Commercial Bank

Bank Rate

It is the rate at which the Central Bank of a country makes advances against
approved securities, or purchases eligible bills of exchange and other commercial
papers, to provide financial accommodation to banks or other specified groups of

institutions.
Sec. 49 of RBI Act defines Bank Rate as the standard rate at which it (the
Reserve Bank) is prepared to buy or rediscount bills of exchange or other

commercial papers eligible for purchase under this Act.

Bank Rate (Discount Rate) affects both cost & the availability of credit. Availability
of credit is restricted by limiting the type & nature of bills eligible for
rediscounting. The effectiveness of Bank Rate as a credit control measure is very
limited in India, as banks are now free to rate of interest as per their discretion.

Liquidity Adjustment Facility (LAF)

Introduced from June 5, 2000, as per the recommendation of Narasimham

Committee the Liquidity Adjustment Facility helps RBI to provide short term
liquidity support to banks. Liquidity Adjustment Facility operates through Repo and

Reverse Repo auctions.

In Repo, RBI lends money to banks and primary dealers against securities for short
term. When a bank is in need of funds it can use the facility of Repo provided by
the RBI and borrow money at Repo rate. RBI goes for repo auctions for injection of
liquidity. Repo means repurchase. In a repo transaction the RBI purchases
securities from the banks and thus lends money with the condition that the bank
will buy back such securities after a specified period which may vary form 1 day to

14 days.
When the RBI wants to increase short term liquidity in the market it reduces the

repo rate.
In Reverse Repo, RBI borrows and banks lend against securities for short term.
When bank has surplus funds, it can use the facility of Reverse Repo and lend
money to RBI by way of purchase of government securities for short term. RBI
goes for Reverse Repo auctions for absorption of liquidity from the market.

Prompt Corrective Action

From December 2002 the RBI has introduced the concept of the Prompt Corrective
Action. This principle has been introduced by RBI as per the core principle of banking
supervision formulated by the Basle Committee on Banking Supervision.

It is a supervisory tool in the hands of the Central bank to prevent bank failures by

taking timely action in case the bank is showing distress signals.

The RBI will subject a bank to prompt corrective action if certain parameters cross
the Trigger Points. The trigger points are: (i) CRAR becomes less than 9%, (ii) Net

NPA goes beyond 10%, (iii) Return on Assets [ROA] becomes less than 0.25%.
When a bank reaches these trigger points the RBI takes certain mandatory actions
like restricting the bank from expanding its risk weighted assets, on opening new
branches, accepting high cost deposits etc.

CAMELS Rating of banks

As per the recommendation of the S. Padmanabhan committee, in 1995, RBI introduce the
CAMELS rating model for rating banks on a five point scale from A to E indicating in
descending order the soundness of banks. In CAMELS rating model C stands for Capital
Adequacy. A for Asset quality, M for Management of the bank, E for Earning, L for
Liquidity and S for System and Control.

In case of foreign banks the rating is based on four parameters called CACS; where
C stands for Capital Adequacy, A for Asset quality, C for Compliance and s for
System and Control.

Statutory Requirement

As per the section 42 (1) of the Reserve Bank of India Act, 1934 all scheduled

banks are required to keep cash reserve with the Reserve Bank of India.
They have to keep this cash reserve by maintaining balance in their current

account(s) with the RBI.

The amount of cash reserve to be kept is a certain percent of the total Net
Demand and Term Liabilities [NDTL] of the bank concerned. This percentage is

varied by notification by RBI from time to time

This percentage is also called the Cash Reserve Ratio i.e. CRR.
With effect from April 24, 2010 the CRR is 6% of the NDTL.
This percentage can be varied by the RBI from time to time by notification. As per
the amendment of the Reserve Bank of India Act sec 42 (1), which has come into
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effect from April 1, 2007 the RBI has now authority to vary the CRR without any
limit. [Prior to this amendment the RBI had power to vary the CRR within the floor

limit of 3% and ceiling of 20%]

Besides the normal CRR, the Act permits RBI to stipulate vide Sec. 42 (1A)
additional Cash Reserve on the incremental Net Demand and Term Liabilities from a
particular date. The rate of additional cash reserve to be maintained is to be
notified by RBI. At present there is no stipulation to maintain additional cash
reserve.