Money Market

 

Money Market:

• Market Place where very short-term debt instruments are traded.
• Short term investment means investment in assets up to one year with high level of  liquidity.
•  The transactions in Money market can be at retail or wholesale level.
• At the wholesale level, it involves large-volume trades between institutions and traders while at  the retail level, it includes money market mutual funds bought by individual investors and money market accounts opened by bank customers. 
• The borrowing and lending in the money market is on unsecured basis. 
• The RBI is the most significant constituent of Money market and the money market is also regulated by RBI.

Money market securities consist of following instruments:

• Call Money /Notice Money/Term Money
• Inter Bank Term Deposits
• Treasury Bills 
• Commercial Bills 
• Certificate of Deposits
• Repurchase Agreements (REPO)
• Collateralized Borrowing and Lending Obligations
• Tri Party Repo Dealing System 

Basel Norms /Accord,BASEL I,Basel II,Basel III,Liquidity Coverage Ratio,Leverage Ratio

 

Basel Norms /Accord:

• Basel accords are the set of international banking regulations issued by the Basel Committee on Banking Supervision from time to time.
• The goal of Basel norms is to coordinate banking regulations across the globe and strengthen the international banking system. 
• As per the accord, bank's capital consists of Tier 1 capital and Tier 2 capital.
• Tier 1 capital is a bank's core capital, whereas tier 2 capital is a bank's supplementary capital. 
• A bank's total capital is calculated by adding its tier 1 and tier 2 capital together.

BASEL  I---

• BASEL 1 focused only on credit risk where credit risk is the possibility of a loss resulting from a borrower’s failure to repay a loan.
• BASEL 1 norms recommended for  Banks  to hold capital equal to 8% of their Risk-weighted assets (RWA) - At least, 4% in Tier I Capital and more than 8% in Tier I and Tier II Capital
• The target of BASEL 1 was to be achieved by 1992 .
• India adopted BSAEL 1 in 1999.

ISSUES with BASEL 1:

The problem was that the risk weights in BASEL 1 do not attempt to take account of risks other than credit  risk,viz., market risks, liquidity  risk and operational risks which can be major cause of  insolvency  exposure to the banks.

Basel II:

• Basel II was introduced in 2004
• It laid down guidelines for capital adequacy with refined definitions, risk management  and disclosure requirements. 
• Basel II attempts to integrate Basel capital standards with national regulations.
• Basel II attempts to create standards and regulations on how much capital financial institutions need to put aside. 
• Banks need to put aside capital to reduce the risks associated with its investing and lending practices.
• It sought for use of external ratings  agencies to set the risk weights for corporate, bank and sovereign claims. 

Operational risk: 

• Risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. 
• Risk can be legal including exposures to fines, penalties, or punitive damages resulting  from supervisory actions, as well as private settlements. 

Shortcoming in Basel II norms led to the Global Financial  crisis of 2008.

Basel III:

• Basel II did not have any explicit regulation for the debt that banks could take on their books, and focused  more on individual financial institutions, while ignoring systemic risk.
• To avoid short term excessive debt, Basel III norms were proposed in 2010. 
• BASEL III focussed on four vital banking parameters viz. capital, leverage, funding and liquidity. 

Liquidity Coverage Ratio(LCR): 

• LCR require banks to hold a buffer of high quality liquid assets sufficient to deal with the cash outflows.
• The minimum LCR requirement will be to reach 100% on 1 January 2019. This is to prevent situations like "Bank Run". 

 Leverage Ratio > 3%: 

Leverage ratio was calculated by dividing Tier 1 capital by the bank's average total consolidated assets;. 

Capital Conservation Buffer, COUNTER CYCLICAL BUFFER, Bank Run

 

Capital Buffers:

• Under Basel norms, there are capital requirements that can be imposed on financial institutions in excess of minimum capital requirements. 
• The objective of these buffers is to counter the after effect of Economic shocks and losses on financial institutions’ assets.
• Capital buffers result in reduction of credit supply so as  to safeguard their own solvency. 
• Capital buffers are variable and flexible and penalties for  non compliances are less stringent than for violations of minimum capital requirements.

The Capital Conservation Buffer (CCB) : 

• CCB is a new concept introduced under BASEL III norms . 
• The concept is to buildup a “Capital Buffer" during good times so that the same can be utilized during stress. 
• The objective is to support the banks during the adverse economic environment conditions,
•  It will help increase banking sector resilience both going into a downturn .
• In India, the minimum capital requirement is 9 % . 
• The CCB should be by 2.5 % above minimum Capital ( The Total Works out to 9+2.5 =11.5 %)

COUNTER CYCLICAL BUFFER ( CCyB ):

• Counter-Cyclical Buffer for banks is intended to protect the banking sector against Losses that could be caused by cyclical systemic risks in the economy. 
• Counter-Cyclical Capital Buffer requires banks to hold additional capital at times when credit rapidly grows up . 
• The buffer can be reduced if the financial cycle turns favorable. 
• Currently, this is not introduced in India.

Capital Conservation Buffer (CCB) vs COUNTER CYCLICAL BUFFER :

• The CCB is a permanent requirement while  CCyB is a temporary measure.
• CCB is based on internal risk while  CCy B is for cyclical risks in credit variation and economic conditions

India and Capital Buffers :

As of  April 2023, Reserve Bank has been decided not to activate countercyclical capital buffer (CCyB) at this point as it is not required.

The framework on the countercyclical capital buffer (CCyB) was put in place by the Reserve Bank of India (RBI) in terms of guidelines in February 2015 wherein, it was advised that the CCyB would be activated as and when the circumstances warranted and that the decision would normally be pre-announced.

Bank Run:

• When several clients of a bank or other financial institution simultaneously withdraw their savings out of worry for the bank’s stability, this is known as a Bank Run. 
• The likelihood of default rises as more individuals withdraw their money, which encourages additional people to do the same. 
• Extreme circumstances may arise when the bank’s reserves are insufficient to cover the withdrawals.

Commercial Banks VS Cooperative Banks

Commercial Banks VS Cooperative Banks:

• Co-operative banks also perform the basic Banking functions but differ from commercial banks.
• Commercial banks are joint-stock companies under the companies' act of 1956, or Public Sector Bank under a separate act of a parliament whereas co-operative banks were established under the co-operative society's acts of different states.
• Commercial bank structure is branch banking structure whereas co-operative banks have a three tier setup.
• Certain sections of Banking Regulation Act of 1949 (fully applicable to commercial banks), are applicable to co-operative banks, resulting only in partial control by RBI of co-operative banks and Co-operative banks function on the principle of cooperation and not entirely on commercial parameters. 

• Primary (urban) cooperative banks are required to maintain certain amount of Cash Reserve and liquid assets while

• Non-scheduled (urban) cooperative banks, should maintain a sum equivalent to at least 3 per cent of their total demand and time liabilities in India on day-to-day basis

• Apart from cash reserve, every primary (urban) cooperative bank (scheduled/non-scheduled) is required to maintain liquid assets, not less than 25 %  of its demand and time liabilities, in the form of cash, gold or unencumbered approved securities in accordance with the provisions of Section 24 of the Banking Regulation Act, 1949 (As Applicable to Cooperative Societies). 

Required Reserves,CAPITAL RESERVES,Excess Reserve,Free Reserve,Undisclosed Reserves

 

DIFFERENT TYPE OF RESERVES:

Required Reserves:

Statutory funds that are to be kept with RBI as to meet liquidity requirements like CRR and SLR.

CAPITAL RESERVES:

• Reserves which are kept aside by the company profits to pay for the company's long-term projects/plans /investments. 
• Ex. Money kept aside by a corporation to construct a new office building.
• There is no legal need to distribute any portion of the reserve as dividends to shareholders, the whole sum may be used to construct a brand-new headquarters.

Excess Reserve: 

• Those funds available with the bank or any financial institution which are in excess of the minimum reserve that is required to be kept as per the statutory law ie CRR and SLR. 
• These reserves act as a safety fund or a buffer that protects the institution against any unforeseen contingency.

Free Reserve: 

• Funds in a company’s balance sheet that are available for distribution as dividends. 
• Essentially, these are the extra amounts, after deductions, that can be utilized to reward shareholders.

Undisclosed Reserves:

• Those reserves which are on the books of the banks but not put in public domain and not listed on the balance sheets or other financial statements.
• These often have characteristics similar to equity and disclosed reserves like profit which is unrealized.

Risk Weighted Assets, Capital Adequacy Ratio

 

Risk Weighted Assets (RWA) ----

• Assets of Banks which are weighted according to the risk.
• RWA are useful in calculating the minimum amount of capital required in compliance to the existing regulations to avoid insolvency and protecting its depositors and investors.
• RWA is used in calculating Capital adequacy Ratio (CAR).
• Riskier the asset --Greater amount of Regulatory capital is required.
• So, G-Sec has least amount of risk while loans to corporates have higher amount of risk, and other instruments lying in between. 

To Understand:

Rs.1bn in G-sec, 

Rs.2bn secured by mortgages, and 

Rs.3bn of loans to businesses. 

The Risk Weight according to Assets are:

1. 0% for G-Sec 
2. 50% for mortgages, and 
3. 100% for the corporate loans. 

The bank's risk weighted assets are:

0 × Rs.1bn + 50% × Rs.2bn + 100% × Rs.3bn = Rs. 4bn. 

So, out of total Rs 6 bn, RWA of the bank is Rs 4 bn. 

Capital Adequacy Ratio (CAR):

The CAR is the capital needed for a bank to meet any financial risk.

CAR is measured in terms of assets (mostly loans) disbursed by the banks. 

The higher the assets, the higher should be the capital retained by the bank and Mathematically:

CAR:

Tier 1 + Tier 2 capital / RWA.

To Understand:

If Banks Tier 1 capital =Rs 12bn and Tier 2 capital = Rs 20 bn. 

Then CAR =

Tier 1 Capital + Tier 2 Capital​ / Risk Weighted Assets =

32/RWA

Since CAR represents a number that shows the risk cushioning health of the bank, banks are required to maintain a safe, higher number to signify their favorability.

Regional Rural Banks , Features of RRBs

 

Regional Rural Banks (RRBs):

RRBs are Scheduled Commercial Banks backed by a strong Scheduled commercial bank, providing Banking facilities to small, marginal farmers, artisans, etc. in rural and semi-urban areas.

RRBs provide basic Banking needs for the development of Agriculture, Trade, Commerce, Industry, and other productive activities in rural areas.

Features of RRBs:

• The two prime regulators of Regional Rural Banks (RRBs) in India are the Reserve Bank of India (The Banking Regulation Act, of 1949) and the NABARD (Section 35(6) of the Banking Regulation Act, 1949).
• Each RRB is operated within a geographical limit only. 
• RRBs are involved in disbursement of wages to the workers of  MGNREGA and Pradhan Mantri Gram Sadak Yojana (PMGSY).
• RRBs provide 75% of their total credit as Priority Sector Lending to fulfill the criterion applicable to commercial banks.
• RRBs provide para-banking facilities such as locker facilities, debit and credit cards, mobile banking, internet banking, and UPI services. 
• RRBs reduce regional imbalances by checking the outflow of rural deposits to urban areas. 
• The Government of India, the concerned State Government and the bank, which had sponsored the RRB contributed to the share capital of RRBs in the proportion of 50%, 15% and 35%, respectively. 
• Regional Rural Bank are owned by the Government of India as the maximum share capital is owned by the Central Government.

Consolidation of RRBs:

• In the year 2005, Dr. V S Vyas Committee recommended for the consolidation of RRB's.
• In 2005, the first phase of amalgamation was initiated Sponsor Bank-wise within a State, bringing down the number of RRBs from 196 to 82. 
• As a result of the second phase of amalgamation during 2011-2014, the number of RRBs was brought down to 56 from 82.

 

REFORMS IN RRB’S : 

• RRBs became financially weak because of  huge NPAs .
• Dr. K.C. Chakrabarty committee  in 2010 recommended for recapitalization of 40 out of 82 RRBs.
• Accepting the recommendations, the centre and other shareholders started to recapitalize RRBs by injecting funds into them. 
• Despite reforms, NPAs remained high and to deal with this, GOI enacted RRB Amendment Act (2015).

RRBs Amendment Act 2015 :

• The Regional Rural Banks (Amendment) Act, 2015, came into effect from 4^th February 2016. 
• The Act raises the amount of authorised capital of RRB's to Rs 2,000 crore and it cannot be reduced below Rs One crore. 
• By raising the authorized capital, the financial capabilities of RB ‘s will be increased. 
• The Act allows RRBs to raise capital from other sources (private sector )other than the existing shareholders . 
• States can increase their share beyond 15 % increasing the role of state in decision making .
• The combined shareholding of the central government and the sponsor bank cannot be less than 51%.

Cooperative Bank

Cooperative Bank:

• Financial institutions which are democratic set-ups where the Board Members are democratically elected with each member entitled to one vote each. 
• Co-operative societies are based on the principles of cooperation, mutual help, democratic decision making, and open membership. 
• Cooperative Banks cater to a services like loans, banking, deposits etc. like commercial banks but widely differ in their values and governance structures.  
• The co-operative banking system, with two broad segments of urban and rural co-operatives, forms an integral part of the Indian financial system. 
•  With a wide network and extensive coverage, these institutions have played an important developmental role in enlarging the ambit of institutional credit by way of inculcating banking habits among the poor and those in remote areas.
• They provide credit to small scale industrialists, salaried employees, and other urban and semi-urban residents.

Regulations for Cooperative Banks:

1. In India, co-operative banks are registered under the States Cooperative Societies Act. 
2. They also come under the regulatory ambit of the Reserve Bank of India (RBI) under two laws, namely, the Banking Regulations Act, 1949, and the Banking Laws (Co-operative Societies) Act, 1955.

 Broadly, co-operative banks in India are divided into two categories -

1. Urban Co-operative Banks and
2. Rural Co-operative Banks

Rural cooperative credit institutions could either be:

1. Short-Term or 
2. Long-Term in nature. 

Long Term Rural Co-operative Banks credit system:

• It take care of needs for long term funding.
• In terms of RBI regulation, Long term cooperatives and PACS are out of purview of RBI, otherwise all other Cooperatives are under RBI regulation.

The Long-term Rural Co-operative credit system comprises of :

1. State Cooperative Agriculture and Rural Development Banks (SCARDBs) or
2. Primary Cooperative Agriculture and Rural Development Banks (PCARDBs).

Long term Rural cooperative societies:

1. These are engaged in providing long term credit needs for production purposes.
2. These   have negligible resource base of their own, and mostly raise resources through borrowings. Their poor recovery performance has affected their ability particularly at the primary level to cater to the credit needs of new and non-defaulting members. 
3. This has also resulted in low paid-up share capital, which constrains their borrowing capacity, and the consequent limited resources have inevitably led to low business levels

Short-Term Rural Co-operative Banks credit system: 

These societies are designed essentially to provide for short-term credit needs for production purposes. 

The short-term rural co-operative credit system comprises of:

1. State co-operative banks (StCBs) 
2. Central co-operative banks (CCBs) 
3. Primary agricultural co-operative Societies (PACS) 

Primary Co-operative Credit Society (PACS):

• PACS are the grassroot level arm of short term co-operative credit, mediate directly with individual borrowers and  grant short-term to medium term loans and also undertake distribution and marketing functions.
• PACS are outside the purview of the Banking Regulation Act, 1949 and hence not regulated by the Reserve Bank of India (RBI website). 
• The funds of the society are derived from the share capital and deposits of members and loans from central co-operative banks. 
• The borrowing powers of the members as well as of the society are fixed. 
• The loans are given to members for the purchase of cattle, fodder, fertilizers, pesticides, etc. 
• A large number of PACS, however, face severe financial problems primarily due to significant erosion of own funds, deposits, and low recovery rates. PACS hold more than 95 % of assets of rural cooperatives.
• These banks need not to maintain CRR and SLR.

Central co-operative banks:

• These are the federations of primary credit societies in a district and are of two types-those having a membership of primary societies only and those having a membership of societies as well as individuals. 
• The funds of the bank consist of share capital, deposits, loans and overdrafts from state co-operative banks and joint stocks. 
• These banks provide finance to member societies within the limits of the borrowing capacity of societies. 
• These banks have to maintain CRR and SLR.

State Co-operative Banks:

• The state co-operative bank is a federation of central co-operative bank and acts as a watchdog of the co-operative banking structure in the state. 
• Its funds are obtained from share capital, deposits, loans and overdrafts from the Reserve Bank of India. The state co-operative banks lend money to central co-operative banks and primary societies and not directly to the farmers. 
• These banks have to maintain CRR and SLR.
• All short term Cooperatives except PACS are regulated by RBI.

Urban Co-operative Banks (UBBs) are classified as:

1. Scheduled Urban Co-operative Banks or
2. Non-scheduled Urban Co-operative Banks

MICRO FINANCE, Issues in Micro Financing, Microfinance vs Microcredit

 

MICRO FINANCE:

• Provisioning of financial services to the marginalised who are  un-bankable. 
• National Bank for Agriculture and Rural Development (NABARD) took this idea and started the concept of microfinance in India. 
• There are two models in India that link the formal financial sector to low-income households in India, namely SHG and MFI bank linkage programme. 

SHG model:

It works on the principle of directly financing of SHG by the banks and

MFI model:

It covers financing of Micro Finance Institution (MFIs) by banking agencies for the purpose of lending the same amount to SHG’s and other small borrowers.

Concept of Microfinance Institutes in India :

• Microfinance in India finds its roots in the early 1970s’ in Gujarat when the Self Employed Women Association (SEWA) was formed to provide banking services to the poor women of unorganized sector. 
• Program linking the Self Help Group to the banking sector was initiated in India in 1989, under NABARD. 
• Various schemes introduced by the present government like Micro Units Development and Refinance Agency (MUDRA) bank and Jan Dhan Yojna has aided in the growth of the micro finance institutions. Both of them target the same poor segment of the society.

The major factors that have fuelled the growth of micro finance in India are:

·         Rapid growth in the Business Correspondent (BC) model, opportunity.

·         Introduction of differentiated bank license and opportunity.

·         Rising participation of the current central government in financial inclusion

·         Micro finance institutions in India are expanding with time due to the financial benefits provided to the unprivileged people of the country.

Issues in Micro Financing in India: 

• High interest rates, 
• No variety in the products offered to the customers and 
• Lower risk mitigation measures 
• Urban poors are not covered
• Poor credit appraisal system, 
• Lack of awareness,
• poor debt management 
• weak loan collection system
• High Non-Performing Assets (NPAs), 

Despite the disadvantages they form a very important part of the functioning of many industries due to easy loans given to those who otherwise cannot afford better facilities. 

Microfinance vs Microcredit:

In micro credit; small loans are given to the borrower but under microfinance financial services  savings accounts and insurance are also provided alongwith loans.