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[Banking] Monetary Policy: Quantitative & QualitativeTools, applications & limitations MSF, LAF, Repo,OMO, CRR, SLR, Revisited before upcoming UrjitArticle

1. Prologue

2. What is monetary policy?

3. Quantitative Tools

1. #1: Reserve Ratios (SLR and CRR)

2. #2: Open Market Operation (OMO)

3. #3: Policy Rate

4. Bank Rate

1. Liquidity Adjustment facility (LAF)

2. LAF Repo Rate

3. Marginal Standing facility (MSF)

4. Reverse repo Rate

5. Repo Rate in recent years:

4. Monetary Policy: limitations

5. Qualitative Tools

1. #1: Margin Requirements/ LTV

2. #2: Consumer credit regulation

3. #3: Selective credit control

4. #4: Moral Suasion

6. Monetary policy tools: Quantiative vs Qualitative

7. Appendix

1. #1: Why High SLR and High CRR are bad?

2. #2: Narsimhan (I) Committee 1991

3. #3: Narsimhan (II) Committee 1998

8. Mock Questions

PrologueNext article is about RBI appointed Urjit Patel Committee on Monetary policy framework.

But before dwelling into that, we must recap the basic concepts of what is monetary policy:its tools and limitations. Otherwise Urjit won’t make much sense.

Hence in a way, this whole article is a prologue to next article.

Why RBI and Why Monetary policy?

Initially people used barter system for trading. But the barter system had many problems ( clickme). Therefore, people switched to money system.

Financial intermediates = middlemen who help in the circular flow of money betweenhouseholds and business firms.

There are two types of financial intermediaries: banking institution and non-bankingfinancial institutions.

RBI controls (all) banks and (some) non-banking financial institutions.

RBI’s main job is to control Money supply in this game, and thereby fight inflation anddeflation.

Inflation = price rise = bad for economy, you know that by common sense.

But Deflation = price decrease = we can buy things at a lower price. Isn’t that good? Why isdeflation bad for economy?

Ans. Every business has ‘fixed cost of production’ say minimum light bill, phone bill, officerent, staff salary etc. So, if prices keep falling and falling (say of Nano car), then carmarker will suffer losses. He has no motivation to expand business. He wants to cut downhis production costs, by firing some of the employees= less new jobs created=unemployment = social unrest.

If prices of everything fall- then custom duty, VAT, excise duty, service tax- their collectionwill also decrease. Then government has less money to spend on education, healthcare,social sector, defense, law and order = poverty, disease, crime.

by the way

TERM meaning Does RBI wantit?

DEFLATION fall in the prices (and fall IN employment.) No.

DISINFLATION Fall in the prices but without causing unemployment. yes (whilefighting inflation)

STAGFLATION stagnation + inflation

prices and wages risebut people can’t find jobs, companies can’t findcustomers.

No

REFLATION policy to stop the fall in price levels, but without causingrise in the price levels (inflation).

yes

What is monetary policy?Policy made by the central bank.

To control money supply in the economy. (and thereby fight both inflation and deflation).

RBI implements monetary policy using certain tools. Two types

quantitative tool qualitative tools

Let’s start from here.

Quantitative Tools

#1: Reserve Ratios (SLR and CRR)

SLR A Bank has to set aside this much money into gold or RBI approved securities. 23%

CRR A Bank has to set aside this much as reserve. Bank cannot lend it to anyone.Bank earns no interest rate or profit on this.

4%

Reserve ratio: SLR, CRR

Suppose economy is showing inflationary trend. Prices of all goods and services areincreasing day by day.

How can RBI stop it using Reserve ratio as a tool?

In this case, RBI should RAISE the reserve ratios.

Observe:

Right now

People deposited total this much money in SBI (net demand & TIMEliabilities NDTL)

100 cr.

CRR (4%) [SBI has to keep this much cash aside for reserve] -4 cr

SLR (23%) [SBI has to invest this much money in RBI approved securities] -23 cr.

Money left with SBI 100-4-23=73Cores.

Say RBI raises SRL to 40% and CRR to 15% then?

Originally 100 cr

SLR 40 -40

CRR 15 -15

Money left with SBI 45 cr.

You can see, when Rajan has raised reserve ratio, money with SBI is reduced (from 73 crores tojust 45 crores.)

What will be its implication?

Imagine you’re a money lender. You’ve 100 crore rupees and you must make Rs.1 croreprofit in a year.

Obviously, you should lend it @1% interest rate. (because 1% of 100 crore = 1 crore.)

But what if you’ve only 2 crore rupees, and you still want to make Rs.1 croer profit in ayear?

Now you must lend it @50% interest rate. (because 50% of 2 cores = 1 crore.)

Observe that as money decreased (from 100 to 2), loan interest rate increased (from 1% to50%).

Same happens when SBI is left with less money (after RBI increases reserve ratio).

Let’s prepare a flow chart.

Situation: Economy has inflationary trend. Prices of goods and services increasing every day.

Solution: RBI raised reserve ratio (CRR, SLR)

Result: SBI is left with less money to lend.

Consequences:

1. SBI raises its loan interest rate

2. Businessmen borrow less money from SBI

3. Businessmen donot start new business. Donot expand existing business

4. Result=Less jobs. Even existing employees discharged. If anyone remains in the job, hedoesn’t get pay raise. He starts cutting down unnecessary expenditure (e.g. buying twonewspapers, getting his shirts ironed, drinking tea @4PM in office and so on. Thus evenpaper-wall, dhobi, chai-walla- everyone’s income reduced.)

5. Result= Less income (Because of above reasons)

6. Result= Less demand of goods and services (because less income).

7. Ultimately shopkeeper will bring down the prices to attract people into buying more things.

Thus inflation is reduced.

You may doubt- what about supply side bottlenecks, what about cost push and demand pullinflation : I’m not going into all that details at the moment, else this article will become longer thanfive kilometers.

Let’s just prepare a summary table:

Policy dear money cheap money

Tool To fight inflation To fight deflation

Reserve Ratio (CRR, SLR) Increase them. Decrease them.

Moving to the next (Quantitative) tool. Under monetary policy

#2: Open Market Operation (OMO)

Open Market Operation= when RBI starts buying/selling government securities to controlmoney supply.

Government securities= piece of paper. It says something like this “give me Rs.100, I’llgive you 8% interest rate for next ten years and after that I’ll repay the principle of Rs.100.”This is how government borrows from others.

Situation: Economy has inflationary trend. Prices of goods and services increasing everyday.

Solution: RBI starts selling government securities in open market.

Result: SBI buys them and thus SBI’s lending money is reduced. Wait. How?

Imagine Rajan is selling “sabzi” (vegetables). If SBI’s chairman Arundhati Madam goes to buyvegetables. Obviously madam’s money will decrease when she buys vegetables.

Then same as usual:

1. SBI left with less money to lend.

2. SBI raises its loan interest rate (to keep profit margin same)

3. Businessmen borrow less money from SBI.

4. Businessmen donot start new business. Donot expand existing business

5. Less jobs

6. Less income

7. Less demand

8. Ultimately shopkeeper will bring down the prices to attract people into buying more things.

Thus inflation is reduced.

During deflation, RBI will do the reverse. (i.e. RBI buys “Sabzi” from SBI). How will it stopdeflation? Think in your head.

Let’s update our table

Policy dear money cheap money

Tool To fight inflation To fight deflation

Reserve Ratio (CRR, SLR) Increase them. Decrease them.

Open Market Operation (OMO) RBI sell securities RBI buy securities

Mock Question

In 2013, UPSC walla asked a very chillar question from this topic.

In context of Indian Economy, ‘Open Market Operation’ refers to

1. Borrowing by scheduled banks from RBI

2. Lending by commercial banks to industries and trade

3. Purchase and sale of government securities by the RBI

4. None of Above

Whenever you face a GS/GK type MCQ, You’ve three choices

Skip If you don’t know the answer, Just leave it instead of risking negative mark.

Attempt Correct answer is Opt C.

Mark nReview.

It means you’ve unsure of the answer. 50:50. So you mark the question number (say45), at the back of your question paper. At the end of exam, if you’re left with 10-15free minutes. You look at the question again, and try to solve it.

So, should you put above question in “mark n review”?

No.

Because it’s a definition based question. If you don’t know the definition of “OMO” youmight tick a wrong answer and fail. Most of the sincere players fail in prelims because ofthis reason. They push their luck in negative marking to overcome an ‘imaginary’ cutoff andthus dig up their own grave. (especially during last 10-15 minutes of the exam.)

Moral of the story: never put “fact/definition” type MCQs in Mark-n-Review.

Let’s solve a bit more complicated MCQ from 2012′s CSAT paper.

Q.Which of the following measures would result in an increase in the money supply in economy?

1. Purchase of government securities from public by central bank

2. Deposit of currency in commercial banks by the public

3. Borrowing by government from the central bank.

4. Sale of government securities to the public by central bank.

Answer choice

1. Only 1

2. 2 and 4

3. 1 and 3

4. 2, 3 and 4

Whenever you face such multiple statement type MCQs, always use “elimination method”. Firstfind a statement that is definitely right or definitely wrong and eliminate choices accordingly.

Focus on first statement “Purchase of government securities from public by central bank”:will it increase money supply in the system?

Imagine Rajan puts an ad in newspaper: bring your Sabzi (vegetables), I’ll buy it. Juntagives him their own veggies, Rajan gives them money. (a classic buy and sell).

Ultimate result: money supply increased in the system- because junta got the money.Meaning #1 definitely correct.

If you think it on technical terms. Central bank purchases government securities=OMO(Open market operation), where money shifts hands from RBI to people.

Hence money supply increased. (In reality, money doesn’t go to ‘aam admi’ directly, butthose bankers and non-banking institutions who participate in OMO). Anyways, #1 is right,Eliminate choices that do not have #1

1. Only 1

2. 2 and 4

3. 1 and 3

4. 2, 3 and 4

Now the final answer depends on whether statement #3 is right or wrong?

Statement #3 says “Borrowing by government from the central bank.” (So, will it increasemoney supply?)

How does Government borrow from Central bank? Does Mohan just callup Rajan anddemand 1 lakh crores? No. Mohan will have to give Rajan that much governmentsecurities (vegetables) and Rajan will give him cash.

Is money supply increased? Yes Mohan sold veggies to Rajan and got Money. WheneverRajan buys veggies and pays – the money supply is increased. (this is similar to OpenMarket operation)

Besides, Mohan can then use money to pay salaries of government staff, pay for rail-road-bridges and other infrastructure projects, pay for MNREGA and so on. Therefore AnswerC: 1 and 3 correct.

Counter- argument?

What if Rajan subsequently sells those (Mohan’s) securities to bankers. Then banker’smoney reduced. Hence #3 is wrong. Therefore final answer A only 1.

So, what’s the final answer: is it A or is it C?

Ultimate judge= UPSC’s official answer key uploaded on their site.

In 2012′s Question paper Test series “A”, this is Q77: and its official answer is “C”. Therefore,both 1 and 3 are correct.

Anyways, what to do in the exam?

Skip If you don’t know the concept better skip.

Attempt This question is attemptable if you don’t drag the logic too much in statement #3.

Mark nReview.

Yes, it can be put under “mark and review” because this is not an absolute fact/absolute definition type MCQ. If you apply some concepts, you can eliminate wrongchoices. But still if doubt persists in the mind (e.g whether Statement 3 is right ornot) then it’s always safe to skip and avoid negative marking.

By the way, What about Statement #2: Deposit of currency in commercial banks by the public.(Will it increase money supply or not?)

Viewpoint 1: yes. Because bank can used it to expand loanable credit. (as explained inMoney creation topic in Class 12 NCERT Macroeconomics page 39 onwards).

Viewpoint 2: no. (Because Bank will have to put some money aside as CRR- so that muchmoney is less in the system.)

Either way it doesn’t change the answer. Because We know that statement 1 is definitely correct.And there is no option where (1,2) are given simultaneously.

Anyways, Moving on…So far, RBI has two tools under monetary policy:

1. reserve ratios (SLR, CRR)

2. Open market operation.

Third and the most important “quantitative” tool is

#3: Policy Rate“Policy rate”= in case of India its Repo rate. Before moving further, let’s refresh our concepts ofBank rate, LAF, MSF, Repo and Reverse repo.

Bank Rate

When banks borrow long term funds from RBI. They’ve to pay this much interest rate toRBI. [Note: different books give different explanation of Bank Rate. I've used NDTV'sdefinition]

At present, Bank rate= 9%

Collateral: nothing. (Bank can borrow money without pledging government securities toRBI)

Bank rate is not the main tool to control money supply these days.

Nowadays, RBI uses LAF Repo rate as the main tool, to control money supply.

Ok then What’s the use of Bank rate?

Penal rates are linked with Bank rate. For example, If a bank doesn’t maintain CRR, SLRas per the prescribed limit.

Then RBI can impose penalty interest on such notorious bank.

At present, Penalty rate = Bank rate + 3% (or 5% in some cases)

Meaning if Bank rate = 9% then penalty rate=9+3=12%

Anyways, what if RBI wants to fight inflation using bank rate as a “tool”?

Obviously they should increase bank rate. That way it becomes harder (more expensive) forbanks to borrow from RBI.=> SBI increases its loan rates (to keep the profit margin same).Result?

Less people get home loan, bike loan, business loans.

Less business expansion

Less jobs

Less incomes

Less demand

Ultimately shopkeeper will bring down the prices to attract people into buying more things.

Thus inflation is reduced.

Let’s update our (stupid) table

Policy dear money cheap money

Tool To fight inflation To fight deflation

Reserve Ratio (CRR, SLR) Increase them. Decrease them.

Open Market Operation (OMO) RBI sell securities RBI buy securities

Bank rate Increase decrease

Liquidity Adjustment facility (LAF)

Liquidity Adjustment facility

RBI started this in 2000. You can imagine it as a “Adda/gambling den/gang-hideout” whereRBI’s clients gather, consumer desi liquor, play cards, watch item songs and borrowmoney from RBI (or lend Money to RBI).

By the way, who are the clients of RBI?= Central and state governments, Banks and non-banking financial institutions (NBFI). NBFI further includes:

AIFI (all India finance institutions) NABARD, SIDBI, EXIM Bank and NationalHousing Bank.

Primary dealers (Morgan Stanley , Goldman Sachs, JP Morgan Chase, StandardChartered Bank, HSBC etc.)

Non-Banking financial companies.

Anyways, Under this LAF “adda”, RBI has two tools:

Repo If client borrows money from RBI (for short term) then client has to pay this muchinterest rate to RBI. At present Repo is 8%. (article written on 29th Jan 2014)

ReverseRepo

If client lends money to RBI (for short term) then RBI has to pay this much interestrate to client. RBI doesn’t like headache. So they made a simple formula: Reverserepo rate= Repo MINUS 1%=8-1=7%.

Collateral:

Problem with running a “adda/gambling-den” = sometimes client drinks too much desiliquor and passes out on floor. Sometimes he even dies because of ‘hooch’. Sometimespolice raids the den, and clients run away with cash and register.

If such things happen, Rajan will be at loss. So, he demands “government securities” ascollataral. So even if client doesn’t repay money on time, Rajan can sell those securities (inopen market operations) and recover money.

LAF Repo Rate

Let’s get a bit technically correct now. Observe following image

Scenario

SBI chairman Arundhati ma’m wants to borrow Rs.100 crore (for short term).

She gives her stash of government securities to Rajan.

Rajan gives her Rs.100 crore.

Madam Also signs an agreement

“I, Arundhati Bhattacharya, agree to buy same securities from Rajan, at 108 crores after 14days.”

Notice that she has agreed to “re-purchase” same securities from Rajan. Therefore itscalled “Repo.”

And how much interest rate did she pay on this “loan”? [108-100]/100=8%. That’s our reporate.

Important:

Recall that SBI also has to keep part of her money in RBI approved securities (underSLR).

So Madam cannot USE those government securities to borrow under Repo Rate fromRajan.

That leads to a new topic

Marginal Standing facility (MSF)

MSF mechanism is same as repo. But some differences

LAF (Repo) MSF

Rajan says “don’t come hereunless you want to borrowminimum Rs.5 crores.”

Minimum Rs. 1 crore.

All clients are welcome i.e.

Central and stategovernmentsBanks – be it commercialbank or RRB orcooperative bankNon-banking financialinstitutions.

Sorry. Not all clients welcome here.Only scheduled commercial banks can borrow underthis window. SBI, PNB, BoB, ICICI etc.This MSF facility is specially created to help themsolve short-term cash mis-match.

You (bankers) cannot pledgesecurities from SLR quota toborrow from this window.

Can use securities from SLR quota.

No limit. You may borrow asmuch as you want. (as long asyou have government securitiesto pledge to me.)

Maximum 2% of NTDL. To put this in crude words, if SBIreceived 100 crores from aam-admi under savings account,current account, fixed deposit etc. then SBI can borrow onlyupto Rs.2 crores from RBI.

Rajan decides Repo rate (8%right now)

MSF = Repo Rate +1% = 8+1=9%. (earlier this margin of 1%used to be higher. But nowadays just 1%!)

for those who still have doubt about Repo vs MSF:for repo borrowing, bank will need to pledge securities to Rajan. But bank cannot use SLR-reserved securities for this.so, imagine if a bank is in dire need of cash, but doesn’t have spare government securities- thenthey can borrow using MSF by pledging those SLR securities. (and under MSF window, Rajanwill demand 1% higher than Repo as one type of ‘punishment’ for pledging SLR securities.)

Reverse repo Rate

Although self-explanatory. But let’s check

Repo = clients borrow from Rajan and pay this much interest rate. (short term loan)

Reverse repo= when Rajan himself borrows from clients, then he has to pay this muchinterest rate to clients.

Collateral = yes. What if police raids this gambling-den, and Rajan runs away to Nepal?Clients can sell Rajan’s Government securities and recover their money.

Reverse repo = Repo MINUS 1% = 8-1% =7%.

Note: in official parlance, they call percentages in “basis points” so 1%=100 basis points.So in that ‘official language’, Reverse repo = Repo MINUS 100 basis points.

Enough cheap jokes. What have we learned so far?

That Rajan controls money supply using monetary policy.

Under Monetary policy, Rajan has various “weapons” (or tools)

1. Reserve ratios (SLR, CRR)

2. OMO: Open market operation

3. Rates: Bank rate, LAF (Repo, Reverse repo), MSF.

We already know how to apply SLR, CRR and OMO to fight inflation (and deflation.) let me pastethe table again.

Policy dear money cheap money

Tool To fight inflation To fight deflation

Reserve Ratio(CRR, SLR)

Increase them. Decrease them.

Open MarketOperation(OMO)

RBI sell securities RBI buy securities

Bank Rate increase it decrease it

Repo rate increase it decrease it

Reverse Repo it’s value is linked with Repo, hence cannot be increased/decreasedindependently.

MarginalStandingFacility

it’s value is linked with Repo, hence cannot be increased/decreasedindependently. Besides MSF= temporary firefighting, cash mismanagement.

We learned that Rajan doesn’t use Bank rate much, to control money supply.

We learned that Rajan doesn’t decide Reverse repo and MSF. (they’re automatically -1%and +1% of Repo rate).

Thus the only thing Rajan has to decide under monetary policy= Repo rate. Therefore,Repo rate is called the “policy rate”

Let’s revisit out flow chart:

Situation: Economy has inflationary trend. Prices of goods and services increasing everyday.

Solution: Rajan increases “Repo rate”. (say from 7.75% to 8%).

Result: it becomes expensive for SBI to borrow from Rajan. They’ll increase their ownrates as well.

Wait. How?

Just like how things roll in Onion biz.

If prices of Onion rise in Maharashtra’s wholesale yard (in Lasangaon), then immediately, retailveggie @Ahmedabad will also raise their onion prices to keep the profit margin same.

What’ll be the consequences (if repo rate is hiked / increased)?

Consequences:

1. SBI raises its loan interest rate (to keep profit margin same)

2. Businessmen borrow less money from SBI.

3. Businessmen donot start new business. Donot expand existing business.

4. Less jobs

5. Less income

6. Less demand

7. Ultimately shopkeeper will bring down the prices to attract people into buying more things.

Thus inflation is reduced.

Policy dear money cheap money

Tool To fight inflation To fight deflation

Reserve Ratio (CRR, SLR) Increase them. Decrease them.

Open Market Operation (OMO) RBI sell securities RBI buy securities

Policy Rate (Repo Rate) Increase it Decrease it

Repo Rate in recent years:

Let’s observe with a graph: how RBI fought inflation/deflation in recent times using Repo rate asthe “main-weapon” of monetary policy.

From above above graph, you can see RBI has frequently changed its repo rate to combat bothinflationary and deflationary trend. But You’d agree that inflation has not been contained. Nomatter what number juggling or statistical interpretations are given- the hardship of common manhas not stopped- be it milk, petrol, onion, LPG anything.

Agreed that prices of onion, sugar, pulses and food are subject to vagaries of monsoonand black marketeering. Rajan cannot do anything about it.

Agreed that crude oil prices are subject to rupee-Dollar exchange rate, external factors andgovernment’s de-regulation of their prices. Rajan doesn’t have much control over this.

But still even in the non-food, non-fuel type commodities- RBI’s monetary policies have failed tocurb inflation. WHY? Observe the following image.

Suppose Vijay Mallay got 100 crore loan from State Bank of India. If you trace the ‘source’ of thatmoney, it’ll turnout 60-70 crores came from bank’s savings account, fixed deposit etc. Rajanlends money in repo rate –yes, but that doesn’t mean banks depend only on Rajan to arrange thecash for its clients.

Suppose Rajan reduces repo rate from 8% to 5%. Banks are not legally required to reduce theirloan interest rates.

The current system is following:

Banks are free to decide their base rate. E.g. SBI’s base rate is 10%.

It means SBI won’t loan money to anyone at an interest rate lower than 10% (except thosefarmers under Interest subvention scheme.)

SBI will link all of its loan products with Base rate. For example

SBI Base rate =10% Calculation Result

Car loan 0.75% above Base rate 10.75%

Two wheeler loan 8.25% above base rate 18.25%

Education loan (upto 4 lakh) 3.5% above base rate 13.5%

Home loan for women (upto 75 lakh) 0.10% above base rate 10.10%

Meaning if SBI changes her Base rate then all of above loan interest rates will changeautomatically.

If Rajan changes his repo rate, will SBI change her base rate?

Not always.

Because those common men are the main suppliers of money to SBI.

RBI is not the main supplier of money to SBI.

SBI will only change its base rate, when she feels necessary for its own profit / losscompared to its competitors.

Does it mean Repo rate system is bogus and ineffective?

Not always.

In developing countries like India, most people park their money in only four things:savings account, fixed deposit (FD), provident fund and LIC. We’ve mutual funds, we’veNPS, we’ve ULIPs, we’ve Rajiv Gandhi equity savings scheme –

but most people (particularly the older generation) feels insecure in into such new things.Therefore lot of money flows into Savings accounts and fixed deposits= SBI’s main sourceof money.

But, In advanced economies, like USA, people don’t invest large portion their income insavings account or FD. They’ve variety of investment options. So, for those Americanbanks, their own Central bank (US Feds) is a significant money supplier.

Hence US Feds’ monetary policy shows faster impact on their American Banks, THANRajan’s monetary policy on Desi banks.

Monetary Policy: limitationsIn developing countries, Monetary fails to bring quick results because

1. People don’t have many investment alternatives. Commercial banks have large deposits.Rajan is not the main or even prominent money supplier for these banks. Whatever Rajandoes, its effect will be felt only after 6-8 months but by that time, new factors would causeanother rise in inflation and Rajan will have to start from scratch again.

2. Non-Monetized economy: in rural areas, many transactions are still of barter nature. (E.g.kiranawalla cum middleman supplies seeds, pesticides, fertilizers- in exchange of share infarmer’s produce.)

3. Lack of financial inclusion. Since most people are not in the banking net. They rely onShroffs and moneylenders. Many of them circulate the black money of cops andpoliticians, and charge 36% interest rate on loans. Rajan has no control over them.

4. Monsoon uncertainty, cyclone, flood, draughts and their effect on food production. Foodinflation =>newspaper walla, washerman, barber, car mechanic everyone will raise theirservice fees to accommodate their raised cost of living. Rajan has no control over them.

5. Crude oil and gold import + negative effect when rupee weakens. Rajan can try to bring1$=Rs.65 to $1=63 Rs. But he has not enough forex reserves to bring $1=Rs.50.

6. Fiscal deficit, illogical schemes. e.g MNREGA worker digs a temporary road. After firstrain, t he road is wiped out= physical infrastructure added to economy… no. Wagesraised…..yes. = this mismatch leads to more inflation.

7. Subsidy leakage, Black money, underground economy.

8. And most importantly, because Rajan uses Multi-indicator approach, he focuses on WPI(minus food and fuel). That’s why Urjit Patel recommends him to target CPI. More on thatin next article.

So far, we learned that RBI has two sets of tools/instruments under monetary policy:

Quantitative tool Qualitative tools

1. Reserve ratios2. OMO3. Policy rate (Repo Rate)

We’ll see them in a moment

Qualitative Tools

#1: Margin Requirements/ LTV

Mallya wants to borrow from SBI. He pledges his company’s shares worth Rs.100 croresas collateral.

For such loans, Rajan can prescribe margin, say 65%.

In that case even if Mallya pledges 100 crores worth shares, SBI can give him 100-65=only 35 Crore rupees as loan.

Using this tool, Rajan can control money supply. e.g. during inflation, he should increasemargin requirement, so Mallya can borrow less=> less job=>less income=>lessdemand=>prices reduced.

If Rajan changes repo rate, it is not compulsory for SBI to change her loan interest rates.(we saw how Alok Nath keeps giving money to SBI, so they are not entirely dependent onRajan.)

But if Rajan changes margin requirements, then SBI and all other banks must obey it. Inother words, this tool has direct impact on money supply.

#2: Consumer credit regulation

Suppose Nano car sells @1 lakh and Rajan has made rule that downpayment cannot beless than 30%.

It means customer must bring Rs.30,000 from his pocket and bank can only give himmaximum 70000 as loan.

How can Rajan fight inflation with this tool?

Increase downpayment from 30%=>50% (meaning bank can give less loan. Customerhimself has to arrange lot of money from his own pocket)

Rajan can make rule “banks cannot accept EMI less than 5000 on car loan.” Observe:

Case #1: 100 EMIs worth 1000 each = 1,00,000. (ignore interest rates)

Case #2: 20 EMIs worth 5000 each=1,00,000. (ignore interest rates)

In case #2: some of the lower-middleclass families may postpone their decision to purchase nanocar (Because they can’t afford higher EMIs.)

Result= less demand=>prices reduced. (indirectly- because car mechanics get less work,number-plate painters get less orders etc. so they reduce fees to attract new clients andretain existing clients.)

Thus, Rajan can control money supply by changing downpayment and installment (EMI)rules.

#3: Selective credit control

Under this, Rajan can specifically instruct bankers not to give loans to traders of certaincommodities e.g. sugar, gur, edible oil etc.

even if the said trader is ready to mortgage his shares/bonds/factory/machine/vehicleanything.

this prevents speculations/ hoarding of commodities using money borrowed from banks.

#4: Moral Suasion

Here Rajan tries to persuade the bankers to do xyz thing. Example

1. Please reduce giving automobile loans- instead park your money in government securities.(above the SLR requirements.)

2. I’ve reduced my repo rate, now you also reduce your base rate.

Rajan will try to influence those bankers via- direct meetings, conference, giving mediastatements, giving speeches @public seminars, university convocations etc. (even wherebankers are not present.) He’ll do so, to build a public opinion, media opinion and influence thosebankers by making them feel ‘guilty’.

Rationingof credit Found in Planned economies/communist nations.

Here central bank will decide “upper limit” to loans in each sector (heavyindustries, service, agriculture, small-scale etc.)So once that ‘quota’ is over. Additional loans cannot be given to thatborrowers from that sector. This also controls money supply.

Directaction

Means RBI gives punishment to erring banks. Punishment can involve: penalinterest, refuses to lend them money from LAF etc. and in worst case evencancels their banking license.

Let’s recap

Monetary policy tools: Quantiative vs Qualitative

Quantitative Qualitative

1. Reserve ratios (SLR, CRR)2. Open Market Operation3. Policy rate (Repo Rate)

1. Margin requirements / LTV2. Consumer credit regulation3. Selective credit control4. Moral Suasion5. Rationing of Credit6. Direct Action

Indirect in nature. (Even if Rajan changes repo rate, itsnot necessary SBI will immediately change its base rate /loan interest rates.)

Direct in nature. (e.g. those marginrequirements)

General- they affect money supply in entire economy- beit housing, automobile, manufacturing- everything.

Selective- can affect money supplyin a specific sector of economy e.g.automobile.

Let’s solve an Official MCQ from UPSC 2012 Question paper

Q. RBI Acts as banker’s bank. This would imply which of the following?

1. Other banks retain their deposits with RBI

2. RBI lends funds to commercial banks in the times of need.

3. RBI advises commercial banks on monetary matters.

Correct Statement

1. Only 2 and 3

2. Only 1 and 2

3. Only 1 and 3

4. 1, 2 and 3

Approach:

Whenever you face such 3 statement MCQ or 4 statement MCQ, Always use “elimination”method. First you find out a statement that is definitely right or definitely wrong. In above case,we can see #2 is definitely right. RBI lends funds to banks in the times of need (Repo, MSF)

So let’s eliminate choices that don’t involve statement #2

1. Only 2 and 3

2. Only 1 and 2

3. Only 1 and 3

4. 1, 2 and 3

This did not help much. We still have three choices left. Observe statement #1: Otherbanks retain their deposits with RBI. That is correct with respect to cash reserve ratio. CRRis one type of deposit that banks make to RBI. (RBI doesn’t pay interest on it- that’s adifferent story).

Meaning #1 is also correct eliminate choices that donot have #1

1. Only 2 and 3

2. Only 1 and 2

3. Only 1 and 3

4. 1, 2 and 3

Only two choices left and the ultimate solution = is statement #3 is correct or not?

Viewpoint #1 Viewpoint #2

The statement says “RBI advises commercial banks onmonetary matters.”The word “advises” makes this statementincorrect. Because RBI doesn’t “Advice” they just order thebanks- be it SLR, CRR, PSL. RBI doesn’t advice, RBI givesorders and direction. Therefore statement #3 is wrong.

RBI does advice thosebanks. We saw it under“Moral Suasion.” Therefore,Statement #3 is right.

Even if we accept that RBI “advices”, still the questions askswhat is implied by “RBI as Banker’s bank.” So, RBI advices “moral suasion” that is a monetary policy tool. RBI’s not doingit as a “Banker” to those banks. Therefore, Statement #3 isdefinitely wrong.

Money Banking and finance,E Narayan Nadar (PHIpublication). He hasspecifically listed this“Advice” function underBanker’s bank topic.

Answer (B) Answer (D)

So, is it B or is it D? Final judge is UPSC.

They had uploaded CSAt-2012 official answer key on their site.

This question is Test Series A, Question #75 and its official answer is “D” = meaning allthree statements are correct.

If you face such MCQ in exam, what should be your approach?

Skip Upto you. But if you start skipping all such question (OMO, Money supply, Banker’sbank), because you’re completely unaware of those topics=that is not pardonable.itshows you’re underprepared for this exam. You should either change your studymethod or change the game- try for some easier exam.

Attempt This question is attemptable, if you don’t ‘nitpick’ over the word “advises” in thirdstatement.

Mark nReview

If you’ve thoroughly prepared the RBI’s monetary tools (both qualitative andquantitative), you can solve it by applying concepts/principles- particularly themoral suasion thing. But if you’re still doubtful over whether #3 is right or wrong,then better skip. If you skip because you’re ‘doubtful’ = that is pardonable. But if youskip because you’re completely unaware of this topic= non-bailable offense.

AppendixThese are the topics I wanted to discuss in the article, but they would break the flow of othertopics. Hence writing them @bottom:

#1: Why High SLR and High CRR are bad?

From the discussion so far, you might think why Rajan only focuses on Repo rate to controlmoney supply. Why not simply raise SLR and CRR requirements.

Let’s check the de-merits of high SLR and CRR:

Prior to LPG reforms in 90s, RBI used to keep SLR and CRR very high. Let’s take an example

A Bank can two types of deposits

Deposit type examples

Time Deposit Fixed deposit (FD) recurring deposit.

Demand Deposit Savings account, current account

Using this money, bank has to count its Net Demand and Time liabilities (NDTL), everyfortnight. Suppose its 100 crores.

Both CRR and SLR are counted on this figure. In the old times, these reserve ratios usedto be as high as 15% and 40% respectively. Observe the effect:

Net Demand and Time Liabilities (NDTL) +100 cr.

Reserve ratios

CRR (15%) (-) 15 [no profit]

SLR (40%) (-) 40 [some profit]

Money left with bank =45 cr.

From 100 crores, barely 45 crores left with the bank. But adding insult to the injury- even hereRBI mandates Priority sector lending (PSL). Meaning, at least 40% of the loans has to be givento farmers, small businessmen, students etc. groups.

Let’s update the table:

Net Demand and Time Liabilities (NDTL) +100 cr.

Reserve ratios

CRR (15%) (-) 15 [no profit]

SLR (40%) (-) 40 [some profit]

Money left with bank =45

PSL (40%) =45 x 0.4 =18 crore.

Money left for big borrowers (i.e. big businessmen, upper middleclass) =45-18=27 crores.

By the way, PSL is counted on annual basis while SLR, CRR counted on fortnight basis soabove table is technically incorrect but I’ve plugged in those numbers only for the sake ofexplanation.

before the 90s- Government would even interfere and order public sector banks to givePSL-loans @cheap interest rates. The local politicians would coerce the branch managerto give PSL-loans to ineligible people. They default on loans, Branch manager cannotrecover money (because defaulter will goto civil court then taarikh pe taarikh.) So, bankwould have to forget about most of those 18 crores given in PSL loans.

Anyways you can see people deposited 100 crores in the bank yet bank is left with barely27 crores (over which, bank has “Freedom” to decide whom they should give the loan.)

What are the consequences for businessmen?

1. High cost of credit (because bank will try to make maximum profit from those 27 crores- sobank will charge very high interest rate on the business loans- to pay off for the staffsalaries, branch office rents and everything.)

2. Businessman cannot expand his business.

3. Less exports.

4. Less tax income for the government.

So in a way- that was also one of the factors leading to Balance of Payment crisis (andsubsequently LPG reforms.) You can read more about that in NCERT Class 11- chapter 2 and 3.

#2: Narsimhan (I) Committee 1991

Plagued by problems and losses in nationalized banks, Government of India formed thisCommittee. Recommendations were:

1. Deregulate interest rates. Let the banks decide their loan interest rates. Accepted.Gradually, we moved to the Base Rate system.

2. PSL loans should be given at normal interest rates. Accepted (but with exception=>interest subvention- that we saw under Nachiket articles.)

3. NPA/Loan default matter should be handled by separate body and not civil courts. Result:Debt recovery tribunal created in 1993. Ultimately SARFAESI Act in 2002.

4. Reduce CRR, SLR. Accepted. Today we’ve them @4% and 23% respectively.

5. Allow Private banks and foreign banks. RBI invited applications in 1993. ICICI, Axis, HDFCand many others got license.

6. Liberate Branch expansion policy. Done (Except that 25% rural branching mandate wesaw under Nachiket articles).

7. Prepare NBFC regulatory framework. Accepted.

8. Government should reduce shareholding (and thereby its official influence) in the publicsector banks. Government agreed. Today government’s shareholding in SBI =~60%.

#3: Narsimhan (II) Committee 1998

Suggested more reforms.

1. allow VRS in the banks so they can get rid of excessive staff.

2. Suggested additional Legal reforms for loan recovery. => SARFAESI 2002.

3. Computerization, electronic fund transfer, legal framework => Payment and SettlementAct=>Retail (ECS, NEFT, credit Card) + Wholesale (RTGS)

4. Permit new private /foreign banks. RBI invited license in 2001= Yes Bank and KotakMahindra got licenses. 2013: RBI again invited applications for bank licenses.

[Note: list of recommendations not exhaustive, I’ve only highlighted important topics that show

‘evolution’ of banking sector in recent times.]

Mock Questions1. With open market operations, RBI can

1. increase liquidity in the economy, but cannot decrease it

2. decrease liquidity in the economy, but cannot increase it

3. Can increase or decrease liquidity in the economy to control money supply.

4. None of above.

2. By which of the following methods, government can reduce money supply in theeconomy?

1. taxation

2. sale of securities to public

3. both A and B

4. neither A nor B

3. During the period of deflation

1. RBI should use dear money policy to combat it

2. Government should reduce its tax rates.

3. both A and B

4. Neither A nor B.

4. IF prices are lowered without causing unemployment, we call it:

1. stagflation

2. reflation

3. disflaction

4. Disinflation.

5. Which of the following contains correct set of quantitative instruments of monetary policy?

1. reserve ratio, bank rate, margin requirements

2. open market operations, margin requirements, regulation of consumer credit

3. cash reserve ratio, bank rate, open market operation

4. None of above

6. Which of the following contains correct set of qualitative instruments of monetary policy?

1. reserve ratio, bank rate, margin requirements

2. credit rationing, margin requirements, regulation of consumer credit

3. cash reserve ratio, bank rate, open market operation

4. None of above

Q7. To counter the effect of deflation, which of the following steps should RBI initiate?

1. decrease reserve ratios

2. buy government securities through open market operation

3. increase policy rate

Answer choices

1. only 1 and 2

2. only 2 and 3

3. only 1 and 3

4. 1, 2 and 3

Q8. To counter inflation, which of the following steps should RBI initiate?

1. Increase reserve ratios

2. sell government securities through open market operation

3. Increase policy rate

Answer choices

1. only 1 and 2

2. only 2 and 3

3. only 1 and 3

4. 1, 2 and 3

Q9. Which of the following may cause deflation in the economy?

1. RBI raises policy rate

2. RBI raises cash reserve ratio

3. RBI sells securities

Choices:

1. only 1 and 2

2. only 2 and 3

3. only 1 and 3

4. all 1,2 and 3

Q10. Money supply in the economy, is affected by

1. Cheap money policy and dear money policy.

2. Open market operation and Moral Suasion.

3. Consumer credit regulation and loan to value ratio.

Choices:

1. only 1 and 2

2. only 2 and 3

3. only 1 and 3

4. all 1, 2 and 3

Q11. An increase in SLR

1. will restrict the expansion of bank’s credit

2. will increase bank’s investment in safe securities

3. will ensure solvency of the banks

choices:

1. only 1 and 2

2. only 2 and 3

3. only 1 and 3

4. all 1,2 and 3

Mains/interview type questions- after we check Urjit Patel’s recommendations on strengtheningmonetary policy.

Hints

1. can increase by buying, can decrease by selling

2. both [or only B, depending on how UPSC examiner interprets the effect of taxation onmoney supply. In one of the reputed book on Banking and finance, author NarayanNadar claimed taxation can affect money supply.]

3. dear money policy during deflation =adds insult to the injury of businessman. Ifgovernment reduces tax- then its revenue collection will drastically reduce. So bothincorrect. [OR debatable- depending on how UPSC examiner interprets the effect oftaxation during deflation.]

4. directly given in the article.

5. see the last table in the article

6. see the last table in the article

7. observe the table before the topic “repo rate in recent years”

8. same as above

9. same as above

10. All correct. (Unless you nitpick and drag the logic too much.)

11. same as above.

Visit Mrunal.org/Economy For more on Money, Banking, Finance, Taxation and Economy.

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The work of Mrunal is under the Creative Commons Attribution-Non Commercial-ShareAlike 4.0 License .Permissionsbeyond the scope of this license may be available at Mrunal.org/contact.

mrunal.org http://mrunal.org/2013/02/economy-banking-ombudsman-meaning-functions-appointment-reforms-explained.html

[Economy] Banking Ombudsman: Meaning, functions,appointment, reforms explained

1. What is Banking Ombudsman (BO)?

2. Appointment & Tenure

3. Jurisdiction

4. Procedure for getting justice?

1. How does BO settle complaint?

2. Punishment

3. Appellate authority for Banking Ombudsman

5. Reforms and Issues

1. #1: Netbanking frauds

2. #2: Need more BOs

6. Location of Offices

7. Mock questions

From UPSC point of view, you don’t need to memorize all minute details given in this article(they’re provided for IBPS/SBI PO exam).

What is Banking Ombudsman (BO)?He hears customers’ complaints against banks.

BO was first setup in UK.

In India, RBI started this scheme in 1995.

Appointment & TenureEarlier RBI used to appoint reputed persons from banking, finance, management, legaletc. sectors as Banking Ombudsmen (BO).

But now RBI has reserved this BO post for its own Chief General Managers and GeneralManagers.

Tenure: 3 years at a time.

Reappointment: yes possible.

JurisdictionBanking Ombudsman (BO) Scheme applies to whole of India (including Jammu andKashmir).

Banking Ombdusmen have jurisdiction over

1. All commercial banks (scheduled and non scheduled, public and private)

2. Regional rural banks

3. scheduled primary co-operative banks

4. NBFCs (BO’s Jurisdiction limited to “loan” part.)

BO is not a replacement of Consumer forum/courts. He merely supplements them.

BO deals with matters less than or equal to Rs.10 lakhs.

Here are some examples situation where BO can help you:

Regular banking

1. Demand draft, cheques, pay orders etc. not issued on time. (or not paid on time)

2. Credit card related complaints (e.g. bank putting hidden charges. Your credit card wasstolen but bank did not disable it even after you called them.)

3. You asked the bank to close your account / credit card but they are not doing it.

4. Bank refuses to open your account without giving valid reasons.

5. Bank closes down your account without valid reasons.

6. Government / your company deposited salary / pension in your account but the bank isnot releasing it on time.

7. Bank is taking out money from your account in pretext of some flimsy charges.

8. Branch office notice board says “10.30 to 5” but staff refuses to provide you service after3.30PM.

9. NRIs having bank account in India and facing problems about remittances etc. (e.g. hedeposited money from America, but his parents are not given money on time.)

Loans

1. Your loan application is not processed in time.

2. Your loan application is rejected without valid reasons.

3. You loan application is accepted but money is not released in time. (and still bank is charging interest on it!)

4. Bank doesn’t follow RBI guidelines regarding loan-recovery agents (e.g. bank hires somecriminals to bully and harass you.)

5. Bank doesn’t follow RBI guidelines regarding loan interest rates.

Procedure for getting justice?You’re unhappy with the bank for xyz reason. But you cannot directly approach BO.

First you’ve to give written complaint to the concerned bank that “I’ve so and so problem.”

and IF the bank doesn’t deal with your complaint within one month, then you canapproach BO.

On the other hand, you cannot approach BO if the matter is older than 1 year.

You don’t need lawyer to approach BO.

You don’t need to pay any fees/ stamp papers for approaching BO.

You can’t approach BO in following situations

1. Matter is higher than Rs.10 lakh.

2. If the matter is pending before any other court, tribunal, forum then you cannot approachBO.

3. If any other court, tribunal, forum has already passed an order on the same matter.

4. You cannot approach BO for frivolous or vexatious complaints (e.g. AC or water coolerwas off when I went to the branch. Someone jumped the queue but security guard didnothing….)

How does BO settle complaint?Upon receiving your complaint, first BO will try to solve the matter via settlement/arbitration (=try to achieve a compromise, conciliation or amicable solution between bankand its customer.)

This has to be done within one month after receiving complaint.

But if either party (customer/bank) is not accept this (compromise/negotiation/settlement)then after 1 month, BO will have to pass “order”.

Now, he’ll ask both parties to present their case/documents etc. And he’ll pass the orderaccordingly.

Two things can happen

1. He rejects your complaint (=bank is not guilty). OR

2. He finds the bank guilty and orders punishment.

PunishmentBO can order the Bank to compensate the actual money loss OR Rs.10 lakh (whichever islower).

In case of Credit card related cases, BO can order the bank to pay additional fines (uptoRs.1 lakh) for the mental harassment caused to the customer.

Appellate authority for Banking OmbudsmanIf either party (Bank / Customer) is unhappy with Ombudsman’s order, then they canapproach the Appellate authority (=Deputy Governor of RBI.)

1. If you’re the customer, you can directly approach him.

2. But if you’re the “Bank”, then you can approach him only after getting permission fromyour Chairman/CMD/MD or CEO. (This ensures Bank’s lower staff doesn’t automaticallygo for frivolous appeals against every order).

Reforms and IssuesBanking Ombudsman scheme was originally started in 1995.

But in subsequent years, RBI made many reforms in it, some of them are:

originally After reforms

Reputed persons from law, finance,banking, Management, administrationetc. can become BO.

Only RBI’s own officers can become BO. (=outsidersnot allowed for this post.)

Banks provided Money+Staff forOmbudsman’s office in their area.

RBI itself gives the money and staff to Ombudsman.

He only accepted paper complaints. Accepts Paper + online complaints.

– Regional Rural Banks put under jurisdiction ofOmbudsman.

– Ombudsman can look into internet-banking relatedcomplaints.

– Banks are required to display salient features of thescheme for common knowledge of public. (e.g.posters in the branch office.)

#1: Netbanking fraudsAccording to RBI’s scheme, Ombudsman can also look into internet banking relatedmatters.

But Ombudsmen across the country often wash away their hands and ask the victim towait for police investigation to finish.

And on the other hand, Banks donot take responsibility saying “net banking frauds asmost of them happen due to customers’ negligence and cyber-crime.”

So ultimately customer has to depend on the police to get justice.

#2: Need more BOsA Committee formed by RBI has recommended that instead of having only 15 Bankingombudsman across country, have one BO appointed for every bank.

The upper limit (of Rs.10 lakh) should be increased.

Location of OfficesBanking Ombudsman has total 15 offices throughout India

Those who’re preparing for IBPS/SBI PO should prepare this table for MCQs, others neednot worry much.

1. A’badGujarat + UT of Diu, Daman, Haveli

2. BangloreKarnataka.

3. BhopalMP+Chattisgarh

4. BhuvneshwarOdisha

5. ChandigarhHP+Punjab+part of Haryana

6. ChennaiTN+Andaman, Nico

7. GuwahatiAll north Eastern states minus Sikkim

8. Hyd.AP

9. JaipurRaj

10. KanpurUP (some areas excluded though)

11. KolkataWB+Sikkim

12. MumbaiMah+Goa

13. DelhiDelhi+J&K+part of UP+Part of Haryana

14. PatnaBihar+Jharkhand

15. ThiruvanthapuramKerala+Lakshdweep+Puducherry

Mock questions

Q1. Which of the following falls under the jurisdiction of Banking Ombudsman

1. Regional Rural Banks

2. Scheduled commercial banks

3. Non Scheduled primary co-operative banks

Answer choice

1. Only 1 and 3

2. Only 2 and 3

3. Only 1 and 2

4. All of them.

Q2. Find correct statements

1. BO is selected and appointed by Finance ministry.

2. BO’s staff and office expenditure are charged on the consolidated fund of India.

1. Only 1

2. Only 2

3. Both

4. None

Q3. Find incorrect statement

1. If the promises made by a sales agent, are not kept by the bank, you cannot approachBO.

2. If the matter involves loss of more than Rs.10 lakhs, you cannot approach BO.

3. The appellate authority for BO is High court of the concerned State.

4. There is one separate BO for Union Territories of India.

Answer choices

1. Only 2

2. 2 and 4

3. 1,3 and 4

4. All of them.

Q4. Which of the following are included in the purview of BO?

1. Net banking

2. Credit cards

3. ATM cards

4. Harassment by Loan recovery agents

Answer choices

1. Only 2 and 3

2. Only 1, 2 and 3

3. Only 2,3 and 4

4. All of them.

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The work o f Mrunal is under the Creative Commons Attribution-Non Commercial-ShareAlike 4.0License.Permissions beyond the scope of this license may be available at Mrunal.org/contact.

mrunal.orghttp://mrunal.org/2013/01/economy-banking-business-correspondents-agents-bca-meaning-functions-financial-inclusion-swabhimaan-common-service-centres-csc.html

[Economy] Banking Business Correspondents Agents(BCA): Meaning, functions, Financial Inclusion,Swabhimaan, Common Service Centres (CSC)

1. What is financial inclusion?

2. Why Business Correspondents system?

3. Who/What is Business correspondent?

4. Who can become Business correspondent for Banks?

5. Functions of Banking Business Correspondents?

6. Swabhimaan

7. Reforms in BC model

1. Common BC

2. NREGA payment

3. Kiosk Banking

8. BCA for Direct Cash Transfer?

9. Mock questions

What is financial inclusion?Give every poor man a bank account. And help him get a loan from banks.

Financial inclusion involves

1. Give formal banking services to poor people in urban & rural areas.

2. Promote habit of money-savings, insurance, pension-investment among poor-people.

3. Help them get loans at reasonable rates from normal banks. So they don’t become victimsin the hands of local moneylender cum thugs.

Three important initiatives taken by RBI for financial inclusion:

1969Lead banking scheme (LBS).RBI assigns a district to a particular bank.That Bank will be responsible for promoting banking services and financialliteracy, in that district.(=financial inclusion).

2005No frills account.Poor people can open bank accounts with very low balance e.g. Rs.5 only.We’ve already discussed that in earlier articles: Click me and click ME

2006Business Correspondents (BC) system. Discussed in this article.

Why Business Correspondents system?If Financial inclusion means “open bank accounts for poor people.” Then what’s the bigdeal, just open a damn account!

Not so easy. India has around 6 lakh villages. Most of them don’t have bank branches.

Ok so Why can’t banks open branches in every village?

No profit

Because Administrative costs will be high= Building rent, telephone, electricity, staff salary,security guards.

On the other hand volume of business is very “low” in village areas=amount of moneydeposited, loans taken.

Means there is No profit. Actually it’ll lead to heavy losses.

Reluctant staff

In many villages, there is no electricity, no good schools/drinking water, naxalite problem=Bank staff doesn’t want to serve there.

Therefore banks don’t like to open branches below district HQ or Tehsil level. Now comesthe problem

Hardships faced by poors

A poor man lives in remote village.

This man has deposited some Rs.2000 in a bank @his tehsil.

Now, He wants to take out some money from his bank account.

So He’ll have to make a trip for 10-20 kms =travel =time and cost.

He is illiterate so he doesn’t know how to fillup bank slips, other paperwork. He needs toask for help here and there in the bank office.

And most banks/post-offices don’t treat poor people with respect or priority like they dowith regular customers.

So, he may have to wait for many hours, move from this table to that table, before he getshis money.

= he cannot return to his village and do his daily job/work.

= his one day’s income is lost.

Same process repeats, when this man wants loan to buy a new cow, pumpset, seeds orfertilizers.

One the other hand, local money lenders in his village, give money quickly, without askingmany questions or requiring him to fillup two dozen application forms. (but then theyextract 36% compound interest from this poor man, thus making his life a living hell.)

Ultimately

1. BanksWe can’t open branches @every village, because it’s not profitable.

2. poorpeople

We can’t make trip to nearest town to access banking facilities, because it isinconvenient.

So, what’s the solution?

How about a “middleman / agent” between banks and the poor people?

Who/What is Business correspondent?Business correspondents are bank representatives.

They help villagers to open bank accounts.

They help villagers in banking transactions. (deposit money, take money out of savingsaccount, loans etc.)

The Business Correspondent carries a mobile device.

The villager gives his thumb impression or electronic signature, and get the money.

Business Correspondents get commission from bank for every new account opened,every transection made via them, every loan-application processed etc.

Who can become Business correspondent for Banks?

1. Non-GovernmentalOrganisations(NGOs)

2. Self Help Groups (SHGs),3. Micro Finance Institutions (MFIs)4. Post Offices5. Insurance agents6. Panchayats7. Civil Society Organisations (CSOs)

8. farmers’ clubs9. Community based organisations

10. Cooperatives societies11. Village Knowledge Centres,12. Agri Clinics/ Agri Business Centers,13. Krishi Vigyan Kendras14. Khadi and Village Industries units15. corporate entities with IT outlets in rural

parts.

Functions of Banking Business Correspondents?1. Create awareness about savings.

2. Give advice to villagers, about how to save/invest money and how to arrange/manageloans.

3. Help the villagers to open bank accounts.

4. Collect loan applications, forward them to bank.

5. Preliminary processing of loan applications for example: verification of person’s identity,home-address etc.

6. Help the Self Help Groups (SHG), to get loans.

7. Help the bank to collect EMIs and recover loan money.

SwabhimaanInitiative by the Finance Ministry + Indian Banks’ Association

launched in 2011

To bridge economic gap between rural and urban India.

ObjectivesMake banking facilities available to every habitat with a population >2000 (by March2012.)

Banks will provide basic services like deposits, withdrawal, Kisan Credit Card (KCCs) etcvia Business Correspondents (BCs) also known as Bank Saathi.

Banks will also working together with the Unique Identification Authority of India (UIDAI)for opening new bank accounts.

Government will send subsidies and social security benefits (pension etc.) directly tobeneficiary’s account.

Beneficiary can withdraw the money from the Business Correspondents (BCs) in theirvillage itself.

Government has provided 500 million rupees to banks for taking these ^initiatives.(e.g.paying Commissions to Bank Saathi, their training cost, doing paperwork with UID.)

Reforms in BC model

Common BCLast year Finance ministry came up with this proposal:

India be divided into 20 clusters.

A common BC be appointed for all public sector banks operating in that geography.

Such a move would improve the economics of the BC model. (otherwise so many BCs,fragmentation=nobody earning decent Commission=nobody improving the servicedelivery.)

Reserve Bank of India (RBI) has permitted all business correspondents (BCs) working forone particular bank, to conduct business for other banks as well.

FINO, India’s largest Business Correspondents company

FINO=Financial Inclusion Network and Operations (FINO).

It is promoted by various Public and Private sector banks and insurance companies likeLIC.

Last year, FINO become the common Business Correspondents company for all publicsector banks operating in Jharkhand.

NREGA payment

Old system New system

1. A villager earns some cashunder MNREGA.

2. Government gives cash tobank.

3. Bank gives it to B.C.4. B.C. deposits it into

MNREGA worker’saccount.

1. All accounts will be maintained by core bankingsystem.

2. So, cash directly goes from Government > Bank>MNREGA worker’s bank account.

3. Villagers will have the freedom to make theirwithdrawals from any BC they choose.

Kiosk BankingThe D.I.Y. (Do it yourself) banking services e.g. ATM, internet kiosks = still expensive.

There is also lack of education + awareness in rural areas about such things.

So even if Government /bank installs such automatic ATM, internet kiosks=> most of thetime they just gather dust.

Therefore, technology-based ‘self-service’ model (e.g ATM, internet kiosks) is not useful atthis stage.

And hence we need Personnel (these Business Correspondents=middlemen). Becauseoften villagers are illiterate, so they can’t even fill up the forms for opening bank accountsor loan-application or filling the deposit slips etc. Business Correspondents are essentialat this stage.

But again problem: The cost per transaction remains high. (Because Bank has to paycommission to B.C.agent.)

Therefore, Chindu has suggested following solution for long term:

Migrate from banking correspondent model to Kiosk banking = mobile vans fitted with ATMmachines+ biometric devices.

They’ll provide banking services in remote areas.

BCA for Direct Cash Transfer?In November 2012, Mohan announced Direct Cash transfer scheme. (will be covered indetail, later)

Anyways, under Direct Cash transfer scheme, Government will directly deposit payments,subsidies, scholarships, pensions etc into the beneficiary’s bank account.

Sounds well and good? Well, here is the big problem

There are about six lakh villages in India.

And despite all these financial inclusion initiatives (of FINMIN+RBI), still only ~75,000villages have a bank branch or business correspondent agents (BCA). So for the poorpeople in remaining ~525000 villages still face the problems we saw` in MNREGApayment withdrawl.

So Direct Cash Transfer will be #EPICFAIL unless each and every village is coveredunder banking services.

Therefore, recently Chindu asked the banks to have at least one bank branch or businesscorrespondent agents (BCA) for every village or group of villages with 1,000 to 1,500households.

In the villages without BCA, Department of Electronics and Information Technology willinstall Common Service Centre (CSC).

This CSCs will serve as the BCA.

Right now, CSC will used only for opening new accounts of beneficiaries under thescheme for direct cash transfer.

Only after banks install the software and complete other technical requirements for cashtransactions, the CSC will allow villagers to withdraw cash from their accounts.

Side note on CSC

Common Services Centers scheme= started in 2006.

Aim= set up of 100,000+ (one lakh) internet enabled centers in rural areas under theNational e-Governance plan (NeGP)

Mock questions

MCQs

Q1. Financial inclusion involves

1. Covering rural poors in banking net.

2. Covering urban poors in banking net.

3. Providing jobs to poor people.

4. Providing vocational training to poor people.

5. Spreading banking awareness among poor people.

Ans.choices

1. Only 1, 3 and 5

2. Only 1,2 and 5

3. Only 3 and 4.

4. All of them

Q2. Find incorrect statements about “Swabhimaan” scheme

1. It was launched by the Ministry of Social justice in 2009.

2. It aims to provide insurance coverage to laborers in unorganized sector.

3. It aims to provide financial inclusion to people residing in remote areas of India.

Ans

1. Only 3

2. Only 1 and 2

3. Only 2 and 3

4. Only 1 and 3

Q3. Who among the following, is/are eligible to become Business correspondents for banks?

1. Post office

2. Panchayats

3. NGO and Insurance Agents

4. Self Help Groups (SHG)

Ans

1. Only 1 and 2

2. Only 2 and 4

3. Only 2 and 3

4. All of them.

Descriptive Questions

1. Swabhimaan (5m)

2. Swavalamban (5m)

3. Common Services Centers scheme (5m)

4. Write a note on National E-governance Plan (NeGP) (10m)

5. Define Financial inclusion. Discuss the initiatives taken to achieve financial inclusion.(15m)

Interview

1. Apart from what is already being done, what new initiatives should be taken to achieve100% financial inclusion?

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इसइस ेणीेणी केके पुरानेपुराने लेखलेख | Previous Articles in this category

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[Fed Tapering:Part1 of 2] Meaning of Fed Tapering, its Negative Impact on IndianEconomy, Worst case scenarios, Balance of Payment Crisis, explained

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[Economy] Quantitative Easing: Meaning, phases, Impacts on Indian Economy, Rupee-Dollar Exchange rate, Pros & Cons, Positive & Negative aspects explained

[Budget] Interim Budget 2014: speech highlights, Funds, Schemes, CSIS, UDAAN,Magnivisualizer, RDB Kit, NIMZ, Essays

The work o f Mrunal is under the Creative Commons Attribution-Non Commercial-ShareAlike 4.0License.Permissions beyond the scope of this license may be available at Mrunal.org/contact.

mrunal.org http://mrunal.org/2012/12/economy-sarfaesi-asset-reconstruction-company-arc-security-receipt-sr-qib-drt.html

[Economy] SARFAESI Act, Asset ReconstructionCompany (ARC), Security Receipts (SR), QIB, DRT,Central Registry

1. What is NPA?

2. Debt Recovery tribunals (DRT)?

3. What is the Sarfaesi Act?

1. Appeal structure

2. Bank: Power to Auction

4. What is ARC?

1. What are Security Receipts (SR)?

2. What is Qualified Institutional Buyer (QIB)?

3. Foreign investment in ARC?

4. ARC New Power: convert Debt into equity

5. Anti-arguments: Debt to Equity conversion

6. What is Central Registry?

7. Misc.Amendments

8. Summary

9. Mock Questions CSAT

10. Boring details

11. Committees

What is NPA?Bank gives loan to a person.

Person fails to make regular payments.

Bank gives him notice to correct his behavior. But he doesn’t.

Bank declares that loan as Non-Performing Asset (NPA) (=Bad Loan)

Currently Indian banks have NPAs worth more than Rs. 1 lakh crores.

Debt Recovery tribunals?Prior to 90s, banks had very hard time recovering bad loans.

Because often, borrowers (loan takers) would file frivolous cases in civil courts, then…taarikh pe taarikh, taarikh pe taarikh….. proceeding would go on for years.

So 1993, Government established Debt Recovery Tribunals to deal with NPA matters.

Now borrower cannot approach civil court, they’ve to goto special Debt Recovery Tribunal(DRT).

This led to some relief, but then DRTs clogged down by truckload of cases. (Even now,more than 60,000 cases pending with DRTs)

In 2002, Government came up with new Act, named “SARFAESI Act”.

What is the Sarfaesi Act?Securitisation

and Reconstruction

of Financial Assets

and Enforcement of Security Interest Act, 2002,

Suppose, Mr.Paraajay has opened factory with Rs.100 crores. He financed this, via mixture ofDebt + equity in following way. (make sure you understand debt vs Equity, if not click me)

Holder Rupees in Cr.

Equity (IPO->Shares) Paraajay and his family 20

Juntaa (public) 30

Debt (loans, Bonds) Business loan from SBI 40

Bonds 10

Total 100

Initially the company runs well and good.

But then Mr.Paraajay doesn’t revise his MBA books often, so he forgets the businessconcepts. His company starts making losses.

He fails to pay loan EMIs for many months.

SBI gives him notice to correct his behavior.

Still, he doesn’t start paying money.

SBI declares this Rs.40 crores loan NPA (Non-Performing Asset).

Once a loan is declared as non-performing asset, SBI can take actions under SARFAESIact, to recover the loan money.

Bank have following powers under SARFAESI Act

1. Take possession of Mr.Paraajay’s assets without requiring court order. (Commericial orresidential, fixed or moving assets.)

2. Auction / Sale them.

3. Change the administration/ Management of those assets.

4. If Mr.Paraajay had sold away the mortgaged asset to third party Mr.X, bank can order Mr.Xto surrender that Asset.

5. If Mr.X owes money to Mr.Paraajay, he can be ordered to pay money.

*ARCs explained after a few paragraphs.

SARFAESI applies only to loans above Rs.10 lakhs.

By the way SARFAESI applies only to those assets “mortgaged/secured” to get the loan.

E.g. if Mr.Paraajay had taken business-loan, SBI would have asked him to sign away hisfactory/machinary/vehicles/land etc. specific items as mortgage.

Hence SBI can attach only ^those assets.

But SBI cannot take away Paraajay’s personal home-furniture, expensive wrist-watch orhis son’s bicycle in the name of SARFAESI.

Similarly, Agricultural land is exempted from SARFAESI attachment.

Appeal structureThe borrower (loan taker) has following options:

Get a stay order from Debt Recoverty tribunal (DRT) against the auction/sale of hisproperties. (He cannot file case in Civil courts.)

Fight the case in DRT.

If unhappy with DRT verdict, he can appeal to Debt Recovery Appellate Tribunal (DRAT).

But before filing appeal with DRAT, he’ll have to deposit 50% of his pending loan money.

Bank: Power to AuctionFirst SBI contacts the experts, gets valuation of Mr.Paraajay’s assets.

Expert says “those assets are worth Rs.50 crores according to present market value ofland/ building/ machinary whatever.”

Then SBI will give advertisement in newspapers “we are auctioning xyzland/machinary/building. Minimum bidding amount is Rs.50 crores. Whoever wishes to bid,send us application along with Rs.50,000 as deposit, and their class 10, 12 mark-sheetsand school leaving certificates, duly attested by a Gazetted officer.”

Problem: sometimes, bidders donot take interest in buying such properties, factories etc.

To fix this problem, Amendment bill of 2011, makes a new provision: if noone else comesto bid in the auction, Bank itself can buy that property.

Here comes the new problem:

Suppose SBI attached a warehouse of Mr.Paraajay.

If the land was in good urban area, SBI could open a new branch office there (or housingfor its employees).

But if plot/factory/house is in some remote area= useless for SBI’s personal business.

Under the Banking regulation Act, a bank cannot keep such immovable property beyond 7years, (max 12 years with RBI’s permission).

So ultimately SBI will have to auction it to someone. What if they don’t get better price?Critiques of the bill say, this is not clarified in the bill.

What is ARC?Asset reconstruction company (ARC).

They buy NPA (Bad loans) from Banks and try to extract maximum money out of it=profit.

They’ve to register with Reserve Bank of India.

Examples:

1. ARCIL (India’s first and largest asset reconstruction company (ARC))

2. Reliance Asset Reconstruction Company Limited by Anil Ambani

In our example, SBI has NPA worth Rs.40 crores.

ARC will buy the NPA file from SBI at a lower rate say 35 crores. (well, SBI is making loss,yes, but something is better than nothing.)

Besides, banks have hundreads of bad loan cases, they donot have time or manpower topursue individual case, sometimes no bidders are interested in auction. All the filework anddonkey labour, In such cases, it’s better for bank to transfer NPA to ARC.

But that doesn’t mean ARC will give 35 crores to the SBI from its own pocket!

Then how will the Asset reconstruction company (ARC) arrange for the money?= viaSecurity Reciepts.

What are Security Reciepts (SR)?In above example, ARC needs Rs.35 crores to buy a Non performing asset from SBI.

So ARC will issue “security reciepts (SR)” worth Rs.35 crores.

Only Qualified Institutional buyers (QIB) can buy these security reciepts (SR).

SR are not “bonds”, they donot carry fixed interest rate.

ARC will promise to pay money on SR, when it gets money the bad loan.

Although, ARC usually promise 9% profit on “security reciepts (SR)”.

So, three possible situations:

1. Qualified institutional buyers (QIB) buy those security reciepts (SR). So Rs.35 cr cashgoes from QIB -> ARC -> SBI.

2. SBI itself recieves SR worth Rs.35 crores for free. (that means ARC will gradually pay themoney to SBI).

3. combination of both: QIBs buy SR worth 30 crores + SBI recieves free SR worth 5 crores.

What is Qualified Institutional Buyer (QIB)?These people have the expertise and the financial muscle to evaluate and invest in the capitalmarkets.

Examples: (click on each to read previous articles on them)

1. Scheduled Commericial Banks

2. Foreign Institutional Investor

3. Mutual Funds

4. Venture Capital Investors

5. Insurance Companies

6. Pension/ Providend Funds

Foreign investment in ARCARC =buy bad loans from banks.

ARC =arrange money from QIBs to buy bad loans from banks.

Problem= Indian QIBs do not invest much in ARCs.

Therefore ARC’s capacity to buy NPA= very low.

And bank themselves don’t have enough expertize or manpower to dispose those NPAsquickly.

Previously Foreign investors could invest only upto 49% in ARC=minorityshareholder=cannot influence company decisions.

Now, Government also increased foreign investment limit in ARCs. This would attractmore investment in ARCs and help in quicker purchase and disposal of NPAs.

Foreign investment in ARC %

Earlier 49%

Now (December-24-2012) 74%

Anyways, back to the topic, let’s recap:

1. SBI had NPA. First solution: auction the property. Did not work out.

2. Second solution: sell it to ARC.

So, ARC purchased the NPA worth Rs.40 crores (at Rs.35 crores).

ARC’s aim= extract maximum money out of this investment. But how?

1. Auction the assets fully or partially. (sell the machinary now, rent the building and wait forland prices to go up for two years and then sell it.)

2. Sell the property in combination with other NPA properties of other defaulters. (similar to“buy one large pizza and get 20% discount on any medium sized pizzas”).

3. Restructure the EMIs of Mr.Paraajay. E.g. instead of 1 lakh per month, give us 75,000 permonth.

4. Change the Management of that asset, appoint its own directors/officers.

5. Order Mr.Paraajay to outsource or lease his business to a another company.

^SARFAESI act empowers ARC to do such things. The amendment Bill adds a new power to theARC.

ARC New Power: convert Debt into equityBefore reading further, Make sure you know the pros and cons of Debt Vs. Equity (alreadydiscussed in an old article click me)

The new Amendment in SARFAESI, empowers ARC to convert debt into equity.(fully or partially).

Share holding Before:

Shares Rupees Cr. %

Paraajay and his family 20 40%

Juntaa 30 60%

Total shares worth 50 100%

Share holding After

Shares Rupees Cr. Approx. %

Paraajay and his family 20 22%

Juntaa 30 33%

ARC 40* 44%

Total shares worth 90 100%

*that is the paper value of original debt (NPA loan of SBI to Mr.Parajaay), Otherwise ARCpurchased it @Rs.35 crores.

Anyways, This leads to two situations:

1. If company starts making more profit in future, ARC will receive more share from thatprofit. (because more profit=more dividend to shareholders.)

2. If price of company’s shares go up in the sharemarket, ARC can sell those shares to thirdparty and make decent profit.

Anti-arguments: Debt to Equity conversionCritiques says this “debt to equity”provision will be abused. This provision is made to help badcorporates. How so? Well consider following:

Bank’s loss

SBI gave Rs.40 crores loan to Mr.Parajaay

He refuses to pay loan=bad loan/NPA.

Then SBI sells this bad loan file to an ARC company @Rs.35 crores.

Hence, SBI’s loss is 40-35=5 crores. (actually more than 5 crores, if we count the possibleinterest rate that he would have paid, if he had not defaulted. And loss figure will bedifferent if he had paid a few installments earlier. Anyways, let’s keep the loss at 5 crore forthe moment.)

ARC’s profit

Now ARC owns the NPA assets. (their investment Rs 35 crores)

Paraajay offers Rs.37 crores and ask ARC to sell the assets to his relative, friend or proxy.

Hence, ARC’s profit is 37-35=Rs.2 crores.

And yet Mr.Parajaay successfully saved Rs.3 crores (because originally he had to payRs.40 crores to SBI, but he walked away by paying just Rs.37 crores!)

Few years back, CVC had held a meeting with Bank chairmans and CBI officers. Theyalleged ^this type of mischief going on, in many loan default cases.

Now under the new provision: if ARC converts its debt into equity (shares), then what willhappen?

1. It is very unlikely that Parajaay’s company will start making huge profits (otherwise itwouldn’t be in bad loan problem in the first place!)

2. It is very unlikely that share-price of Parajaay’s company will go up in sharemarket.(because it has negative publicity due to NPA).

Hence it is very unlikely that ARC will make huge profit out of this “Equity”.

Then Mr.Parajaay can simply offer them a way out : “sell those shares to me, in myfriend,relative,driver or peon’s name @Rs.37 crores.”

And ARC would agree, because 37-35=Rs.2 crores profit!

Side question

How would Mr.Parajaay arrange those Rs.37 crores?

Ans. If Mr.Parajaay is “totally awesome” then he wouldn’t give 37 crores from his own pocket.He’d just open another company, get new loan from second bank, issue IPOs to get money from

juntaa. Then Iski topi uske sar pe.

^This is (one of the many) reasons why Mr.Ratan Tata said following thing:

Overseas people go bankrupt or companies go bankrupt. Here they never do–theycontinue to be sick and still operate. Then they are operating to kill you with destructivecompetition (using predatory pricing etc.)

(Airline business) is proliferated by many operators, some of them in financial trouble.

I would hesitate to go into the (airline) sector today in the sense that the chances are thatyou would have a great deal of competition which would be unhealthy competition.

Bank Employee unions are also against the “Debt to Equity” clause of SARFAESI amendment.(When they had gone on strike to oppose Banking Amendment bill , they also cited this Debt-equity reason as well.)

Central RegistryPreviously, borrowers used to forged property documents and get loans from multiplebanks by giving them duplicate property documents as security.

So when borrower refuses to pay up loan, many banks would make claim for the sameproperty!

To fix this problem, Reserve Bank of India (RBI) setup Central Registry in 2011, underSARFAESI.

This central registry has details of all properties against which loans have been taken.

Any person or bank can inspect records of this registry to make sure the mortgagedproperty is genuine.

Official name: Central Registry of Securitisation Asset Reconstruction and SecurityInterest of India (CERSAI)

Misc.Amendments1. In public interest, Union Government can issue notification that xyz provision of

SARFAESI act may not apply or may apply with modifications to a class or classes ofbanks or financial institutions. Suppose many textile exporters have taken loans frombanks but due to global recession they are not receiving payments and hence unable torepay loans. In that case, Government can order notification that “SARFAESI will apply toall loans except those given for textile-export business.”

2. Earlier a borrower could approach Debt Recovery tribunal (DRT) to get stay order againstbank/ARC. New amendment says DRT cannot grant any stay order unless both parties(Borrower vs. lender bank) are heard. This will ensure the process of law is not misusedby unscrupulous borrowers to get stay orders just to delay money-recovery.

3. Bill proposes to enable banks and financial institutions to enter into settlement orcompromise with the borrower. It also seeks to empower the Debts Recovery Tribunal topass an order acknowledging any such settlement or compromise.

SummarySARFAESI empowers banks and other financial institutions to attach secured assets of aloan defaulter and sale, auction or manage them without requiring court intervention.

Parliament passed the amendment to SARFAESI Act and the debt recovery tribunal, inWinter session 2012.

Salient features of new amendment

1. Bank can buy for the NPA property if there are no otherbidders.multi-state co-operative banks can also takeactions under SARFAESI.

2. Borrower can’t get stay orders from DRT easily.Can make settlement / compromise withBank/ARC.

3. Asset reconstructioncompanies (ARC)

can convert their debt into equity (fully or partially)

4. Governmentcan prohibit or modify SARFAESI’s applicability in publicinterest.

Apart from this amendment, Government has also increased foreign investment limit in ARCsfrom 49 to 74%.

Mock Questions

Q1. Which of the following are Qualified Institutional buyers (QIB)?

1. ICICI

2. LIC

3. EPFO

4. FII registered with SEBI

1. Only 2 and 3

2. Only 1 and 4

3. Only 2 and 4

4. All of them.

Q2. Which of the following is not correct about SARFAESI act?

1. It mandates the Rural regional banks to lend atleast 15% of their total loans to ruralcottage industries.

2. It empowers banks to reduce their NPAs.

3. It empowers RBI to impose penalties on Bank responsible for NPAs.

1. Only 1 and 2

2. Only 2 and 3

3. Only 2

4. Only 1 and 3

Q3 Find Correct Statement

1. Foreign investment is prohibited in asset restructing companies.

2. To enjoy the priviledges under SARFAESI act, the Asset Reconstruction Companies haveto get themselves registered with SEBI.

1. Only 1

2. Only 2

3. Both

4. None

Boring details

1. Recovery of Debts Due to Banks and FinancialInstitutions Act of 1993 (RDBF)

Established Debt Recoverty tribunal(DRT) and

2. Securitisation and Reconstruction of FinancialAssets and Enforcement of Security Interest Actof 2002 (SARFAESI)

Helps banks recover money frombad loans.

3. Enforcement of Security Interest and Recoveryof Debts Laws (Amendment) Bill, 2011

Passed in Lok Sabha in Dec 2012,to amend above two laws (RDBF +SARFAESI)

CommitteesSARFAESI was based on recommendation of these two Committees

1. Committee on Banking Sector Reforms (Narasimham Committee II), 1998

2. Restructuring of weak Public Sector Banks -Verma Committee

The latest amendment (Debt to Equity), is based on recommendations of Alok Nigam Panel onARCs, made by Finance Ministry.

New Discussion Forum!By the way, I’ve an announcement to make. Many readers were suggesting a discussionplatform should be created (e.g. Anthropology optional, RBI aspirants, RAS, CSIR, APFCetc.) Because it is not very convenient to carry on or follow discussions via thesecomments below every article. Plus, if you’re browsing this site via mobile phone,then every time you’ve to scroll-down a mile long page just to read or reply comments=very inconvenient.

So, I’ve setup a dedicated forum: Mrunal.org/forum

In the same forum, I’ve setup a thread on “ Current affairs marathon“, with the aim that,candidates can discuss current affairs with each-other, or atleast mention the topics theyconsider important, so everyone can do self-study. Here is theLink: mrunal.org/forum/discussion/3/csat-current-affairs-marathon-2012-13.

Everyone invited to participate.

You may also start your own threads to discuss about RAS, CSIR, CDS, AFCAT etc. withyour peers.

No registration needed, just login with your facebook/gmail account.

इसइस ेणीेणी केके पुरानेपुराने लेखलेख | Previous Articles in this category

[Economy] Special 301 Report, Priority List, Implication on India, Nexvar case,Compulsory License, Patent Evergreening, IPR protection, USTR explained

[Economy] Nokia Tax Row: Royalty Payment, Chennai Plant, Finland DTAA, MicrosoftTakeover, UNICITRAL, TDS, Withholding Tax explained

[Economy] New Bank Licences: Bandhan, IDFC, Bharatiya Mahila Bank; Differential Banklicences, Bimal Jalan Committee, Narsimhan Committee; arguments favor against, Banknationalization, Historic evolution of Banking sector in India

[Fed Tapering:Part1 of 2] Meaning of Fed Tapering, its Negative Impact on IndianEconomy, Worst case scenarios, Balance of Payment Crisis, explained

[Fed Tapering:Part2 of 2] Measures to immunize Indian Economy against negativeimpacts of Fed Tapering, Currency Swap, Dollar Swap, FCNR swap, Brics bank explained

[Economy] Quantitative Easing: Meaning, phases, Impacts on Indian Economy, Rupee-Dollar Exchange rate, Pros & Cons, Positive & Negative aspects explained

[Budget] Interim Budget 2014: speech highlights, Funds, Schemes, CSIS, UDAAN,Magnivisualizer, RDB Kit, NIMZ, Essays

The work of Mrunal is under the Creative Commons Attribution-Non Commercial-ShareAlike 4.0 License .Permissionsbeyond the scope of this license may be available at Mrunal.org/contact.

mrunal.orghttp://mrunal.org/2012/12/economy-banking-amendment-bill-issues-features-problems-reforms-meaning-explained.html

[Economy] Banking Amendment Bill: Issues, Features,Problems, Reforms meaning explained

1. What is Banking Regulation Act?

2. RBI Power #1: Can remove entire Board of a Bank

3. RBI Power #2: Connected Lending Prevention

4. RBI Power #3: Unclaimed Accounts

5. Public Banks Issue#1: Need consolidation

6. Public Banks Issue#2: Need more investment

7. Banks issue #3: More voting rights for investors

8. Foreign Banks Issue #1: Stampduty

9. Foreign Banks Issue #2: Want to invest in Commodity

10. Standing Committee problem

11. Set: parliament

1. Parliament fight #1: Commodity speculation

2. Parliament Fight #2: Competition Monitoring: RBI vs CCI

12. Anti-Bill arguments

Boring technical details intentionally skipped. I don’t do Ph.D on current affairs, neither shouldyou.

What is Banking Regulation Act?It is governs all public sector banks (SBI, PNB etc.) and private sector banks.(ICICI, HDFCetc.) in India.

Set : Finance Minister’s Office

Finance minister and RBI governor are holding a meeting.

Chindu Yaar many new players want to open banks in India. But they can’t, becauseyou’re not giving new licenses, So what is your problem?

RBIgovernor

Well, I’m given powers to regulate public and private sector banks, under BankingRegulation Act 1949.But those powers are not enough.So, I’m not going to give new bank-licenses to anybody, unless and until you getme more powers, by updating that Banking Regulation Act.

Chindu Ok, I’ll move a Banking laws (Amendment) bill, to amend the necessary things.Butfirst tell me what new powers do you need?

RBI Power #1: Can remove entire Board of a Bank

RBI At present, if a Bank doesn’t play by my rules, I can remove its CEO or one or twodirectors. But that is not enough. What if the whole board of directors is involved insome mischief.So, I want powers to remove the entire board of directors.I also want you to increase the rates of existing monetary penalties that I can imposeon a bank if it disobeys my rules, directives or gives me false information.

Chindu Ok agreed.I’ll get you the powers to supersede boards of the banks if anyirregularities.And I’ll increase the penalty rates as well.Anything else?

RBI Second problem. Connected lending.

Chindu What is that?

RBI Power #2: Connected Lending PreventionSuppose Mr.Paraajay gets license to open a new bank.

He opens Pawn-Fisher bank, people deposit their hard earned cash in it.

Ideally, bank should lend this money to the home, car, education and business-loanseekers, who then pay interest and thus bank makes profit.

Bank must make good profit, so It can pay 1) good interest rate to its bank accountholders. 2) good dividends to its share holders.

But Mr.Paraajay also owns another company, Pawn-Fisher airlines.

And this airlines company is making losses. Mr.Paraajay gives loans from Pawn-Fisherbank to Pawn-Fisher airlines @very low interest rate, to fix the mess.

And or, this Pawn-Fisher airlines gets the bank loan @market rates from the Pawn-FisherBank but it doesn’t pay EMIs regularly, yet the bank doesn’t take any action.

Similarly, Mr.Paraajay also opens Pawn-Fisher Mutual funds, but it also makes losses,and money is transferred from bank deposits to mutual funds, to cover up those losses.

These type of activities = Not good, because in long term, bank will collapse anddepositors’ money will be stuck.

RBI So, I must be given powers to check the records and account-books of those mutualfunds, insurance and other companies associated with a bank.

Chindu Agreed.you’ll get the power to inspect those other business arms of a bank.Anything else?

RBI Yes, money from unclaimed bank accounts.

RBI Power #3: Unclaimed AccountsIf Mr.X has not used his bank account for more than 10 years, it is called “unclaimed bankaccount.”

There are crores of rupees in such unclaimed bank accounts, it increases theAdministrative burden on bank employees (=need to maintain files etc)

Plus there is also an opportunity to commit a fraud. for example some bank employeeknows that Mr.X’s bank account is never checked, then he’ll forge checkbooks signatureor some other trick to withdraw money from Mr.X’s account.

RBI so we must take some measure to tackle this issue.

If a bank account is not operated for more than 10 years, bank will have totransfer its money in the “Depositor Education and Awareness Fund”And I’ll appoint a Committee to use money from this fund to create awareness.Although if Mr.X returns, he can claim his money and that bank will have topay him interest also.

Chindu Agreed. Anything else

RBI Yes one tea, two samosas and four more powers

1. If any person wants to buy more than 5% shares of any bank, he’ll have totake permission from me. And before giving him approval, I can put conditionson him, For example give me deposit worth Rs.xyz, so if you play somemischief, I’ll take away your deposit.

2. If primary cooperative societies want to continue their banking business, they’llhave to get a license from me.

3. I can conduct special audits of cooperative banks because they’re more liableto collapse and frauds.

4. If a bank fails to maintain the prescribed minimum amount of Cash ReserveRatio (CRR) on any day, I can demand penalty interest from that bank.

Chindu All agreed. Anything else.

RBI That’s enough for now.

Chindu Ok then please leave my cabin and send the SBI chairman in. He too had anappointment with me.

Public Banks Issue#1: Need consolidation

SBIchief

Good morning Mr. Finance Minister. As you’re aware, SBI is the largest public sectorbank in India, we’ve more than 11,000 branches. Yet if you make a list of top 5biggest banks of the world, our name doesn’t figure.

Chindu Why is it so?

SBI This is because too many small public banks exist in India. So, the ‘incoming-money’(from people to bank accounts) gets fragmented in so many bank branches. Finally,we don’t have enough cash, to expand in a big way.

Chindu Ok so what do you want from me?

SBIThere is need for consolidation in the banking sector so India can have two tothree large public banks that can compete globally.For this, I need you to simplify Banking Companies Acquisition and Transfer ofUndertakings Act.And to exclude bank mergers from the scrutiny of Competition Commission ofIndia (CCI).Bank mergers should need only approval of RBI.

Chindu Agreed.

PSU Banks Issue#2: Need more investment

SBI Right now the Public Sector banks cannot issue shares worth more than Rs.3000crores. I want you to relax this, because We need lot of investment.

Chindu Ok agreed. You can issue more shares, including bonus shares and rights issue etc.(already explained click me)But you’ll have to take permission from CentralGovernment + RBI if you want to do it.

SBI Agreed.

Banks issue #3: More voting rights for investors

SBI Before moving on, I must thank you for allowing us to issue bonus shares etc. Butthat alone will not bring investment in public or private sector banks.

Chindu Why?

SBIBecause in shareholders’ meetings, voting is done on many issues (forexample election of board of directors, changing name of company etc.).A shareholder should have voting rights proportional to the number of sharesheld by him.But in case of public banks, the shareholders have only 1% voting rightirrespective of number of shares held. So they cannot heavily influence anyDecision.I need you relax these voting rights. Only then foreign investors will beattracted to invest in Indian banks.

Chindu Agreed. We’ll revise the voting rights.

Revised voting rights

Voting rights (%)

Bank Example Before After

Private sector HDFC, ICICI 10 26

Public sector SBI , PNB 1 10

Chindu Anything else.

SBI No this is all for now.

Chindu Then you may leave. But please send the chairman of Citibank in, he too had takenappointment and is waiting outside.

Foreign Banks Issue #1: Stampduty

Chindu Ok what can I do for you?

Citibank When I transfer my branches from the main company to the subsidiary company, Idon’t want to pay stamp duty. This should help me expand my business in India.

Chindu Agreed. Anything else.

Citibank Yes there is one more matter

Foreign Banks Issue #2: Want to invest in Commodity

CitibankRight now, the Banks can trade in shares, bonds and currencies speculationbut the Banking Regulation Act forbids them from trading in commodities.But we (foreign banks) see huge profit making opportunity in that sector.So we need you to amend Banking regulation Act, to allow the banks toinvest in Commodities market.

Chindu Agreed.

Standing Committee problemAfter a bill is introduced in parliament, it goes to the Standing Committee of Parliament forparticular subject.

for example Banking Regulation bill to Standing Committee on finance.

They inspect the bill clause by clause, put forward their recommendations. And then votingis done.

In case of Banking regulation bill, after the parliamentary Standing Committee on Financeput its report, Chindu added some new provisions in it.

so opposition parties got angry “this wasn’t part of the original bill, if you want to add newprovisions, then this bill must be sent back to the Standing Committee for re-consideration”.

Set: parliamentIn the parliament, Opposition members are shouting slogans. (as usual)

Meera Kumar says “beth jayiye, beth jayiye, kripyaa shaant ho jayiye .”(as usual)

Parliament fight #1: Commodity speculation

Chindu What is the problem?

Oppn. The share-market and mutual funds = regulated by SEBI.Similarly Commoditymarket= regulated by Forward Market Commission (FMC)

Chindu So?

Oppn.So, if banks invest in commodity futures, it would lead to high-risk speculativetrading, especially with those Foreign banks.What if some investors loose money because of this?The Forward Markets Commission (FMC) doesn’t have enough powers tosafeguard them. because1) FMC doesn’t have legal powers for compulsory registration of traders.2) FMC doesn’t have power to impose huge financial penalty.Parliament is yet to pass Forward Contract Regulation Act (FCRA)Amendment Bill, which aims to empower FMC.And more importantly, you added the this Commodity provision in banking bill,after it was reviewed by Standing Committee. So this bill must be sent back tostanding Committee for review.

Chindu No, no, no. if bill goes back to standing Committee, it’ll take lot of time.Ok I back off, Iremove this provision, so there is no need to send this bill back to standingCommittee.

Parliament Fight #2: Competition Monitoring: RBI vs CCI

Chindu Friends, I also propose that only RBI’s permission should be necessary for Bankmergers and acquisitions. Competition Commission of India should not play anyrole in it.

Opposition Not acceptable. Again this is new provision added after Standing Committeegave its report. So, send the bill back to Standing Committee.

Chindu No, no, no. if bill goes back to standing Committee, then it’ll delay theimplementation.Ok I back off, I remove this provision.CCI will have the power toinvestigate and clear mergers and acquisitions in the banking sector.

Lok sabha passed the bill.

Rajya Sabha also passed the bill.

Now this bill file will goto President. Once he signs it, this bill will become a “Law”.

Anti-Bill argumentsIn December, employees of public banks went on strike. (although SBI employees did not jointhe strike.)

The Bank unions give following Anti-Bill arguments:

Government claims “more banks = more branches = more poor people get bankingfacilities = financial inclusion”. But it is mere lip service. Because new corporatebanks/foreign banks won’t have any interest in serving poor people.

If mergers are allowed then rural branches will close down and/or rural banking operationswill be outsourced via contractual business route.

This type of ‘privatization’ will negatively affect our job security and interests of those poorpeople.

Statistics indicate that only 50 percent of people in India have bank accounts.

The Centre should focus on educating rural people and cultivating banking habit amongthem instead of taking steps to merge banks or diluting voting rights.

Merger of banks will de-stablise public sector banks, then corporate firms will start theirown banks and gobble up public savings. And that money will be misused for the benefit offew corporate honchos and not for the general public.

Although Chindu counters them saying “these banking reforms= new banks will be opened=more employment. (he expects 6,000 new bank branches and recruitment of 84,000 people nextyear.)

Critiques also argue that

It seems the whole exercise is not a comprehensive banking reform but just firefightingbecause 1) Foreign banks and domestic players put pressure on FM to help them getbank licenses. 2) RBI blackmails FM to get more powers. 3) FM comes with bankingregulation bill. Prime objective of this bill seems to help private players get new bankinglicenses.

Government should further relax the voting rights otherwise, Government will keepabusing its majority shareholding to further its own political goals and election agendas.

e.g. in 2008, public sector banks were asked to forgo farmers’ loans (Debt Waiverscheme). Although Government promised to refund the loan-money to banks on behalf offarmers but it is not a good business practice.

Summary

The Banking regulation bill, 2011 was passed in the Winter session of parliament in Dec.2012.

The salient features of the Banking regulation bill are (list not exhaustive)

1. RBI can inspect books of associate business arms of a bank.

2. RBI can supercede entire board of directors of a bank.

3. RBI can conduct special audits of cooperative banks.

4. Cooperative societies cannot carryout banking activities without license from RBI.

5. A “Depositor Education and Awareness Fund to receive money from deposit accounts notoperated for more than 10 years.

6. Increased the penalties and fines for violating Banking Regulation Act.

7. Public Banks can obtain more capital via bonus shares and rights issue.

8. Increases the voting rights of shareholders in Public and Private sector banks.

9. Prior approval of RBI necessary if a person wants to purchase more than 5% shares of abank.

10. Banking Mergers and acquisition will fall under purview of CCI.

11. Bank will have to pay penalty interest rate, if it doesn’t maintain CRR on daily basis.

12. Foreign banks exempted from stampduty payment for certain cases.

इसइस ेणीेणी केके पुरानेपुराने लेखलेख | Previous Articles in this category

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The work of Mrunal is under the Creative Commons Attribution-Non Commercial-ShareAlike 4.0 License .Permissionsbeyond the scope of this license may be available at Mrunal.org/contact.

mrunal.orghttp://mrunal.org/2012/10/economy-bretton-woods-fixed-exchange-rate-system-imf-world-bank-meaning-explained.html

[Economy] Bretton Woods and Fixed Exchange Ratesystem : Meaning Explained

I had posted this article somewhere in April 2012 but because of a technical glitch this article (andmany other articles on economy) got wiped out of the server. So here I’m re-posting the samearticle. If you had already read it, no need to read again because Content has not been changed.

1. What is Bretton Woods?

2. Why is important?

3. Result of Bretton Woods

4. Main Players in this Conference

5. Impact of World War II on Economy

6. Agenda of conference

7. Fixed Exchange Rate system.

8. Roosevelt Vs Mohan:

9. Fast forward to 1970s

10. Inflation and Gold Prices

11. Do we need Bretton Woods?

While reading newspaper columns about global economy or Eurozone crisis etc. you may havecome across a sentence, multiple times : “we need another Bretton woods.” so,

What is Bretton Woods?It’s a place in New Hampshire State of USA, just like BASEL is a city in Switzerland.

Why is important?In 1944, President Roosevelt hosted a conference here, to rebuild the world economy,after Second World War.Delegates of 44 allied nations (िम रा ) had came to participate in this conference.

Officially it is known as United Nations Monetary and Financial Conference , commonlyknown as Bretton Woods because of the place where it was held.

This conference resulted into creation of four extremely important things

Result of Bretton Woods1. IMF

They give short-term loans to help nations settle the balance of payment crisis.

They’ve a system called “SDR” :Special Drawing rights. (requires another article)

2. World Bank

Officially known as IBRD :International bank for reconstruction and Development,that time

They give long term soft loans to rebuild the third world.

Soft loans= interest rate is very low. Sometimes you don’t have to pay back theprinciple.

3. GATT (General Agreement on Trade and Tarrif) – later becomes WTO

To facilitate the international trade.

This will later become WTO. Already written an article on this.

4. Fixed Exchange Rate system. (although Discarded in 1970s)

Explained in this same article.

Main Players in this meetingTotal 44 nations participated, but Main players were:

US President Franklin D Roosevelt

UK Prime Minister Winston Churchill

Lord John Maynard Keynes, Famous economist, UK treasury advisor.

India @Bretton Woods

Absent from the meeting: Mohan, Montek, Pranab, and Chindu (good otherwise they’dhave messed up International Economy, just like they did to Indian Economy.)

India was represented by Sir C.D. Deshmukh, he was the first Indian Governor of RBI, Thisgentleman had cracked IAS exam in British-raj ,known as ICS exam in those days . AndNo, he is not the grandfather of Ritesh Deshmukh.

Back to the topic,

Impact of World War II on EconomySecond world war started in 1939, ended in 1945

There is large scale bombing and destruction in the world. Production has declined.

Agriculture, Dairy, Manufacturing, Export- everything is brought to standstill=huge inflation

Agenda of conferenceHelp rebuilt the World Economy. Provide money, loan, finance to needy nations. (WorldBank)

After WW2, lot of colonies will get independence (India, Sri Lanka…), they’ll introduce theirown national currencies without control of big superpowers (Britain, France etc) and they’llenter in international trade in their own capacity.(Exchange rates, IMF)

Hence, Some rules/order had to be created to facilitate smooth international trade. (GATT)

Fixed Exchange Rate system.

What is Fixed Exchange Rate System?

Under this system, if RBI says $1=30 rupees, and you’ve 30 rupees and want to convert itin dollars but the Foreigners are willing to give 1 dollar to you…don’t worry.

RBI will accept your 30 rupees and give your one dollar out of its own reserve and viceversa.

Cons are obvious : When India is not exporting enough and not attractive enough foreigninvestment (in dollars) and still RBI keeps paying people in dollars, one day the banklockers will be empty, there will be no dollars to pay. System will collapse.

But it has Pros (advantages) in the times of uncertainty- When you’re writing on a cleanslate, after WW2, if every nation decides to have a fixed exchange rate system- it leads tostability and predictability in Exchange rates = good for foreign trade.

Roosevelt Vs Mohan: Pegging the Currencies(Fictional, technically incorrect, imaginary)

President Roosevelt: ok I say we put fixed exchange rate system. Let’s fix the rates that 40Rupees will equal to 1 dollar. 15 Yens will equal to 1 dollar. 12 Pounds will equal to 1 dollar andso on. In short, I’m pegging your currencies to US Dollar. Thus Dollar will be the international

reserve currency. AND Your country’s RBI (central bank) will make sure these exchange ratesdon’t fluctuate more than 1% from these values.

Mohan: ya man, but what if the exchange rate fluctuates? for example, What If I start running mycountry in a totally pathetic and irresponsible manner and hence nobody wants to invest in Indiaso supply of dollar is low but demand of dollar is high- because Indians love gold and we’ve toimport crude oil and pay in dollars. In short, this will fluctuate the exchange rates between Dollarvs Rupee.

President Roosevelt: Let me ask you a question. Suppose Onions are selling 100 rupees a kilobecause of low supply but suddenly farmers produce fresh new 50 million tonnes of onions andsupply it to market, what will happen?

Mohan: Easy! Onion Price will drop down to 40 rupees a kilo because the supply has increased.

President Roosevelt: yes dude, the same way, whenever exchange rate fluctuates from ourstandard rate, you’ll tell your RBI to supply dollars from its own forex reserves in to the market tocalm down the demand and bring the rate back to normal level.

If the reverse happens: (Onions are selling @ 2 rupees a kilo) then you tell your RBI to buy allOnions dollars using its own rupees, until the supply is reduced and price is back to normal.

Mohan: What nonsense is this? If 40 rupees equals 1 dollar but then what does 1 dollar equal to?What is the value of your own dollar? Why should we accept your dollar as international reservecurrency?

President Roosevelt: I’ve fixed the value of your currency to my dollars. And I’m fixing the valueof my own dollars to Gold. 1 ounce of Gold shall equal to 35 dollars. Meaning you walk in with 35dollars in my RBI (Federal Reserve Bank of USA), and you’ll get one ounce of gold in return.Gold will remain precious forever. So, it’s not like we’re running the show in thin air. Dollars arebacked by GOLD.

Mohan: ya man but what if my RBI doesn’t have enough dollars in its lockers? What will we dothen?

President Roosevelt: don’t worry, come to IMF. They’ll arrange short term loans for you, indollars.

Mohan: but still, why should we fix price of our currency to dollars? Why should we accept dollaras the reserve currency and not Yuan, Yen or Pound? Why should we accept you as our bigboss?

President Roosevelt: Because I’ve the aukaat to pay enough gold, so I say dollars will be theinternational reserve currency. IF you’ve enough gold reserve in your RBI, come sit in the chairand we’ll see whether rupee is strong enough to become the international reserve currency or

not.

Even Britain is so financially bankrupt after Second World War, they don’t have the guts to tell meset this exchange rate according to their Pounds. Btw, I also got some nuke missiles in mylimousine.

Mohan: no no…I was just kidding man. I’m well aware that you’re the superpower bothfinancially and militarywise.

President Roosevelt: Besides When we’ve a stable and fixed exchange system like this, it’llensure smooth and long term trade deals between merchants of various countries. When youdon’t have fixed exchange rate system, it is bad for economy. For example, today your call-centerboss may give you free lunch and coffee because $1=60 rupees but next day when value ofrupee declines and it is $1=50 rupees, same boss will even stop running the water-cooler in youroffice. Third day when $1=40 rupees, He will just kick you out because outsourcing generate thatmuch profit for him. Such uncertainty, is not good for economy.

And since Gold is in limited supply, Dollar will be spent carefully, and so your currency will be inspent carefully. i.e. Since currencies are ‘pegged’, you will not indulge in extravagant spending insubsidies, welfare schemes, tax-reliefs or debt-waivers to farmers. This ensures fiscal discipline=> That ensures less Fiscal deficit = less inflation.

Mohan: Mr. President Sir, I think I got the point now. I’ll tell my RBI Governor here to sign theBretton Woods agreement papers, because fixed exchange rate system sounds safe and good.

Fast forward to 1970sAs you can see, the fixed exchange rate system, is good for stable international tradeenvironment, atleast on paper.

But this system can run smoothly only as long as USA has the aukaat to pay gold to everyswinging dude that walks with dollars into their RBI (US Treasury).

Problem started with Cold War. Both USA and USSR (not Russia), are busy in an armsrace, building new tanks, missiles and submarines every week.

They’re also giving huge donations and help to poor nations, in order to win their supportand dominate the region. This is a non-productive activity, they’re basically wasting money.

Now, USA gets involved in a very lengthy and expensive Vietnam War from 1959 to 1975.

Inflation and Gold PricesFact: War leads to inflation

Fact: Inflation decreases the value of your money.

Fact: Gold becomes more expensive because of Inflation.

US still kept fixed value of 35 dollars = 1 ounce of gold. But thanks to this inflation, Gold istrading at higher price in open market – 40 dollars per ounce.

So there is an opportunity to make quick money, just tell the RBI manager to take suitcasefull of dollars from RBI’s locker to US Federal Reserve, take their gold in return, and sell itto the local jeweler at higher market price and use this profit to fix india’s problems-poverty, education etc. (may be by starting another welfare scheme named after Nehru-Gandhi family.)

For a while, US Presidents had enough clout over international politics so that they couldforce other nations’ RBI managers not to indulge in such cheap profiteering. But Vietnamwar is fast deteriorating America’s clout and now RBIs of various countries have startedlining up with their suitcases full of dollars and they want gold in return.

1971, President Nixon decides that if we continue giving gold for dollars, we will gobankrupt. There will be no gold left in our lockers. So I give up. I’m not going to let anyoneexchange their dollars for my gold.

And thus Bretton Wood system breaks down.

1973, World moves to floating exchange rate system.

What is Floating Exchange rate? Governments / Central Banks don’t fix exchange rateshere. It is left to the Forex markets, private players and laws of supply anddemand.Government /RBI will only intervene if there is huge fluctuation in the exchangerates.

Do we need Bretton Woods?With respect to the Eurozone crisis (click ME), many columnists write “We need anotherBretton Woods”.

They don’t actually mean that we need to move back to the same old Fixed Rate exchangesystem, in which every currency was pegged to Dollar and Dollar was pegged to Gold.Because that fixed rate thing is impractical in real life scenario, as we saw in aboveparagraphs.

Just imagine, if tomorrow World starts running according to Bretton Woods system, whatwill happen?

We know that China already has more than 1000 billion dollars in its Forex Reserves. SoPeople’s Bank of China will send its Probationary officer with suitcases full of dollars andtake away all the gold from Fort Knox*. They don’t even need to fight a war, USA will comedown to its knees financially.

[*Fort Knox is a place in Kentucky State, US Government keeps the gold reserves in thisplace.]

In real life, not that China will actually do so, but the mere threat and possibility will keepUSA on its toes. Hence US will not agree to Fixed Exchange rate in the first place.

There is no chance any other country will agree to become the ‘big brother’ and let theircurrency become the reserved currency and peg it to gold.

Especially India, because if we peg our 10,000 Rupees to one ounce of Gold and declarethat we are the new international reserve currency, just like dollar before 1970s, What willbe the Result? Pegged currency means Government can’t do extravagant spending inMNREGA. They’ll have to stop subsidy on diesel, kerosene, LPG and fertilizers, becausethey can dole out only as much rupees as the amount of gold held in RBI’s locker.

As You can understand, no political party has the guts to do that, hence no nation will wantto become the big brother or Sacrificial goat (Bali kaa Bakraa) for “another BrettonWoods”.

So, The sentence “We need another Bretton Woods” is just a metaphor, to say that all thePresidents, Prime ministers and Economists of the world should meet up once again andhold conference in some gambling den, drink some Desi liquor (देसी दा ), watch someItem-song, brainstorm for new ideas and start something from scratch, totally new, Just likethe Gentlemen at Bretton Woods did, in 1944.

Then what to do?

It could be anything, untried and untested before like-

China could agree that we’ll not dump our products in foreign market, we will not keep ouryuan under-valued,

US could agree that we’ll bring back our troop from Afghanistan and cut down on ourDefense Expenditure and its inflationary effect on world economy. We will also stopsupporting Pakistan. Thus reducing defense Expenditure of India in the arms race= thatwill also reduce fiscal deficit of India= India could decrease taxes=boost for economy andworld trade.

Iran could agree that we’ll stop our irrelevant obsession with nuke weapons and give up,So that UN removes the sanctions and our traders can make more money, thus improvingthe standard of living for Iranian aam-aadmis.

EU could agree that we’ll kick out Greece, because it’s just way too messed up beyondfixing.

And India could agree that we’ll bring all the black money from Switzerland and use it tofinance our bogus Government schemes and subsidies instead of looting the aam-aadmivia direct and indirect taxes, to finance those things.

And finally you and I could agree that facebook is a waste of time, so a serious Aspirantshould concentrate on his studies instead of uploading funny/motivational photos there.

इसइस ेणीेणी केके पुरानेपुराने लेखलेख | Previous Articles in this category

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The work of Mrunal is under the Creative Commons Attribution-Non Commercial-ShareAlike 4.0 License .Permissionsbeyond the scope of this license may be available at Mrunal.org/contact.

mrunal.org http://mrunal.org/2012/10/economy-cheque-truncation-system-cts-2010-rbi-meaning-advantages-explained.html

[Economy] Cheque Truncation System (CTS-2010):Meaning, Advantages explained

1. What is cheque clearing house?

2. What is MICR code?

3. What is Cheque Truncation System (CTS)?

4. What are the benefits of Cheque Truncation?

5. CTS-2010

What is cheque clearing house?Suppose a party from Delhi pays you via cheque of Citibank and you have account in SBI,Ahmedabad. You deposit this cheque in your area’s SBI branch.

Now the SBI branch manager would send his [overworked, underpaid] Bank PO toCitibank’s office in A’bad. He’d show the cheque, collect the cash and return to deposit themoney in your account.

But SBI would be getting thosands of cheques everyday- some from ICICI, some fromCitibank, some from axis and so on. SBI cannot send its staff to every other bank to getthe cash, that’d be extremely time consuming.

Therefore To simplify this cheque transection process, each bank will send arepresentative to a central place and exchange cheques drawn on each other.

This centralized place is called clearing house/processing house.

Reserve bank of India is act as clearing house.

In cities where RBI’s office doesnot exist, usually SBI or other public sector bank acts asthe clearing house.

What is MICR code?By seeing the PIN code, a postman can know the destination of an envelope. Same wayby using the MICR code, RBI (clearing house) can know the name of a bank, location ofits branch from where the cheque was issued= faster clearing of cheques.

MICR = Magnetic ink character recognition.

At the bottom of every cheque, you’d see some black colored numbers with weird lookingfonts. That is the MICR code.

These numbers are printed with a special ink containing iron oxide, so that it can beautomatically read by a special machine.

Ofcourse this sounds similar to bar codes, but there is a difference: unlike barcode, youcan read the MICR code and decode it, without the use of special machines.

What is Cheque Truncation System (CTS)?Under the old paper cheque based clearing, the SBI bank will send the paper cheque tothe clearing house and get the money and then transfer it to your account.

This is still time consuming. because SBI (or any bank) would need to physically move thecheques to a clearing house.

So RBI came up with a new idea known as ‘Cheque Truncation System (CTS)’.

In this Cheque Truncation System (CTS), SBI branch will not send the paper cheque tothe clearing house, but instead, it’d merely scan the cheque, and electronically send theimage + MICR data, to the clearing house.

From the clearing house, the data would goto the paying bank (Citibank in our example),they will inspect the MICR data, signature on the scanned image and release the moneyto SBI.

This process is faster and more safer than the conventional paper-cheque clearingmethod.

What are the benefits of Cheque Truncation?It Eliminates the time, money and manpower wasted during physical movement ofcheques (from banks to clearing house).

Thus, Cheque Truncation =faster clearing = better service to customers,

Cheque Truncation system reduces the scope for clearing-related frauds

There is no fear of losing cheque in transit.

CTS-2010In the year 2010, RBI came up with the guidelines for Cheque Truncation system. (CTS2010)

The banks would need to upgrade a few things to comply with CTS 2010 standards ofRBI.

For example, in their branch offices, they would need to buy scanners and install specialsoftware provided by RBI, to securely transfer and receive the scanned image and data.

They may need to change the color-scheme of chequebooks so that signature andhandwriting is visible in the scanned image. And so on…

Problem: some jholachhaap banks, are yet to comply with RBI’s CTS 2010 guidelines.

Hence recently RBI issued a warning to all banks:

RBIGovernor:

upgrade your banking infrastructure according to CTS 2010guidelines, before the end of Sept. 2012 so that UPSC may aska question on this topic.Whenever we do something, our prime objective is not toimprove the economy but to harass the UPSC aspirants.

Branchmanager ofLena Bank:

indeed, whaat an idea sir-ji

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mrunal.orghttp://mrunal.org/2014/01/banking-white-label-atm-meaning-features-advantages-limitations-financial-inclusion-nested-design-contagion-risk.html

[Banking] White Label ATM: Meaning, Features,Advantages, Limitations, Financial Inclusion, NestedDesign, Contagion Risk

1. What is White label-ATM?

2. What’s the difference between Brown label vs White label ATM?

3. Stakeholder/Players in White label ATM game?

4. Why do we need White Label ATM?

5. How does White Label ATM help in financial inclusion?

6. Facilities @White label ATM?

7. Where does the Commission come?

8. White label ATM: Challenges/Limitations/Problems

9. Mock Questions

What is White label-ATM?

Traditionally, Automated Teller Machines (ATMs) have respective bank’s logo. So just bylooking, this is SBI’s ATM, this is ICICI’s ATM and so on.

But White label ATM doesn’t have such Bank logo, hence called White label ATMs.

RBI has given license / permission to non-bank entities to open such ATMs.

Any non-bank entity with a minimum net worth of Rs.100 crore, can apply for white labelATMs. (not just NBFC, any non-bank entity can apply.)

Late 80s: first ATM in India; 2012: RBI issues guideline for White label; 2013: RBI giveslicense/permission.

Tata Communications Payment Solutions Limited =the first company to get RBI’spermission to open White label ATMs.

They started their chain under brandname “Indicash”.

Other White label= Muthoot Finance, Srei Infra., Vakrangee Software, Prizm Payments,AGS. More than 15 companies given such permission.

What’s the difference between Brown label vs White label ATM?

Brown Label ATM White label ATM

When banks outsourced the ATM operations to athird party.

When ATMs are owned and operated bynon-bank entities but they are not doing‘outsourcing-contract’ from a particularbank.

The private company owns & operates the ATMmachine, pays office rent. They negotiate with thelandlord, electricity company, telecom companyand so on.

Same

The bank (which has outsourced this work)provides cash for that ATM.

Sponsor bank provides the cash.

ATM has logo of that bank (which has outsourcedthis work).

No. White label ATM doesn’t have suchlogo. Not even of the sponsor bank.

No such compulsion. They’ve to compulsory open a few ATMsin (tier 3 to tier 6) areas. (explained aftera few paragraphs)

RBI not involved directly. These outsourcingcompanies have contractual obligation with theirrespective banks.

RBI directly involved because thesewhite label Companies have toseparately get license/permission fromRBI to run business.

Initially, RBI did not permit White label ATMs, and Banks wanted to reduce the operational cost,so they came up Brown Label ATM (outsourcing) system.

So in a way, the evolution is: (Bank’s own ATM) =>(Brown Label) => (white label)

Stakeholder/Players in White label ATM game?

RBI Gives license/permission to open White label ATMs. Under Payment andSettlement Systems Act, 2007. (And NOT under Banking regulation act orSARFAESI Act, Ombudsman or any other act.)

(non-bank)White LabelATMcompany

Rents the place, looks after maintenance and servicing of the machine.

Sponsorbank

Loads the cash in those White label ATMs. This also ensurescounterfeit/fake currency notes are not circulated through white label ATM.

Paymentnetworkoperator

Visa, Mastercard, the National Financial Switch (NFS under NationalPayment Corporation of India.)They provide technical connectivity in the system.

Why do we need White Label ATM?

1. ATMs offer convenience to customer (Because he doesn’t need to visit Bank branch everytime). ATMs are open 24/7, and even on holidays.

2. Convenience to bank, because they don’t have to keep large staff/office (compared to asystem without ATMs). It reduces their cost of branch-operation.

3. But in India, ATM penetration has been very low. Observe:

Country Approx. No. of ATMs per 10 lakh population

USA 1400

UK 500

China 200

India less than 100

Most of the ATMs concentrated in urban areas- that too only at prime locations e.g. nearshopping malls and airports= financial inclusion not achieved.

How does White Label ATM help in financial inclusion?

RBI requires White label-ATM companies to install machines in the ratio of

Two ATMs in (tier 3 to 6 place) : One ATM in (tier 1-2 place).

Confused? Observe:

Center city census definition:

population is ____

White Label ATM

Metropolitan Tier 1 10 lakh and above if company wants to Setup ONE ATM here,

Urban 1 lakh and above

Semi-Urban Tier 2 50,000 to 99,999

Tier 3 20,000 to 49,999 Then, company must install TWO ATMs here.

Tier 4 10,000 to 19,999

Rural Tier 5 5,000 to 9,999

Tier 6 Less than 5,000.

For example, RBI has permitted Tata to deploy 15000 White label ATMs. Meaning [2/(2+1)] x15000 = 10,000 ATMs will be setup in the rural and semi-urban areas. = more access to ATM=financial inclusion.

Facilities @White label ATM?

1. Any customer from belonging to any bank, can use it.

2. Every month, Five transactions are free.

3. White label ATM users can also withdraw a maximum of 10,000 per transaction.

4. Open 24/7 and on holidays

5. Value added services like mobile recharge, utility bill payments etc.

Where does the Commission come?

White ATM Company doesn’t run for charity or goodwill. Company has to make profit. So wheredoes the asli-maal/commission come?

Before White label ATM With White Label

1. If you used card in your own bank’s ATM= everythingfree.

2. If you used card on other bank’s ATM= first fivetransactions free (every month). After that commissioncharges of Rs.~17-20 for taking out money and Rs. 5-9 for making balance inquiry or mini statement. (Thiscommission directly charged on your account.)

1. First five transactionsfree every month.

2. Then, transaction fee~Rs.15 and balanceinquiry fee ~Rs.5 BUTthis commission is paidby your bank to theWhite label Company.

3. White label companycannot directly chargemoney on you. (RBIrules).

4. Although it doesn’tmean White labelATM=totally “Free”because your bank willcut those charges fromyour account.

Additionally, White Label ATM company can make commission from

1. value added services @their ATM e.g electricity /telephone bill payments, mobilerecharge, DishTV-Tatasky recharge etc.

2. Selling advertisement space in the room and above the door.

White label ATM: Challenges/Limitations/Problems1. For a white label ATM company, biggest challenges = office rent + Security guard.

2. If they want to make profit, every White ATM needs to get at least 75-125 transactions perday= very unlikely, especially when RBI requires them to setup 2/3rd of the ATMs in semi-urban and rural areas.

3. Even in Bangalore, some of the white-label ATMs are getting barely 2-3 customers everyweek=loss making business at the moment.

4. Despite the entry of White Label ATM companies, the regular banks have not slowed downtheir ATM expansion drive, because branded ATM=passive advertisement and customerloyalty. Result? ATMs everywhere =too much competition= small players will bleed out justlike in aviation business.

5. Last year, a lady was brutally attacked in ATM booth in Bangalore. Police have warned allbanks to put security guards=input cost increased. Banks themselves admitting “fivetransactions free every month=loss making” in this scenario.

6. SBI has the largest ATM network in India (30,000+)= economies of scale= they’resupposed to be making profit. But this week, even SBI chairman herself has admitted theirATM business is making losses. So, it is unlikely that White label ATM companies will runprofitably for a long period of time.

7. Customer complaint: failed ATM transactions = matter falls into Issuing Bank (=bankwhere you have account). Some critiques fear it will lead to taarikh pe taarikh becausedata records are with sponsor bank and machine maintenance is under ATM company’sresponsibility.

Nested Design

RBI appointed Nachiket Mor Committee on financial services, talks about this limitation.

The White label-ATM does not have direct access to the settlements system. (like SBI orICICI has access to RBI monitored NEFT online money transfers.)

Instead White label ATM is tied with a ‘sponsor-bank’. And the sponsor bank looks afterthe settlement. Sponsor bank loads and withdraws the cash from those “machines”.Example Federal Bank is the sponsor bank for Tata’s White label ATMs.

Mohan Ok so what’s the problem?

Nachi Nested Design= contagion risk.

Contagion = Bad condition in one institution leads to negative effects in the other institutesin the market.

Suppose few of Tata’s White label ATMs break down for xyz reason (hacking, staffnegligence or whatever) and some clown starts baseless rumoring onfacebook/twitter/whatsapp that Tata’s ATMs not working because federal bank hasstopped supplying cash.

Another clown then starts rumor mongering that Federal Bank is about to collapsebecause of NPAs and hence not honoring its obligation to Tata.

Result: Fed.Bank account holders panic and line up at other ATMs (sponsored or owned byother banks) to pull out their money = these type of “runs” destabilize the banking system.Extreme cases lead to situation like Cyprus-Banking crisis.

Mohan But don’t the banks have CRR and SLR to arrange cash in such emergencysituations?

Nachi Yes they have. But with nested design, they’re exposing themselves to additional“contagion-risk” from other banks/White-label ATM companies. Especially whenWhite label ATM company grows too large in very short time and sponsor bankcannot foresee the cash requirements.

Mohan Then what’s your recommendation?

NachiWhite label ATM companies should be directly linked to settlement system,without sponsor banks.RBI should allow White Label Banking Business Correspondent agents.[Same like earlier BC, but they can work with multiple banks at the back-end.]Potential candidates= NBFCs, mobile phone companies, consumer goodscompanies, the post office system, existing corporate BCs, andmilk/agri./sugar etc. real sector cooperatives.

Mock Questions1. Who among the following can operate White label ATMs?

1. Nationalized Banks

2. Scheduled Commercial Banks

3. Retail Banks

4. None of above.

2. What is “Indicash” ATM?

1. Brown label ATM chain under Indus Bank

2. Brown label ATM chain under Bank of India.

3. White label ATM chain owned and operated by Tata

4. White label ATM chain owned and operated by Prizm payments

3. Correct statements about White label ATMs

1. RBI permits non-bank entities to setup White Label ATMs under Banking regulationAct.

2. Only Non-Banking financial companies with 15 years of experience can open Whitelabel ATMs.

3. In case of failed transaction, the complaint is automatically sent to BankingOmbudsman.

4. None of above.

4. Correct statements about White label ATMs

1. Company has to open 2/3rd of its ATM in areas having tier 3 to tier 6 levelpopulation.

2. Before opening such booths in rural areas, the company has to get permission fromNABARD.

3. Both 1 and 2

4. Neither 1 nor 2

5. Incorrect statements about White label ATMs

1. The operator company is required to maintain SLR and CRR reserves similar to ascheduled commercial bank.

2. To prevent conflict of interest, RBI has forbidden White label companies fromproviding Value added services in such booths.

3. Both 1 and 2

4. Neither 1 nor 2

6. What is the role of a Sponsor bank in White label ATM system?

1. provide maintanance and service to the equipment

2. provide cash to the equipment

3. both 1 and 2

4. Neither 1 nor 2

7. Suppose RBI rules require the company to open ATMs in Urban: Rural areas in the ratio of5:9. If Muthoot Finance owns total 3500 ATMs, how many of them are located in the ruralareas?

1. 225

2. 1250

3. 2250

4. None of above

8. Suppose RBI rules require the company to open ATMs in Urban: Rural areas in the ratio of1:1,at the end of the given year. In January 2014 Muthoot Finance owns total 3000 ATMsbut its rural:urban ratio is 8:7. So, by 31st December 2014, How many new rural ATMsshould they open to comply with RBI’s rules?

1. 400

2. 300

3. 200

4. none of above

9. The ratio of Indicash White label ATMs in urban: rural areas is 4:5. If Indiacash opened360 new ATMs each in both urban and rural areas, then ratio will be 7:8. So, originally,how many ATMs did Indicash have in rural areas?

1. 640

2. 560

3. 600

4. None of Above

10. The ratio of Indicash’s urban:rural ATMs is 3:2 and total number of ATMs is 600. IfIndicash wants to change this ratio to 7:3, what should it do?

1. Add 200 ATMs in rural area

2. Add 200 ATMs in urban area

3. Add 200 ATMs each in both rural and urban areas

4. None of above

Descriptive:

1. Despites certain risks and limitations, the White label ATM has a potential role in financialinclusion. Elaborate. (10m | 200 words)

2. Define White label ATM. What are its features, advantages and limitations? (10m | 200words)

3. What are the differences between White label and Brown Label ATM? (5m | 100 words)

Visit Mrunal.org/Economy For more on Economy.

इसइस ेणीेणी केके पुरानेपुराने लेखलेख | Previous Articles in this category

[Economy] Special 301 Report, Priority List, Implication on India, Nexvar case,Compulsory License, Patent Evergreening, IPR protection, USTR explained

[Economy] Nokia Tax Row: Royalty Payment, Chennai Plant, Finland DTAA, MicrosoftTakeover, UNICITRAL, TDS, Withholding Tax explained

[Economy] New Bank Licences: Bandhan, IDFC, Bharatiya Mahila Bank; Differential Banklicences, Bimal Jalan Committee, Narsimhan Committee; arguments favor against, Banknationalization, Historic evolution of Banking sector in India

[Fed Tapering:Part1 of 2] Meaning of Fed Tapering, its Negative Impact on IndianEconomy, Worst case scenarios, Balance of Payment Crisis, explained

[Fed Tapering:Part2 of 2] Measures to immunize Indian Economy against negativeimpacts of Fed Tapering, Currency Swap, Dollar Swap, FCNR swap, Brics bank explained

[Economy] Quantitative Easing: Meaning, phases, Impacts on Indian Economy, Rupee-Dollar Exchange rate, Pros & Cons, Positive & Negative aspects explained

[Budget] Interim Budget 2014: speech highlights, Funds, Schemes, CSIS, UDAAN,Magnivisualizer, RDB Kit, NIMZ, Essays

The work of Mrunal is under the Creative Commons Attribution-Non Commercial-ShareAlike 4.0 License .Permissionsbeyond the scope of this license may be available at Mrunal.org/contact.