So when borrower refuses to pay up loan, many banks would make claim for the same
property!
To fix this problem, Reserve Bank of India (RBI) setup Central Registry in 2011, under
SARFAESI.
This central registry has details of all properties against which loans have been taken.
Any person or bank can inspect records of this registry to make sure the mortgaged
property is genuine.
Official name: Central Registry of Securitisation Asset Reconstruction and Security
Interest of India (CERSAI)
Misc.Amendments
1. In public interest, Union Government can issue notification that xyz provision of
SARFAESI act may not apply or may apply with modifications to a class or classes of
banks or financial institutions. Suppose many textile exporters have taken loans from
banks but due to global recession they are not receiving payments and hence unable to
repay loans. In that case, Government can order notification that SARFAESI will apply to
all loans except those given for textile-export business.
2. Earlier a borrower could approach Debt Recovery tribunal (DRT) to get stay order against
bank/ARC. New amendment says DRT cannot grant any stay order unless both parties
(Borrower vs. lender bank) are heard. This will ensure the process of law is not misused
by unscrupulous borrowers to get stay orders just to delay money-recovery.
3. Bill proposes to enable banks and financial institutions to enter into settlement or
compromise with the borrower. It also seeks to empower the Debts Recovery Tribunal to
pass an order acknowledging any such settlement or compromise.
Summary
SARFAESI empowers banks and other financial institutions to attach secured assets of a
loan defaulter and sale, auction or manage them without requiring court intervention.
Parliament passed the amendment to SARFAESI Act and the debt recovery tribunal, in
Winter session 2012.
Salient features of new amendment
1. Bank can buy for the NPA property if there are no other
bidders.
multi-state co-operative banks can also take
actions under SARFAESI.
2. Borrower cant get stay orders from DRT easily.
Can make settlement / compromise with
Bank/ARC.
3. Asset reconstruction
companies (ARC)
can convert their debt into equity (fully or partially)
4. Government
can prohibit or modify SARFAESIs applicability in public
interest.
Apart from this amendment, Government has also increased foreign investment limit in ARCs
from 49 to 74%.
Mock Questions
Q1. Which of the following are Qualified Institutional buyers (QIB)?
1. ICICI
2. LIC
3. EPFO
4. FII registered with SEBI
1. Only 2 and 3
2. Only 1 and 4
3. Only 2 and 4
4. All of them.
Q2. Which of the following is not correct about SARFAESI act?
1. It mandates the Rural regional banks to lend atleast 15% of their total loans to rural
cottage industries.
2. It empowers banks to reduce their NPAs.
3. It empowers RBI to impose penalties on Bank responsible for NPAs.
1. Only 1 and 2
2. Only 2 and 3
3. Only 2
4. Only 1 and 3
Q3 Find Correct Statement
1. Foreign investment is prohibited in asset restructing companies.
2. To enjoy the priviledges under SARFAESI act, the Asset Reconstruction Companies have
to get themselves registered with SEBI.

1. Only 1
2. Only 2
3. Both
4. None
Boring details
1. Recovery of Debts Due to Banks and Financial
Institutions Act of 1993 (RDBF)
Established Debt Recoverty tribunal
(DRT) and
2. Securitisation and Reconstruction of Financial
Assets and Enforcement of Security Interest Act
of 2002 (SARFAESI)
Helps banks recover money from
bad loans.
3. Enforcement of Security Interest and Recovery
of Debts Laws (Amendment) Bill, 2011
Passed in Lok Sabha in Dec 2012,
to amend above two laws (RDBF +
SARFAESI)
Committees
SARFAESI was based on recommendation of these two Committees
1. Committee on Banking Sector Reforms (Narasimham Committee II), 1998
2. Restructuring of weak Public Sector Banks -Verma Committee
The latest amendment (Debt to Equity), is based on recommendations of Alok Nigam Panel on
ARCs, made by Finance Ministry.
New Discussion Forum!
By the way, Ive an announcement to make. Many readers were suggesting a discussion
platform should be created (e.g. Anthropology optional, RBI aspirants, RAS, CSIR, APFC
etc.) Because it is not very convenient to carry on or follow discussions via these
comments below every article. Plus, if youre browsing this site via mobile phone,
then every time youve to scroll-down a mile long page just to read or reply comments=
very inconvenient.
So, Ive setup a dedicated forum: Mrunal.org/forum
In the same forum, Ive setup a thread on Current affairs marathon, with the aim that,
candidates can discuss current affairs with each-other, or atleast mention the topics they
consider important, so everyone can do self-study. Here is the
Link: mrunal.org/forum/discussion/3/csat-current-affairs-marathon-2012-13.
Everyone invited to participate.
You may also start your own threads to discuss about RAS, CSIR, CDS, AFCAT etc. with
your peers.
No registration needed, just login with your facebook/gmail account.
mrunal.org
http://mrunal.org/2012/12/economy-banking-amendment-bill-issues-features-problems-reforms-meaning-explained.html
[Economy] Banking Amendment Bill: Issues, Features,
Problems, Reforms meaning explained
1. What is Banking Regulation Act?
2. RBI Power #1: Can remove entire Board of a Bank
3. RBI Power #2: Connected Lending Prevention
4. RBI Power #3: Unclaimed Accounts
5. Public Banks Issue#1: Need consolidation
6. Public Banks Issue#2: Need more investment
7. Banks issue #3: More voting rights for investors
8. Foreign Banks Issue #1: Stampduty
9. Foreign Banks Issue #2: Want to invest in Commodity
10. Standing Committee problem
11. Set: parliament
1. Parliament fight #1: Commodity speculation
2. Parliament Fight #2: Competition Monitoring: RBI vs CCI
12. Anti-Bill arguments
Boring technical details intentionally skipped. I dont do Ph.D on current affairs, neither should
you.
What is Banking Regulation Act?
It is governs all public sector banks (SBI, PNB etc.) and private sector banks.(ICICI, HDFC
etc.) in India.
Set : Finance Ministers Office
Finance minister and RBI governor are holding a meeting.
Chindu Yaar many new players want to open banks in India. But they cant, because
youre not giving new licenses, So what is your problem?
RBI
governor
Well, Im given powers to regulate public and private sector banks, under Banking
Regulation Act 1949.But those powers are not enough.
So, Im not going to give new bank-licenses to anybody, unless and until you get
me more powers, by updating that Banking Regulation Act.
Chindu Ok, Ill move a Banking laws (Amendment) bill, to amend the necessary things.But
first tell me what new powers do you need?
RBI Power #1: Can remove entire Board of a Bank
RBI At present, if a Bank doesnt play by my rules, I can remove its CEO or one or two
directors. But that is not enough. What if the whole board of directors is involved in
some mischief.
So, I want powers to remove the entire board of directors.
I also want you to increase the rates of existing monetary penalties that I can impose
on a bank if it disobeys my rules, directives or gives me false information.
Chindu Ok agreed.Ill get you the powers to supersede boards of the banks if any
irregularities.And Ill increase the penalty rates as well.Anything else?
RBI Second problem. Connected lending.
Chindu What is that?
RBI Power #2: Connected Lending Prevention
Suppose Mr.Paraajay gets license to open a new bank.
He opens Pawn-Fisher bank, people deposit their hard earned cash in it.
Ideally, bank should lend this money to the home, car, education and business-loan
seekers, who then pay interest and thus bank makes profit.
Bank must make good profit, so It can pay 1) good interest rate to its bank account
holders. 2) good dividends to its share holders.
But Mr.Paraajay also owns another company, Pawn-Fisher airlines.
And this airlines company is making losses. Mr.Paraajay gives loans from Pawn-Fisher
bank to Pawn-Fisher airlines @very low interest rate, to fix the mess.
And or, this Pawn-Fisher airlines gets the bank loan @market rates from the Pawn-Fisher
Bank but it doesnt pay EMIs regularly, yet the bank doesnt take any action.
Similarly, Mr.Paraajay also opens Pawn-Fisher Mutual funds, but it also makes losses,
and money is transferred from bank deposits to mutual funds, to cover up those losses.
These type of activities = Not good, because in long term, bank will collapse and
depositors money will be stuck.
RBI So, I must be given powers to check the records and account-books of those mutual
funds, insurance and other companies associated with a bank.
Chindu Agreed.
youll get the power to inspect those other business arms of a bank.
Anything else?
RBI Yes, money from unclaimed bank accounts.
RBI Power #3: Unclaimed Accounts
If Mr.X has not used his bank account for more than 10 years, it is called unclaimed bank
account.
There are crores of rupees in such unclaimed bank accounts, it increases the
Administrative burden on bank employees (=need to maintain files etc)
Plus there is also an opportunity to commit a fraud. for example some bank employee
knows that Mr.Xs bank account is never checked, then hell forge checkbooks signature
or some other trick to withdraw money from Mr.Xs account.
RBI so we must take some measure to tackle this issue.
If a bank account is not operated for more than 10 years, bank will have to
transfer its money in the Depositor Education and Awareness Fund
And Ill appoint a Committee to use money from this fund to create awareness.
Although if Mr.X returns, he can claim his money and that bank will have to
pay him interest also.
Chindu Agreed. Anything else
RBI Yes one tea, two samosas and four more powers
1. If any person wants to buy more than 5% shares of any bank, hell have to
take permission from me. And before giving him approval, I can put conditions
on him, For example give me deposit worth Rs.xyz, so if you play some
mischief, Ill take away your deposit.
2. If primary cooperative societies want to continue their banking business, theyll
have to get a license from me.
3. I can conduct special audits of cooperative banks because theyre more liable
to collapse and frauds.
4. If a bank fails to maintain the prescribed minimum amount of Cash Reserve
Ratio (CRR) on any day, I can demand penalty interest from that bank.
Chindu All agreed. Anything else.
RBI Thats enough for now.
Chindu Ok then please leave my cabin and send the SBI chairman in. He too had an
appointment with me.
Public Banks Issue#1: Need consolidation
SBI
chief
Good morning Mr. Finance Minister. As youre aware, SBI is the largest public sector
bank in India, weve more than 11,000 branches. Yet if you make a list of top 5
biggest banks of the world, our name doesnt figure.
Chindu Why is it so?
SBI This is because too many small public banks exist in India. So, the incoming-money
(from people to bank accounts) gets fragmented in so many bank branches. Finally,
we dont have enough cash, to expand in a big way.
Chindu Ok so what do you want from me?
SBI
There is need for consolidation in the banking sector so India can have two to
three large public banks that can compete globally.
For this, I need you to simplify Banking Companies Acquisition and Transfer of
Undertakings Act.
And to exclude bank mergers from the scrutiny of Competition Commission of
India (CCI).
Bank mergers should need only approval of RBI.
Chindu Agreed.
PSU Banks Issue#2: Need more investment
SBI Right now the Public Sector banks cannot issue shares worth more than Rs.3000
crores. I want you to relax this, because We need lot of investment.
Chindu Ok agreed. You can issue more shares, including bonus shares and rights issue etc.
(already explained click me)But youll have to take permission from Central
Government + RBI if you want to do it.
SBI Agreed.
Banks issue #3: More voting rights for investors
SBI Before moving on, I must thank you for allowing us to issue bonus shares etc. But
that alone will not bring investment in public or private sector banks.
Chindu Why?
SBI
Because in shareholders meetings, voting is done on many issues (for
example election of board of directors, changing name of company etc.).
A shareholder should have voting rights proportional to the number of shares
held by him.
But in case of public banks, the shareholders have only 1% voting right
irrespective of number of shares held. So they cannot heavily influence any
Decision.
I need you relax these voting rights. Only then foreign investors will be
attracted to invest in Indian banks.
Chindu Agreed. Well revise the voting rights.
Revised voting rights
Voting rights (%)
Bank Example Before After
Private sector HDFC, ICICI 10 26
Public sector SBI , PNB 1 10
Chindu Anything else.
SBI No this is all for now.
Chindu Then you may leave. But please send the chairman of Citibank in, he too had taken
appointment and is waiting outside.
Foreign Banks Issue #1: Stampduty
Chindu Ok what can I do for you?
Citibank When I transfer my branches from the main company to the subsidiary company, I
dont want to pay stamp duty. This should help me expand my business in India.
Chindu Agreed. Anything else.
Citibank Yes there is one more matter
Foreign Banks Issue #2: Want to invest in Commodity
Citibank
Right now, the Banks can trade in shares, bonds and currencies speculation
but the Banking Regulation Act forbids them from trading in commodities.
But we (foreign banks) see huge profit making opportunity in that sector.
So we need you to amend Banking regulation Act, to allow the banks to
invest in Commodities market.
Chindu Agreed.
Standing Committee problem
After a bill is introduced in parliament, it goes to the Standing Committee of Parliament for
particular subject.
for example Banking Regulation bill to Standing Committee on finance.
They inspect the bill clause by clause, put forward their recommendations. And then voting
is done.
In case of Banking regulation bill, after the parliamentary Standing Committee on Finance
put its report, Chindu added some new provisions in it.
so opposition parties got angry this wasnt part of the original bill, if you want to add new
provisions, then this bill must be sent back to the Standing Committee for re-
consideration.
Set: parliament
In the parliament, Opposition members are shouting slogans. (as usual)
Meera Kumar says beth jayiye, beth jayiye, kripyaa shaant ho jayiye.(as usual)
Parliament fight #1: Commodity speculation
Chindu What is the problem?
Oppn. The share-market and mutual funds = regulated by SEBI.Similarly Commodity
market= regulated by Forward Market Commission (FMC)
Chindu So?
Oppn.
So, if banks invest in commodity futures, it would lead to high-risk speculative
trading, especially with those Foreign banks.
What if some investors loose money because of this?
The Forward Markets Commission (FMC) doesnt have enough powers to
safeguard them. because
1) FMC doesnt have legal powers for compulsory registration of traders.
2) FMC doesnt have power to impose huge financial penalty.
Parliament is yet to pass Forward Contract Regulation Act (FCRA)
Amendment Bill, which aims to empower FMC.
And more importantly, you added the this Commodity provision in banking bill,
after it was reviewed by Standing Committee. So this bill must be sent back to
standing Committee for review.
Chindu No, no, no. if bill goes back to standing Committee, itll take lot of time.Ok I back off, I
remove this provision, so there is no need to send this bill back to standing
Committee.
Parliament Fight #2: Competition Monitoring: RBI vs CCI
Chindu Friends, I also propose that only RBIs permission should be necessary for Bank
mergers and acquisitions. Competition Commission of India should not play any
role in it.
Opposition Not acceptable. Again this is new provision added after Standing Committee
gave its report. So, send the bill back to Standing Committee.
Chindu No, no, no. if bill goes back to standing Committee, then itll delay the
implementation.Ok I back off, I remove this provision.CCI will have the power to
investigate and clear mergers and acquisitions in the banking sector.
Lok sabha passed the bill.
Rajya Sabha also passed the bill.
Now this bill file will goto President. Once he signs it, this bill will become a Law.
Anti-Bill arguments
In December, employees of public banks went on strike. (although SBI employees did not join
the strike.)
The Bank unions give following Anti-Bill arguments:
Government claims more banks = more branches = more poor people get banking
facilities = financial inclusion. But it is mere lip service. Because new corporate
banks/foreign banks wont have any interest in serving poor people.
If mergers are allowed then rural branches will close down and/or rural banking operations
will be outsourced via contractual business route.
This type of privatization will negatively affect our job security and interests of those poor
people.
Statistics indicate that only 50 percent of people in India have bank accounts.
The Centre should focus on educating rural people and cultivating banking habit among
them instead of taking steps to merge banks or diluting voting rights.
Merger of banks will de-stablise public sector banks, then corporate firms will start their
own banks and gobble up public savings. And that money will be misused for the benefit of
few corporate honchos and not for the general public.
Although Chindu counters them saying these banking reforms= new banks will be opened=
more employment. (he expects 6,000 new bank branches and recruitment of 84,000 people next
year.)
Critiques also argue that
It seems the whole exercise is not a comprehensive banking reform but just firefighting
because 1) Foreign banks and domestic players put pressure on FM to help them get
bank licenses. 2) RBI blackmails FM to get more powers. 3) FM comes with banking
regulation bill. Prime objective of this bill seems to help private players get new banking
licenses.
Government should further relax the voting rights otherwise, Government will keep
abusing its majority shareholding to further its own political goals and election agendas.
e.g. in 2008, public sector banks were asked to forgo farmers loans (Debt Waiver
scheme). Although Government promised to refund the loan-money to banks on behalf of
farmers but it is not a good business practice.
Summary
The Banking regulation bill, 2011 was passed in the Winter session of parliament in Dec.2012.
The salient features of the Banking regulation bill are (list not exhaustive)
1. RBI can inspect books of associate business arms of a bank.
2. RBI can supercede entire board of directors of a bank.
3. RBI can conduct special audits of cooperative banks.
4. Cooperative societies cannot carryout banking activities without license from RBI.
5. A Depositor Education and Awareness Fund to receive money from deposit accounts not
operated for more than 10 years.
6. Increased the penalties and fines for violating Banking Regulation Act.
7. Public Banks can obtain more capital via bonus shares and rights issue.
8. Increases the voting rights of shareholders in Public and Private sector banks.
9. Prior approval of RBI necessary if a person wants to purchase more than 5% shares of a
bank.
10. Banking Mergers and acquisition will fall under purview of CCI.
11. Bank will have to pay penalty interest rate, if it doesnt maintain CRR on daily basis.
12. Foreign banks exempted from stampduty payment for certain cases.
mrunal.org
http://mrunal.org/2012/10/economy-bretton-woods-fixed-exchange-rate-system-imf-world-bank-meaning-explained.html
[Economy] Bretton Woods and Fixed Exchange Rate
system : Meaning Explained
I had posted this article somewhere in April 2012 but because of a technical glitch this article (and
many other articles on economy) got wiped out of the server. So here Im re-posting the same
article. If you had already read it, no need to read again because Content has not been changed.
1. What is Bretton Woods?
2. Why is important?
3. Result of Bretton Woods
4. Main Players in this Conference
5. Impact of World War II on Economy
6. Agenda of conference
7. Fixed Exchange Rate system.
8. Roosevelt Vs Mohan:
9. Fast forward to 1970s
10. Inflation and Gold Prices
11. Do we need Bretton Woods?
While reading newspaper columns about global economy or Eurozone crisis etc. you may have
come across a sentence, multiple times : we need another Bretton woods. so,
What is Bretton Woods?
Its a place in New Hampshire State of USA, just like BASEL is a city in Switzerland.
Why is important?
In 1944, President Roosevelt hosted a conference here, to rebuild the world economy,
after Second World War.
Delegates of 44 allied nations ( ) had came to participate in this conference.
Officially it is known as United Nations Monetary and Financial Conference, commonly
known as Bretton Woods because of the place where it was held.
This conference resulted into creation of four extremely important things
Result of Bretton Woods
1. IMF
They give short-term loans to help nations settle the balance of payment crisis.
Theyve a system called SDR :Special Drawing rights. (requires another article)
2. World Bank
Officially known as IBRD :International bank for reconstruction and Development,
that time
They give long term soft loans to rebuild the third world.
Soft loans= interest rate is very low. Sometimes you dont have to pay back the
principle.
3. GATT (General Agreement on Trade and Tarrif) later becomes WTO
To facilitate the international trade.
This will later become WTO. Already written an article on this.
4. Fixed Exchange Rate system. (although Discarded in 1970s)
Explained in this same article.
Main Players in this meeting
Total 44 nations participated, but Main players were:
US President Franklin D Roosevelt
UK Prime Minister Winston Churchill
Lord John Maynard Keynes, Famous economist, UK treasury advisor.
India @Bretton Woods
Absent from the meeting: Mohan, Montek, Pranab, and Chindu (good otherwise theyd
have messed up International Economy, just like they did to Indian Economy.)
India was represented by Sir C.D. Deshmukh, he was the first Indian Governor of RBI, This
gentleman had cracked IAS exam in British-raj ,known as ICS exam in those days. And
No, he is not the grandfather of Ritesh Deshmukh.
Back to the topic,
Impact of World War II on Economy
Second world war started in 1939, ended in 1945
There is large scale bombing and destruction in the world. Production has declined.
Agriculture, Dairy, Manufacturing, Export- everything is brought to standstill=huge inflation
Agenda of conference
Help rebuilt the World Economy. Provide money, loan, finance to needy nations. (World
Bank)
After WW2, lot of colonies will get independence (India, Sri Lanka), theyll introduce their
own national currencies without control of big superpowers (Britain, France etc) and theyll
enter in international trade in their own capacity.(Exchange rates, IMF)
Hence, Some rules/order had to be created to facilitate smooth international trade. (GATT)
Fixed Exchange Rate system.
What is Fixed Exchange Rate System?
Under this system, if RBI says $1=30 rupees, and youve 30 rupees and want to convert it
in dollars but the Foreigners are willing to give 1 dollar to youdont worry.
RBI will accept your 30 rupees and give your one dollar out of its own reserve and vice
versa.
Cons are obvious : When India is not exporting enough and not attractive enough foreign
investment (in dollars) and still RBI keeps paying people in dollars, one day the bank
lockers will be empty, there will be no dollars to pay. System will collapse.
But it has Pros (advantages) in the times of uncertainty- When youre writing on a clean
slate, after WW2, if every nation decides to have a fixed exchange rate system- it leads to
stability and predictability in Exchange rates = good for foreign trade.
Roosevelt Vs Mohan: Pegging the Currencies
(Fictional, technically incorrect, imaginary)
President Roosevelt: ok I say we put fixed exchange rate system. Lets fix the rates that 40
Rupees will equal to 1 dollar. 15 Yens will equal to 1 dollar. 12 Pounds will equal to 1 dollar and
so on. In short, Im pegging your currencies to US Dollar. Thus Dollar will be the international
reserve currency. AND Your countrys RBI (central bank) will make sure these exchange rates
dont fluctuate more than 1% from these values.
Mohan: ya man, but what if the exchange rate fluctuates? for example, What If I start running my
country in a totally pathetic and irresponsible manner and hence nobody wants to invest in India
so supply of dollar is low but demand of dollar is high- because Indians love gold and weve to
import crude oil and pay in dollars. In short, this will fluctuate the exchange rates between Dollar
vs Rupee.
President Roosevelt: Let me ask you a question. Suppose Onions are selling 100 rupees a kilo
because of low supply but suddenly farmers produce fresh new 50 million tonnes of onions and
supply it to market, what will happen?
Mohan: Easy! Onion Price will drop down to 40 rupees a kilo because the supply has increased.
President Roosevelt: yes dude, the same way, whenever exchange rate fluctuates from our
standard rate, youll tell your RBI to supply dollars from its own forex reserves in to the market to
calm down the demand and bring the rate back to normal level.
If the reverse happens: (Onions are selling @ 2 rupees a kilo) then you tell your RBI to buy all
Onions dollars using its own rupees, until the supply is reduced and price is back to normal.
Mohan: What nonsense is this? If 40 rupees equals 1 dollar but then what does 1 dollar equal to?
What is the value of your own dollar? Why should we accept your dollar as international reserve
currency?
President Roosevelt: Ive fixed the value of your currency to my dollars. And Im fixing the value
of my own dollars to Gold. 1 ounce of Gold shall equal to 35 dollars. Meaning you walk in with 35
dollars in my RBI (Federal Reserve Bank of USA), and youll get one ounce of gold in return.
Gold will remain precious forever. So, its not like were running the show in thin air. Dollars are
backed by GOLD.
Mohan: ya man but what if my RBI doesnt have enough dollars in its lockers? What will we do
then?
President Roosevelt: dont worry, come to IMF. Theyll arrange short term loans for you, in
dollars.
Mohan: but still, why should we fix price of our currency to dollars? Why should we accept dollar
as the reserve currency and not Yuan, Yen or Pound? Why should we accept you as our big
boss?
President Roosevelt: Because Ive the aukaat to pay enough gold, so I say dollars will be the
international reserve currency. IF youve enough gold reserve in your RBI, come sit in the chair
and well see whether rupee is strong enough to become the international reserve currency or
not.
Even Britain is so financially bankrupt after Second World War, they dont have the guts to tell me
set this exchange rate according to their Pounds. Btw, I also got some nuke missiles in my
limousine.
Mohan: no noI was just kidding man. Im well aware that youre the superpower both
financially and militarywise.
President Roosevelt: Besides When weve a stable and fixed exchange system like this, itll
ensure smooth and long term trade deals between merchants of various countries. When you
dont have fixed exchange rate system, it is bad for economy. For example, today your call-center
boss may give you free lunch and coffee because $1=60 rupees but next day when value of
rupee declines and it is $1=50 rupees, same boss will even stop running the water-cooler in your
office. Third day when $1=40 rupees, He will just kick you out because outsourcing generate that
much profit for him. Such uncertainty, is not good for economy.
And since Gold is in limited supply, Dollar will be spent carefully, and so your currency will be in
spent carefully. i.e. Since currencies are pegged, you will not indulge in extravagant spending in
subsidies, welfare schemes, tax-reliefs or debt-waivers to farmers. This ensures fiscal discipline
=> That ensures less Fiscal deficit = less inflation.
Mohan: Mr. President Sir, I think I got the point now. Ill tell my RBI Governor here to sign the
Bretton Woods agreement papers, because fixed exchange rate system sounds safe and good.
Fast forward to 1970s
As you can see, the fixed exchange rate system, is good for stable international trade
environment, atleast on paper.
But this system can run smoothly only as long as USA has the aukaat to pay gold to every
swinging dude that walks with dollars into their RBI (US Treasury).
Problem started with Cold War. Both USA and USSR (not Russia), are busy in an arms
race, building new tanks, missiles and submarines every week.
Theyre also giving huge donations and help to poor nations, in order to win their support
and dominate the region. This is a non-productive activity, theyre basically wasting money.
Now, USA gets involved in a very lengthy and expensive Vietnam War from 1959 to 1975.
Inflation and Gold Prices
Fact: War leads to inflation
Fact: Inflation decreases the value of your money.
Fact: Gold becomes more expensive because of Inflation.
US still kept fixed value of 35 dollars = 1 ounce of gold. But thanks to this inflation, Gold is
trading at higher price in open market 40 dollars per ounce.
So there is an opportunity to make quick money, just tell the RBI manager to take suitcase
full of dollars from RBIs locker to US Federal Reserve, take their gold in return, and sell it
to the local jeweler at higher market price and use this profit to fix indias problems-
poverty, education etc. (may be by starting another welfare scheme named after Nehru-
Gandhi family.)
For a while, US Presidents had enough clout over international politics so that they could
force other nations RBI managers not to indulge in such cheap profiteering. But Vietnam
war is fast deteriorating Americas clout and now RBIs of various countries have started
lining up with their suitcases full of dollars and they want gold in return.
1971, President Nixon decides that if we continue giving gold for dollars, we will go
bankrupt. There will be no gold left in our lockers. So I give up. Im not going to let anyone
exchange their dollars for my gold.
And thus Bretton Wood system breaks down.
1973, World moves to floating exchange rate system.
What is Floating Exchange rate? Governments / Central Banks dont fix exchange rates
here. It is left to the Forex markets, private players and laws of supply and
demand.Government /RBI will only intervene if there is huge fluctuation in the exchange
rates.
Do we need Bretton Woods?
With respect to the Eurozone crisis (click ME), many columnists write We need another
Bretton Woods.
They dont actually mean that we need to move back to the same old Fixed Rate exchange
system, in which every currency was pegged to Dollar and Dollar was pegged to Gold.
Because that fixed rate thing is impractical in real life scenario, as we saw in above
paragraphs.
Just imagine, if tomorrow World starts running according to Bretton Woods system, what
will happen?
We know that China already has more than 1000 billion dollars in its Forex Reserves. So
Peoples Bank of China will send its Probationary officer with suitcases full of dollars and
take away all the gold from Fort Knox*. They dont even need to fight a war, USA will come
down to its knees financially.
[*Fort Knox is a place in Kentucky State, US Government keeps the gold reserves in this
place.]
In real life, not that China will actually do so, but the mere threat and possibility will keep
USA on its toes. Hence US will not agree to Fixed Exchange rate in the first place.
There is no chance any other country will agree to become the big brother and let their
currency become the reserved currency and peg it to gold.
Especially India, because if we peg our 10,000 Rupees to one ounce of Gold and declare
that we are the new international reserve currency, just like dollar before 1970s, What will
be the Result? Pegged currency means Government cant do extravagant spending in
MNREGA. Theyll have to stop subsidy on diesel, kerosene, LPG and fertilizers, because
they can dole out only as much rupees as the amount of gold held in RBIs locker.
As You can understand, no political party has the guts to do that, hence no nation will want
to become the big brother or Sacrificial goat (Bali kaa Bakraa) for another Bretton
Woods.
So, The sentence We need another Bretton Woods is just a metaphor, to say that all the
Presidents, Prime ministers and Economists of the world should meet up once again and
hold conference in some gambling den, drink some Desi liquor ( ), watch some
Item-song, brainstorm for new ideas and start something from scratch, totally new, Just like
the Gentlemen at Bretton Woods did, in 1944.
Then what to do?
It could be anything, untried and untested before like-
China could agree that well not dump our products in foreign market, we will not keep our
yuan under-valued,
US could agree that well bring back our troop from Afghanistan and cut down on our
Defense Expenditure and its inflationary effect on world economy. We will also stop
supporting Pakistan. Thus reducing defense Expenditure of India in the arms race= that
will also reduce fiscal deficit of India= India could decrease taxes=boost for economy and
world trade.
Iran could agree that well stop our irrelevant obsession with nuke weapons and give up,
So that UN removes the sanctions and our traders can make more money, thus improving
the standard of living for Iranian aam-aadmis.
EU could agree that well kick out Greece, because its just way too messed up beyond
fixing.
And India could agree that well bring all the black money from Switzerland and use it to
finance our bogus Government schemes and subsidies instead of looting the aam-aadmi
via direct and indirect taxes, to finance those things.
And finally you and I could agree that facebook is a waste of time, so a serious Aspirant
should concentrate on his studies instead of uploading funny/motivational photos there.
[Economy] Special 301 Report, Priority List, Implication on India, Nexvar case, Compulsory
License, Patent Evergreening, IPR protection, USTR explained
[Fed Tapering:Part2 of 2] Measures to immunize Indian Economy against negative impacts
of Fed Tapering, Currency Swap, Dollar Swap, FCNR swap, Brics bank explained
mrunal.org http://mrunal.org/2012/10/economy-cheque-truncation-system-cts-2010-rbi-meaning-advantages-explained.html
[Economy] Cheque Truncation System (CTS-2010):
Meaning, Advantages explained
1. What is cheque clearing house?
2. What is MICR code?
3. What is Cheque Truncation System (CTS)?
4. What are the benefits of Cheque Truncation?
5. CTS-2010
What is cheque clearing house?
Suppose a party from Delhi pays you via cheque of Citibank and you have account in SBI,
Ahmedabad. You deposit this cheque in your areas SBI branch.
Now the SBI branch manager would send his [overworked, underpaid] Bank PO to
Citibanks office in Abad. Hed show the cheque, collect the cash and return to deposit the
money in your account.
But SBI would be getting thosands of cheques everyday- some from ICICI, some from
Citibank, some from axis and so on. SBI cannot send its staff to every other bank to get
the cash, thatd be extremely time consuming.
Therefore To simplify this cheque transection process, each bank will send a
representative to a central place and exchange cheques drawn on each other.
This centralized place is called clearing house/processing house.
Reserve bank of India is act as clearing house.
In cities where RBIs office doesnot exist, usually SBI or other public sector bank acts as
the clearing house.
What is MICR code?
By seeing the PIN code, a postman can know the destination of an envelope. Same way
by using the MICR code, RBI (clearing house) can know the name of a bank, location of
its branch from where the cheque was issued= faster clearing of cheques.
MICR = Magnetic ink character recognition.
At the bottom of every cheque, youd see some black colored numbers with weird looking
fonts. That is the MICR code.
These numbers are printed with a special ink containing iron oxide, so that it can be
automatically read by a special machine.
Ofcourse this sounds similar to bar codes, but there is a difference: unlike barcode, you
can read the MICR code and decode it, without the use of special machines.
What is Cheque Truncation System (CTS)?
Under the old paper cheque based clearing, the SBI bank will send the paper cheque to
the clearing house and get the money and then transfer it to your account.
This is still time consuming. because SBI (or any bank) would need to physically move the
cheques to a clearing house.
So RBI came up with a new idea known as Cheque Truncation System (CTS).
In this Cheque Truncation System (CTS), SBI branch will not send the paper cheque to
the clearing house, but instead, itd merely scan the cheque, and electronically send the
image + MICR data, to the clearing house.
From the clearing house, the data would goto the paying bank (Citibank in our example),
they will inspect the MICR data, signature on the scanned image and release the money
to SBI.
This process is faster and more safer than the conventional paper-cheque clearing
method.
What are the benefits of Cheque Truncation?
It Eliminates the time, money and manpower wasted during physical movement of
cheques (from banks to clearing house).
Thus, Cheque Truncation =faster clearing = better service to customers,
Cheque Truncation system reduces the scope for clearing-related frauds
There is no fear of losing cheque in transit.
CTS-2010
In the year 2010, RBI came up with the guidelines for Cheque Truncation system. (CTS
2010)
The banks would need to upgrade a few things to comply with CTS 2010 standards of
RBI.
For example, in their branch offices, they would need to buy scanners and install special
software provided by RBI, to securely transfer and receive the scanned image and data.
They may need to change the color-scheme of chequebooks so that signature and
handwriting is visible in the scanned image. And so on
Problem: some jholachhaap banks, are yet to comply with RBIs CTS 2010 guidelines.
Hence recently RBI issued a warning to all banks:
RBI
Governor:
upgrade your banking infrastructure according to CTS 2010
guidelines, before the end of Sept. 2012 so that UPSC may ask
a question on this topic.
Whenever we do something, our prime objective is not to
improve the economy but to harass the UPSC aspirants.
Branch
manager of
Lena Bank:
indeed, whaat an idea sir-ji
mrunal.org
http://mrunal.org/2014/01/banking-white-label-atm-meaning-features-advantages-limitations-financial-inclusion-nested-design-contagion-
risk.html
[Banking] White Label ATM: Meaning, Features,
Advantages, Limitations, Financial Inclusion, Nested
Design, Contagion Risk
1. What is White label-ATM?
2. Whats the difference between Brown label vs White label ATM?
3. Stakeholder/Players in White label ATM game?
4. Why do we need White Label ATM?
5. How does White Label ATM help in financial inclusion?
6. Facilities @White label ATM?
7. Where does the Commission come?
8. White label ATM: Challenges/Limitations/Problems
9. Mock Questions
What is White label-ATM?
Traditionally, Automated Teller Machines (ATMs) have respective banks logo. So just by
looking, this is SBIs ATM, this is ICICIs ATM and so on.
But White label ATM doesnt have such Bank logo, hence called White label ATMs.
RBI has given license / permission to non-bank entities to open such ATMs.
Any non-bank entity with a minimum net worth of Rs.100 crore, can apply for white label
ATMs. (not just NBFC, any non-bank entity can apply.)
Late 80s: first ATM in India; 2012: RBI issues guideline for White label; 2013: RBI gives
license/permission.
Tata Communications Payment Solutions Limited =the first company to get RBIs
permission to open White label ATMs.
They started their chain under brandname Indicash.
Other White label= Muthoot Finance, Srei Infra., Vakrangee Software, Prizm Payments,
AGS. More than 15 companies given such permission.
Whats the difference between Brown label vs White label ATM?
Brown Label ATM White label ATM
When banks outsourced the ATM operations to a
third party.
When ATMs are owned and operated by
non-bank entities but they are not doing
outsourcing-contract from a particular
bank.
The private company owns & operates the ATM
machine, pays office rent. They negotiate with the
landlord, electricity company, telecom company
and so on.
Same
The bank (which has outsourced this work)
provides cash for that ATM.
Sponsor bank provides the cash.
ATM has logo of that bank (which has outsourced
this work).
No. White label ATM doesnt have such
logo. Not even of the sponsor bank.
No such compulsion. Theyve to compulsory open a few ATMs
in (tier 3 to tier 6) areas. (explained after
a few paragraphs)
RBI not involved directly. These outsourcing
companies have contractual obligation with their
respective banks.
RBI directly involved because these
white label Companies have to
separately get license/permission from
RBI to run business.
Initially, RBI did not permit White label ATMs, and Banks wanted to reduce the operational cost,
so they came up Brown Label ATM (outsourcing) system.
So in a way, the evolution is: (Banks own ATM) =>(Brown Label) => (white label)
Stakeholder/Players in White label ATM game?
RBI Gives license/permission to open White label ATMs. Under Payment and
Settlement Systems Act, 2007. (And NOT under Banking regulation act or
SARFAESI Act, Ombudsman or any other act.)
(non-bank)
White Label
ATM
company
Rents the place, looks after maintenance and servicing of the machine.
Sponsor
bank
Loads the cash in those White label ATMs. This also ensures
counterfeit/fake currency notes are not circulated through white label ATM.
Payment
network
operator
Visa, Mastercard, the National Financial Switch (NFS under National
Payment Corporation of India.)
They provide technical connectivity in the system.
Why do we need White Label ATM?
1. ATMs offer convenience to customer (Because he doesnt need to visit Bank branch every
time). ATMs are open 24/7, and even on holidays.
2. Convenience to bank, because they dont have to keep large staff/office (compared to a
system without ATMs). It reduces their cost of branch-operation.
3. But in India, ATM penetration has been very low. Observe:
Country Approx. No. of ATMs per 10 lakh population
USA 1400
UK 500
China 200
India less than 100
Most of the ATMs concentrated in urban areas- that too only at prime locations e.g. near
shopping malls and airports= financial inclusion not achieved.
How does White Label ATM help in financial inclusion?
RBI requires White label-ATM companies to install machines in the ratio of
Two ATMs in (tier 3 to 6 place) : One ATM in (tier 1-2 place).
Confused? Observe:
Center city census definition:
population is ____
White Label ATM
Metropolitan Tier 1 10 lakh and above if company wants to Setup ONE ATM here,
Urban 1 lakh and above
Semi-Urban Tier 2 50,000 to 99,999
Tier 3 20,000 to 49,999 Then, company must install TWO ATMs here.
Tier 4 10,000 to 19,999
Rural Tier 5 5,000 to 9,999
Tier 6 Less than 5,000.
For example, RBI has permitted Tata to deploy 15000 White label ATMs. Meaning [2/(2+1)] x
15000 = 10,000 ATMs will be setup in the rural and semi-urban areas. = more access to ATM=
financial inclusion.
Facilities @White label ATM?
1. Any customer from belonging to any bank, can use it.
2. Every month, Five transactions are free.
3. White label ATM users can also withdraw a maximum of 10,000 per transaction.
4. Open 24/7 and on holidays
5. Value added services like mobile recharge, utility bill payments etc.
Where does the Commission come?
White ATM Company doesnt run for charity or goodwill. Company has to make profit. So where
does the asli-maal/commission come?
Before White label ATM With White Label
1. If you used card in your own banks ATM= everything
free.
2. If you used card on other banks ATM= first five
transactions free (every month). After that commission
charges of Rs.~17-20 for taking out money and Rs. 5-
9 for making balance inquiry or mini statement. (This
commission directly charged on your account.)
1. First five transactions
free every month.
2. Then, transaction fee
~Rs.15 and balance
inquiry fee ~Rs.5 BUT
this commission is paid
by your bank to the
White label Company.
3. White label company
cannot directly charge
money on you. (RBI
rules).
4. Although it doesnt
mean White label
ATM=totally Free
because your bank will
cut those charges from
your account.
Additionally, White Label ATM company can make commission from
1. value added services @their ATM e.g electricity /telephone bill payments, mobile
recharge, DishTV-Tatasky recharge etc.
2. Selling advertisement space in the room and above the door.
White label ATM: Challenges/Limitations/Problems
1. For a white label ATM company, biggest challenges = office rent + Security guard.
2. If they want to make profit, every White ATM needs to get at least 75-125 transactions per
day= very unlikely, especially when RBI requires them to setup 2/3rd of the ATMs in semi-
urban and rural areas.
3. Even in Bangalore, some of the white-label ATMs are getting barely 2-3 customers every
week=loss making business at the moment.
4. Despite the entry of White Label ATM companies, the regular banks have not slowed down
their ATM expansion drive, because branded ATM=passive advertisement and customer
loyalty. Result? ATMs everywhere =too much competition= small players will bleed out just
like in aviation business.
5. Last year, a lady was brutally attacked in ATM booth in Bangalore. Police have warned all
banks to put security guards=input cost increased. Banks themselves admitting five
transactions free every month=loss making in this scenario.
6. SBI has the largest ATM network in India (30,000+)= economies of scale= theyre
supposed to be making profit. But this week, even SBI chairman herself has admitted their
ATM business is making losses. So, it is unlikely that White label ATM companies will run
profitably for a long period of time.
7. Customer complaint: failed ATM transactions = matter falls into Issuing Bank (=bank
where you have account). Some critiques fear it will lead to taarikh pe taarikh because
data records are with sponsor bank and machine maintenance is under ATM companys
responsibility.
Nested Design
RBI appointed Nachiket Mor Committee on financial services, talks about this limitation.
The White label-ATM does not have direct access to the settlements system. (like SBI or
ICICI has access to RBI monitored NEFT online money transfers.)
Instead White label ATM is tied with a sponsor-bank. And the sponsor bank looks after
the settlement. Sponsor bank loads and withdraws the cash from those machines.
Example Federal Bank is the sponsor bank for Tatas White label ATMs.
Mohan Ok so whats the problem?
Nachi Nested Design= contagion risk.
Contagion = Bad condition in one institution leads to negative effects in the other institutes
in the market.
Suppose few of Tatas White label ATMs break down for xyz reason (hacking, staff
negligence or whatever) and some clown starts baseless rumoring on
facebook/twitter/whatsapp that Tatas ATMs not working because federal bank has
stopped supplying cash.
Another clown then starts rumor mongering that Federal Bank is about to collapse
because of NPAs and hence not honoring its obligation to Tata.
Result: Fed.Bank account holders panic and line up at other ATMs (sponsored or owned by
other banks) to pull out their money = these type of runs destabilize the banking system.
Extreme cases lead to situation like Cyprus-Banking crisis.
Mohan But dont the banks have CRR and SLR to arrange cash in such emergency
situations?
Nachi Yes they have. But with nested design, theyre exposing themselves to additional
contagion-risk from other banks/White-label ATM companies. Especially when
White label ATM company grows too large in very short time and sponsor bank
cannot foresee the cash requirements.
Mohan Then whats your recommendation?
Nachi
White label ATM companies should be directly linked to settlement system,
without sponsor banks.
RBI should allow White Label Banking Business Correspondent agents.
[Same like earlier BC, but they can work with multiple banks at the back-end.]
Potential candidates= NBFCs, mobile phone companies, consumer goods
companies, the post office system, existing corporate BCs, and
milk/agri./sugar etc. real sector cooperatives.
Mock Questions
1. Who among the following can operate White label ATMs?
1. Nationalized Banks
2. Scheduled Commercial Banks
3. Retail Banks
4. None of above.
2. What is Indicash ATM?
1. Brown label ATM chain under Indus Bank
2. Brown label ATM chain under Bank of India.
3. White label ATM chain owned and operated by Tata
4. White label ATM chain owned and operated by Prizm payments
3. Correct statements about White label ATMs
1. RBI permits non-bank entities to setup White Label ATMs under Banking regulation
Act.
2. Only Non-Banking financial companies with 15 years of experience can open White
label ATMs.
3. In case of failed transaction, the complaint is automatically sent to Banking
Ombudsman.
4. None of above.
4. Correct statements about White label ATMs
1. Company has to open 2/3rd of its ATM in areas having tier 3 to tier 6 level
population.
2. Before opening such booths in rural areas, the company has to get permission from
NABARD.
3. Both 1 and 2
4. Neither 1 nor 2
5. Incorrect statements about White label ATMs
1. The operator company is required to maintain SLR and CRR reserves similar to a
scheduled commercial bank.
2. To prevent conflict of interest, RBI has forbidden White label companies from
providing Value added services in such booths.
3. Both 1 and 2
4. Neither 1 nor 2
6. What is the role of a Sponsor bank in White label ATM system?
1. provide maintanance and service to the equipment
2. provide cash to the equipment
3. both 1 and 2
4. Neither 1 nor 2
7. Suppose RBI rules require the company to open ATMs in Urban: Rural areas in the ratio of
5:9. If Muthoot Finance owns total 3500 ATMs, how many of them are located in the rural
areas?
1. 225
2. 1250
3. 2250
4. None of above
8. Suppose RBI rules require the company to open ATMs in Urban: Rural areas in the ratio of
1:1,at the end of the given year. In January 2014 Muthoot Finance owns total 3000 ATMs
but its rural:urban ratio is 8:7. So, by 31st December 2014, How many new rural ATMs
should they open to comply with RBIs rules?
1. 400
2. 300
3. 200
4. none of above
9. The ratio of Indicash White label ATMs in urban: rural areas is 4:5. If Indiacash opened
360 new ATMs each in both urban and rural areas, then ratio will be 7:8. So, originally,
how many ATMs did Indicash have in rural areas?
1. 640
2. 560
3. 600
4. None of Above
10. The ratio of Indicashs urban:rural ATMs is 3:2 and total number of ATMs is 600. If
Indicash wants to change this ratio to 7:3, what should it do?
1. Add 200 ATMs in rural area
2. Add 200 ATMs in urban area
3. Add 200 ATMs each in both rural and urban areas
4. None of above
Descriptive:
1. Despites certain risks and limitations, the White label ATM has a potential role in financial
inclusion. Elaborate. (10m | 200 words)
2. Define White label ATM. What are its features, advantages and limitations? (10m | 200
words)
3. What are the differences between White label and Brown Label ATM? (5m | 100 words)
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