Nationalized Banks and Public Sector Banks

Public Sector Banks (PSBs)

If the government holds majority stake, i.e,. more than 50 % stake of an enterprise, then it is known
as Public Sector Unit (PSU). Government is the owner of the PSU, and is responsible for
the managerial control of the enterprise.
Similarly, if the majority stake (>50 %) of a bank is held by the government (generally, central
government), then it is known as Public Sector Bank (PSB).

To know whether a bank (or any enterprise) is a public sector bank, just take a note on
the stake of government.

Nationalized Banks
If some private entity or individual holds the majority stake (>50 %) of a bank, then it is a Private
Sector Bank. Now if the government buys the majority stake of the private bank, and take
the managerial control of it, then it will be known as Nationalized Bank, and the process will be
known as Nationalization.

Note that the bank earlier was a private bank, but after the nationalization process, it became
a Nationalized Bank. Hence to know whether a bank is a nationalized bank, just take a note on
the history of the bank (private -> public) and the stake of government in it.

Nationalized Bank vs. PSB

Now it is evident that a nationalized bank is always a public sector bank (PSB), because
the government (in turn the public) owns it (>50 % stake), but a PSB may not be a nationalized
bank (if the government itself creates the bank, with majority stake).

History of Nationalization

 The Reserve Bank of India (RBI) was nationalized with effect from January 1, 1949, on the
basis of Reserve Bank of India (Transfer to Public Ownership) Act, 1948.
 The Central government entered the banking business with the nationalization of
the Imperial Bank of India in 1955 (60% stake bought by RBI), and renamed State Bank of India
(SBI) under State Bank of India Act, 1955. In 2008, government acquired RBI's stake in SBI to remove any
conflict of interest, because RBI is the banking regulatory authority.
 The 7 other state banks became the subsidiaries of SBI, after
being nationalized on 1959, under State Bank of India (Subsidiary Banks) Act, 1959. Currently 2 SBI
subsidiaries are merged, making total 5 SBI associate banks.
 The major nationalization took place in July 19, 1969 under former PM Smt. Indira
Gandhi, under Bank Nationalization Act, 1969. 14 major banks were nationalized at that time, making 84
% of total branches coming under government control. However, on February 10, 1970, the Supreme
Court held the Act void on the grounds that it was discriminatory against the 14 banks and that
the compensation proposed to be paid was not fair compensation.

A fresh Ordinance was issued on February 14, which was later replaced by Banking Companies
(Acquisition and Transfer of Undertakings) Act, 1970.
 The next nationalization process took place in 1980, making 6 other banks nationalized. 91
% of total branches came under government control, through Banking Companies(Acquisition and
transfer of Undertakings) Ordinance, 1980.

Which banks are Nationalized Banks?

This is a debated topic. If we consider the definition of Nationalized banks, then the criteria is - the
bank need to be a private bank prior nationalization. This criteria is satisfied by RBI, SBI, SBI
associates and all other banks that are nationalized in 1969 and 1980 (total 14 + 6 - 1 = 19, '-1'
because New Bank of India is merged with Punjab National Bank in 1993).

But it is better not to call RBI, SBI, or SBI associates as a Nationalized Banks. Because,
they draw power from different Acts, like -

 RBI - Reserve Bank of India (Transfer to Public Ownership) Act, 1948

 SBI - State Bank of India Act, 1955
 SBI Associates - State Bank of India (Subsidiary Banks) Act, 1959
Banks that are nationalized in 1969 and 1980 draw power from Banking Companies (Acquisition
and transfer of Undertakings) Act of 1969 and 1980, are known as Nationalized Bank.

These total 19 banks are designated as Nationalized Banks by RBI in their website too -

(Please refer - http://www.rbi.org.in/commonman/English/scripts/banksinindia.aspx)

Also note that IDBI Bank Ltd. is denoted as Other PSBs in the website.

Bharatiya Mahila Bank (BMB) is a government-owned bank from the beginning. So there is no
process of nationalization involved. Hence it is a Public Sector Bank.

Now we can calculate the total number of Public Sector Banks (PSB) as -

 SBI and SBI Associates - 6 banks

 Nationalized banks (both 1969 & 1980) - 19 banks
 IDBI bank - 1 bank
 BMB bank - 1 bank
Total = 6 + 19 + 1 + 1 = 27 PSBs

This was the calculation till March 31, 2017.

But w.e.f April 1, 2017, the 5 associate banks of SBI and Bharatiya Mahila Bank (BMB) are merged
with SBI.
Therefore, as on 18/06/2017, the number of Public Sector Banks (PSB) is 27 - 5 - 1 = 21
Nationalization vs. Privatization
Nationalization is the process for a government to expand its economic resources and power,
whereas Privatization is the process where government-owned companies are spun off into
the private sector.

SBI Merger with Associate Banks and BMB

Read this article of SBI Merger

SBI Merger
Merger of Associate Banks with SBI
All branhces of -

 State Bank of Bikaner and Jaipur (SBBJ)

 State Bank of Hyderabad (SBH)
 State Bank of Mysore (SBM)
 State Bank of Patiala (SBP), and
 State Bank of Travancore (SBT)
will function as branches of State bank of India (SBI) w.e.f April 1, 2017.

The merger order of all these 5 associate banks with SBI has been issued by
the Government of India, as -
 Acquisition of State Bank of Bikaner and Jaipur Order 2017
 Acquisition of State Bank of Hyderabad Order 2017
 Acquisition of State Bank of Mysore Order 2017
 Acquisition of State Bank of Patiala Order 2017
 Acquisition of State Bank of Travancore Order 2017,
dated February 22, 2017, and were published under Extraordinary Part-II Section-3
Subsection-i in The Gazette of India sanctioning the Acquisition of SBBJ, SBH, SBM,
SBP, and SBT by SBI in terms of SBI Act, 1955 Section 35 Subsection 2.

Merger of Bharatiya Mahila Bank with SBI

 All branches of Bharatiya Mahila Bank (BMB) will function as branches of State Bank of
India (SBI) w.e.f April 1, 2017.

The merger order of BMB with SBI has been issued by the the Government of India as -
Acquisition of Bharatiya Mahila Bank Limited Order 2017, dated March 20, 2017, and was
published under Extraordinary Part II Section-3 Subsection-i in The Gazette of
India sanctioning the Acquisition of SBM by SBI in terms of SBI Act, 1955 Section 35
Subsection 2.

Effects on SBI
 This merger has catapulted SBI into one of the top 50 global banks (up
from 55th position in 2016)
 SBI's balance sheet size is Rs. 33 lakh crore
 The total number of branches and ATMs of SBI has
become 24,017 and 59,263 respectively.
 The customer base of SBI is now over 42 crore.
 Post-merger, SBI has the ability to successfully process 15,000 transactions /
second, versus actual utilization of 4,600 transactions / second, making it "future ready".
 SBI now has a deposit base of more than Rs. 26 lakh crore, and advances of Rs.
18.50 lakh crore (tentative figure)
 Out of the 5 head offices of the associate banks, SBI will retain only 2. 3 head
offices of the associate banks will be unbound along with 27 zonal offices, 81 regional
offices, and 11 network offices (according to SBI MD Dinesh Kumar Khara)

Public Sector Banks (H/Q, heads, taglines)

This is a list of Public Sector Banks (PSB) in India, along with their headquarters, heads,
taglines, etc.

Note that this is a dynamic list, which will change throughout the year. If any
changes occur, readers are requested to notify by commenting or mailing us, so that
this page is always updated for the benefit of readers.

Last Updated - 16/12/2017

 Allahabad Bank (www.allahabadbank.in)

Founded - April 24, 1865
H/Q - Kolkata, West Bengal
CMD - Usha Ananthasubramanian
Tagline - A tradition of trust
--------------------------------------------------------------------
 Andhra Bank (www.andhrabank.in)
Founded - Nov 20, 1923
H/Q - Hyderabad, Andhra Pradesh
CMD - Suresh N Patel
Tagline - Where India banks
--------------------------------------------------------------------
 Bank of Baroda (www.bankofbaroda.com)
Founded - July 20, 1908
H/Q - Vadodara (Baroda), Gujarat
CMD - PS Jayakumar
Tagline - India's International Bank
--------------------------------------------------------------------
 Bank of India (www.bankofindia.com)
Founded - Sep 7, 1906
H/Q - Mumbai, Maharashtra
CMD - Dinbandhu Mohapatra
Tagline - Relationship beyond banking
--------------------------------------------------------------------
 Bank of Maharashtra (www.bankofmaharashtra.in)
Founded - 1935
H/Q - Pune, Maharashtra
CMD - Ravindra Prabhakar Marathe
Tagline - One family one bank
--------------------------------------------------------------------
 Bhartiya Mahila Bank (www.bmb.co.in) - Merged with SBI
Founded - 2013, Merged - April 1, 2017
--------------------------------------------------------------------
 Canara Bank (www.canarabank.com)
Founded - 1969 (Canara Bank Ltd. in 1910)
H/Q - Bengaluru, Karnataka
CMD - Rakesh Sharma
Tagline - Together we can
--------------------------------------------------------------------
 Central Bank of India (www.centralbankofindia.co.in)
Founded - Dec 21, 1911
H/Q - Mumbai, Maharashtra
CMD - Rajeev Rishi
Tagline - Central to you since 1911
--------------------------------------------------------------------
 Corporation Bank (www.corpbank.com)
Founded - Mar 12, 1906
H/Q - Mangalore, Karanataka
CMD - Jai Kumar Garg
Tagline - A premier public sector bank
--------------------------------------------------------------------
 Dena Bank (www.denabank.com)
Founded - 1938
H/Q - Mumbai, Maharashtra
CMD - Ashwani Kumar
Tagline - Trusted family bank
--------------------------------------------------------------------
 IDBI Bank Ltd. (www.idbi.com)
Founded - July 1964
H/Q - Mumbai, Maharashtra
CMD - Mahesh Kumar Jain
Tagline - Banking for all / Aao sochein bada
--------------------------------------------------------------------
 Indian Bank (www.indianbank.in)
Founded - Aug 15, 1907
H/Q - Chennai, Tamil Nadu
CMD - Kishore Kumar Kharat
Tagline - Your tech-friendly bank
--------------------------------------------------------------------
 Indian Overseas Bank (www.iob.in)
Founded - Feb 10, 1937
H/Q - Chennai, Tamil Nadu
CMD - R. Subramania Kumar
Tagline - Good people to grow with
--------------------------------------------------------------------
 Oriental Bank of Commerce (www.obcindia.co.in) - updated
Founded - Feb 19, 1943
H/Q - New Delhi, NCR (Gurgaon)
CMD - Mukesh Kumar Jain
Tagline - Where every individual is committed
--------------------------------------------------------------------
 Punjab & Sind Bank (www.psbindia.com)
Founded - June 24, 1908
H/Q - New Delhi, NCR
CMD - Jatinder Bir Singh
Tagline - Where service is a way of life
--------------------------------------------------------------------
 Punjab National Bank (www.pnbindia.com)
Founded - May 19, 1894 (founder - Lala Lajpat Rai)
H/Q - New Delhi, NCR
CMD - Sunil Mehta
Tagline - The name you can bank upon
--------------------------------------------------------------------
 State Bank of India (www.statebankofindia.com) - updated
Founded - July 1, 1955 (earlier Imperial Bank of India)
H/Q - Mumbai, Maharashtra
CMD - Rajnish Kumar
Tagline - Pure banking nothing else / The nation's banks on us / With you all the
way
--------------------------------------------------------------------
  Syndicate Bank (www.syndicatebank.in) - updated
Founded - 1925
H/Q - Manipal, Karnataka
CMD - Melwyn Oswald Rego
Tagline - Faithful and Friendly / Viswasaneeya Hitheshi
--------------------------------------------------------------------
 UCO Bank (www.ucobank.com)
Founded - Jan 6, 1943
H/Q - Kolkata, West Bengal
CMD - Ravi Kishan Takkar
Tagline - Honors your trust
--------------------------------------------------------------------
 Union Bank of India (www.unionbankofindia.co.in) - updated
Founded - Nov 11, 1919
H/Q - Mumbai, Maharashtra
CMD - Rajkiran Rai G.
Tagline - Good people to bank with
--------------------------------------------------------------------
 United Bank of India (www.unitedbankofindia.com)
Founded - 1950
H/Q - Kolkata, West Bengal
CMD - Pawan Kumar Bajaj
Tagline - The bank that begins with "U"
--------------------------------------------------------------------
 Vijaya Bank (www.vijayabank.com)
Founded - 1931
H/Q - Bengaluru, Karnataka
CMD - RA Sankar Narayana
Tagline - A friend you can bank on

Cooperative Banks
In normal commercial banking, the banking business is owned or maintained by
government (in case of Public Sector Banks) or some private entity (in case of Private
Sector Banks). In this case, banks, on behalf of government or that private entity, lends to
other individuals or business, i.e., borrowers. The sole purpose of this commercial banking
is profit.

But in case of cooperative banking, some small private entities or individuals come
together, and form a small financial institution (by their own funds / member funds),
and lend to the members of that institution. Note that the banking business here is
on cooperative basis, i.e., one member is helping / lending to other member (now they do
lend to non-member individuals or entities as normal banks). These financial institutions are
known as Cooperative Banks.
 Purpose of Cooperative Banks
Initially, cooperative banks were set up to meet the credit needs in rural area, especially to
prevent money lenders, but now they have vast area of services as follows -

 Agricultural and allied activities

 Rural-based industries
 Small trade and industry in Urban areas, etc.

Structure of Indian Cooperative Banks

Cooperative banks in India have a 3-tier structure -

 Primary Credit Societies(village/town/urban centers)

 Central Cooperative Banks (district-level)
 State Cooperative Banks (state-level)

Urban Cooperative Banks (UCBs)

Primary (urban) Credit Societies that meet certain criteria can apply to RBI for a banking
license to operate as Urban Cooperative Banks (UCBs).
 Managerial aspects, like registration, management, recruitment,
administration, etc. are controlled by Registrar of Cooperative Societies (RCS) of the
respective state governments (as per Co-operative Societies Acts)
 Banking aspects are governed by RBI (as per Banking Regulation Act, 1949)

These banks cater to the needs of small borrowers including retail traders, small
entrepreneurs, professionals, salaried persons, etc.

District Central Cooperative Banks (DCCB)

DCCBs are cooperative banks at the district-level. Each district generally will have only
one DCCB. Following the establishment of NABARD in 1982, the supervisory function of
these banks has been passed on to NABARD.

State Cooperative Banks (SCB)

SCBs are cooperative banks at the state-level. A number of DCCBs report to
an SCB. NABARD has the supervisory authority over these SCBs.
 Note that DCCB and SCB has three supervisors - RCS, RBI and NABARD, whereas UCBs
are controlled by RCS and RBI.

Postal Bank of India

Postal Bank of India

The government is to set up a Postal Bank of India by utilizing its 1,55,000 Post
Offices across the country. Though the final structure is yet to decide, but it seems Postal
banks will have a distinct structure from other Payment Banks and will compete
with universal banks.

RBI Governor's speech at 80th anniversary of RBI

"In the coming year, we will have many new players in the banking eco-system, such
as payment banks, small finance banks and possible a postal bank competing with
existing universal banks, regional rural banks, cooperative banks, and a variety of non-
bank finance companies", said RBI governor R. Rajan, outlining the developments in
the central bank at an event to commemorate RBI's 80th anniversary.

Expected Structure

 The government is planning a non-payments bank structure for Postal Bank of India
 This will leverage the Postal Department's real estate
infrastructure, vast distribution network (1,55,000 Post Offices across the country)
 It will also facilitate Financial Inclusionplan

Note that the Postal Department has already applied for a payments
bank licence after RBI initiated the licensing process last year. But it is expected that if it
gets licence, Postal Bank will be a non-payments bank, or universal bank

MUDRA Bank
According to Budget 2015-16, the union government will set up Micro Units Development
and Refinance Agency (MUDRA) Bank with a capital of Rs. 20,000 crore to finance
the micro-finance sector of India, under Pradhan Mantri Mudra Yojana.

Purpose of MUDRA Bank

The Bank will regulate and refinance all Micro-Finance Institutions (MFIs) in
 India, which lends to / finances the Micro, Small and Medium Enterprises
(MSMEs) engaged in manufacturing, trading and services activities.

Finance Minister said, "The measures would not only help in increasing
access of finance to the unbanked but also bring down the cost of finance from the last
Mile Financers to the micro/small enterprises, most of which are in the informal sector".

Budgetary allocation
Rs. 20,000 crore corpus is allocated to set up the MUDRA bank. Another Rs. 3,000
crore would be provided to it, to create a Credit Guarantee corpus for
guaranteeing loans to the micro finance sector.

Responsibility of MUDRA bank

 Laying down policy guidelines for MSME financing business
 Registration and regulation of MFI entities
 Accreditation / rating of MFI entities
 Formulating and running a credit guarantee scheme for providing guarantees to
the loans which are being extended to micro-enterprises
 Creating a good architecture of last mile credit delivery to micro business under the
scheme of Pradhan Mantri Mudra Yojana, etc.

Priority Sector Lending

Finance Ministry also directed that MSME loans would be treated as Priority Sector
Lending (PSL) and a separate sub-limit of 7.5 % in PSL is being created for the Micro
Enterprises.

Some points on MUDRA Bank

 It is to be set up as an apex refinancer, which will fund over 50 million
entrepreneurs, who generally do not have access to formal credit. These micro
entrepreneurs also provide jobs to other people, thus creating an opportunity of inclusive
growth.
 It will fund micro units which are more efficient and adds more value to the
economy than the corporates. According to the Economy Census 2014, the gross fixed
assets of these (approx) 5.77 crore micro units is Rs. 11.5 lakh crore.62 % of these are
owned by Scheduled Caste (SC), Scheduled Tribes (ST) and Other Backward Castes
(OBCs).
 The MUDRA architecture is indigenously designed to fund the Indian non-formal
sector

Small and Payment Bank

Small Banks
 The objectives of setting up of Small Banks are to further financial inclusion, by providing
-

 Provision of savings facilities to under-served and un-served sections of the

population
 Supply of Credit to small business units, small farmers, micro and small
industries, and other unorganized sector entities, in their limited area of operations,
through high technology - low cost operations
Activities of Small Banks -
 The area of operations of the small bank will normally be restricted
to contiguous districts in a homogenous cluster of states/UTs so that
the bank has the 'local feel' and culture. Branch expansion for first 3 years,
need RBI's prior approval.
 Primarily undertake basic banking activities,
like acceptance of deposits and lending to small farmers, small businesses, micro
and small industries and unorganized sectors.
 It can also undertake other simple financial activities with the prior
approval of RBI.
 It cannot set up subsidiaries to undertake non-banking financial
services (NBFC) activities.
Capital Requirements -
The minimum paid-up capital is Rs. 100 crore.

Funds Deployment -
In view of the inherent risk (since it can lend) of a small bank, it shall be required to maintain
a minimum Capital Adequacy Ratio (CAR) of 15 % of its Risk Weighted Assets
(RWA) on a continuous basis. However, as small banks are not expected to deal
with sophisticated products, the CAR will be computed under simplified Basel I standards.

Payments Bank
The objectives of setting up of Payments Banks are to further financial inclusion, by
providing -

 Small Savings accounts

 Payments / remittance services to migrant labor workforce, low
income households, small businesses, other unorganized sector entities and other users.
Activities of Payment Banks -
1. They can accept Demand Deposits, but will initially be restricted to hold
a maximum balance of Rs. 1,00,000 per individual customer
2. Issuance of ATM / Debit Cards, but they cannot issue Credit Cards
3. Payments and remittance services through various channels
4. They can act as Business Correspondents (BC) of another bank (following RBI
guidelines)
5. Distribution of non-risk sharing simple financial products, like Mutual Funds
(MF) units and insurance products, etc.
6. They cannot undertake lending activities (means cannot disburse loans)
Capital Requirements -
The minimum paid-up capital is Rs. 100 crore.

Funds Deployment -
Apart from amounts maintained as Cash Reserve Ratio (CRR) with RBI, it will be required
to invest minimum 75 % of its demand deposits in Statutory Liquidity Ratio
(SLR) eligible government securities / T-bills with maturity up to 1 year, and
hold maximum 25 % in current and time/fixeddeposits with other Scheduled Commercial
Banks (SCBs) for operational purposes and liquidity management.

Small Banks vs. Payment Banks

1. Small Banks can accept demand and time deposits from public as commercial
banks do (Savings, Current, Fixed, Recurring deposits, etc.)
But, Payment Banks can take only demand deposits (Savings and Current
deposits), and cannot issue Credit cards (however, can issue Debit cards)
2. Small Banks can give loans only to small business units, small
farmers, micro and small industries, and other unorganized sectors, but not
to large industries.
But, Payment Banks cannot give any type of loans to public, but
can invest in government securities or T-bills.
3. The target of Small Banks is to supply credit to small business units, small
farmers, micro and small industries, and other unorganized sector entities, in
their limited area of operations. And provisions for savings for poor people.
The target of Payment Banks is payments / remittance services to migrant labor
workforce, low income households, small businesses, other unorganized
sector entities, and savings for poor people.

Deposit Insurance - DICGC

Customers deposit their money in banks to avail several services provided to them by their
respective banks. But what if the bank itself fails, or merges with another bank, or it
becomes cease to exist? What will happen to the valuable deposits of the customers?

Considering these, bank deposits are provided with insurance covers in most of
the banking systems in the world. India is no exception. However, the insurance cover
may be in full or part.
 Deposit Insurance in India
All the banks operating in Indian territory (with some exceptions) are covered under
the deposit insurance facility provided by Deposit Insurance and Credit Guarantee
Corporation (DICGC), a fully owned subsidiary of RBI. It established on July 15,
1978 with Deposit Insurance and Credit Guarantee Corporation Act, 1961.

DICGC insures all bank deposits (including saving, current, fixed, recurring) up to
a maximum limit of Rs. 1 lakh (principal with interest).

Banks insured under DICGC

 Commercial banks - Public sector banks, Private Sector Banks, Foreign Banks
operating in Indian territory, Regional Rural Banks, Local Area Banks
 Cooperative banks - State, Central and Primary Cooperative Banks (collectively
called Urban Cooperative Banks, or UCB) that have amended Cooperative Societies
Act, empowering RBI to control them
Currently approx. 2,130 banks are insured by DICGC.

Not covered under DICGC

 Cooperative banks operating in Meghalaya, Chandigarh, Lakshadweep and Dadra &
Nagar Haveli
 Primary Cooperative Societies
Insurance coverage
DICGC protects bank deposits that are payable in India, including savings, current, fixed,
recurring, etc. except the following deposits -
 Foreign government deposits
 Central and state government deposits
 Inter-bank deposits, etc.
Note that this insurance is aimed to cover individual customer deposits or small business
with maximum cover up to Rs. 1 lakh. Therefore the above exceptions are justified.

Insurance Premiums
Customers need not pay any premium to insure their deposits. DICGC charges a
nominal premium from the banks. Customer deposits are automatically (from the
customer's point of view) insured when they open any kind of deposits with the bank.

Insurance Claim
In case of a bank failure, customers need not make
any claim under deposit insurance (in contrast to other insurances, where insurance
claim is needed).
 The official liquidator would make a claim on customers' behalf to the DICGC. DICGC is
bound to pay the valid insurance claim within 2 months period from receipt of claim from
the liquidator. The liquidator then provides the claim amount to each customer.

When DICGC is liable to pay

4. If a bank goes into liquidation (fails)
5. If a bank is reconstructed or amalgamated / merged with another bank

Know Your Customer (KYC)

If you visit to a bank branch to open a bank account, you first need to let them know who
you are, and where do you live. Without knowing these information, a bank will not open
your account. This process of knowing about you (customer) is Know Your Customer
(KYC).

Components
It is obvious now, that KYC process has 2 components -
 Identity - Who are you?
 Address - Where do you live?
Two more things are necessary - your photograph and your signature / thumb
impression (These two are the most important)

Documents
The government has notified 6 documents as 'Officially Valid Documents (OVDs) for the
purpose of proving your identity -
 Passport
 Driving License
 Voters' Identity Card
 PAN Card
 Aadhaar Card issued by UIDAI
 NREGA Card
If these documents also contain your address, then no separate proof of address will be
required. Otherwise, you need to provide another valid address proof.

Special case -
Suppose, you don't have any of the OVDs specified above to proof your identity. Then can
you open an account?
 The answer is YES!
However, the account opened cannot be a normal account. It will be a limited
facility account, termed as 'Small Account'. Limitations such as -
 Balance at any point of time, shouldn't exceed Rs. 50,000
 1 year Total Credit shouldn't exceed Rs. 1,00,000
 Total withdrawal and transfers shouldn't exceed Rs. 10,000 / month
 Foreign remittances cannot be credited
Such accounts remain operational initially for a period of 12 months (1 year), and
thereafter, for a further 1 year (if the holder can prove that he has applied for any of
the OVDs in respective office within 1 year of opening the account).

Situational Question (asked in IBPS, SBI or other banking exams)

If a customer comes to your branch to open an account, but doesn't have any valid
documents as proof of identity, then would you open an account for him?

The answer is YES (as you already know now!)

Take his photograph and make him sign or provide thumb impression. And tell him you
are opening a 'Small Account' for him (also tell him about the limitations, and the need
to submit valid documents within 1 year)
Please note that KYC should be completed within 1 year of opening Small
Account, and KYC is mandatory.

Refer - RBI Press Release - Aug, 2014

http://rbi.org.in/scripts/BS_PressReleaseDisplay.aspx?prid=31935

e-KYC
It is electronic KYC. As the term means, here KYC will be done electronically (online).
Note that it is possible only (or atleast for now) for those who have valid Aadhaar
numbers with them.

You have to authorize the UIDAI (the issuer of Aadhaar card), by explicit consent, to
release your identity / address through biometric authentication to the bank
branches (or, business correspondents (BC)).

UIDAI then will transfer your data (that was taken from you when you applied for Aadhar
card) to the bank, and KYC will be done electronically.
 Pradhan Mantri Jan-Dhan Yojana (PMJDY)

Pradhan Mantri Jan-Dhan Yojana (PMDJY)

PMJDY is a National Mission for Financial Inclusion (to include excluded-population for
financial/banking services). A number of financial services is provided to
the PMJDY account holder in an affordable manner, like -
 Savings and Deposit Accounts
 Remittances (transferring money to other accounts)
 Credit
 Insurance
 Pension, etc.

PMJDY Slogan
'Mera Khata Bhagya Vidhata' (meaning in English - 'My Bank Account - The Creator of
the Good Fortune')

PMJDY Account opening procedure

PMJDY accounts can be opened in the followings with Zero balance -
 Bank branch (Public sector, Private sector and Regional rural banks)
 Business Correspondents / Bank Mitr outlets
Note that there is no minimum balance criteria for opening PMJDY accounts
(without cheque book). But if someone wants to avail the cheque book facility, he needs to
maintain minimum balance criteria.

PMJDY Benefits
 Deposits attract interests (you will get interest on your account balance)
 Accidental Insurance cover of Rs. 1 lakh
 Life Insurance cover of Rs. 30,000
 After satisfactory operation of the PMDJY account for 6 months period, an Overdraft
(OD) facility will be permitted, upto Rs. 5,000 (only one account per household,
preferably female account holder of that household)
 Beneficiaries of governmental schemes (like LPG subsidy, etc.) will get Direct
Benefit Transfer (DBT) in these accounts (subsidy amount will be directly credited to your bank
account)
 Access to Pension, Insurance products
 Easy transfer of money across India (remittances)
 No minimum balance criteria (unless you avail cheque book facility)
 RuPay Debit Card will be provided
Note that RuPay Debit Card must be used at least once in 45 days
 PMJDY Statistics (as on February 28, 2015)
6. Public Sector Banks - Total 10.7298 crore accounts
7. Private Sector Banks - Total 0.5702 crore accounts
8. Regional Rural Banks - Total 2.3804 crore accounts
Total 13.6804 crore PMJDY accounts has been opened in India (as on Feb 28,2015)

PMJDY Administrative Structure

9. Mission Head - Finance Minister Shri Arun Jaitley
10. Mission Incharge - Finance Secretary Dr. Hasmukh Adhia
11. Mission Director - Joint Secretary (Financial Inclusion) Shri Rajesh Aggarwal
12. Additional Mission Director - Director (Financial Inclusion) Dr. Alok Pande

PMJDY Guinness Book of World Records

PMJDY scheme of government recently recognized by Guinness Book of World
Record for most bank accounts opened (approx 1.8 crore) in 1 week (during August 23 -
29, 2014).

The Certificate states, "The most bank accounts opened in 1 week as a part of
financial inclusion campaign is 18,096,130 and was achieved by Department of
Financial Services, Government of India (India) from 23 to 29 August 2014"

Lending Money - Cash Credit and Overdraft

Lending money is one of the two major activities of any bank. Banks accept depositsfrom
public for safe keeping and pay interest to them. They then lend this money to
earn interest on this money. In a way, the banks act as intermediaries between the people
who have the money to lend and those who need the money to carry out business
transactions.

Spread – The difference between the rate at which the interest is paid on deposits and
is charged on loans, is called the “spread”.

Lending Activity – Commodities, Debts, Financial instruments, Real Estate, Automobiles,

Consumer durable goods, Documents of title.

Apart from the above categories, the Banks also lend to people on the basis of
their perceived personal worth. Such loans are called clean and the banks are
understandably cagey about extending such loans. The credit card arms of the various
banks, however, fill up this void.
a. CASH CREDIT (CC) ACCOUNT – This account is the primary method in
which banks lend money against the security of commodities and debt. It runs like
a current account except that the money that can be withdrawn is not restricted to
the amount deposited in the account. Instead, the account holder is permitted
to withdraw a certain sum called “limit” or “credit facility”in excess of the
amount deposited in the account.
Cash Credits are, in theory, payable on demand. These are, therefore, counter part
of Demand Deposits of the banks.

b. OVERDRAFT (OD) – The word “overdraft”means the act of overdrawing from a bank
account. In other words, the account holder withdraws more money from a bank
account that has been deposited in it.

Now try to understand about the differencesbetween these two -

The primary differences between cash credit and over draft is how they are secured and
whether the money is lent out of a separate account.

Cash Credit (CC) Over Draft (OD)

More commonly offered Can be used for any

User
for businesses than individuals purpose, individual or business

Allowed against a host of

other securitiesincluding financial instruments,
Security can be a tangible
like shares, units of MFs, surrender value of LIC
Security asset, such as stock, rawmaterials,
policyand debenturesetc. Some ODs are even
or some other commodity
granted against the perceived “worth”of
an individual, known as clean ODs.

A certain percentage of Acts more like a traditional loan. Money is lent

Credit
the value of thecommodities / as with a cash credit account, but a wider range
Limit
debts pledged by the a/c holder of collateral can be used to secure the credit.
Bill Discounting
If the drawer of the bill does not want to wait till the due date of the bill and is need of
money, he may sell his bill to a bank at a certain rate of discount. The bill will
be endorsed by the drawer with a signed and dated order to pay the bank.
The bank will become the holder and the owner of the bill. After getting the bill, the
bank will pay cashto the drawer equal to the face value less interest or discount at an
agreed rate for the number of days it has to run. This process is known as discounting
of a bill of exchange.

For example, a drawer has a bill of Rs. 10,000. He discounted this bill with his bank2
months before its due date, at 15 % p.a.rate of discount. Discount will be = Rs. 1,000 x
15/100 x 2/12 = Rs. 250. Thus the drawerwill receive a cash worth Rs. 9,750 and will
bear a loss of Rs. 250.
The bank will keep this bill in possession till the due date. On maturity (due date) the
bank will present the bill to the acceptor and will receive cash from him (if the bill is
honored). In case, the acceptor does not make the payment to the bank, then
the drawer or any person who has discounted the bill have to take this liability and
will pay cash to the bank.

N.B. Until the bill is honored on the due date, there is always a chance the drawer will
become liable on the bill. This is called a Contingent Liability – a liability that will only
arise if a certain event occurs – the acceptor does not honor the bill.

Non Performing Assets (NPA)

Bank Assets
Assets are something that you own, meaning you are the legal owner of the asset.
Similarly, bank assets are those things that a bank owns. It can be physical property (like
land, equipment, buildings, etc.) or financial property.

Banks generally have four types of assets - Physical Assets, Loans/Advances,

Reservesand Investments. (Read the topic - Bank Assets and Liabilities for detail).

Among the above four types, loans or advances are the most important and riskyasset of
a bank. It is most important because, it can generate maximum profit, and at the same
time, it is the most risky because if the borrower fails to repay the loan amount, then the
bank will face loss.

Non-Performing Assets (NPA)

If the borrower (of a loan/advance from a bank) is unable
to repay the interest and principal repayments to the bank, for a considerable amount
of time, then the loan/advance will be called non-performing.
Since loans/advances are assets of the bank, it will be known as Non-performing
Assets (NPA).
In Indian context, if the borrower has failed to make interest or principal payments for 90
days (3 months), then the loan/advance is considered NPA.

(In layman's terms NPA refers to - you lend money, but you don't get it back when
you expected)

Recovery/Non-recovery of NPA
Interests earned on loan repayments are the most important income of a bank. Therefore,
due to default in repayment, banks will suffer loss. Though, by selling the collateral
securities(if any) against the loan - banks could recover the loan amount, the process
of selling the securities (with the help of Asset Reconstruction Companies, and they
will charge fee) is a tedious and long term job, and even
the seizure of mortgage or hypothecation, etc is difficult process.

Moreover, if the company or individual borrower becomes bankrupt, then the loss will
be catastrophic for the lender bank. Even in some cases, there could be
some corrupted bank officials who would sanction loan touncreditworthy borrowers
for bribes, or ministerial / political pressures!

Conditions to become NPA

An asset becomes NPA when it ceases to generate income for the bank -

 Term Loan - Interest and/or installment of principal amount

remain overdue for more than 90 days
 Overdraft / Cash Credit - The account remains 'out of order' for 90 days
 Bill - The bill remains overdue for more than 90 days in the case of bills
purchased and discounted
 Short duration crops - The installment of principal or interest
remains overdue for 2 crop seasons
 Long duration crops - The installment of principal or interest
remains overdue for 1 crop season
 Securitisation transaction - The amount of liquidity
facility outstanding for more than 90 days
 Derivative transaction - The overduereceivables representing
positive mark-to-market value of a derivative contract, if these
remain unpaid for 90 days from the specified due date for payment.

NPA Classification
Banks are required to classify NPAs into the following 3 categories, based on
thenonperforming period and the realisability(recoverability) of the dues -

 Substandard Assets - (90 days - 12 months)

Assets remained NPA for less than or equal to 12 months (1 year)
 are Substandard Assets.

Such an asset will have well defined credit weaknesses that jeopardise
the liquidation of the debt and are characterized by the distinct possibility that
the banks will sustain some loss, if deficiencies are not corrected.
 Doubtful Assets - ( > 12 months)
Assets remained Substandard assets for 12 months (1 year) are Doubtful Assets.

Such an asset will have all the weaknesses inherent in substandard assets, with
the added characteristic that the weakness make collection or liquidation in full -
on the basis of currently known facts, conditions and values - highly questionable
and improbable.
 Loss Assets -
Assets where loss has been identified by the bank or internal/external auditors or
the RBI inspection, but the amount has not been written off wholly.

Such an asset is considered uncollectible and of such little value that

its continuance as a bankable asset is not warranted although there may be some
salvage or recovery value.

Upgradation of NPA to Standard

If arrears of interest and principal are paid by the borrower in case of loan
accounts classified as NPAs, the account should no longer be treated
as nonperforming and may be classified as 'standard' accounts.

Current NPA status in India

According to Moody's analyst ICRA, the percentage of gross NPAs (GNPAs) for
the banking sector (both PSBs and private banks) is expected to worsen from 3.9
% of advances in fiscal 2013-14 to about 4 - 4.2 % in 2014-15.

SARFAESI Act, 2002

Before reading this article, go through the article on - Non-performing Assets (NPA)

SARFAESI Act, 2002

The Securitization and Reconstruction of Financial Assets and Enforcement of

Security Interest Act (SARFAESI), 2002 was enacted to empower the banks and financial
institutions (lenders) to recover their bad loans / NPAs from the borrowers, without
the intervention of the court.
 Applicability of the Act

 Secured Loans - SARFAESI Act is applicable only for the secured

loans (meaning loans backed by underlying securities). In this case, banks or financial
institutions can seize and/or sell the underlying securities, like hypothecation, pledge,
mortgage, etc and recover the loan amount.
 Unsecured Loans / Agricultural lands - For unsecured loans (not backed
by underlying securities) or agricultural loans (where agricultural land is the underlying
security), banks cannot seize or sell by itself. In these case, banks need to move
to court and file Civil caseagainst the defaulters.

Why SARFAESI Act?

Earlier to recover the bad loans / NPAs, banks needed to move to the courts - Debt
Recovery Tribunal (DRT) and Debt Recovery Appellate Tribunals (DRAT), which made
the recovery a long-term process, and there were severalloopholes which could be
misused by the borrowers.

Then Andhyarujina committee recommended to enact a new legislation for

the establishment of Securitization and Reconstruction
companies and empower the banks and financial institutions to take possession /
seize the securities without moving to the courts.

Provisions of the Act

If any borrower fails to discharge his liability in repayment of any secured debt within 60
days (2 months) of Notice, the secured creditor is conferred with powers under
the SARFAESI Act to -
 Take possession of / seize / auction /sell the secured assets of the borrower
 Takeover of the management of the business of the borrower
 Appoint any person to manage the secured assets, etc.
Note that agricultural property is exemptedfrom the provisions of the Act.

Some Securitization Companies and Reconstruction Companies in India

 Asset Reconstruction Company (India) Ltd. (ARCIL)
 Assets care & Reconstruction Enterprise Ltd. (ACRE)
 ASREC (India) Ltd.
 Pegasus Assets Reconstruction Pvt. Ltd.
 Phoenix ARC Pvt. Ltd.
 Priority Sector Lending
Banks try to do business on those sectors that could generate most profits for them,
like corporate sector, etc. There are several other sectors that might not get
adequate creditsupply (loans), if special dispensation is not provided
by RBI (because banks can ignore those sectors, as those will generate less profit for
banks).

Therefore, RBI has mandated that all banks need to provide credit to those special
categoryareas, (Financial Inclusion), known as Priority Sector.

Priority Sectors
Priority Sector includes following categories -

1. Agriculture and Allied Activities (like dairy, fishery, animal husbandry, poultry, etc.)

a. Direct Finance -
 Without limit - to individual farmers, SHGs, JLGs, small and marginal
farmers, distressed farmers indebted to moneylenders, etc.
 With limit (up to Rs. 2 crore per borrower) - corporates in these activities, producer
companies, partnership firms, cooperatives, etc.
b. Indirect Finance -
 If the loan limits per borrower is more than Rs. 2 crore, then it will be treated
as Indirect Finance.

2. Micro and Small Enterprises

Bank loans to Micro and Small Manufacturingand Service Enterprises are
considered Priority Sector Lending. However, there are some upper limits -

a. Plant and Machinery Investment -

 Micro Enterprises - < Rs. 25 lakh
 Small Enterprises - > Rs. 25 lakh, but < Rs. 5 crore
b. Equipment Investment -
13. Micro Enterprises - < Rs. 10 lakh
14. Small Enterprises - > Rs. 10 lakh, but < Rs. 2 crore
 3. Education
Loans to individuals for educational purposes with the following limits -
15. Education in India - < Rs. 10 lakh
16. Education abroad - < Rs. 20 lakh

4. Housing
Loans to individuals with the following limits for construction / purchase of a dwelling
unit per family, excluding bank's own employees' loans -
1. Metropolitan areas (population above 10 lakh) - Rs. 25 lakh
2. Other than metropolitan areas - Rs. 15 lakh
Note - Bank's own employees get low interest Housing loan from that bank, so loans
granted on them is not considered as Priority Sector Lending.

5. Weaker Sections
The following borrowers are considered as Weaker Sections -
1. Small and marginal farmers
2. Artisans,village and cottage industries (max. credit limit Rs. 50,000)
3. Scheduled Castes (SC) and Scheduled Tribes (ST)
4. Beneficiaries of Differential Rate of Interest (DRI) scheme
5. Beneficiaries of some government schemes, like NRLM, SJSRY, SRMS, etc.
6. Self Help Groups (SHG)
7. Distressed farmers indebted to non-institutional lenders
8. Individual women beneficiaries upto Rs. 50,000 per borrower, etc.

6. Micro Credit
Loans upto Rs. 50,000 per borrower to the poor in rural, semi-urban and urban areas,
either directly or in a group, will constitute micro credit.

PSL targets and sub-targets

The target for lending to the redefined priority sector is retained at 40 % of Adjusted Net
Bank Credit (ANBC) or credit equivalent of off-balance sheet exposure, whichever
is higher, for all Scheduled Commercial Banks (SCBs).

Target - Total PSL = 40 % of ANBC

1. Sub-target - Total Agriculture = 18 %
2. Sub-target - Advances to Weaker Sections = 10 %

Unused PSL fund to form MUDRA Bank

Unused PSL funds of commercial banks will be used to set up the Rs. 20,000
crore corpus of the proposed MUDRA Bank (read previous post on MUDRA Bank).

The bank will use at least 65 % of its funds for lending to micro enterprises run by
members of Scheduled Castes and Tribes.

New proposals on PSL

1. To enhance credit to Small and marginal farmers, a separate sub-target of upto 8 %
2. Loans for Agri-processing and Agri-infrastructure would be included in PSL
3. Loans to Medium Enterprises would be included in PSL (Micro and Small Enterprises are
currently included)
4. A separate sub-target of 7.5 % to be created for the Micro Enterprises
5. Loans upto Rs. 5 crore for Social infrastructure, like schools, health cares, drinking water,
sanitation, etc. are being included under PSL, for towns of less than 1 lakh population
6. Renewable Energy sector is being added to PSL, upto Rs. 10 crore loans

Pledge, Hypothecation, Mortgage, Lien

Securities for loan
If you want a loan from a bank (or any other financial institution), you generally need to
provide some kind of security against the loan to the bank. There are several types
of securities, against which a bank will offer you a loan -

 Pledge - It is used when the bank (or, lender, known as pledgee) takes
actual possession of the securities, such as goods, certificates, golds, etc, (you
provide it to bank to avail loan) which are generally movable in nature.
Bank keeps the securities with itself, and provide loan to you.
Bank will return the securities (possession of goods) to you (borrower, known
as pledgor), after you repay all the debts (i.e., loan) to the bank. In case you
are unable to pay back, then the bank has the right to sell the assets,
and recover the loan amount (with interest).

Example - Gold loans, Jewellry loans, advances against NSC (National Saving
Certificates), or loans against any other assets.
 Hypothecation - It is used when you (borrower) have the
actual possession of the asset, for which you have taken the loan. Generally, this is
charged against loans for movable assets, like car, bus, etc. (i.e., vehicle loans).
 Here, the assets (bus, car, etc.) remain with you, and you are hypothecated to
the bank for the loan granted.
In case you are unable to repay the loan amount, then the bank has the right to
sell the asset (bus, car, etc.), (which is possessed by you) and recover the total
amount (with interest).

Example - Car loans, Bus loans, etc.

 Mortgage - It is used when you (borrower) have the actual possession of
the assets, for which you are granted loan (e.g., house loan), or against which you
are granted loan (e.g., house mortgaged). Mortgages are generally those assets,
which are permanently attached with Earth surface, like house, land, factoryetc.
In case you are unable to repay the loan amount, the bank has
the right to seize and sell the mortgage, and recover theloan amount (with
interest).
 Lien - It is almost similar to Pledge, except that in case of lien,
the lender can only detain the asset/goods until the borrower repays the loan, but
have no right to sell the asset, unless explicitly declared in the lien contract. (For
a pledge, the lender can sell the asset, if the borrower is unable to pay the loan)

Note the followings -

Movable assets - Pledge, Hypothecation, Lien
Immovable assets - Mortgage

Possessed by lender - Pledge, Lien

Possessed by borrower - Hypothecation, Mortgage

Base Rate
Base Rate System
Bank lends money to its customers by loans or advances or other credit facilities. It
charges some interest on the lending / credit. Does a bank need to follow any
specific rules while providing money to its customers?

Yes, banks follow Base rate system, formulated by RBI. Base rate is
the minimum chargeable interest for the credit sanctioned to the customer (meaning, no
bank can offer loans to its customers below this interest rate).

Base rate system replaced the Benchmark Prime Lending Rate (BPLR) system on July 1,
2010.

Situational Question
 Suppose you are an officer in a rural bank. A poor people comes in your branch
seeking loan for his house (or some other reason). Can you offer him a loan, bearing
interest below the Base Rate?

The answer is YES, if he is eligible for DRI scheme. (criteria described below)

Exclusions
There are some few exclusions, where you can grant loan below base rate, as -
 Differential Rate of Interest (DRI) Schemebeneficiaries
 Loans to bank's own employees (including retired employees)
 Loans to bank's depositors against their own deposits (e.g., granting loan
on his own fixed deposit, etc.)

DRI Scheme
As per RBI guidelines, for lending under DRI scheme, banks are required to grant
loans at concessional rate of interest to the eligible beneficiaries -
 Family income ceiling per annum in rural and urban area should be less than Rs.
18,000 and Rs. 24,000 respectively
 Borrower should not be benefited under any subsidy-linked schemes of government
 Max. limit of loan - Rs. 15,000. For housing loan, it could be up to Rs. 20,000
 Banks are required to lend 1 % of their total outstanding
advances under DRI Scheme every year.

Automated Teller Machine (ATM)

Automated Teller Machine (ATM) is a computerized machine (specialized computer)
that provides the customers of banks the facility to access their accounts for
dispensing cash and to carry out other financial (e.g., remittances) as well as non-
financial (e.g., balance check) transactions, without visiting the bank branch.

Services / Facilities provided by ATMs -

 Cash Withdrawal
 Account Information
 Cash Deposit (not permitted at WLAs)
 Regular Bill Payment
 Purchase of Vouchers
 PIN change
 Mini / Short Statement
 Cheque book request
 Loan Account Enquiry, etc.

Classification
ATMs can be classified depending on the owner and operator -

1. Bank-owned ATM
These are owned and operated by individual banks.

2. White Label ATM (WLA)

These type of ATMs are set up, owned and operated by non-bank entities
(e.g., NBFCs). WLAs are authorized under Payments and Settlement Systems Act,
2007 by RBI. These have following features -
 Logo displayed on the machine or premises will be of WLA Operator's.
However, customers can use these ATMs, as of using other bank ATMs (bank other than card
issuing bank)
 Cash deposit is not permitted in the WLA machine (as of now).
3. Brown Label ATM (BLA)
These type of ATMs are set up and owned by a Service provider, but cash
management (operation) and connectivity is provided by a sponsor bank (brand of this
bank is used on the ATM).

By using BLAs, banks have the opportunity to cut the huge cost of setting up of an ATM
(bank-owned ATM)

Note -
ATMs - bank (owner), bank (operator)
WLAs - non-bank (owner), non-bank (operator)
BLAs - non-bank (owner), bank (operator)

Cards - Debit, Credit, Prepaid Cards

Instead of carrying and using cash, you can use cards for all your financial transactions.
Hence, these are known as Plastic Money.

According to the issuance, usage and payments, Cards can be classified into 3 types -

1. Debit Cards - These are issued by banks, which are linked to a bank
 account (meaning you need a bank account (savings, current, etc.) before having a Debit
card). Debit cards are also known as ATM cards.

Note that you need to have balance in your account, before you make
any financial transaction. These can be used for several purposes like -

 withdraw cash from an ATM

 purchase goods and services at Point of Sale (POS) / E-commerce (online -
domestic & international; however for international transaction, it needs to be enabled by bank)
 fund transfer / remittances (only domestic), etc.

2. Credit Cards - These are issued by banks or other institutes approved by RBI. There
is a credit limit on transactions. These may or may not be linked to a bank account.

Note that you can make transactions, even if you don't have balance in your account (if
linked with bank account), subject to a credit limit approved by the issuer of the credit
card. This can be thought as a loan / advance from the issuer, which you need to pay
back after a certain period of time. Use of Credit cards are same as that of the Debit
cards.

3. Prepaid Cards - These are issued by banks or non-banks, where value is paid
in advance. There are several forms of prepaid cards, like Smart cards or Chip
cards, Internet wallets, Mobile wallets, etc.

Prepaid cards can be further classified into two types -

 Issued by banks - also known as Open System Prepaid Cards, which are issued
by banks. These are similar to Debit cards in usage, but you don't need a bank account to get
this type of card. You just need to pay in advance, with a maximum limit of Rs. 1
lakh (previous limit Rs. 50,000)
 Issued by authorized non-bank entities - also known as Semi-Closed System
Prepaid Cards, which are issued by authorized non-bank entities. There are
some restrictions on the usage of these cards - can be used only for purchase of goods and
services at POS / E-commerce (online) and for domestic remittances,
but cannot withdrawmoney from ATMs.
Also, you don't need a bank account, but need to pay in advance to the non-bank entity, with
a max. limit of Rs. 1 lakh.

# Reader's Question
Can Credit Card be issued without bank account?
(Now after reading the article, you already know the answer)
 Credit cards may or may not be linked with a bank account, meaning you don't need to
have a bank account, to be issued with a Credit Card. However, before issuing you
a Credit card, the issuing bank or other RBI approved institutions (e.g. NBFCs) will verify
your credibility.

Non Banking Financial Corporations (NBFC)

Non Banking Financial Companies (NBFC)
NBFCs are financial institutions that provides almost similar banking services (like
providing loans and credits) but doesn't possess banking license. So there are
some limitation / restriction in its services.
NBFCs are registered under the Companies Act, 1956, whereas banks are regulated
under Banking Regulation Act, 1949.

Differences between a Bank and an NBFC

 It cannot accept Demand Deposits from public. If someone want to invest in an
NBFC, it could have some maturity (like happens in time deposits). Though some special
permission is given to LIC and GIC by RBI. These two NBFC can take demand deposits.
 It is not a part of the Payments and Settlement System of India.
 It cannot issue cheques drawn on itself.
 Deposits are not insured or covered under Deposit Insurance and Credit
Guarantee Corporation (DICGC), which generally covers the bank accounts.

White Label ATM (WLA) - NBFC ATMs

Most of the ATMs belong to banks, but the cash dispensing machines that
are owned and operated by NBFCs are called White Label ATMs. Surely
they charge extra money for providing this service, and generally operates in semi-
urban and rural areas (tier III to VI areas)

NBFCs that provides WLA - Tata Communications Payment Solutions, Prizm Payment
Services Pvt. Ltd, Muthoot Finance Ltd, Vakrangee Ltd, BTI Payments Pvt. Ltd., Srei
Infrastructure Finance Ltd, RiddiSiddhi Bullions Ltd. (total 7 as of May 2014)

NBFC businesses -
 loans and advances
 acquisition of shares, stocks, bonds
 insurance, etc.

Letter of Credit
Letter of Credit (L/C)
It is a guarantee in the form of a letter, issued by a buyer's bank. Suppose you want
to buy or sell some goods from or to a foreign country. It is very much possible that
you don't know the seller or buyer. And also the laws regulating the trade may
be different. Therefore, both the seller and the buyer need some kind of guarantee to
seamlessly perform the trade. Here Letter of Credit comes into action.
The steps involved is very much as follows -

Step 1 - First a contract is signed between the buyer and the seller.
Step 2 - The buyer comes to his bank, and the bank issues a Letter of Credit, on behalf of
the buyer, to the seller.
Step 3 - After getting the Letter of Credit, seller knows that he will be paid surely. So
he consigns the goods to a Carrier, in exchange of a Bill of Lading (Carrier provides it to
the Seller)
Step 4 - Seller takes the Bill of Lading and provide it to his bank (i.e., seller's bank), who
eventually transfers it to buyer's bank, who then provides it to the buyer.
Step 5 - Buyer takes the Bill of Lading, and gives it to the Carrier. The Carrier then getting
his own Bill of Lading, delivers the goods to the buyer.
Step 6 - Carrier then asks his payment from the Seller, by providing his Bill of Lading, that
he has actually delivered the goods.
Step 7 - Seller then asks his bank (i.e., sellers bank) for payment, who eventually asks
the buyers bank. The buyers bank settles the payment.

Now you can see that the risks involved is much minimized by using the Letter of Credit,
as the seller is guaranteed to be paid by the buyers bank upon delivery of goods.

Even in case, if the buyer doesn't pay the full amount to his bank (buyers bank),
the buyers bank is obliged to pay the amount to the sellers bank. The buyers bank can
later settle the amount with his buyer, as happens in loans or advances.

Since bank guarantee also provides a type of guarantee. Then what is

the difference between a Letter of Credit and Bank Guarantee?

Letter of Credit Bank Guarantee

Paid only if the contract is breached, i.e.,

Nature Paid only if the contract is satisfied
not satisfied

Ensures a transactionproceeds as Insures a buyer or seller from loss or damagedue

Use
planned to non-performance by the other party

Bank Assets and Liabilities

Bank Assets
Assets are something that you own, meaning you are the legal owner of the asset.
Similarly, bank assets are those things that a bank owns. It can be physical property (like
land, equipment, buildings, etc.) or financial property.

Banks generally have four types of assets -

  Physical Assets - These are relatively minor assets of banks, that generally
doesn't earn money for bank. Physical assets include land, furniture, equipment,
buildings, etc.
 Loans / Advances - These are the most important assets of bank, because
these are the primary source of their earning. Banks get interest from the loans /
advances they lend to customer.
 Reserves - Banks need to maintain some reserves, so that they can meet
the demands of their customers and facilitate daily transactions (e.g., a customer
comes to a bank, and demands to withdraw money, or encash a cheque. Banks
need to maintain reserve in its vault to meet these).
 Investments - Banks invest some of its money in government securities,
or other investment instruments (like, buying shares, etc.). Investments are less
riskier than loan (loans can become NPA), and have less return (loans bear high
interest return) for a bank.

Bank Liabilities
Liabilities are something that you owe, meaning assets (of some other person) you hold,
which you need to return to its original owner. Similarly, bank liabilities are
those things that a bank owes to its customers, or investors. It
includes financial property and debts (for electricity, office supplies, employee wages,
etc.)

Banks generally have several type of liabilities. (Note that this is not exhaustive list)
 Customer Deposits - These are the most important liabilities of a bank.
These are the assets for customers, but liabilities for banks. Banks need to return
the money on demand or after a maturity period.
 Certificate of Deposits (CD) - Banks issue Certificate of Deposits to the
general public to raise money. These are also liabilities of a bank, because banks
need to return the amount invested by the investor.
 Borrowings - Banks can borrow from other banks or financial
institutions, including External Commercial Borrowings (ECB), which need to be
returned. These are also liabilities of a bank.
 Other liabilities - There are several other type of liabilities, like wages,
taxes, leases, pension obligations, etc.

Capital and Assets

# Readers' Question
What is the difference between capital and asset?

Assets
Assets are those tangible and intangible things that you own. You can sell them in
the market to get money, or you can retain those for your personal enjoyment. Also, there
are some assets which you cannot directly sell to get the money, or the value of the
asset cannot be properly assessed.
 Tangible Assets - land, building, machinery and equipment, goods, raw materials,
factory, cash in bank accounts, etc.
 Intangible Assets - patents, copyrights, goodwill, etc. Monetary value of
these intangible assets is hard to assess.
Assets can also be classified depending on liquidity -
 Fixed assets (property, plant and equipment, i.e., PP&E, which cannot be easily
converted into cash)
 Current assets (liquid assets like cash or bank accounts, which are easily convertible
into cash)

Capital

Capital is the fund that is required to run a business, like buying machinery and equipment,
etc., to produce goods and services. Generally, funds are arranged from
the investors and the lenders.

Only those assets, which are used to make money, or to run business, or to produce
goods and services, are considered as Capital.

Now, consider the following example -

Suppose you have bought a van which is used in your business to make profit, then
this asset can be considered as Capital Asset, whereas if you have bought a luxury
car, which is for your personal use only, but of no-value for your business, then it will be
your Asset, not a Capital Asset.

Now, don't confuse Capital Assets with Capital. Capital is only fund, taken from
the investors or lenders to run business. Funds taken
as loans from banks or bonds from investors will be liabilities of the business, which
need to pay back, but is the Capital for the business. Funds taken from shareholders are
also Capital, but is not a liability for the business.

Mutual Funds (MF)

Suppose you have surplus money after your monthly expenses. Now you want
to invest those money to earn a good profit. But the problem is you don't
know where and how muchto invest, and you don't know the risks involved in
buying shares. Even you may not know which company is better than other and less
riskier to invest. In general, you may not have sufficient expertise in investment.

So it is better to seek help of some expert, than taking risk of self investment. Here comes
the job of a Mutual Fund (MF). MFs are managed by professionals, who know very
well where and how much to invest (as they are experienced in this field, but you are not,
your expertise is elsewhere).

Mutual Fund pools money from several investors and then invests those money
categorically to several investment securities, like stocks, bonds, short-term money
market instruments, precious metals (e.g., gold), etc.
 You will invest in a Mutual Fund (MF), and will forget about it. Professionals will manage
the investments, and you will get your return after a certain period of time. You don't
require to pay constant attention, you just let the portfolio manager
(professional) make essential decisions for you.

Also, note that there is another reason for you to invest in MF - you have tax saving
options on return amount, if you invest in a Mutual Fund.

MF structure
An MF is set up in the form of a trust that has a Sponsor, Trustees, Asset Management
Company (AMC).

 Sponsor - The trust is established by a sponsor (you can think it, like a promoter of a
company). The Trust needs to be registered with SEBI (regulator of Capital Market).
 Trustees - Trustees hold property of MF for the benefit of unit holders (you are one
of those unit holders)
 Asset Management Company (AMC) - AMCs manage the fund and
makes investment in various types of securities (you don't need to take decisions, they will).
AMCs should be approved by SEBI.
Note that, the trustees have the authority to provide direction over the AMC, and
they monitor the performance and compliance of SEBI rules and regulations by
the mutual fund.

Net Asset Value (NAV)

NAV is the total value of fund assets, excluding liabilities, per unit of the fund, which is
calculated by the Asset Management Company (AMC) after every business day. This is
also known as bid value. It represents an MF's per share market
value. Investors buy fund shares at this price (bid price, or NAV).

NAV = (Current market value of all Assets - all Liabilities) / no. of unit outstanding shares

For an example, suppose an MF has assets of Rs. 100 lakh and liabilities of Rs. 20
lakh, and has total 4 lakh shares outstanding. Then the NAV or bid price (price per share
value) would be
(100 - 20) / 4 = Rs. 20 per share

Kisan Credit Card - KCC

Kisan Credit Card (KCC)
KCC is a Credit Card (exclusively) for the farmers of India. It allows farmers to have cash
credit (CC) facility without visiting bank repeatedly to ask for bank loans for agricultural
 activities.

KCC scheme was announced in Budget speech of Mr. Yashwant Sinha (FM in 1998-99)
and introduced in 1998 by Government of India, RBI and NABARD. It is to
be implemented by Commercial banks, RRBs and Co-operatives.

Key Benefits -

 It made the credit facility process much simpler for the farmers, who are generally
illiterate or poorly educated.
 Earlier farmers needed to apply for loan facility every year, but KCC removed
the redundant process, by providing hassle-free and on-time credit facility.
 Repayment is allowed after the harvest period. This made it easier for the farmers,
because they got the time to sell their produce to the market, and then repay the debt of the
bank.
 As KCC is a credit card, withdrawal of funds became much easier (e.g., from ATMs)

Eligibility -
 Farmers (Individuals / Joint borrowers), who are owner cultivators
 Tenant Farmers, Oral Lessees, Share Croppers
 Self Help Groups (SHG), Joint Liability Groups (JLG), etc.

Activities covered under KCC -

 to meet the short-term requirements for cultivation of crops
 post harvest expenses
 produce marketing loan
 consumption requirements of farmer households
 working capital for maintenance of farm assets and agriculture-allied activities, like
dairy animals, inland fishery, etc.
 investment credit requirement for agriculture and allied activities, like pump sets,
sprayers, dairy animals, etc

General Credit Card - GCC

While Kisan Credit Card (KCC) is aimed to provide credit facility for agricultural /
farm activities, General Credit Card (GCC) is aimed to cater to the non-
farm entrepreneurial credit needs of individuals.

Note that GCC is not intended for the consumption needs of individuals (normal Credit
Cards), but this scheme is made for the entrepreneurial credit needs of individuals under
the priority sector.

People who are qualified for Priority Sector Lending (PSL) can avail this facility. This GCC
scheme is brought under RBI's Financial Inclusion Plan (FIP).
 Int'l Development Banks - ADB, WB, IMF, NDB, AIIF
There are several development banks in the world with the principal goal
of development among others. From India's point of view, the most notable among those
development banks are the followings -

 Asian Development Bank (ADB)

 World Bank (WB)
 International Monetary Fund (IMF)
 New Development Bank (BRICS-NDB)
 Asian Infrastructure Investment Bank (AIIF), etc.
Here we shall discuss each of them in brief. Note that NDB (click me) and AIIF (click
me) were already discussed in previous articles.

Asian Development Bank (ADB)

ADB is a regional development bank, headquartered in Metro Manila, Philippines. It was
established on Aug 22, 1966, to facilitate economic development in Asia, with the
motto 'Fighting poverty in Asia and the Pacific'.

President - Takehiko Nakao

Membership - 67 countries

ADB invests in -
 Infrastructure
 Health care services
 Financial system
 Public administration system
 Preventing Climate change
 Managing natural resources, etc.

Devices for ADB's assistance -

 Loans
 Grants
 Policy Dialogue
 Technical assistance
 Equity Investments, etc.
 ADB recently released its Asian Development Outlook (ADO) with the title 'Financing
Asia's Future Growth'. It forecasted that India will overtake China in terms of growth
rate in fiscal years 2015 and 2016.

Below is a comparative chart published by ADB -

World Bank (WB)

World Bank is a financial institution of United Nations (UN), established on July
1944, headquartered in Washington D.C., USA. It provides loans to developing
countries for their capital programs. The official goal of WB is the reduction of poverty,
and the motto is 'Working for a World Free of Poverty'.

President - Jim Yong Kim

Membership - IBRD (188 countries), IDA (172 countries)
Note that World Bank is a component of World Bank Group (WBG), which is a family
of 5 international organizations that make leveraged loans to poor countries -
7. International Bank for Reconstruction and Development (IBRD) - lends
to governments of middle-income and creditworthy low-income countries
8. International Development Association (IDA) - provides interest-free loans, called credits,
and grants to governments of the poorest countries
9. International Finance Corporation (IFC) - is the largest global development institution focused
exclusively on the private sector (not governments)
10. Multilateral Investment Guarantee Agency (MIGA) - promotes foreign direct investment
(FDI) into developing countries to support economic growth, reduce poverty and improve
people's lives. It fulfills this mandate by offering political risk insurance (guarantees) to
investors and lenders.
11. International Center for Settlement of Investment Disputes (ICSID) - provides international
facilities for conciliation and arbitration of investment disputes.

Note that, together, IBRD and IDA make up the World Bank, whereas all these 5 institutions
form the World Bank Group.

International Monetary Fund (IMF)

IMF is an international financial organization, established on December 27,
1945, headquartered in Washington D.C., USA.

President - Christine Lagarde

 Membership - 188 countries

IMF work area -

12. promotes international monetary cooperation
13. promotes exchange rate stability
14. facilitates balanced growth of international trade
15. provides resources to help members in balance of payments (BOP) difficulties
16. assist with poverty reduction

Devices of IMF's assistance -

17. Keeps track of the economic health of member countries, it alerts them to risks on the horizon
18. provides policy advice
19. lends to countries in difficulty
20. provides technical assistance
21. training to help countries improve economic management

BRICS
BRICS Nations
BRICS acronym is given to 5 major emerging economies of the world - Brazil, Russia,
India, China and South Africa, which was formerly known as BRIC (excluding South
Africa). In 2010, South Africa is added to the group.

These 5 major emerging economies have the following characteristics in common -

 developing countries, or newly industrialized countries

 large and fast-growing economies
 have significant influence on their regional and global affairs

Some statistics (as of 2014)

 Combined GDP - USD 16.039 trillion(approx. 20 % of combined GDP of world)
 Population - approx 3 billion (41.4 % of world population)
 Combined Forex reserve - USD 4 trillion
 Land area - more than 1/4th of world land

BRICS summit
Since 2010, BRICS summit is being held annually. Russia will host 7th BRICS
summit in July, 2015. 6th BRICS summit was held in Brazil in 2014.
 New Development Bank BRICS (NDB BRICS)
In 2014 BRICS summit, member countries came together to form a multilateral
development bank as an alternative to World Bank and IMF (which are US-dominated).

Each member country will have single vote and there will be no Veto power* for the
members (In contrast, World Bank assigns votes based on capital share, meaning voting
power is proportional to capital!).

Some points regarding NDB BRICS (will start lending in 2016) -

 Initial Capital - USD 100 billion (China USD 41 billion, Brazil + Russia + India = 3 x
USD 18 billion = USD 54 billion, South Africa USD 5 billion)
 Reserve Currency Pool - USD 100 billion(apart from the initial capital)
22. Headquarter - Shanghai, China
23. Regional Center - Johannesburg, South Africa
24. First President - from India
25. First Chairman of the Board of Directors - from Brazil
26. First Chairman of the Board of Governors - from Russia
(Note that each member country got something!)

Asia Infrastructure Investment Bank (AIIB)

The Asian Development Bank Institute (ADBI) published a report in 2010 pointing out
that the Asia-Pacific region requires approx. USD 8 trillion from 2010 to 2020 for
its infrastructure and economic development. For the very purpose
of development, Chinesegovernment has proposed Asia Infrastructure Investment Bank
(AIIB), which will look after the developmental requirements specifically for this region.

Why AIIB?
The other international financial institutions, like World Bank, International Monetary
Fund (IMF) and Asian Development Bank (ADB) - are dominated by US,
Europe and Japan (according to China) with their own interests. Also, the long demanded
(by developing countries, like BRICS nations) voting rights and quota reform has been
pending in IMF, which also helped in the creation of an alternate solution.

Therefore, China proposed the bank (AIIB) with authorized capital of USD 100 billion ,
with initial subscribed capital of USD 50 billion
Establishment and Member countries
A signing ceremony was held in Beijing on October 24, 2014, where 21 countries signed
the bill for establishment of the bank -

China, India, Thailand, Malaysia, Singapore, Pakistan, Bangladesh, Philippines,

Brunei, Kazakhstan, Kuwait, Cambodia, Laos, Myanmar, Nepal, Vietnam, Mongolia,
Oman, Qatar, Sri Lanka and Uzbekistan.

In 2015, more countries have joined - Jordan, New Zealand, Saudi Arabia, Tajikistan,
United Kingdom (UK), etc.

Founding members
China's Finance Ministry said, "any country that signs and ratifies the articles can
still officially become a 'founding' member", though they need to be accepted by
the existing members first. In that sense, all the signatories before March 31,
2015 deadline will be considered as "founding" members.

India in AIIB
Smt. Usha Titus, Joint Secretary of Economic Affairs division of Ministry of Finance,
signed the MoU on behalf of India at the signing ceremony on October 24, 2014.

Secretary-General of AIIB
China's Vice Finance Minister Jin Liqun has been appointed as the Secretary
General of Asia Infrastructure Investment Bank (AIIB).

Headquarter of AIIB
The bank is to be headquartered in Beijing, China, and is to be operational from end
of 2015.
Note the bank will be backed by China, as it will hold the majority stake of the bank.

Voting rights
The AIIB will have voting rights based on benchmarks, which will be
a combination of GDP and Purchasing Power Parity (PPP). Based on
these China and India will be the largest stakeholders of the bank.

US pressure on some states

However, due to the pressure of USA, some countries like Australia, South
Korea and Japan are yet to join the bank.
 Monetary Policy of RBI
Monetary Policy

Monetary policy is the process by which central bank, the monetary authority of a country,
controls the supply of money in the economy. In India, Reserve Bank (RBI) is the sole
authority to frame the monetary policy.

As per the recommendations of Urjit Patel Committee, RBI adopted the release
of monetary policy on bi-monthly basis, i.e., bi-monthly monetary policy.

Operating Target and Operating Procedure of Monetary Policy

To understand the Monetary Policy of RBI, you have to understand the following terms
specified by it -

1. Policy Rate
The fixed overnight repurchase rate (repo rate) under the Liquidity Adjustment Facility
(LAF) is the single monetary policy rate.

2. Operating Target
The Weighted Average Call-money Rate (WACR) is the operating target of monetary
policy.
Note that Call money is the overnight funds that are lent by one bank to another bank.

3. Operating Procedure
Once the policy rate is announced in the bank's statements on Monetary policy,
the operating procedure aims at modulating liquidity conditions so as to achieve
the operating target (meaning - anchor the call money rate around the policy rate / repo
rate). This is the first leg of monetary policy transmission to the financial system and
the economy.

4. Liquidity Management
RBI uses the pro-active liquidity managementmechanism to achieve the operating
target. The main features of this framework, which was announced on August 22, 2014,
and implemented since September 5 are as follows -

a. Assured Liquidity Operations -

Assured access to central bank liquidity of 1 % of bank's Net Demand and Time
Liabilities (NDTL) (meaning Demand deposits - Current and Savings; and Time
deposits - Term and Recurring). This 1 % comprises -

 0.25 % of NDTL provided through overnight fixed repo auctions, conducted daily at
the policy rate (repo rate), and
 0.75 % of NDTL provided through 14-day variable rate term repo auctions,
conducted on every Tuesday and Friday.

b. Fine-tuning Operations -
Fine-tuning operations through variable rate repo / reverse repo auctions
of maturities ranging from overnight to 28 days, to even out frictional liquidity
mismatches that occur in spite of assured Liquidity Operations

c. Open Market Operations (OMO) -

Outright OMO through auctions and anonymous screen-based trading on the Negotiated
Dealing System - Order Matching (NDS-OM) platform to mange enduring liquidity
mismatches

d. Special Operations -
Special Operations are also conducted on holidays to help market participants tide over
pressured arising from one-off events such as tax payments, government spending,
balance sheet adjustments and payment and settlement requirements.

5. Standing Facilities

a. Marginal Standing Facility (MSF) -

A Marginal Standing Facility (MSF) allows market participants to access central
bank liquidity at the end of the day (including Saturdays), even after
providing assured and fine-tuning operations.

Under MSF, up to 2 % of their (market participant's) stipulated Statutory Liquidity Ratio

(SLR) holdings of government securities in addition to excess SLR as collateral at
a rate set at 100 basis points (bps)above the policy rate (meaning - MSF rate = Repo
rate + 1 %)

b. Reverse Repo -
Fixed rate daily overnight - reverse repo auctions are conducted at the end of the
day (including Saturdays) to allow market participants to place their surplus liquidity with
the RBI at a rate set at 100 bps below the policy rate (meaning - Reverse Repo rate =
Repo rate - 1 %). It operates as a de facto standing facility.

Note that the MSF rate and the fixed overnight reverse repo rate define an informal
corridor for limiting intra-day variations in the call rate.

1st Monetary Policy - April 7, 2015

 RBI governor Shri Raghuram Rajan has decided to keep the policy rate and cash reserve
ratio unchanged. Followings are the current rates -

 Repo rate (policy rate) - 7.5 % (rate charged by RBI to banks)

 Reverse Repo rate = Repo rate - 1 % = 6.5 % (rate at which RBI pays interest to
banks)
 MSF rate = Repo rate + 1 % = 8.5 % (rate charged by RBI to banks)
 Bank rate = 8.5 % (rate charged by RBI to banks)
 Cash Reserve Ratio (CRR) - 4 % (percent amount to be stored with RBI, in terms of
account balance or reserves)
 Statutory Liquidity Ratio (SLR) - 21.5 %(percent amount to be stored with itself, in
terms of golds or government securities - cannot be lent to public

Open Market Operations (OMO)

Open Market Operations (OMO)
If the central bank of a country, on behalf of the government, raises money from the open
market by selling government securities, or inject money supply in the market by
purchasing the government securities, then it will be known as Open Market Operations
(OMO).

Note the term Open Market Operations: it simply means operations (selling/buying
government securities) performed in the Open Market. OMO performs a major role
in Monetary Policy.

In India, Reserve Bank of India (RBI), on behalf of Union government, performs this
Open Market Operation.

Purpose of OMO

 Adjust the liquidity condition in the market on a durable basis -

a. If there is excess liquidity in the market - RBI will sale the government securities, thereby
sucking out the rupee liquidity
b. If the liquidity conditions are tight (i.e., less liquidity) - RBI will buy the government
securities from the market, thereby releasing liquidity into the market
 Government raises money from the market, when it needs money for governance
purpose.

Government Securities
 There are several government securities with different maturity dates, which are used for
different purposes, as follows -
 Treasury Bills (T-Bills)
 Cash Management Bills (CMBs)
 Dated Government Securities
 State Development Loans (SDLs)
All these government securities are discussed in past article - Click here

Example
RBI on November 2014, announced to sell Rs. 12,000 crore government
securities/bonds through Open Market Operations (OMO) to mop up liquidity from the
market.

As part of the OMO, RBI would sell securities maturing in 2017 (bearing interest rate of 8.07
%), 2020 (7.8 %), 2022 (8.08 %) and 2027 (8.26 %).

Market Stabilization Scheme (MSS)

MSS Background

In the year 2004, Foreign Institutional Investors (FIIs) started buying Indian
stocks in dollars. This resulted in an oversupply of USD in Indian market.

To counter this, RBI started buying USD, and in return, supply equivalent amount of Indian
Rupees (INR) in the market. This action resulted in over-liquidity in Indian market (due
to rupee supply), and at the same time massive increase in forex reserves (due
to dollar purchase).

This liquidity overhang situation forced the government to mop up the Rupees from the
market by creating MSS Bonds.

Market Stabilization Scheme (MSS)

Under this scheme, RBI, on behalf of government, raises money from the market by
providing government securities, like Treasury Bills, Dated Securities, etc.

But the difference is - the raised money doesn't go to the government account (as in
normal cases). Instead, the money is stored in separate Market Stabilization Scheme
Account (MSSA). The sole purpose of this scheme is to suck out the over-liquidity from
the market (as in the above situation), not for government expenditure.
 Settlement Systems of India
India has two main electronic funds settlement system for one-to-one transactions -
 National Electronics Funds Transfer (NEFT)
 Real-time Gross Settlement (RTGS)

Transactions can be bulk (meaning one-to-many or many-to-

one transactions) and repetitive (regularly happening, like monthly) in nature. This type
of transactions are routed through Electronic Clearing Service (ECS), and of two types -
 ECS Credit
 ECS Debit

National Electronics Funds Transfer (NEFT) - one-to-one

NEFT payment system facilitates one-to-one funds transfer. In this system, individuals,
firms and corporate can electronically transfer funds from any bank branch to
any individual, firm or corporate, having an account with any other bank in the country
which is NEFT-enabled.

Note that, recipient should have a bank account (so that transfer can be traced), but the
person who is transferring fund need not have any account, but in that case, there is
a maximum transfer limit of Rs. 50,000 (for this walk-in customers, need to provide
their identity documents).

But if he/she transfer fund from an account, then there is no limit of maximum transfer,
though per transaction max limit is Rs. 50,000. e.g., For transferring Rs. 1
lakh through NEFT, there will be 2 transactions.

Note that NEFT settles transactions on net-basis and works in hourly batches. Currently,
there are 12 batches (8 am to 7 pm) on weekdays and 6 batches (8 am to 1 pm) on
Saturdays. Banks wait and collect all the transactions made within an hour, and
then settles the transaction (not individually, known as netting). For an example, if you
make a transaction on 8:30 am, then your settlement will wait till the hourly batch of 9 am,
and at 9:00 am, your transaction will be settled.

Transaction Costs -
No inward transaction cost for NEFT
But for outward transactions -
 Up to Rs. 10,000 - maximum Rs. 2.5 + Service Tax
  Above Rs. 10,000 to Rs. 1 lakh - maximum Rs. 5 + Service Tax
 Above Rs. 1 lakh to Rs. 2 lakhs - maximum Rs. 15 + Service Tax
 Above Rs. 2 lakhs - maximum Rs. 25 + Service Tax

Real-Time Gross Settlement (RTGS) - one-to-one

In this system, settlements are done on real-time (meaning, instantly, or without delay,
note that NEFT need to wait for an hourly batch) and on gross
basis (meaning, individually, transaction will not be netted with others like NEFT which are
settled in hourly batches). RTGS is the fastest possible money transfer system through
the banking channel.

Note that RTGS is meant for high-value transactions, and there is

a minimum transaction limit of Rs. 2 lakhs (no upper limit). All the transactions go
through the books of RBI.

RBI on Dec 15, 2014, increased RTGS total business hours from 7 hours 30 minutes to 12
hours. Now the business hour will be 8 am to 8 pm on weekdays against the earlier 9
am to 4:30 pm.

Transaction Costs -
No inward transaction cost for RTGS
But for outward transactions -
27. Rs. 2 lakhs to Rs. 5 lakhs - maximum Rs. 30 per transaction
28. Above Rs. 5 lakhs - maximum Rs. 55 per transaction

ECS Credit - one-to-many (single debit, multiple credit)

ECS Credit facility is used by an institution, where it needs to pay several recipients on
a regular basis (may be monthly). Here single debit is made on the payers
account and multiple credit is made to the beneficiaries or recipients.
For example, for paying salary, dividend, pension, etc. one can use this ECS Credit facility
(e.g., employers account is debited once, and several employees are paid salary, by
crediting their accounts)

ECS Debit - many-to-one (multiple debit, single credit)

ECS Debit facility is used by an institution, for raising debits to a large number
of accounts. E.g., bill payment for consumers of utility services (like electricity bills
deducted from bank accounts of several customers, and credited to the electricity supplier's
account), periodic investments in mutual fund, insurance premium, etc.
 Note, that there are several other payment systems, like Immediate Mobile Payment
System (IMPS, need to register mobile number), Aadhaar-enabled Payment System
(AEPS, need an Aadhar card), etc.

Financial Inclusion
World Bank report shows that approx. 2.5 billion (250 crore) working-age adults globally -
more than half of the total adult population of the world - have no access to the formal
financial services delivered by regulated financial institutions.

Instead they depend on informal systems which bear high risks. They turn to
the moneylender for credit, buy livestock as a form of savings, etc. It is evident that
appropriate financial services can help improve household welfare and spur
small enterprise activity.

Financial Inclusion
Financial Inclusion process is the conscious effort of the government or central bank of a
country to deliver financial services to the excluded sector of the society (by including
them).

The Government of India and the Reserve Bank of India (RBI) have been
making efforts to promote Financial Inclusion as a major national objective of the
country. Some of the efforts -
 Nationalization of banks
 Building up of robust branch network of Scheduled Commercial Banks (SCBs), Co-
operatives and Regional Rural Banks (RRBs)
 Introduction of mandated Priority Sector Lending (PSL) targets
 Lead bank schemes
 Formation of Self Help Groups (SHGs)and Joint Liability Groups (JLGs)
 Permitting Banking Correspondents(BCs) to be appointed by banks to provide door
step delivery of banking services
 Zero Balance accounts like Basic Savings Bank Deposit Accounts
(BSBDAs), Small Accounts, Jan-Dhan Accounts, etc.
The primary objective of all above initiatives is to reach the financially excluded sector of
India.

Financial Inclusion data sources

 Financial Inclusion data is presented on 5 major sources, as follows -
 National Sample Survey Organization (NSSO) survey results
 Population Census of government (currently 2011 census)
 CRISIL-Inclusix index
 RBI study on 'Financial Inclusion' in India
 World Bank 'Financial Access Survey' results

RBI Policy Initiatives

 RBI advised all banks to open BSBDA accounts with facilities like no minimum
balance, ATM facility, etc.
 Relaxed and simplifed KYC norms - to facilitate easy opening of bank accounts,
especially for Small Accounts with balances not exceeding Rs. 50,000, etc.
 Simplified Branch Authorization Policy - Domestic Scheduled Commercial Banks
(SCBs) are permitted to freely openbranches in Tier-2 to Tier-6 center (population less than 1
lakh) under general permission, subject to reporting to RBI, etc.
 Mandatory Branches in Un-banked villages - bank are directed to allocate at least
25 % of total number of branches to be opened during the year in un-banked (Tier
5 and Tier 6) rural centers
 Opening of intermediate brick and mortar structure - for effective cash management,
documentation, customer grievance redressal, etc - Micro branches to be opened in rural area,
and can be operated by Business Correspondents
 Financial Literacy Centers (FLCs) - to literate customers in financial matters, etc.
 Licensing of New Banks - with aim to further spread the banking services

JLG and SHG

Joint Liability Group (JLG)
Before understanding JLG, you have to know, what are different types of liability.

 Jointly Liable - Suppose, two ore more persons have some liability (e.g., taken
a loan). Then for a jointly liable system, they each are fully liable to the loan (meaning if one is
unable to pay, then other is fully liable to pay the whole amount of loan)
 Severally Liable - In this type of liability, each is liable only to his own portion of
the liability (i.e., loan) (meaning if one is unable to pay for whatever reason, other will not be
sued, or bothered, he will be liable for only his portion of loan)
Therefore, JLG is an informal group (comprising around 4-10 person) for the purpose of
availing bank loan on individual basis (Severally Liable) or through group
mechanism against mutual guarantee (Jointly Liable).

Generally, the members of JLG would engage in a similar type of economic activity in
the Agriculture and Allied Sector. The members would offer a joint undertaking to
the bank that enables them to avail loans. They support each other in carrying out their
occupational and social activities.
Self Help Group (SHG)
SHG is a small voluntary group (less that 20) of poor people, generally from the same
economic background. They promote small savings among their members, and make
a common fund, which is kept in a bank.

SHGs comprise poor people, and they generally do not have access to formal financial
institutions (banks). So this concept helps them to directly connect with banks. Also they
act as the forum for the members to provide space and support each other.

Currently there are several SHG bank linkage program for this purpose.

Money Laundering
Money Laundering

Laundering means concealing/hiding the origins of money, that are obtained

through illegal means, violating the laws of land. It often involves transfers to/from foreign
banks or legitimate businesses to hide the illegal nature of the money, and make it appear
as obtained form legitimate source.

In broad sense, Money Laundering is the process of converting Black Money into White
Money.

Civil or Criminal Offense?

Often we talk about Black Money that are stashed abroad, mainly to avoid high taxes of the
land. These money could have legitimate or illegitimate origin.

If these are achieved through legitimate sources, but to avoid taxes, are stored in foreign
countries, then we simply call these as Black Money (not considered as Money
Laundering). This is a case of civil offense.

But in Money Laundering, the Black Money must involve a predicate crime, such as
the violation of IPC, etc, and is considered as criminal offense.

Stages of Money Laundering

Money Laundering involves three distinct stages, as follows -

 1. Placement
Illegitimate money / Dirty Money is collected and placed into a legitimate financial
institution, generally in the form of cash (a way to hide trace). This stage is known
as Placement of Illegitimate money.

2. Layering
Layering is the stage, where the illegitimate money is processed through several financial
transactions to change its form and hide its trace, so that it is difficult to follow and find its
source.

It may consist of -

 Bank to bank transfer

 Wire transfer between different accounts, possibly in different names and in different
countries
 Changing the nature of currency
 Purchasing other instruments, or assets to change the form of money, etc.

3. Integration
In this stage, the illegitimate money returns to the mainstream economy as
a legitimate one. This may involve a final bank transfer to the account of the business,
where the launderer wants to invest. In this stage, the legitimate-looking money is difficult
to trace back to its illegitimate source.

Prevention of Money Laundering Act, 2002 (PMLA)

The PMLA, 2002 is the principal framework in India to combat money laundering cases.
It defines money laundering offence and provides for the freezing,
seizure and confiscation of the proceeds of crime.

Some features -
 RBI, SEBI and IRDA have been brought under the PMLA, making the provision of this
act to be applicable to all the financial institutions in India, including banks, MFs, Insurance
companies, etc.
 The monitoring agency of Anti-Money Laundering activities in India is the Financial
Intelligence Unit (FIU-IND). It is an independent body reporting directly to the Economic
Intelligence Council (EIC), headed by the Finance Minister.
 Punishment includes imprisonment up to 3 - 7 years, with fine up to Rs. 5 lakh.
 Banks' Obligations

 To follow the KYC norms properly

 Maintain records for - nature and value of the transaction, single or series of
transactions, keep record for 10 years, etc.
 Verify and maintain the records of identity of all clients, etc.

Issuance of Currency

According to RBI Act 1934, Section 22, RBI has the sole right to issue bank notes of
all denominations. RBI is responsible for the design, production and management of
the currency of India, with the goal of ensuring an adequate supply of clean and genuine
notes.

The responsibility for coinage vests with the Government of India on the basis of The
Coinage Act, 2011. RBI acts as an agent of government which
merely distributes the coins in the market.

Denominations
Currently, RBI has issued currency notes in the denomination of Rs. 10, 20, 50, 100,
500 and 1000. However, it can issue notes with denomination up to Rs. 10,000, as per the
provision of RBI Act, 1934.

Coins are presently being issued by the government in the denomination of 50 paise, Re.
1, Rs. 2, 5, and 10. Coins up to 50 paise are called 'Small coins' and Rupee
1 and above are called 'Rupee coins'. Coins can be issued up to the denomination of Rs.
1000 in terms of The Coinage Act, 2011.

Liabilities
 Small and Rupee Coins - Government of India
 Rupee One banknote - Government of India (signed by Finance Secretary)
 Banknotes above Rupee One - Reserve Bank of India (signed by RBI Governor)

Minimum Reserve System to issue currency

 India adopted Minimum Reserve System in the tenure of RBI governor Sir Benegal Rama
Rau in 1957. In this system, RBI is required to maintain a minimum reserve of Rs. 200
crore in gold and forex, of which at least Rs. 115 crore should be in gold form (earlier
India followed Proportional Reserve System) to issue currency in India.

(Note that the above figure may be outdated!)

Determination of volume and value of banknotes to be printed

RBI based on the demand requirement indicates the volume and value of banknotes to
be printed each year to the government which get finalized after mutual consultation.

The quantum of banknotes to be printed depends on the followings -

 Requirement for meeting the demand of banknotes
 GDP growth
 Inflation rate
 Replacement of Soiled and Mutilated notes
 Reserve Stock requirements, etc.

Notes and Coins production

 Notes are printed at 4 Printing Presses, located at - Nashik, Dewas,
Mysore andSalboni
 Coins are minted at 4 Mints, located at - Mumbai, Noida, Kolkata and Hyderabad

Currency circulation
RBI currently manages the currency operations through its -
29. 19 Issue Office located at - Ahmedabad, Bengaluru, Belapur, Bhopal, Bhubaneswar,
Chandigarh, Chennai, Guwahati, Hyderabad, Jaipur, Jammu, Kanpur, Kolkata, Lucknow,
Mumbai, Nagpur, New Delhi, Patna, Thiruvananthapuram
30. A wide network of Currency chests
The Issue offices receive fresh banknotes from the printing presses of RBI, and
then send the notes to the designated branches of commercial banks.

Currency Chest - RBI has authorized selectcommercial bank branches to

establish currency chests, which would act as storehouses for banknotes and rupee
coins on behalf of RBI. These chest branches are expected to distribute banknotes and
rupee coins to other bank branches in their area of operation.
 Small Coin Depot - Some bank branches are authorized by RBI to establish Small Coin
Depot to store Small coins (i.e., below Rupee 1 coins), which will distribute the coins in
their area of operation.

Clean Note Policy

Problems to deal with

 Stapling on note bundles

 Writing number of note pieces in loose packets on watermark windows, disfiguring the
watermark impressionand rendering it difficult for easy recognition
 Banks do not sort notes into - Re-issuables and Non-issuables - while issuing to public
 Issuing Soiled notes to public
- Therefore to address these problems of currency handling, RBI came up with its 'Clean Note Policy'

Clean Note Policy

 No stapling of any note packet and instead secure note packets with paper bands
 Banks should sort notes into - Re-issuables and Non-issuables
 Banks should forthwith stop writing of any kind on watermark window of bank notes
 Issue only Clean Notes to public

Soiled and Mutilated Notes

Soiled Notes
Soiled notes are those notes -
 became dirty
 slightly cut
 in the denomination of Rs. 10 and above, which are in two pieces. However,
the cut should not pass through the number panels
Soiled notes can be exchanged at -
 counters of public sector bank (PSB) branch
 currency chest branch of a private sector bank
 Issue office of RBI
Note that, there is no need to fill any type of form to exchange Soiled Notes. Also note
that the exchange is in full value, meaning you will get the whole amount of the soiled
note in exchange.

Mutilated Notes
Mutilated notes are those notes -
 are in pieces (more than two)
 essential portions are missing. Essential portions are - name of issuing
authority, guarantee, promise clause, signature, Ashoka Pillar emblem / portrait of Mahatma
Gandhi, water mark
Mutilated notes are exchanged at the same places described above (for Soiled
notes), without filling any type of form.

However, note that the exchange value can be in full or part, according to RBI (Note
Refund) Rules. (depending on the mutilation of the notes, you will get the value)

Also, there is another exchange facility for mutilated notes, referred to as Triple Lock
Receptacle (TLR). (Put the mutilated notes in a TLR cover along with details, and deposit it
in the TLR box at RBI Issue Office. Amount will be returned by means of a bank
draft or pay order).

Excessively Soiled, Brittle, Burnt Notes

Notes which have become excessively soiled, brittle, or burnt can
be exchanged only at Issue Office of RBI. (need to approach to the Officer-in-charge of
the Claims Section, Issue Department of RBI).

Money Market - Part I

Money Market
It generally provides investment avenues of short time tenor, by definition for a
maximum one year. Money market transactions are generally used for funding the
transactions in other markets including Government securities market, Capital
market and meeting short term liquidity mismatches.

The one year tenor can be classified into -

 Overnight market - tenor of transactions is one working day (also
called Call Money market)
 Notice Money market - tenor from 2 days to 14 days
 Term Money market - tenor from 15 days to 1 year

Instruments used
Money market instruments include Call Money, Repos, T-Bills, Commercial Papers (CP),
Certificate of Deposits (CD), and Collateralized Borrowing and Lending Obligations
(CBLO).
Borrowing money from RBI
Banks can borrow money from RBI with or without securities, and for 1 day to 1 year
period. Depending on these, there are 3 ways to borrow money from RBI, and hence 3
rates -

1. Repo (Repurchase) rate -

This is a type of collateral lending by RBI. Here, banks sells securities (gov. securities) to
RBI with a repurchase agreement (meaning banks will buy back those securities
at future date with extra interest). The rate charged by RBI is known as Repo rate.

It comes under Liquidity Adjustment Facility (LAF) of RBI monetary policy (i.e., a way
to adjust market liquidity, along with reverse repo).

Banks borrow money by repo to meet their daily mismatches. Repo auctions are
conducted by RBI on a daily basis, except Saturdays. Here, minimum bid size is of Rs. 5
crore and multiple. All commercial banks (except RRBs) can borrow
through repo facility. Repo borrowings have a tenure of 1 day to 90 days.

2. Marginal Standing Facility (MSF) -

Now think what will happen if banks are not able to maintain their daily mismatches even
with repo (it happens!). Hence RBI provided (from 2011) one more facility to banks
- Marginal Standing Facility (MSF). Albeit its a penalty rate (because banks are not able to
maintain their mismatches with repo), and always higher than repo rate (currently 100
basis point higher).

In this scheme, banks borrow money with minimum bid size of Rs. 1 crore and multiple.
The tenure is of 1 day only, and banks can borrow 1 % of their respective NDTL under this
scheme.

3. Bank Rate -
For the long term, i.e., 90 days to 1 year, banks can borrow money from RBI with bank
rate. As it is a long term borrowing, the rate is higher than repo rate.

Banks doesn't need any collateral or security, while borrowing for a long
term under Bank Rate. It is not used as a monetary policy to adjust the market, rather
 used to re-discount Bills of Exchange (refer our previous article on Discounting Bills of
Exchange), or other Commercial Paper.

Lending money to RBI

Now come to the lending part. Now think, what is the purpose of Reverse Repo? Why
banks will lend money to RBI, and when?

If a bank is able to maintain its money requirements properly, and has surplus money, then
it would be better for the bank to lend to RBI, rather than keeping it with itself.
Because, lending money will give the bank interests in reverse repo rate.

Its again a collateralized lending to RBI with repurchase agreement, as repo (works as
opposite to repo).

Liquidity Adjustment Facility (LAF)

Repo and Reverse Repo together forms the Liquidity Adjustment Facility. It is a very
essential and efficient tool of RBI to adjust the market liquidity. Since raising or reducing
the rates, will make the banks raise or reduce its own rates to its customer (public), and of
a short term tenure.

Money Market - Part III

Please read previous posts on Money Market - Part I & II (link in Blog Archive section)

Money Market Instruments (other than government issued)

1. Call, Notice, Term Money

This is a method by which banks lend or borrow money from each other to maintain
their daily needs. Note that no collateral security is needed, but interest need to be paid.

Call Money - deals in overnight (1 day) funds

Notice Money - deals in funds for 2 to 14 days
Term Money - deals in funds for 15 days - 1 year

Note that this is completely used in Inter-bank market. Eligible participants are -

 Scheduled Commercial Banks (SCBs), excluding RRBs

 Co-operative Banks, other than Land Development Banks
 Primary Dealers (PDs)
2. Certificates of Deposit (CD)
CDs are certificates issued by banks or other financial institutions (need to be qualified
before issuing) to the general public, to raise short-term resources within the umbrella
limit.

In the form of - Dematerialized (through Demat account) or Usance Promissory Notes

Issuer - Scheduled Commercial Banks (excluding RRBs), permit-granted Financial

Institutions (FIs)
Issued to - individuals, corporations, companies (including banks), trusts, etc.

Maturity - Bank CDs (7 days - 1 year) and FI CDs (1 - 3 years)

Minimum size - Minimum amount of CD is Rs. 1 lakh, and multiple thereof

3. Commercial Papers (CP)

CPs are unsecured instrument issued in the form of a promissory note (refer to my
previous post to know more), that are issued by corporates.

In the form of - Promissory Notes

Issuer - Corporates, Primary Dealers (PDs), Financial Institutions (FIs). Note that all
the corporates are not eligible for issuing CPs. They need a good rating (generally 'A-2',
refer SEBI) from either rating agencies - CRISIL, ICRA, CARE, FITCH Ratings India Pvt.
Ltd, etc.

Issued to - Individuals, banks, other corporates, NRI, FII (need SEBI approval)

Maturity - 7 days to 1 year

Minimum size - Minimum amount of CP is Rs. 5 lakh and multiple thereof

4. Inter-Corporate Deposits (ICD)

These are issued by one corporate to other for their money requirements. You can think
ICDs as analogous to Inter-bank deposits (call money, notice money, term money).

These are helpful for low-rated corporates, because they are not eligible to
issue Commercial Papers (CP) to general public and raise money. So the alternative way
for them, is to use ICDs.

Money Market - Part II

Instruments of Money Market
Now, its time to learn about the several instruments that work in Money Market. Note that
the tenure of the money market is overnight (1 day) to 1 year (365 days). So, all
the instruments here works within this tenure. Though there is no such restriction, or no
such obvious line of distinction.
Government Instruments

1. Treasury Bills (91 - 364 days)

Treasury Bills or T-Bills are the most important and used mean for the government to
acquire money from the market, to maintain its money requirements. On behalf of
the government, RBI issues T-Bills to public as auction on some fixed date.

These are the least risky money market instrument and have 3 maturity periods - 91 days,
182 days, 364 days (meaning you can claim for your return only after these term periods).
Note that Treasury Bill is a type of debenture (already discussed in the article - Equity &
Debt), hence doesn't require any collateral as security. You only buy a T-Bill, because you
know that government will never default on your payment.

Treasury Bills are issued on discount basis and can be redeemed at par, and it doesn't
bear any interest. Let clear with an example -

Suppose you want to buy a T-Bill of Rs. 10,000 with 91 days maturity. RBI may tell you that
the
discount rate is 1.5 %. So you can redeem a discount of = 10,000 x 1.5/100 = Rs. 150.
This means you can buy the treasury bill in Rs 10,000 - 150 = Rs. 9,850 (your profit will
be Rs. 150, which you can redeem as discount). After 91 days (the maturity), you go
to RBI to get the return, and RBI will give you Rs. 10,000.
Summary - You buy the T-Bill in Rs. 9,850 and get in return Rs. 10,000 (face value). Note
that, there is no interest involved in T-Bill.

2. Cash Management Bill (CMB) (< 91 days)

Government can take loans from RBI as Ways and Means Advances (WMA; will discuss
in later posts). But there is a limit on WMA advances, and the loans above
the limit bears extra interest. Therefore, it is better for the government to
acquire money from the general public. Cash Management Bill (CMB) is such instrument
that helps government to maintain its temporary cash requirements for less than 90 days.

Note that, T-Bills can not be used for the temporary (upto 90 days) or urgent
requirements. CMB comes handy for this purpose, instead of high interest loans.

Features of CMB is almost similar to that T-Bills including auction process, discount to
the face value, etc.

3. Dated Securities
Though definition-wise this doesn't come under Money Market. But it is better to discuss it
here in government security section.
Dated Securities are long-term securities that helps government to take money from
public for more than 1 years. Here government issues securities that bear a date of
a distant future, which could help in long-term development projects, or otherwise.

It is important to mention here, that state governments cannot issue T-Bills to public. So
state governments can issue only Dated Securities for a long term. These are known
as State Development Loans (SDL).
 Gilt-edged Security - All the government securities are collectively called gilt-edged
securities, or government securities.

Negotiable Instruments - Part I

What is a negotiable instrument?

Negotiability of an instrument depends on 2 criteria -

 Price Rigidity - The price of the instrument is not firmly established, and can
be adjusted depending on the circumstances. If it cannot be adjusted or be changed, then it
is non-negotiable.
 Transferability - The instrument can be transferred from one party to another,
provided all proper documentation are included and valid. But if the ownership cannot be
transferred, then it is deemed to be a non-negotiable instrument.
For example, Certificate of Deposit (CD) is a negotiable instrument, whereas Indian Government
Savings bonds are non-negotiable instruments.

Negotiable Instruments Act, 1881 (India)

It is a British colonial age act that is still in use. It defines 3 types of negotiable instrumentsthat are
widely used in Indian market - Promissory Notes, Bills of exchange, Cheques.

Before going into the topics, let some concepts be cleared first -

 Unconditional Undertaking / Promise -You are promising or undertaking to pay without any
condition
 Unconditional Order - You are providing an order (to someone, or some institution, or bank) to
pay without any condition
Two more concepts -
 Pay to Bearer - Pay the amount to, whoever comes with (bears) the instrument and
demands to be paid
 Pay to Order - Pay to a certain person, not anybody

Promissory Notes -
It is a negotiable instrument in writing with an unconditional undertaking/promise, signed by
a maker, to pay a certain amount of money to the order, or bearer of the instrument.

What we get from the definition?

 It should be in writing
 It is an unconditional undertaking / promise to pay
 It should be signed by the maker / issuer. Remember it involves only 2 parties - the maker and
the payee.
 Payable to both bearer and order of the instrument

Bills of Exchange -
It is a negotiable instrument in writing with an unconditional order, signed by a maker, ordering a
certain person/institution, to pay a certain amount of money to the order, or bearer of the
instrument.

What we get from the definition?

 It should be in writing
 It is an unconditional order to pay (not an undertaking) [refer previous post for the
difference]
 It should be signed by the maker / issuer. Remember it involves 3 parties -
the maker/drawer/issuer,
the drawee (may be a bank, or institution, or other person, whom the drawer is directing for
payment to the payee) and
the payee (whom the drawer is paying)
 Payable to both bearer and order of the instrument

Cheques -
It is a special type of bill of exchange, which is drawn on a specified
banker (i.e., drawee is always banker), and not expressed to be payable otherwise than on
demand.

What we get from the definition?

 It is a special type of Bill of Exchange, where drawee is fixed (i.e., the banker)
 As it a Bill of exchange, it is therefore an unconditional order to pay
 It should be signed by the maker / issuer (i.e., the account holder of a bank).
Remember it involves 3 parties -
the drawer (e.g. account holder),
the drawee (always banker), and
the payee (whom the drawer is paying)
 It should be paid on demand (i.e., whenever the cheque is presented to the bank)
 Payable to both bearer and order of the instrument

Example - The drawer is the individual who issues the cheque, instructing
the bank(drawee) to pay the recipient (payee)
Note - In case of cheque, drawee is always a banker or bank, whereas in case
of BOE, draweecould be bank or any person

Now try to clear the differences between these three -

Bill of
Promissory Note Cheque
Exchange
Unconditional undertaking, or pro Unconditional order to pa Unconditional order
Nature
mise to pay y to pay

3 parties – drawer, 3 parties – drawer,

Parties 2 parties – maker, payee
drawee, payee bank, payee

Liability of Drawer
Liability
(maker) is secondary,
Liability Liability of maker is primary of drawer(maker)
drawee (e.g. bank)
is primary
is primary

Both drawerand pay

Special Maker and payee must be Both drawerand payeem eemay be the same
cases two different persons ay be the same person person for Self-
cheque

Can be presented
for payment only when it
Accepta No need of acceptance of maker, is accepted by drawee(ac Does notrequire
nce while presenting for payment ceptance is must, any acceptance
before drawee can be
made liable upon it)

Can be drawn
Drawee can
Conditio A maker cannot put payable
put conditions only if he
ns any conditions on it to bearer or on
accepts the bill
demand

When
made payable to bearer, Payable immediatel
If doesn't contain payee’sname,
Legality it is notconsidered yon
but state to be payable to bearer,
cases as illegal (entitled to 3 demand without an
is illegal.
days of graceunless it is y days of grace
payable on demand)

If dishonored, a notice of Notice of

Dishono dishonor is required to be dishonor is not
If dishonored, no notice required
r given by necessary. Want
the holder (payee) to of assets in the
 the maker of the bill hands of banker is
(drawer) sufficient notice

Crossing of Cheques
Bearer Cheque & Ordered Cheque
There are two types of cheques -
 Payable to bearer -
Whoever bears or holds the instrument. If you don't provide any crossing on the cheque, then it
will be a bearer cheque. If you take it to the bank counter, you will be able to en-
cash the cheque, without any issue.
 Payable to order -
Only to a certain person/institution. If you provide a crossing on the cheque, it will be a ordered
cheque. There will be several conditions for an ordered cheque as described below.

Crossing of Cheques are defined in Section 123 of Negotiable Instrument Act, 1881.
There are four types of crossing (i.e., putting conditions on cheque):

1. Crossed Generally [Putting Two Parallel Transverse Lines on the cheque]

It provides the condition to the banker that the amount can be credited to any account but
through a banking channel, so that the beneficiary may be traced.

2. Crossed Specially [Putting the name of the banker, e.g., SBI, ICICI, etc]
Here the bank makes payment only to the banker whose name is written in the crossing. It
is more safe than the generally crossedcheques, because it restricts to the
only banker you want to use.

3. Account Payee / Restrictive Crossing - [Putting the word 'Account payee']

The collecting bank is supposed to credit the amount only to the account of
payee, nowhere else.

4. Non-negotiable Crossing - [Putting the word 'Not Negotiable']

Here, you are making the cheque (which is a negotiable instrument) non-negotiable. It
means you cannot endorse the cheque to other person (restricting the transferability, refer
to the previous posts)

For a better understanding of Not-negotiable crossing, here is an example scenario -

A buys a car from B, A gives a cheque crossed ‘not negotiable’. B gives it to C. C loses the
cheque and it is found by D. D forges C’s endorsement and endorses it over to E. If the
cheque is dishonored, E can sue D, but has no recourse to sue A, B or C, as it is
marked ‘not negotiable’. Even though E accepted the cheque in good faith and ‘for
value’ he cannot get a better title than the prior endorser D, who had none. Without the
words ‘not negotiable’ E could have sued A, B, or D as prior endorsers (C can’t be sued
as his endorsement was forged).

Cheque Truncation System (CTS)

As per Negotiable Instrument Act, 1881, each and every cheque is required to
be presented to the drawee bank (paying bank) for the payment.

Earlier, cheques deposited by customers, used to be presented by

the collecting bank (customer's bank) to the paying bank (cheque issuer's bank). Thus, it
required the physical movement of the cheque from collecting bank to the paying bank,
consuming a significant amount of time to clear the cheque. (Consider several cheque to
be cleared in several paying banks! How much time it could take!)

Then, came the concept of Clearing house. Banks decided to meet in this clearing house,
which acted as the central place and settle their net amounts of cheques. Thus it reduced
cheque processing time because they need not visit several paying bank, taking several
cheques.

Cheque Truncation System (CTS)

At present, we got a new concept of cheque clearing. Instead of sending
the cheque physically by the collecting bank to the paying bank, an electronic
image (scan copy, along with all necessary details) is transmitted to the drawee/paying
bank for payment through the clearing house.

This reduced the time drastically, as CTS stopped the physical movement of cheque from
one bank to another, and also the costs involved with it.

Grid-based CTS clearing

RBI implemented CTS in the National Capital Region (NCR) of New Delhi,
Chennai and Mumbai with effect from February 1, 2008, September 24, 2011 and April 27,
2013 respectively.

After migration of the entire cheque volume from MICR system to CTS, the
traditional MICR-based cheque processing has been discontinued in these 3 locations.

Based on the advantages realized and experience gained, RBI decided to operationalize
CTS across the country. Accordingly, Grid-based CTS clearing has been launched in these
3 locations.
  New Delhi Grid - NCR of New Delhi, Haryana, Punjab, UP, Uttarakhand,
Bihar, Jharkhand, Chandigarh
 Mumbai Grid - Maharashtra, Goa, Gujarat, MP, Chattisgarh
 Chennai Grid - Andhra Pradesh, Telengana, Karnataka, Kerala, Tamil Nadu,
Odisha, West Bengal, Assam, Puducherry

CTS Clearing Cycle

Step 1 - The Collecting bank (or branch) captures the data (on MICR band), and
the images of a cheque using their Capture System (comprising scanner, core
banking or other application)
To ensure security, safety and non-repudiation of data/images, end-to-end Public Key
Infrastructure (PKI) has been implemented in CTS.

Step 2 - The Collecting Bank sends the data and captured

images duly signed and encrypted to the central processing location (Clearing House).
The Clearing House processes the data, and arrives at the settlement figure and transfers
the images and requisite data to the Paying bank. This is known as presentation
clearing.

Step 3 - The Paying Bank receives the images and data from the Clearing
House for payment processing. The paying bank generates the return file for unpaid
instruments. The return file/data are then sent to the Clearing House.

Step 4 - The return file/data is processed by the Clearing House in the return
clearing session and in the same way as presentation clearing session. Then these are
provided to the Collecting bank.

Step 5 - The Collecting bank processes the data received from Clearing House. The
whole process is known as Clearing Cycle.

The Clearing Cycle is treated as complete once the Presentation clearing and the
associated Return clearing sessions are successfully processed.

Amendment in NIA Act, 1881 for CTS

RBI has confirmed that with amendments to Section 6 and 1(4) and with addition
of Section 81A in the NIA Act, 1881, the truncation of cheques has been legalized.
 Demand Draft (DD)
Demand Draft
It is a negotiable instrument similar to a bill of exchange, with some special features.

Demand Draft or DD is always issued by a bank (drawer) on behalf of its customers after
taking the amount from him/her. The bank then directs another bank or its own
branches (drawee) to pay a certain sum (the amount received from the customer) to the
specified party (payee, whom the customer wants to pay).

You could think that why would you use a Demand Draft instead of a Cheque. There
are few good reasons behind it -

 Before issuing a DD, the bank will take the amount (advance payment) from
the customer, i.e., the payment is guaranteed. But in case of Cheque, it could bounce, if
the account of the customer doesn't have sufficient balance in it. So, to eliminate the risk,
the payee could ask you to provide a DD instead of a Cheque.
 For issuing a DD, you don't need a bank account, you can go to
the bank counter, and issue it. But cheque is inherently related with a bank account.

Now, try to understand about the differences between a Demand Draft and a Cheque -

Demand Draft (DD) Cheque

Drawer – bank only (individual pays), Drawer – individual/ac holder,

Parties Drawee – Same or other banks, Payee Drawee – banker of individual, Payee
– any party – any party

DD can only be made payable to a

Cheques can also be made payable
Negotiability specified party, also known as pay to
to the bearer, along with pay to order
order

Orders of payment by a bank to another Orders of payment from an account

Payments
bank holder to the bank

Can be dishonored, depending

Honor Always honored, because already paid
on account balance

Issuer party is backed by a bank Issuer party is liable to the cheque

Guarantee
guarantee and not backed by a bank guarantee

Defined Not precisely defined in NIA Act NIA Act, 1881

Forex
Foreign-exchange reserves (forex) are assets of a country, generally held by the central bank, and
held in foreign currencies. For India, RBI is authorized to maintain Indian forex, which is generally
held in US Dollar, or other foreign currencies.
 But the question is why do a country hold forex reserve?
There are few reasons behind this. However most important is -

 Influence Exchange Rate - If India has a large amount of forex, then it can target a
certain exchange rate. For example, If India wants to increase the value of Indian Rupee (INR),
India could sell its dollar reserves to buy INR on the foreign exchange market. The increased
demand would appreciate the INR. In a fixed exchange rate, forex reserves can play an important role in
trying to keep a target exchange rate.
 Guarantor for External Debts / Liabilities- If India holds a large amount of forex, then foreign
countries, or foreign banks (like, World Bank, ADB, etc) will be much willing to provide long term or short
term loans. Because, they will understand that India has the ability to payback the loan. It reflects
as credit worthiness.

Indian forex

India has four types of forex assets -

 Foreign Currency Assets - This is the most important part of forex, and
holds the maximum portion of it. It simply means how much foreign
currency (generally dollar) India holds (Jan 23, 2015 - USD 2,97,510)
 Gold Reserves - This is the next most important part. How much gold India
holds (Jan 23, 2015 - USD 19,377 worth gold)
 Special Drawing Rights (SDR) - These are the drawing rights, or a claim
to currency, that a country holds with IMF, that can be sold or bought. Note that it
can be exchanged with currencies. (Jan 23, 2015 - USD 4,047)
 Reserve Position in the IMF - Also known as Reserve Tranche Position
(RTP). It also represents a forex, to some extent (Jan 23, 2015 - USD 1,101)

FERA and FEMA

Foreign Exchange Regulation Act (FERA), 1973
Government of India (PM was Smt. Indira Gandhi) enacted Foreign Exchange
Regulation Act (FERA) in 1973 , which came into force w.e.f. January 1,
1974, to regulate all Indian exchanges or dealings with foreign countries.

At the time of legislation of the law, India had acute shortage of foreign exchange
(forex). The government then tried to restrict (very strictly) the exchanges, or dealings of
India with foreign countries. But the rules and regulations were so stringent that it had a
great impact on the import and export of currency.

There were several issues with this act, like -

 Law violators were treated as criminal offenders (instead of civil offenders)
 Wide power on the hand of Enforcement Directorate (E.D) to arrest any person,
seize any document (Corporate world found themselves at the mercy of E.D.!)
 Control everything that was specified, relating to foreign exchange, aimed
at minimizing dealings in forex and foreign securities, etc.

Foreign Exchange Management Act (FEMA), 1999

FERA was too strict on regulating the foreign exchanges, that acted like
an obstacle in foreign trade, and had become incompatible with the pro-
liberalization policies of government.

Hence government of India, under PM Shri. Atal Bihari Vajpayee repealed the FERA Act,
and introduced FEMA in 1999. This time, instead of "regulating" the foreign exchange,
government tried to "manage" it (with simpler norms).

FEMA has brought a new management regime of foreign exchange with the
new framework of the World Trade Organization (WTO). Also, it brought with it
the Prevention of Money Laundering Act, 2002, w.e.f. July 1, 2005.

Difference between FERA and FEMA

FERA FEMA

To conserve forex and to prevent To facilitate foreign tradeand

Objectives
misuse maintainforex

Consisted of 81 sectionswith great Consists only 49 sectionsand is much

Provisions
complexity simpler

Power of Wide power on the hands of

Search & a police officer (not below the rank Power curtailed to a great extent
Seize of Deputy SP)

Criminal offence, and was not

Civil offence, and
Violation compoundable(charges could not
is compoundable(charges can be dropped)
be dropped)

only citizenshipwas the criteria to More than 6 month stay in India is

Residential
determine the residential status of the criteria to determine the residential
status
a person status of a person

Capital Market - Part I

While Money Market deals with short-term (up to 1 year) funds, Capital Market deals
with medium and long term (more than 1 year) funds. It refers to all facilities and
institutional arrangements for borrowings and lending medium and long term funds.
Borrowers - private business corporations, PSUs, government, etc.
Lenders - individual, institutional investors, banks, financial institutions,
government, etc.

Capital Market
Capital market is the part of a financial market, where companies that need capital for its
business purpose, issue stocks or bonds to the investors and raise
money. Investors invest in capital market to earn profit from its investment.

They have two options for investment - either buy equity (stock)
instrument, or debt (bonds, debentures) instrument. (Refer my previous post on Equity &
Debts)

Primary and Secondary Market

Sometimes, a company directly approaches a market to get some investment and
raise capital. For this purpose, they can work with lead managers or merchant bankers,
who help them to raise money.
If investors directly provide money to the company (meaning, company raises capital
directly from investors), then it means that the trading is in Primary Market.

After an investor has shares or bonds (whatever instrument he/she bought from the
company in Primary Market), can sell his/her shares/bonds to other investors.
All consequent buying or selling will be traded in the Secondary Market (meaning,
investors doesn't buy instruments directly from the company in a Secondary market).

Issues in Primary Market

There are several type of Issues in a Primary market -

1. Initial Public Offering (IPO) - A company when first time wants to raise money from
the market, issues shares to the general public (meaning, previously shares held only by
the founding members, or the company itself). This first time share issue is known
as Initial Public Offering (IPO).
After IPO, the company becomes a public company, because the general public is also
the shareholder/stakeholder of the company. It is now listed in one or more stock
markets for trading in Secondary Market.

2. Follow-On Public Offering (FPO) - After sometimes (after IPO), suppose, the company
again wants to issue shares (shares held by company) to the public, then it will be known
as Follow-On Public Offering. Note that this is done in Primary Market (investors buy
directly from company), not in Secondary market (investors buy from other investors, or
stock markets)

Confusion - Don't confuse FPO as Secondary Market offering. As I discussed earlier,

that Secondary market deals only within the investors, not with
the company, whereas, IPO and FPO work between the company and the investor (hence
in Primary Market).

Company in need of capital, can raise money, by issuing shares to its existing
shareholders, or to non-shareholders.
3. Rights Issue - If the company issues shares to existing shareholders in per share
basis, then the percentage stake will not be diluted. This is known as Rights Issue.
For an example, suppose a company issues 1:3 Rights Issue @ Rs. 50/share. It means
an existing shareholder having 3 shares already can buy 1 new share at Rs. 50. Note
that the percentage stake is not diluted, because every shareholder again holds
the same percentage of shares.

4. Preferential Issue - If the company issues shares to some other selected

(preferred) people who is not an existing shareholder, then it will be known
as Preferential Issue. Note that percentage stake is diluted here, because new person
becomes shareholder.

Trade in Secondary Market

After the IPO, investors have the securities they bought, and the company has
the money/capital. The company then lists the securities on one or more Stock
Exchanges (like BSE, NSE, Nasdaq, etc).
Companies apply to the respective stock exchanges to get their stocks listed, after paying
a listing fee. Listing facilitates the subsequent buying and selling of the securities through
current and prospective investors. This enables investors to
make profits, reduce risks, invest in prospective growth areas, and so on (and making a
lot of speculations! ups and downs in stock market)

Note that in Secondary market, investors can buy and sell their stocks from and to other
investors.

Some Stock Exchanges -

Bombay Stock Exchange (BSE), National Stock Exchange (NSE), New York Stock
Exchange (NYSE), NASDAQ, Japan Exchange Group, Euronext, London Stock Exchange,
Hong Kong Stock Exchange, Deutsche Bourse, TMX Group, etc.

Equity and Debts

Investment in Corporate Sector
Suppose, you want to invest in a corporate sector. What options do you have?

You have two options for investment - invest in stocks/equity/share or invest

in bonds/debentures of the company.

First option points to Equity instrument, whereas the second option to Debt instrument.

Equity Instrument
If you buy an equity instrument (i.e., shares), then you will be a (kind of) owner of the
company, known as stakeholder or shareholder. The company is not liable to you. If the
company generates profit, then you will get a part of it (as dividends, will explain later), and
if generates loss, then you too have to bear it.

You buy a share by paying an amount to the company, you don't get anything in return
except the claim of being a stakeholder or shareholder. You will be only profited (i.e,
benefited), when the company provides dividends to its shareholders.
Debt Instrument
If you buy a debt instrument (i.e., bonds, debentures), then you will be a liability of the
company, and you won't be the (kind of) owner of it. Whether
the company generates profits or make loss in its business, it is bound to provide you
the investment you made as bonds or debentures, with interest.

You buy a bond, you will get monthly/quarterly (whatever the payment time is) return from
the company, where you invested. But you will never be a stakeholder.

Now, try to summarize the differences of equity and debt instruments -

Equity Debt

Equity, or Stock are securities that are Debtinstruments are assetsthat

Nature a claim on the earnings and assets of require a fixed payments to
a corporation. the holder, usually with interest.

Issuing a bond (debt instrument)

Allows a company to acquire funds, often
Use
for investment, without incurring debts
increases the debt burdenof the bond
issuerbecause contractual interest
payments must be paid –
unlike dividends, they cannot be
reduced or suspended

Those who purchasesequity instruments Bond holders do not

(e.g., stocks) gain ownership of the
business, whose sharesthey hold. In other
Ownership
words, they gain the right to voteon the
issues important to the firm. In addition,
they have claimson the future earnings.
gain ownership in the business or
have any claims to thefuture profitsof
the borrower. The borrower’s only
obligation is
to repay the loan with interest

Bonds are less risky – should

Share holdersgets profits or losses, as and
the company run into trouble, bond
Risks when business makes it, making it highly
holdersare paid first, before other
risky
expenses are paid.

Investors only earns when company

Returns are periodic and almost
issues dividends, that happens when
Earnings fixed. Coupons or monthly interest is
the companywants to share the profit to
earned.
theirshare holders

Raising capital using equity is that Raising capital using debt is

Raising
the companywho issues shares need not a burden to the company, as they
Capital
pay any money to the share holders. have to pay theinterest monthly

Instruments Shares, Dividends Bonds, Debentures, Certificates,

Mortgages, Leases, Notes, or
 other agreements between a lender
and a borrower

Dividends and Debentures

Now come to dividends and debentures. Don't get confused on these two. Dividends is
a equity instrument, whereas debenture is a debt instrument.

Dividends - When a company generates profits, it can use that amount whether
as reinvestment in the company (to extend business, or buy new equipment, etc.), or as
to share among the stakeholders / shareholders, or both.
If it shares the profit among the shareholders, then it is known as Dividends (generally
denoted as Dividends Per Share, or DPS). Shareholders gets dividends on per
share basis.

Debentures - It is a kind of debt instrument, but without collateral. You will buy
a debenture only because you believe that the issuer (may be a company or government)
will not default on its payment to you. They will not provide any security as collateral for
your investment. The reputation of the issuer is enough for you to buy a debenture.

The best example could be a Treasury Bill (T-Bill), issued by government. You know
that government will never default on payment, so you buy a T-Bill, which is a debenture.
(I shall elaborate T-Bill in next blogs)

Sensex
Share Index
After a private company goes public, throughInitial Public Offering (IPO), or become a public
company, it is important to know about how the 'public company' is working. Would it be better
to invest in that particular company than some other? For facilitating investors interests, the
concept of share market index has aroused.

Sensex
Indian version of the share index is Sensex (Sensitive Index, coined by Indian stock market
analyst, Deepak Mohoni). It is maintained by Bombay Stock Exchange (BSE) in Mumbai,
the business capital of India. It takes care of 30 financially sound and well-established Indian public
companies shares or stocks (already discussed about shares in previous post 'Equity & Debt')

Now, let's clear about primary and secondary market.

 Primary Market - You buy shares from company itself

 Secondary Market - You buy shares from some other shareholder, rather than the company,
meaning the share is already gone through the Primary market.

Types of Shares
 Before going to how you could calculate sensex, it is important to know about different types
of shares -

 Restricted Shares - restricted to its own employees, or insiders, cannot be issued

to public without special permission
 Float Shares - freely bought of sold in public (consider as floating in public market)
 Outstanding Shares - represents all the shares the company actually issued, either to
the public or to its own employees (meaning, restricted shares + float shares)
 Authorized Shares - maximum share that a company can issue. Shareholder's Vote is
necessary to increase or decrease it.

Now clear this types with a suitable example -

Suppose company X has 1,000 Authorized shares. But, it issued 300 shares to public (Float Shares),
200 shares to own employees/executives (Restricted Shares), and retained remaining 500 shares in
its treasury.

Therefor, Outstanding shares makes to 300 + 200 = 500 shares

Sensex Calculation - free-float capitalizationmethod

Step 1 - Find Market Capitalization (no. of outstanding shares x price per share)

Step 2 - Multiply with free-float factor (which is determined by percentage of floated

shares to outstanding shares)

Now, think do a public investor need to know about the shares that are kept in the treasury of
the company, while investing? Answer is no. What shares are in the public market (floating
share) is important instead.

From the above example,

Percentage of floating shares to outstanding shares = (floating / outstanding) x 100 %

= (300 / 500) x 100 % = 60 %

This percentage makes free-float factor = 0.6

Now, suppose the price of each share of the company X is Rs. 150. Then market capitalization of the
company is = outstanding shares x price per share

= 500 x Rs. 150 = Rs. 75,000

Therefore, the free-float market capitalization becomes = market cap x free-float factor

= Rs. 75,000 x 0.6 = Rs. 45,000

Note - This is a demonstrative example, not actual figure, just for learning purpose.

Nifty

While Sensex is the name of the share index of 30 companies in S&P BSE, CNX Nifty is the name of
the share index of 50 companies of S&P National Stock Exchange (NSE)

S&P - Standard & Poors, an international financial services company

CNX - CRISIL NSE Index

Derivatives Market
To understand the concept of Derivatives, first try to understand the following example -
Suppose you want to invest in shares, or bonds, or some other instruments. But you don't know
what will happen to your investment, meaning, your (bought) share may give you profit, or give
you loss (you often hear news, that someone has lost all his money in shares), because it all depends
on the company how it works in the market (same thing applies for other investments too).

Certainly there is always a risk factor that works in your investment in these type of instruments. So,
to reduce the risk, there is a concept of Derivatives.

Derivatives
A derivative is a contract / agreement between two or more parties, whose value depends on or
associated with one or more underlying assets (e.g., shares, bonds, commodities, currencies, etc.)

Derivatives are one of the three main categories of financial instruments -

 Stocks (i.e,. equities or shares) (already discussed in previous post)

 Debt (i.e., bonds, mortgages) (already discussed in previous post)
 Derivatives (our topic of discussion)
 Let's start with an example -
Suppose you want to buy an asset with Rs. 500 (example figure just to understand the concept). But
you are worried what will be the market price of the asset after some months, and their is a high
probability (your speculation) that the market price can become less than Rs. 400. So in that case
you will make a loss of around Rs. 100.

Therefore, you decide to make an agreement with an investor, stating that you want to sell him
the asset in Rs. 550 after 6 months (future agreement). The investor agrees with the agreement,
because he thinks, he can sell the asset at a higher profit (may be Rs. 600, investor's speculation), if
the market price is high.

Now analyze. If the market price of the asset after 6 months, becomes Rs. 650, then
the investor will get a profit of Rs. (650 - 550) = Rs. 100. But you will get the fixed profit of Rs. (550 -
500) = Rs. 50, irrespective of the market price.
But if the market price of the asset becomes Rs. 420, then the investor will make a loss of Rs. (550 -
420) = Rs. 130, whereas you won't make any loss, but a fixed profit of Rs. (550 - 500) = Rs. 50.

Note that you won't make any loss, if you make the Derivatives agreement, however your profit will
be fixed (may be less, if you don't make the agreement). You reduce the risk of any loss, in this type
of derivatives agreement, and this process of reducing risk is known as Hedging.
Also note that, the value of the Derivatives is dependent on your asset (known as underlying asset).

Types of Derivatives
 Forwards
 Futures
 Options, etc.

Forward Contracts

Forward contract (or forwards) is a non-standardized contract between two

parties tobuy or sell an asset at a specified future date, where the price is decided today (on
agreement day)

Points to be noted -

 Buy/Sell will be done in future date

 Price is decided today (reduces risk for the seller)
 These are not standardized (no Future Exchange is involved. Contract is made just
between buyer and seller - private agreement)

Future Contracts

Future contract (or futures) is a standardized contract between two parties to buy or sell an asset at
a specified future date, where the price is decided today (on agreement day)
 Points to be noted -

31. Buy/Sell will be done in future date

32. Price is decided today (reduces risk for the seller)
33. These are standardized (in contrast to Forwards). Contracts are negotiated at Future
Exchanges, that acts as an intermediary between buyer and seller. There is also a guarantee
from Clearing Houses)
Option Contracts
Option contract (or options) is an agreement/contract between two parties that
gives purchaser the right to buy or sell (option to buy/sell) an asset at a specified future
date, where the price is decided today (on agreement day)

Points to be noted -
34. Buy/Sell will be done in future date
35. Price is decided today
36. Options are the right to buy or sell, not an obligation, meaning the purchaser of the
option, could buy/sell the asset, but if he doesn't want to, then he has no obligation to buy/sell it.
But in case of Forward and Future contracts, there is an obligation to buy/sell the asset (they
are legally bound to buy/sell the asset).
There are other types of derivatives, like Warrants, Swaps, etc.

Demat account
Demat Account

Earlier, shares and securities were issued to investors in physical form (like certificates
etc.). Physical possession of certificates had several risks - like fear of theft, management problem
for individuals who used to invest in several shares or securities at several times, or wear and tear of
those certificates (If you lose any certificate, you lose your valuable investment return!)

Then dematerialized account (in short Demat account) was invented to reduce those risks. In this
account, all type of shares and securities are being stored in dematerialized / digital form(meaning
material form is converted to digital form).

Operating a Demat account is as simple as operating an online bank account. After opening a Demat
account, you will be quoted a demat account number. You will use this account number to all type
of electronic settlements of trade in shares or other securities.

Demat Conversion - Rematerialization

 Converting physical records of investments into digital form is known
as "dematerialization" of securities. The reverse is also possible if someone wants to
use physical records instead of demat account, and the process is known
as "rematerialization".
In that case, one has to fill in a Remat Request Form (RRF) to convert the digital
certificates into equivalent physical certificates.

Application Supported by Blocked Amount (ASBA)

Investment on Shares

The traditional process of applying in Initial Public Offers (IPO), Follow-on Public
Offers (FPO), Right Issues, etc. (i.e., investing in shares) is to use cheque as a mode
of payment and submitting applications.

It has some problems associated -

 Investors have to pay the entire fee upfront (at the time of bidding for shares)
 Refunds (in case bidding failed) through cheques usually take up to 45 days.

Applications Supported by Blocked Amount (ASBA)

SEBI (capital market regulator) introduced ASBA in September, 2008 in Indian Capital
market to facilitate the application process for shares to benefit the investors, by
removing the above problems.

ASBA is an application to buy shares, where investors authorize the bank (mediates the
process) to block the application money in his bank account. Investors
cannot withdraw the blocked amount, until the whole process is over.

 If the investor is selected for share (means he is allotted shares /

bidding successful), then his blocked amount will be automatically debited from his account,
and an equivalent share will be credited in his Demat Account.
 If the investor is not selected for share (means his bidding is unsuccessful), then
the blocked amount will be unblocked, and he can withdraw that amount as per his wish.
Note that ASBA solved the above two problems.

Interests in the Blocked Amount

Under ASBA, the blocked amount will continue to earn interest during the application
processing period, if held in an interest bearing account (like savings account,
etc.). Bank will mark a lien on the deposit, which will be removed immediately after the
allotment process is completed.
 Merger, Acquisition, Amalgamation, JV
Merger
A merger refers to a combination of two or more companies, usually of same size, into one
company.

What happens in merger?

 The shareholders of the company being merged become shareholders of the larger
company
 The assets and liabilities of a company get vested into the assets and liabilities of
another company
 Identity of one ore more entities (smaller companies) is lost to the larger company (to
whom the smaller companies are merged), but no new entity is formed

It can be thought as a marriage between two companies of same size, in which one
company survives its own name (larger company), and the other (smaller company) ceases
to exist as a legal entity.

For example, merger of ING Vysya Bank with Kotak Mahindra Bank (KMB)

Types of Mergers

1. Horizontal Merger - It occurs when the two merging companies both produce similar
product in the same industry or sector.

For example, merging of Coca-cola and Pepsi beverage division would be a Horizontal
merger.

2. Vertical Merger - It occurs when both the merging companies operate in the
same industry, but at different stages in the production of the same finished good.

For example, merger of a tire producing company with a car manufacturing company would
be a Vertical merger.

3. Conglomerate Merger - It occurs when the two merging firms operate in different
industry or sector.

For example, if a shoe company, merges with a soft drink company, then it would be an
example of Conglomerate Merger.
 Amalgamation
Amalgamation is the transfer of all or some part of assets and liabilities of one or more
companies to a new company.

What happens in Amalgamation?

 All of the companies lose their identities, and a new separate entity is born
 Shareholders of all the companies get shares of the new company

For example, Maruti Motors operating in India and Suzuki based in

Japan amalgamated to form a new company, named Maruti Suzuki (India) Limited.

Acquisition
Acquisition of a company (usually smaller) by another company (usually bigger) refers to the
transfer of ownership right in the property and asset of acquired company to the acquiring
company, without any combination of companies.

What happens in Acquisition?

 Acquiring company purchases majority stake (>50 %) in the acquired company,
thus getting the controlling/ownership right
 Both the acquiring and the acquired company survive as legal entities.

For example, Facebook acquired Whatsapp in USD 19 billion last year.

Joint Venture (JV)

Joint Venture is a business agreement between two or more companies for a finite time,
to develop a new entity and new assets, by contributing their equity/stock.

The companies exercise their control over the new enterprise, and share -
revenues/profits and expenditures/losses.

What happens in Joint Venture?

37. Both the companies remain independent. They just contribute in the Joint Venture for a
particular product as per agreement, for a finite time
38. Control, Profits, Losses, Costs, etc. are shared by themselves as per agreement

For example, Tata Docomo is a joint venture between Tata Teleservices (India) and NTT
Docomo (Japan).

Revenue, Fiscal and Primary Deficits

Revenue Deficit
For every financial year, government plans a budget. Government needs to predict how
much it hopes to earn as revenue and how much to spend as expenditure.
Suppose, for a financial year, government predicts to earn revenue of Rs. 525 crore (just
a figure to understand) and expects to spend Rs. 400 crore. Then the predicted Net
Revenue will be predicted revenue minus predicted expenditure, i.e., Rs. (525 - 400) crore
= Rs. 125 crore.

Note that this is just a prediction or expectation. After that financial year, the government
calculates that it earned Rs. 500 crore as revenue and spent Rs. 420 crore (expenditure).
Therefore, the actual Net Revenue is calculated as Rs. (500 - 420) crore = Rs. 80 crore.

You can see, that the government expected to earn a Net revenue of Rs. 125 crore,
but actually it earned Rs. 80 crore. This mismatch is known as Revenue Deficit. The
reverse case is Revenue Surplus (when predicted Net revenue is greater than the actual
one)

You must notice that the government may nothave an actual loss of revenue (in this case
actual revenue is greater than actual expenditure, that means profit, not loss).

Same concept goes for business too.

Fiscal Deficit
In the Revenue Deficit/Surplus, deficit or surplus was calculated on
the predicted and actual Net Revenue.
But, if the government actually makes the deficit, then we are talking about Fiscal Deficit.
That means, if the government spends more than it earns in a financial year, then
(obviously) the expenditure is greater than the revenue, leading to the Fiscal Deficit.
Note Fiscal Deficit means actual loss of revenue, while Revenue Deficit can mean actual
loss, or actual profit, for the financial year.

Also note that, while calculating Fiscal Deficit, we need to exclude the borrowings of the
government (because it certainly is not actual revenue, its a debt, that the government
needs to pay back to the lender/investor)

Primary Deficit
After borrowing from the investors, government needs to pay interest on the borrowings. If
these interests are deducted from the Fiscal Deficit, then we get the Primary Deficit.

Fiscal Responsibility and Budget Management Act (FRBM), 2003

FRBM Act was legislated to institutionalize financial discipline and
improve macroeconomic and public fund management, reduce fiscal deficit, by making
a balanced budget. It was introduced by former finance minister Shri Yashwant Sinha.

The goal was to -

1. Eliminate Revenue Deficit of the country
2. Build Revenue Surplus thereafter
3. Then bring down the Fiscal Deficit to a manageable 3 % of GDP, by March
2008.
But it was suspended due to the international financial crisis (recession) of 2007.

Current scenario and targets

Finance Minister Shri Arun Jaitley promised in Union Budget 2014, to lower the fiscal
deficit to 3.6 % of GDP by 2015-16, and 3 % by 2016-17 to meet the original target of 3
% of GDP set by FRBM Act.

For current fiscal year (2014-15), the government may be able to meet the fiscal
deficit target of 4.1 % of GDP.

Balance of Payment
Balance of Payments (BOP) of a country is its record of all financial
transactions performed between the residents (meaning individual, firms, government) and
the rest of the world (albeit within a period, usually a financial year).
Here a point need to be mentioned, BOP data isn't concerned with actual 'payments',
rather with 'transactions'.

Now the question is does it really 'balances'?

The answer is may not be. Though theoretically it should be zero, meaning that assets
(credits) and liabilities (debits) should balance, but in practice there is mostly
a mismatch.

It generally happens, when the outward transaction is more than the inward
transaction, and then is termed as Balance of Payment Deficit (BOP deficit). Also, BOP
surplus is possible, for the reverse case.

BOP Accounts
For the international trade, a country's BOP deals with three types of accounts -

1. Current Account - It is the most important of the three. It has

mainly four components - goods, services, income and current
transfers (meaning worker's remittances, donations, aids, etc.). It is very obvious
now - if the outflow of this components are more than the inflow, it will result
in Current Account Deficit (CAD).
2. Capital Account - All international capital transfers are recorded here
(Capitals meaning non-financial assets, such as land and non-produced assets,
such as mine)
3. Financial Account - It contains the direct investment (remember FDI,
ODI), portfolio investment, reserve assets, etc.
Often the last two accounts are mentioned as a single one - Capital and Financial
Account.

Trade Deficit
From the above discussion you hopefully learned the concept of BOP deficit and Current
Account Deficit (CAD). Since we are talking about 'international' transactions, its better to
know about the Trade Deficit.

It is very much simple - negative balance of trade, meaning country imports more
than exports. As a result currency is flowing outward.
(On a personal note - Reduce gold use. Indian currency flows outward. Government
spends a lot for importing gold from foreign countries!)
Taxation in India - Part I (Direct and Indirect Taxes)
Paying tax to the government is duty of the citizens. This collected tax is used
for building the nation in terms of infrastructure or other developments, paying salary to
public servants, and provide uncountable services to the general public. In other words, it is
the taxpayer's money which is utilized to benefit them, where the government merely
works as the manager of the fund.

Constitutional point of view on Taxes

According to Indian Constitution, central or state governments can impose taxation and
make laws regarding it. There are total 3 lists -

1. List I - specific areas where only the central government (by Parliament)
can make laws
E.g., Income tax (except agricultural income), Customs duty, Corporation tax, etc.
2. List II - specific areas where only the state governments (by State
Legislature) can make laws
E.g., Agricultural income tax, Land revenue, Stamp duty, etc.
3. List III - some common areas, where both central and state
governments can make laws, known as concurrent list.

Classification of Taxes
Taxes are classified into 2 broad categories depending on the ultimate
bearer and transferability of the tax -

1. Direct Taxes
If the liability to pay a tax and the burden of the tax falls on the same person, then it is
known as Direct Tax. Now try to understand it with the example of Income tax -

Income tax is imposed on you, it means that you are liable to pay the tax (you
will directly pay the tax to the government) and you cannot shift the burden to others.

2. Indirect Taxes
If the liability to pay a tax is imposed on one person and the burden of the tax falls on
some other person, then it is known as Indirect Tax. Now try to understand it with the
example of Sales tax -

In case of Sales tax, the liability to pay the tax to the government is on shopkeeper, who in
turn shifts the tax amount to the customer by including it in the price of the commodity.
(He pays the tax to the government, but recoversthe amount from the customer,
thus shifting the burden to the customer)
So, in case of Indirect Tax, the liability is on someone (here, shopkeeper), but
the burden is actually shifted to another person (here, customer).

Taxation in India - Part II (All about taxes, Budget

2015-16)
A. Direct Taxes

1. Income Tax - Every individual whose total income exceeds taxable limit is liable to
pay income tax, according to income tax slabs and rates (no change in this year Budget
2015-16)

E.g., Currently, general individuals with total income up to 2.5 lakh need not pay
any income tax, whereas, if income exceeds 2.5 lakh limit then they need to pay income
tax with rates according to slab.

For example, if someone's income is Rs. 3.5 lakh, he needs to pay income tax of Rs.
3,50,000 x 10 % = Rs. 35,000 that year (10 % rate, because income falls in that tax slab)

Note that income tax is paid annually (financial year).

Senior Senior
Tax
General (including women) citizens (60 to less citizens (80
rate
than 80 years) years and above)

No
0 – 2.5 lakh 0 – 3 lakh 0 – 5 lakh
tax

10 % > 2.5 lakh – 5 lakh > 3 lakh – 5 lakh -

20 % > 5 lakh – 10 lakh > 5 lakh – 10 lakh > 5 lakh – 10 lakh

30 % > 10 lakh > 10 lakh > 10 lakh

2. Corporate Tax - It is generally levied on

the income of registered companies and corporations. In General Budget 2015-16, this
 tax is reduced by 5 % from previous 30 % to 25 %, to improve the investment environment
and ease of doing business in India.

For example, if in a year company X makes total income of Rs. 5 crore, then it needs to
pay corporate tax of Rs. 5,00,00,000 x 25 % (new rate) = Rs. 1.25 crore to the
government.

3. Wealth Tax - It was imposed on property or wealth of an individual, after assessing

the value of it. In General Budget 2015-16, this tax is abolished.

4. Gift Tax - It is paid to the government by the recipient of a valuable gift, after assessing
the value of the gift.

There are several other Direct Taxes (Estate Duty, Fringe Benefit Tax / Perquisite Tax,
Expenditure Tax, etc.), which are directly levied from the taxpayer by the government.

(Now try to justify the reason, why these are Direct taxes)

B. Indirect Taxes

1. Sales Tax - This tax is charged on the sales of movable goods or commodities. It is
charged by both central and state governments as follows -
 Inter-state sale of goods - Central government
 Intra-state (within state) sale of goods - respective State governments
Currently, sales tax is only levied by central government, and is known as Central Sales
Tax (CST), whereas, state-level sales tax is levied as Value Added Tax (VAT).

2. Value Added Tax - VAT is almost similar to Sales Tax (except that tax is added in
different stages of goods from producer to customer, for more information on calculation
refer a Class X Maths book). It is imposed on purchase of goods and services, and is
an Indirect Tax.
3. Service Tax - This tax is levied on the customers who avail services provided
by service providers. Over the past few years, service tax has been expanded to
cover new services.

Following are some example on which service tax is levied - telephone, advertisement,
beauty parlor, restaurant, health center, banking, maintenance services, consultancy
services, etc.

Note that the customer indirectly pays the service tax to the government (customer pays to
the service provider, who in turn pays to the government) (as it is an indirect tax)

Government has increased the service tax in this years Budget to 14 % from earlier 12.36
%.

4. Excise Duty - Excise Duty is levied on

goods produced inside India. Producers or manufacturers of goods are liable to
pay excise duty to the government. The rate is different for different type of goods.

5. Customs Duty and Octroi - Customs Duty is levied on

goods imported in India from foreign countries. The rate depends on
the nature of goods. This duty is often payable at port of entry, like ports, airports, etc.

Octroi is the entry tax which is levied on goods (for consumption, sale or use) entering a
particular jurisdiction, generally a municipality.

6. Entertainment Tax - It is charged from cinema owners, which in turn is charged to

the viewers.

There are several other Indirect Taxes (Anti-Dumping Duty, Toll Tax etc.), which
are not directly levied to the customer (taxpayer) by the government, but ultimately the
customers bear the burden of tax (after availing the goods or services)
(Now try to justify the reason, why these are Indirect taxes)

Goods and Services Tax (GST) -

In Union Budget 2015-16, government has planned to implement GST by April 2016. It will
simplify the current indirect tax structure by replacing multiplicity of taxes
with a single tax for all goods and services. There will be a common GST compliance
which will be done by all kinds of businesses including manufacturers, service providers,
traders, etc.

For more information on GST, refer this post.

Cess and Surcharge

Some other taxes, you often hear about -

Education Cess - Most taxes (like Income tax, excise duty, service tax, etc) in India are
subject to an education cess, which is generally 2 - 3 % of the total tax payable. Education
cess is deducted and used for education of poor people in India.

Surcharge - It is an extra tax that may be added to the existing tax calculation. Note
that surcharge is applied on the total tax amount.

Swacch Bharat cess - extra 2 % cess is proposed to be introduced on the value

of services in General Budget 2015-16, which will effectively make the service tax as 14
% + 2 % = 16 %

National Income - Part I

National Income is the total value of all the new goods and services produced as final output of
a country in a year.

First try to understand how a product is manufactured and sold.

Typically, goods are produced in several stages. At one stage, raw materials are converted by firms,
and then sold to another firms for next stage. Value is added at each intermediate stages. At
the final stage, a retail selling price is tagged with the final product. Note that the retail
 price reflects the value added in terms of all the resources used in all the previous
stages of production.

Final goods
To avoid the problem of double counting, only the value at the final stage, i.e., the retail price of
the final good is included (not the value added in all the intermediate stages - the cost of
production and profit)

Therefore, while considering National Income, the value of all the final goods (and services)
produced in a year in a country is calculated.

For example, suppose a car has a retail price of Rs. 5 lakh. This retail price includes Rs. 2.5
lakh for components, Rs. 50,000 for assembly of components, and Rs. 1 lakh for marketing purpose,
and also a Profit of Rs. 1 lakh.
To avoid double-counting, the national income accounts only the value at the final stage (in this
case Rs. 5 lakh, i.e, the selling price of the car)

Methods of calculating National Income

Consider the following example first -
Suppose, you bought a book worth Rs. 100. It means, your expenditure is Rs. 100, income of
the bookseller is Rs. 100, and the value of the book is Rs. 100.
Therefore, the transaction involves 3 elements -

 Expenditure by purchaser
 Income of seller
 Value of goods
All of the transactions can be looked at in the same way, making 3 methods of calculating National
Income -

1. Production Method - This method is based on the total production of a

country during a year. The combined value of the new and final output produced in
all sectors of the economy (including foreign income of production) is considered
to determine the national income.
2. Income Method - This method adds all incomes received by the factors of
production generated in the economy during a year. It includes wages from
employment, profits to firms, interests to lenders, rents to landlords,
and income from abroad.
3. Expenditure Method - This method adds all spending in
the economy by households and firms on final goods and
services and spending by government.

1. Gross Domestic Product (GDP)

GDP is generally calculated in territorial (note Domestic) basis,
meaning all (note Gross) finished products within the border of a country is considered.
Therefore, all domestic products including international companies operating in India and
excluding Indian workers/companies operating in foreign countries, accounts
for GDP of India.

GDP = domestic products + foreign income in India - Indian income in foreign countries

2. Gross National Product (GNP)

GNP is generally calculated in national basis, meaning finished products of a nation is
considered, whether it is within the country or abroad.
Therefore, to determine GNP, deduct foreign income in India and add Indian income in
foreign countries with GDP.

GNP = GDP - foreign income in India + Indian income in foreign countries

3. Net National Income (NNP)

Value of a product gets depreciated after consumption due to wear and
tear. Depreciation does not become part of anybody's income.
Therefore, to determine NNP, deduct the depreciation from the GNP.

NNP = GNP - depreciation

4. National Income (NI)

Note that all of the above variables are evaluated at market prices. It includes indirect
taxes (imposed on goods and services), which need to pay to government, making
the market price high. Also, there may be government subsidies on the prices of
some commodities (like, LPG, etc.), making the market price low.
Therefore, to determine NI, deduct the indirect taxes from NNP and add the subsidies with
the NNP.

NI = NNP - indirect taxes + subsidies

Gross Domestic Product (GDP)

The value of all the finished goods and services produced within a country's border in
a year is the GDP of that country. (read previous post - National Income - Part II)

It generally includes - public and

private consumption, government spending, investments, and net exports (i.e., total
exports - total imports).

GDP = consumption + government spending + investments + (exports - imports)

GDP is commonly used as an indicator to determine the economic health of a country.

GDP of India
Nominal GDP of India (October 2014, by IMF) is approx. USD 2.047 trillion, which
makes India 10th largest economy of the world (in terms of nominal GDP).

GDP Growth
While discussing about economic health of a country, the actual GDP (in terms
of monetary value) is not considered. Instead, GDP growth reflects how healthy
an economy is (you often hear about GDP growth of India is say 5.5 %, but not say, USD 2
trillion)

Note that, if we talk about GDP growth, then there should be some standard GDP,
with respect to which, current GDP growth will be measured. That standard is determined
by economists, and the year is referred to as base year for calculating GDP growth of
current year.

New GDP base year

Earlier 2004-05 financial year was used to determine the GDP growth of current financial
year. On that basis, GDP growth of India for 2013-14 was 4.7 %.
It means, that if GDP in 2004-05 were say Rs. 100, then the total GDP of India in 2013-
14 became Rs. 104.7.

Central Statistical Office (CSO) under Ministry of Statistics & Programme

Implementation (MOSPI) has changed the base year to 2011-12(from that 2004-05). And
with respect to the GDP of 2011-12, Indian economy grew by 6.9 % in 2013-14.

Role of Inflation/Deflation
GDP is calculated with the market prices of finished goods and services of
an economy (read previous post on methods of measurement). Therefore it is influenced
with the inflation (or, deflation) of the economy.

Therefore, it is required to correct the GDP by removing

the influence of Inflation or Deflation. Depending on this, GDP is of 2 types -

1. Nominal GDP - GDP without adjusting the inflation or deflation influences.

Therefore, it can be misleading, because inflation can make GDP look higher,
while deflation can make it look lower than the actual GDP.
2. Real GDP - GDP with adjusted (removed) inflation or deflation. It depicts
the actual GDP of an economy.
Note that, in the new base year methodology, government has adopted Consumer Price
Index (CPI), instead of Wholesale Price Index (WPI), to adjust the GDP.

Appreciation and Depreciation

Each country has its own currency (except some European countries
in Eurozone use common currency - 'Euro'), and each currency has its own valuation.
Therefore, for a foreign transaction, there should be a mechanism to convert one currency
to another (to know how much of one currency is equivalent to other). The rate is known
as Conversion rate, or Exchange rate.

For example, currently (February 9, 2015), 1 US Dollar = Rs. 62.15, or Re. 1 = USD 0.016 is
the conversion rate between Indian Rupees (INR) and US Dollar (USD).

Depreciation
Note carefully, that if the conversion rate of INR to USD (USD @ Rs.
62.15) increases (meaning more Indian rupee is needed to buy a US Dollar), then
the valuation of Indian Rupee decreases. It means depreciation of Indian Rupees with
respect to US Dollar.

Appreciation
Whereas, if the conversion rate of INR to USD decreases (meaning less Indian rupee is
needed to buy a US Dollar), then the valuation of Indian Rupee increases. It
means appreciation of Indian Rupees with respect to US Dollar.

Example
For example, currently the conversion rate is USD @ Rs. 62.15. So, to buy 100 USD, we
need to spend Rs. (100 x 62.15) = Rs. 6215.

Now suppose, INR depreciates to Rs. 65 per USD (note 62.15 -> 65 is an increment, but
actually the value of INR decreased, meaning more INR needed to buy the same amount of
USD). Therefore to buy the same 100 USD, we need to spend Rs. (100 x 65) = Rs. 6500. It
means we need to spend more (Rs. 285 more), because of
the depreciation of INR to USD.

Similarly, if INR appreciates to Rs. 60 per USD (note 62.15 -> 60 is a decrement, but
actually the value of INR increased, meaning less INR needed to buy the same amount of
USD). Therefore to buy the same 100 USD, we need to spend Rs. (100 x 60) = Rs. 6000. It
means we need to spend less (Rs. 215 less), because of the appreciation of INR to USD.

Devaluation and Revaluation

Devaluation of a country's currency means the deliberate attempt by
the government through its monetary policy to decrease its value (currency's) with
respect to foreign currencies. Note that the value is decreased by changing the foreign
exchange rate.

Conversely, if the value is deliberately increased by the government by changing

the foreign exchange rate of the currency, then it will be Revaluation of the currency.
 Devaluation vs. Depreciation
Both Depreciation and Devaluation decreases the value of the country's currency with
respect to other currencies (generally a major foreign currency, like USD, etc). But
the difference lies on the driving factor -
Depreciation occurs depending on the market forces of the world economy,
whereas Devaluation is the result of government's deliberate attempt to reduce its value.

Devaluation vs. Redenomination

If the face value of the currency is changed (reduced, or increased), without changing
the foreign exchange rate, then it will be known as Re-denomination. It is neither
a devaluation nor a depreciation.
Note that for devaluation or depreciation, foreign exchange rate will be changed.

Inflation - Part I
Suppose, you lived in "peace" (in context of your spending) in the year 2010, when you
boughtvegetables or fruits (or any other commodity) in much less price (than present). But
at present i.e. in 2015, the prices of the same things have gone up which means you have
to spend much more, than you used to spend in 2010. This phenomenon is known
as Inflation.

And if the government thinks that the year 2010 was "ideal" year to compare
the prices with, then the year can be determined as base year (fixed by government; and
generally changes with trends in economy throughout periods of time)

For example, if in 2010 (suppose fixed as base year), the price of potato was Rs. 20 / kg,
but the price has increased significantly throughout the period, becoming Rs. 25 /
kg in 2015. Then the inflation would be simply (25 - 20) / 20 x 100 % = 25 %

Note carefully, we cannot have a clear picture of overall inflation by taking only
one commodity. But then, we cannot even take all commodities (millions!) to
measure inflation. Therefore, it is logical to take few (say 400 or 600, only a figure) most
used and important commodities in market to measure inflation.

Also note that the price of commodities can be less than the base year. then it will be
known as Deflation (opposite of Inflation).

Stages of Inflation
Depending on the intensity of inflation, we can have several stages -

 Creeping Inflation - (slow) - 2 - 4 % inflation

 Trotting Inflation - (moderate) - 4 - 10 % inflation
 Galloping Inflation - (fast) - 10 - 20 %inflation
 Hyper Inflation - (very fast) - more than 20 % inflation
 Types of Inflation
Inflation can occur for several reasons, hence there are several types of inflation -
 Demand-Pull Inflation -
This type of inflation occurs, when the total demand for goods and services exceeds
the available supply in the market (meaning more goods needed, but limited stock). As an
effect, prices of those commodities increase. It is also known as Excess-Demand Inflation.
 Pricing Power Inflation -
This type of inflation occurs, when business houses or industries increase
prices of commodities to increase theirprofit margin significantly. Generally, they have few or
no competitors in their market segment, making their business into monopoly. It is also known
as Administered Price Inflation or Oligopolistic Inflation.
 Cost-Push Inflation -
This type of inflation occurs, due to the increase in prices of raw materials, wage of
employees, etc. making the ultimate product more costly. For example, price of car will rise, if
the price of raw materials to make a car increases.
 Sectoral Inflation -
This type of inflation occurs in a sector, due to the rise in prices in another sector, on which the
sector is dependent on. For example, ticket price of bus will increase due to
the increased price of diesel.

Measurement of Inflation
Price indices are used to measure the relative price changes (of goods and services) in
a region (generally a country) during a specific period of time (e.g., financial year,
or quarter, or month).

With the price indices, we comprehend about how much the price of goods and
services has increased (Inflation) or decreased (Deflation) from a fixed normal year,
known as base year (with respect to this base year, we calculate how much increase or
decrease in prices happened in this current year).

Price indices are generally used to measure the cost of living in order to determine
the wage increases necessary to maintain a constant standard of living.

Price Indices
Goods and services are provided to the consumer by the producer. It follows
several stages / levels in between -

 producer level (produced, or manufactured) - PPI

 wholesale level (at wholesale market, before going to the retail market) - WPI
 retail / consumer level (at retail market, from where consumers buy) - CPI

Wholesale Price Index (WPI)

WPI is used to track prices of goods at the wholesale stage (meaning goods sold in bulk,
rather that retailed), and traded between organizations, before going to consumers.

It is practically impossible to find price changes of all the goods traded in

an economy (millions of goods!). So it is logical to take a sample set, or 'basket of
 goods' (e.g., 676 commodities, or goods) to measure the inflation (few important goods
taken for measuring price changes).

Then determine a base year (e.g., 2004-05, 2010-11), with respect to which the current
inflation will be measured. WPI indicator tracks the price movement of each
commodity individually, and then determine through the averaging principle (Methods
like Laspeyres formula, Ten-day Price Index, etc. are used)

Note that all commodities are classified into 3 groups, and then their weighted average is
taken for measuring WPI -

 Primary Articles (e.g., food, non-food, mineral, etc.) - 20.1 % of total weight
 Fuel & Power (Coal, Mineral Oil, Electricity, etc.) - 14.9 % of total weight
 Manufactured Articles (food products, beverages, woods, paper, chemicals,
machinery, transport, etc.) - 65 % of total weight

Indian wholesale prices increased by 0.11 % in December 2014 after being flat (0 %)
in November 2014.

Consumer Price Index (CPI)

While WPI is calculated in wholesale stage, CPI is determined at retail stage,
where consumers are directly involved. Hence, CPI method better measures
the effect of inflation on general public. RBI adopted CPI as the key measure for
determining Inflation situation of economy, on recommendation of Urjit Patel committee.

CPI measures changes in prices, paid by consumers for a basket of goods (similar
to WPI, but here retail goods, instead of wholesale goods).

There are 3 broad types of CPIs - (for different type of consumers; new CPI system of 2012)

 CPI for Urban population, known as CPI (Urban)

 CPI for Rural population, known as CPI (Rural)
 Consolidated CPI for Urban and Rural, which is based on CPI (Urban) and CPI
(Rural) - key measure for CPI
CPI in India decreased to 144.90 Index Points in December
2014 from 145.50 in November.

Producer Price Index (PPI)

PPI is used to track pure price changes at producer level for goods as well
as services. PPI prices of many products and some services are determined form first
commercial transaction.
Note that in contrast to WPI, PPI doesn't contain tax components, keeping inflation free
of tax fluctuations.

The government of India has set up (Sep, 2014) a committee (13 members), headed
by Professor B.N.Goldar, to devise PPI for Indian economy. It is an international
 standard, which is followed by major economies (e.g., USA) of the world.

Why devising PPI in India?

 Currently, there is no index tracking inflation in service sector, that contributes
about 55 % to India's GDP (note that WPI doesn't track services sector in India)
 PPI tracks inflation excluding tax components. It will help to track
actual change in prices (note that WPI, CPI, both includes tax components)

Reflation

If the government tries to increase Inflation rate to stimulate economy, then it will be known
as Reflation. It can be done by -

 Increasing money supply to the market

 Reducing taxes, etc.
When Reflation is needed?
When the economy is in highly deflated state, i.e., in Deflation, where price level of commodities is
too low, or value of money is too high (meaning you can buy a lot of goods with small amount of
money!)

Disinflation

It is the opposite of Reflation. Disinflation process will be used by the government, if it tries
to decrease the Inflation rate to recover the economy from a high Inflation state. It can be done by -

 Decreasing money supply to the market

 Increasing taxes, etc.
When Disinflation is needed?
When the economy is in highly inflated state, i.e., in Inflation, where price level of commodities is
too high, or value of money is too low (meaning you can buy a small amount of goods with a lot of
money!)

Note that Reflation and Disinflation are the process of increasing and decreasing the Inflation rate,
respectively. But Inflation and Deflation are the state of economy, where the price level of goods
are too high and too low, respectively.

For example, suppose Inflation of January is 5 % (Inflation) and February is 4 % (Inflation). Then you
can say that the price is disinflated by 5 - 4 = 1 %, but is still in Inflated state (in Inflation) in
February.

Now suppose Inflation of January is 1 % (Inflation) and February is -2 % (Deflation). Then you can say
that the price is disinflated by 1 - (-2) = 3 %, and is in Deflated state (in Deflation) in February.
 There are two extreme cases of Inflation -

 Hyperinflation - This is an extreme situation of Inflation in an economy, when the

country experiences very high price level of goods (which is rapidly accelerating), and the
real value of money is very low (which is rapidly depreciating).
In this situation, people try to hold foreign currencies (e.g., USD), because their local currency
has very low value.
 Stagflation - This is an extreme situation of Inflation, which is associated with high
unemployment (stagnant inflation). It raises a dilemma for government, because
reducing inflation will rise unemployment, while reducing unemployment will
increase inflation.

Inflation Targeting
Inflation is a key concern for every economy. Governments or central banks always try to
keep inflation in a manageable level (low), because, the impact of inflation falls directly on
the daily life of the citizens (like, high price of goods, etc.).

Some central banks explicitly declare a target to keep inflation within the limit. This
explicit declaration is known as Inflation targeting. However, whether it is explicitly declared
or not, every central bank tries to keep inflation in a manageable level.

Inflation targeting adopted by RBI

Recently, RBI and Union Government signed an agreement on Monetary Policy
Framework to focus on flexible inflation targeting.

As per the agreement, RBI will have to maintain Consumer Price Index (CPI)-
based inflation targets below 6 % by January 2016, and 4 % (+/- 2 %) from 2016-
17 financial year (onwards).

With this inflation targeting, RBI will be more accountable, because if it fails to meet
the inflation target set by it, then RBI will have to explain reasons to the government.

Recommended by Urjit Patel Committee

The transition from Monetary Targeting suggested by Chakravarty Committee (1988)
to Inflation Targeting suggested by Dr. Urjit Patel Committee (2015) is similar to
the practice adopted by central banks in developed countries.

LIBOR, MIBOR, MIBID

Inter-Bank Offer Rate
When a bank offers loan to other banks (or any other financial institutions), then
it charges interest on that loan. The interest rates charged on the loans vary from bank to
bank. But these rates need to follow a benchmark, so that interest rates does not
differ too much among them (meaning, it should not happen, that an X bank charges 10 %
interest per annum on a loan, whereas, Y bank charges 20 % on the same type of loan, it
should be at par)
 Generally, Inter-bank offer rate is of short-term nature (overnight to 1 year), and
is followed for deciding interest rates to be charged on the loans offered to other banks
(refer Call / Notice / Term Money) (inter-bank market). It acts like a benchmark for
deciding interest rates.

Several financial markets follow different Inter-bank offer rates, like -

 London Inter-Bank Offer Rate (LIBOR)

 Mumbai Inter-Bank Offer Rate (MIBOR)
 Tokyo Inter-Bank Offer Rate (TIBOR)
 Singapore Inter-Bank Offer Rate (SIBOR)
 Hong Kong Inter-Bank Offer Rate(HIBOR), etc.

LIBOR
LIBOR was first published in 1986 for three currencies - USD, GBP (Great Britain Pound)
and JPY (Japanese Yen). Later on several other currencies were added in the list
(currently 10 currencies). It is published daily at 11:30 A.M (London time) by Thomson
Reuters, and Libor rates are determined for 15 borrowing periods (e.g., overnight, 1
week, 2 weeks, 1 month, etc. up to 1 year).

Formerly the Libor was maintained by British Bankers' Association (BBA), but the
responsibility is now transferred to Intercontinental Exchange.

# Reader's Question
How is Libor rate calculated?
At 11:00 AM, major banks (18 major global banks for the USD Libor) are called to
participate on the survey asking for the inter-bank offer rates. The highest four and
the lowest four interest rates (on the survey) are trimmed out (not used for calculation).
Then the remaining (remaining 10 for USD Libor) interest rates are averaged, and makes
the Libor rate.

Libor rate is published at 11:30 A.M. This happens for all the 10 currencies, taking major
banks for each currency.

MIBOR
MIBOR rate is for Indian inter-bank market, and is calculated on daily basis by National
Stock Exchange (NSE), along with Fixed Income Money Market and Derivative
Association of India (FIMMDA).

It is a weighted average of lending rates of a group

of banks (including Public Sector banks, Private Sector Banks, Primary Dealers, Foreign
Banks in India, etc.), on funds lent to first-class borrowers (well rated borrowers)

MIBOR is published on different timings (e.g., 9:40 A.M., 11:30 A.M. etc), and for
several maturity periods (e.g., overnight, 3 days, 2 weeks, 1 month, etc.)
 MIBID
Mumbai Inter-Bank Bid Rate (MIBID) is the opposite of MIBOR. While MIBOR is the
benchmark rate at which banks are willing to offer loans to other bank, MIBID is the
benchmark rate at which banks are willing to take loans (paying the MIBID interest rate)
from other banks.

Note that MIBID rate is always less than MIBOR rate, because, banks will try to pay less
interest after taking loans, and will try to getmore interest while offering loans. It is also
the weighted average of interest rates at which several banks (taken as survey) are willing
to pay.

Currently FIMMDA and NSE came with a new product, named as 'FIMMDA-NSE
MIBID/MIBOR' which acts like the benchmark for the inter-bank market in India (taking
both MIBOR and MIBID together)

Products linked with LIBOR/MIBOR

 Call, Notice, Term Money

 Forward Rate Agreements
 Future Interest Rate
 Interest Rate Swaps (IRS)
 Swap Options
 Overnight Index Swaps, etc.

Non Residential Indians (NRI) Accounts

Non-Resident Ordinary (NRO)
You are a citizen of India. You work here, and you have a good income. Now suppose, you
want to move to a foreign country (for whatever purpose) (meaning you are going to be
an NRI). Then what will you do to for your Indian earnings, like rent, dividends? Or may
be you want to send remittances from foreign country. Then the handy account for you
is Non-Resident Ordinary (NRO) Rupee Account.

The balance maintained in this type will be Rupee (INR) dominated. You can
open Savings, Current, Fixed, Term - types of account.

Non-Resident External (NRE)

You are already an NRI. You have foreign currency with you. You can open this type
of NRE Account. Note that you have to deposit foreign currency while opening this
account (can use traveler's cheque or notes).
 The balance will be maintained in Rupee (INR). This will facilitate mostly in
your remittances to India. You have several options or opening Savings, Current, Fixed,
Term accounts.

Foreign Currency Non-Resident Bank (FCNR(B))

This is another type of account for NRIs and almost similar to NRE account. However there
are some major differences -
 You can only maintain your FCNR(B) account in foreign currencies (like, Pound,
Dollars, Euro, Yen, etc)
 Only one type of deposit is allowed - term deposit of 1 to 5 year maturity.

Now, try to compare these three types of accounts -

Non-Resident Foreign Currency Non-

Non-Resident (Ordinary)
(External) Rupee Resident (Bank)
Rupee Account (NRO)
Account (NRE) Account (FCNR(B))

Rupee Denominated USD, Pounds, Euro,

Currency Rupee Denominated (INR)
(INR) Yen, etc.

NRI,
Who can
Resident before becoming NRI NRI
open?
an NRI

A/c type CASA, Fixed/Term CASA, Fixed/Term Only Fixed/Term

To park overseas To maintain account

To park Indian earnings,
savings remitted to in foreign currency.
Purpose like rent,
India Only term deposit of 1
Indian salary, dividend, etc.
by converting to INR to 5 years

Only interest on NRO

Repatriation accountbalance (after Yes Yes
deducting TDS)

Taxed as per applicable slab

Tax Tax free Tax free
rate
NOSTRO, VOSTRO, LORO Accounts
Nowadays, bank operations are not confined within a national border. Banks are
opening branches in foreign countries. But the problem is - Is it possible for a bank to
open branch in each and every country?
Obvious answer is no. Then what is the easiest way to handle this situation?

Open an account in the foreign countries' bank!!

Here Nostro, Vostro and Loro accounts come into play. Note that all these accounts are
termed as one's own country-basis.

NOSTRO Account
Italian word 'nostro' means 'ours'. Hence, Nostro account points at - "Our account with
you"
Nostro accounts are generally held in a foreign country (with a foreign bank), by
a domestic bank (from our perspective, our bank). It obviates that account is maintained in
that foreign currency.

For example, SBI account with HSBC in U.K.(may be)

VOSTRO Account
Italian word 'vostro' means 'yours'. Hence, Vostro account points at - "Your account with
us"
Vostro accounts are generally held by a foreign bank in our country (with a domestic
bank). It generally maintained in Indian Rupee (if we consider India)

For example, HSBC account is held with SBI in India. (may be)

LORO Account
Again, Italian word 'loro' means 'theirs'. Therefore, it points at - "Their account with
them"
Loro accounts are generally held by a 3rd party bank, other than the account
maintaining bank or with whom account is maintained.
For example, BOI wants to transact with HSBC, but doesn't have any account,
while SBI maintains an account with HSBC in U.K. Then BOI could use SBI account. (again
may be)

Line of Credit (LoC)

Line of Credit (LoC) - What do we get from the term?
To what extent (i.e., line) we can get loan / advance (i.e., credit). Of course, LoC are
generally given to the corporate for business purpose (though, often we hear news
about government giving Rs. XXX Line of Credit to ZZZ country for development)

Note that this is generally given to corporate for business, on their Cash Credit (CC)
Accounts (already discussed about CC in my previous post. Please refer that)

General Procedure
Banks analyze the audited Balance sheet of the prospective borrower (businessman) to
appraise their needs and checking their capacity to absorb the credit. The borrowers need
to furnish their financial details in the form of Credit Monitoring Arrangement (CMA)
data to the bankers and file an application for loan.

This application is then processed by the bank and a suitable Line of Credit (LoC) (limit) is
allowed to the borrower.

The overall limit (LoC) is structured into various types of facilities or accounts - each with
its own limit under the overall LoC (meaning, several accounts, which to be formed, have
their own limit, which collectively is under overall LoC).

The borrower is then asked to surrender the security or title to the bank (as collateral)
and open suitable accounts (mostly Cash Credit Accounts, with different underlying
securities) with the bank.

Thereafter, the borrower can operate these accounts within the limit, i.e., Line of Credit.

Banking Ombudsman
Ombudsman is an official appointed to investigate individual's complaints against
a company or organization, especially a public authority (Google definition of
'Ombudsman').

To facilitate customer complaints resolution process, RBI introduced

this fast and inexpensive (no fee to avail this facility) Ombudsman
Scheme in 1995 under Section 35A of Banking Regulation Act, 1949. In this
scheme, RBI appoints the Banking Ombudsman, generally a senior official,
to redress customer complaints against deficiency in certain banking services provided by
a bank.

Banks covered under this scheme

 Scheduled Commercial Banks (SCBs)
 Regional Rural Banks (RRBs)
 Scheduled Primary Co-operative Banks

Banking Ombudsmen and their location

Currently, total 15 Banking Ombudsmen have been appointed by RBI, and
their offices are located mostly in the state capitals -

Allahabad, Bengaluru, Bhopal, Bhubaneshwar, Chandigarh, Chennai, Guwahati,

Hyderabad, Jaipur, Kanpur, Kolkata, Mumbai, Delhi, Patna, Thiruvanthapuram

Legal power of Ombudsman

Banking Ombudsman is a quasi-judicialauthority, who has legal power to summon both
the parties - Bank and its customer, to facilitate
the resolution of complaint through mediation.

Banking Ombudsman Scheme, 2006

The latest scheme is Banking Ombudsman Scheme, 2006, which has wider extent and
scope than its previous versions, like online submission of complaints is possible. Also,
if customer is not satisfied with the resolution provided by Ombudsman, he can approach
the Appellate authority, i.e., Deputy Governor of RBI.

Complaint process
A customer can file a complaint before the Ombudsman, only after the followings -
 If he has not received any reply from the bank within a period of 1 month after
the bank has received his complaint (meaning, customer has to complain to the bank first,
then Ombudsman)
 If the bank rejects the complaint of the customer
 If the customer is not satisfied with the reply from the bank
He can file a complaint by writing on a plain paper, or online, or email to the Banking
Ombudsman (under whose jurisdiction the bank branch is)

Note that, Banking Ombudsman is not meant to replace the traditional Consumer
Courts or Forums, but the scheme only supplements them. Also note that this scheme
deals with complaints of max. Rs. 10 lakh disputes.
ADR and GDR
Depository Receipts (DR)
A publicly listed (stock exchange listed) company might want to raise money
from foreign countries (in contrast to its domestic country). So it will list
its securities (stocks or equities) to a foreign country's stock exchange in form
of Depository Receipts (DR).

Therefore, DRs are a type of negotiable financial security (usually stocks/equity) by

a foreign publicly listed company, which are traded on a local Stock exchange (e.g.,
american company trading on Bombay Stock Exchange).

Example -
An American company (publicly listed in New York Stock Exchange, or any other stock
exchange in USA) might want to raise money from foreign countries (like, India). So, it will
list its securities in Indian stock exchanges (may be Bombay Stock Exchange) by means
of Depository Receipts. Then Indian investors can invest in these securities.

American Depository Receipts (ADR)

Depository Receipts were first started in USA in late 1920s. DRs issued by any company
of USA/America will be known as American Depository Receipts (ADR). ADRs, generally,
are traded in US Dollar.

Global Depository Receipts (GDR)

DRs became popular in other parts of the world after its introduction in USA. DRs of all other
countries (other than USA) will be known as Global Depository Receipts (GDR).

Issuance of DRs
When a foreign company intends to list its securities on another country's stock
exchange, it goes through DR mode. Steps -
1. The shares of the foreign company (which the Depository
Receipts represent) aredelivered and deposited with thecustodian bank (bank
that facilitates the company's DR).
2. On receipt of the delivery of shares, thecustodian bank creates Depository
Receipts (DR) and issues to investors in the country (investor's country, not
company's country)
3. These DRs are then listed and traded in the local stock exchange of that
country.

Recession and Subprime Lending

Recession
For a healthy economy, a country needs to have smooth economic
activities of production, distribution and consumption of goods and services at all
levels. But what if all these activities drastically reduced (due to some reason) to a very low-
state and continues to be in that state for a long time?
 This kind of slowdown or a massive contraction in economic activities, is known
as Recession. It may last for some quarters, which have a great adverse effect on
the growth of an economy (making negative GDP growth, may be). Other adverse
effects, like -
 Unemployment
 Drop in Stock Market
 Decline in Housing Market
 Business losses
 Social effects, like low living standards, low wages, etc.
The technical indicator of a recession may be two consecutive quarters of negative
GDP growth. Recessions can occur for excessive subprime lending, as described below.

Subprime Loans
A bank generally follows a credit scoring system to determine borrowers eligibility for
a loan. If a borrower doesn't have a good credit history, then the bank can deny him/her
a loan. But if the bank decides to allow him/her a loan (even with that limited
credit history), then the loan is known as subprime loan.
This type of loan carries more credit risk, and therefore carries higher interest rate. Think
what will happen, if he/she eventually cannot pay back the loan (with extra interest rate on
it!)

US Subprime Crisis of 2007-09

US banks started to lend subprime loans to the low credit borrowers,
with houses, or properties as mortgage. They thought that if the borrowers become
unable to pay back, then they could seize the properties and sell in high prices
to recover the loans.

But what happened is the prices of houses/properties declined drastically, leading

to mortgage delinquencies and devaluation of housing-related securities. This led the
banks to become bankrupt (e.g., Lehman Brothers), because they couldn't recover the
amount of their huge subprime lending against mortgage securities.

Current Recession in Venezuela

Due to political instability and falling oil prices, Venezuelan economy (highly dependent
on oil exports) shrank by 2.8 % in 2014, while inflation topped 64 %. It
led Venezuela to fall in recession.
DEAF Scheme
There are several accounts in banks which are not operated for 10 years (or more), or
there are deposits which are unclaimed for 10 years (or more). There is little possibility
that the deposits will be reclaimed by the owner (as it is unclaimed for that long period).

RBI decided to acquire those unclaimed amounts and create a fund, which could be used
for the good of the public. It amended the Banking Regulation Act, 1949, by
adding Section 26A, which empowers RBI to establish the Depositor Education and
Awareness Fund (DEAF).

All the unclaimed amounts in the banks need to be transferred within 3 months after
becoming 10 years default, to the DEAF fund. Also note that the transfer is allowed only
in electronicmode.

The goal of this DEAF fund is to promote depositor interest, like educating them, or
creating awareness among them, or some other purpose.

Situational Question
If someone comes to your bank and claims for his/her deposit (which has already
been transferred to DEAF fund, because it defaulted for 10 years), what will you do?

You will verify his/her claim, and after successful verification, will honor the claim.

Note that the bank would be liable to pay the amount to the depositor/claimant and claim
refund of such amount from the DEAF fund (even after 10 years).

Interest Rate Swap (IRS)

# Readers' Question
Please explain Interest rate swap with example

An Interest Rate Swap (IRS) is a financial instrument that works in a derivative market,
where two parties exchangeinterest rate payments between them.

IRS is useful when one party wants to receive paymentwith a variable interest rate, while the
other party wants to limit future risk with a fixed interest rate.

Clear the concept with an example -

Example
 Suppose, two companies X and Y has come up with anagreement of Interest Rate Swap (IRS) with
a nominal value of Rs. 1,00,000.

Company X offers a fixed rate of 5 % per annum to Y on the nominal amount, whereas Y agrees to
pay a variable rate, like Mibor rate + 2 % per annum to X in return. Note that Mibor rate changes
on daily basis, making the rate avariable one.

(Don't take the following figures of Mibor rate as actual!)

Here, both X and Y know that Mibor rate (variable) will remain roughly around 3 % (just a figure),
making italmost equal to the fixed rate, i.e., 3 + 2 = 5 %. Note thatX will make a profit if the Mibor
rate is greater than 3 %, because in that case, Y will pay X more than 3 + 2 = 5 %.

Conversely, if the Mibor rate is lower than 3 %, then X will make a loss, because Y will
pay less than 3 + 2 = 5 %.

Clear it with figures -

CASE 1 - Mibor rate is greater than 3 %, say 3.5 %

 Y will pay 3.5 + 2 = 5.5 % interest rate on thenominal amount (i.e., Rs. 1 lakh) to X at the end
of that year, making total interest = Rs. 1,00,000 x 5.5 % = Rs. 5,500 interest
 Also, X will pay the fixed 5 % interest rate on the same nominal amount of Rs. 1 lakh, making
totalinterest = Rs. 1,00,000 x 5 % = Rs. 5,000 interest.
Note that only the net difference is settled in case of Interest Rate Swap, meaning only Rs. 5,500 -
5,000 = Rs. 500 will be paid to X by Y.
In this case X made a profit, while Y faced a loss of Rs. 500.

CASE 2 - Mibor rate is less than 3 %, say 2.5 %

 Y will pay 2.5 + 2 = 4.5 % interest rate on the nominal amount (i.e., Rs. 1 lakh) to X at the
end of that year, making total interest = Rs. 1,00,000 x 4.5 % = Rs. 4,500 interest
 Also, X will pay the fixed 5 % interest rate on the same nominal amount of Rs. 1 lakh, making
total interest = Rs. 1,00,000 x 5 % = Rs. 5,000 interest.
Note that only the net difference is settled in case of this Interest Rate Swap, meaning only Rs.
5,000 - 4,500 = Rs. 500 will be paid to Y by X.
In this case Y made a profit, while X faced a loss of Rs. 500

Why IRS agreement?

 To hedge (reduce risk) an investment
 To earn some extra money, with a little risk (in the above example, Y agreed in IRS
with X, because, he hoped that if Mibor rate gets increased, making the total interest rate (Y
paying to X) greater than the fixed interest rate (X paying to Y), then he will make
a profit (refer Case 2). Albeit he risked a little (refer Case 1)
Note that the risk is less, because they both know that Mibor rate will remain roughly around 3
% (not making huge difference from 3 %. Mibor rate will never become, say, 6 % or 1 %, etc.)
(just a figure). Selecting a good variable rate (like Libor, Mibor, etc.) is very much important for
IRS.

Disinvestment
Investment can be thought as the conversion of money into securities /
assets (you invest in some company, means you use your money to buy some security,
like shares, bonds, debentures, etc.)

Conversely, Disinvestment can be thought as the conversion of securities /

assets into money.

Generally, disinvestment is the action of an organization, or government,

selling its asset (may be shares, or stocks, or any other security) or its subsidiary. In
return, the organization or government gets, or raises money, which it can use for other
purpose.

Example
Currently, the government sold 63.16 crore shares (10 % stake) of Coal India Limited
(CIL) on January 30, 2015, reducing government stake in CIL to 79.65 % (from 89.65 %).
By this disinvestment, government raised Rs. 22,558 crore. (meaning, government sold
some of its shares, and raised money against it)

Why Disinvestment by government?

 Financing the fiscal deficit (to reduce it)
 Financing large-scale infrastructure development
 To reduce government debt
 Any other purpose

Financial Market Entities

1. Commercial Banks
Commercial banks include Public Sector Banks (PSB), Private Sector
Banks and Foreign Banks. The main activity of these banks
are acceptance of deposits from the public for the purpose of lending or investment.

2. Cooperative Banks
Coop Banks are also allowed to raise deposits and provide advances from and to
public. Urban Cooperative Banks (UCBs) are controlled by respective state
governments and RBI, while other Coop banks are controlled by NABARD and state
governments. Except for certain exemptions in paying a higher interest on deposits, the
UCBs regulatory framework is similar to the other banks.

3. Non-Banking Financial Companies (NBFCs)

NBFCs are allowed to raise money as deposits from the public and lend through various
instruments including leasing, hire purchase, bill discounting, etc. These
are licensed and supervised by RBI.

4. Primary Dealers (PDs)

PDs deals with government securities both in Primary market and Secondary market.
Their basic responsibility is to provide markets for government securities and strengthen
the government securities market.

5. Financial Institutions (FIs)

FIs are those developmental institutions that provide long-term
funds for industry and agriculture. FIs raise their resources through long-term
bonds from the financial market and borrowings from international FIs.

6. Payment and Settlement System / Clearing Houses / Currency Chests

An efficient and effective Payment and Settlement system is a necessary condition for a
well running financial system. Maintenance of Clearing Houses at various centers,
creation of currency holding chests in different geographical areas and creation of the
mechanism for electronic transfers of funds (EFT) are vital activities undertaken by RBI.

7. Stock Exchanges
A stock exchange is duly approved by capital market regulator to
provide sale and purchase of securities on behalf of investors. The stock exchanges
provide Clearing House facilities for netting of payments and securities delivery.
Securities include equities, debt, derivatives, etc.

8. Brokers
Only brokers are approved by capital market regulator to operate on the stock exchange.
Brokers perform the job of intermediary between buyers and sellers of securities. They
help build-up an order book, carry out price discovery and are responsible for broker's
contracts being honored. The services are subject to brokerage.

9. Equity and Debt Raisers

Companies wishing to raise equity or debt through stock exchanges have to approach the
capital market regulator with the prescribed applications and a proforma for permission to
raise equity and debt and get them listed on a stock exchange.

10. Investment Bankers / Merchant Bankers

Merchant banks undertake a number of activities such as undertaking the issue of stocks,
fund raising and management. They also provide advisory
services and counsel on mergers and acquisitions (M&A), etc. They are licensed
by capital market regulator.

11. Foreign Institutional Investors (FIIs)

FIIs are foreign-based funds authorized by capital market regulator to invest in the
Indian equity and debt market through stock exchanges.

12. Depositories
Depositories hold securities in demat form (not in physical form),
maintain accounts of Depository Participants (DPs), who in turn, maintain sub-
accounts of their customers. On instructions of the stock exchange clearing house,
supported by documentation, a depository transfers securities from the buyers to sellers
accounts in electronic form.

13. Mutual Funds (MFs)

An MF is a form of collective investment that pools money
from investors and invests in stocks, debt and other securities. It is a less
risky investment option for an individual investor. MFs require the regulators' approval to
start an Asset Management Company (AMC) and each scheme has to be approved by
the regulator before it is launched.

14. Registrars
Registrars maintain a register of share and debenture holders and
process share and debenture allocation, when issues are subscribed. Registrars too need
regulator's approval to do business.

Pre-2005 Banknotes and MG-2005 Series

Banknotes Series
Since Independence of India, three different series of banknotes are issued -

1. Ashoka Pillar Banknotes - Issued in 1949

2. Mahatma Gandhi (MG) Series 1996 - Issued in 1996
3. Mahatma Gandhi (MG) Series 2005 - Issued from 2005

MG Series - 2005 Banknotes

These series banknotes are issued in the denomination of Rs. 10, 20, 50, 100,
500 and 1000, and contain some additional new security features that MG Series-
1996 doesn't have. Started from August 2005, MG Series - 2005 banknotes are currently
being used in India.

It is very easy to distinguish MG-Series 2005 notes from its predecessors, because these
notes bear the year of printing on the reverse side.

Withdrawal of Pre-2005 Banknotes

RBI changed the design of pre-2005 banknotes and introduce new security features
primarily to minimize the risk of counterfeiting. So that the economy can
be protected from counterfeiters or forgers.

Also, the withdrawal exercise is in conformity with the standard international practice of
not having multiple series of notes in circulation at the same time.

Public can visit any bank branch, or RBI Issue Office to exchange pre-2005 banknotes.
Recently, the deadline of January 1, 2015 has been extended to June 30, 2015 by RBI.

Situational Question
RBI has given a deadline for the exchange of pre-2005 banknotes. What will happen to
those notes (that will still remain in circulation) after the deadline? Will those remain a
legal tender?

RBI has clarified that the public can continue to freely use those notes for
any transaction and can unhesitatingly receive those notes in payment, as all
such notes continue to remain legal tender.

But public is encouraged to exchange pre-2005 notes with MG Series-2005 notes.