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APEC - 2021
Indian Economy
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Syllabus for prelims

Economic and Social Development

Sustainable Development,
•Poverty, Inclusion, Demographics,
•Social Sector Initiatives, etc.
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Common mistakes to avoid

Too many sources – instead limited

sources, more revision
Skipping NCERT books – read thoroughly

Getting into technical aspects – for us

only concept is important

Types of questions in prelims

-- conceptual, basic understanding, easy

-- not factual in nature for the large part
-- terminology
-- interrelations
-- testing the understanding
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Demand and supply

demand is the quantity of a good that consumers are

willing and able to purchase at various prices during a given
period of time

supply is the amount of a resource

that firms, producers, labourers, providers of financial
assets, or other economic agents are willing and able to
provide to the marketplace or directly to another agent in
the marketplace
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National income accounting

GDP,GNP

NDP,NNP

Money

Began with barter system

Evolved from there to present day

currency notes, bank money
Even crypto currency
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I promise to pay the bearer the sum of _____

rupees
What British era – converted to gold/silver
does it
mean? Now – converted to other notes ex:
2000 = 500x4

Currency notes

Because
of the Are bonds
promise
by RBI
governor
Zero interest
Anonymous bearer bonds
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What is a bank?

Deposits – money increases, flexibility,

theft avoided
Loans – Borrow, invest, profit or
contingency
Business of a bank – accept deposits,
give loans

Assets and liabilities of a bank

Demand deposits = CASA

Time deposits = FD

Total deposits = Demand + Time

deposits
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RBI was established as a regulator

RBI act 1934

Started working from 1935 jan 1st

1935 to 37  HQ was in Kolkata, after

that in Mumbai (current)

Why At that time?

Economic troubles after 1st WW

Dr BR Ambedkar wrote a book – the problem

of the rupee – in which he recommended

Hilton Young Commission recommended it

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RBI

19 regional offices, 9 sub regional offices

RBI headed by governor

Current governor – Shaktikanta das

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RBI

1st governor – Osborne Smith

1st in Independent India – CD deshmukh

Longest serving – Benegal rama rao (49 -

57)

RBI

1949 -- nationalized

RBI is a statutory body – by an act of

parliament
Is it an autonomous body?
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RBI act, 1934

Act mentions functions can be taken

over by government anytime
Structurally it does not have provisions
of autonomy
But in operation – Independence exists.

Independence

RBI an Will depend on the governor

agency
under YV reddy, Subbarao, Raghuram Rajan
finance
ministry
Very aggressive and vocal about
independence
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Why independence?

Growth – inflation conflict

in the short run
In the long run, price
stability helps in growth

Minimum reserve system of RBI(1956)

Although we have fiat currency, just as a

symbolic measure we keep a min reserve

200cr worth reserve – 115 cr worth of gold

and 85 cr worth of foreign currencies
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Monetary policy (currently)

Major 1> Interest rate determination

goals
2>protecting depositors

3> Inflation targeting

RBI + government : focus on

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Monetary policy

Earlier – RBI decided monetary policy

completely
After amendment to RBI act in 2016 –
Monetary policy committee
Has to meet at least once in a quarter

Monetary policy committee (6 members)

RBI Governor Govt Appointed by

central government

Dy. Governor Appointed by

(monetary policy) central government

Officer nominated Appointed by

by the central board central government
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How does it work

Voting and majority votes

RBI governor will have a casting vote

No veto to governor

What does MPC do?

Decide repo rate

The resolution adopted by the MPC is published after

the conclusion of every meeting
every six months,
the Reserve Bank is (1) the sources of inflation and
required to publish
a document called
the Monetary
Policy Report to (2) the forecast of inflation for 6-18 months ahead.
explain:
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Monetary policy framework agreement

(2015)

MPFA Government and RBI agree on what

should be the range of inflation
4 +/- 2% currently -- Flexible Inflation
Targeting (FIT)
Inflation can be in the range of 2 to 6%

MPFA goals

MPFA Operating target and operating procedure to be estd

If violated for 3 consecutive quarters, considered as

failure

In case of failure – RBI required to provide the reasons

for the failure, and propose remedial measures and the
expected time to return inflation to the target
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Functions of RBI

1> Banker to government (center and

state)
2> Implement’s country’s monetary
policy
3> Acts as agent of govt wrt India’s
membership of IMF

Functions of RBI
4>handles borrowing program of govt ( both c and s)

5> Issues currency

6> Banker to banks

7>Guardian of banking system and money market

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Functions 8> Custodian of foreign exchange

of RBI reserves of the country(440bil$ oct2019)
9> Lender of last resort

10> controller of credit

1. Banker to government (center and state)

Holds government accounts

Wherever RBI not present, SBI will act as

a proxy
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2> Implement’s country’s monetary policy

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3. govt’s agent in IMF

4>handles borrowing program of govt ( both c and

s)

Govt’s incomes are irregular, while

expenditure is regular
So loans are imperative

Government issues bonds(securities) to

take loans
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Borrowing of government

PDMA In other countries – US, UK etc central bank does not

handle borrowing of government

There is a separate independent agency – Public Debt

Management Agency(PDMA), Debt Management Office
(DMO) etc
Currently RBI has to manage inflation on one hand +
manage debt of government on the other

Need for PDMA

1> Address conflict of interest in RBI

2> remove fragmentation in public debt management – currently

foreign debt managed by central govt, domestic debt by RBI

3> Cash and investment management with a comprehensive

view of government’s financial situation can be done

4> Deepening of bond market

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5> Issues currency

2rs and above notes – printed and distributed by RBI

1rs note and coin, other coins – printed/minted by GOI,

distributed by RBI on behalf of GOI

RBI can print currencies up to 10,000 as per the coinage

act

RBI board has authority to print new denomination

currencies also (200rs, 2000rs not present in coinage act)

6. Banker to banks

Banks can deposit, borrow money from

RBI
Individuals cannot open accounts in RBI

Smooth interbank transactions

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7. Guardian of banking system and money market

Granting licenses

Controlling branch expansion

Bank inspection

8. Custodian of forex reserves

All forex reserves of the country held by

RBI
Any new currency entering and leaving
also managed.
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9. Lender of Last resort

If no one else is lending to the bank, RBI

will
Not the first resort, because interest
rates are higher than the market

10. Controller of credit

Using qualitative and quantitative

measures
Controls the credit supply using these

Controls the economy using the control

over credit
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Quantitative and qualitative measures to

control credit
Quantitative Qualitative
Bank Rate Rationing of credit

Cash reserve ratio Margin requirements

Statutory liquidity ratio Regulating consumption

loans

Repo and reverse repo Moral suasion

Marginal standing facility Direct action

Creation of credit

Money
that is
High powered money /
printed
by RBI Government money/
is
called reserve money/ M0
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Velocity of circulation

Average number of times money passes

from one hand to another in a given time
Higher the velocity, higher inflationary
pressure
More money and velocity of money both
can create inflation

Factors affecting velocity

Some Income distribution -- Money in the hands of

indicative poor people has higher velocity than the rich.
factors
 If more people borrow money for purchase=>
higher velocity.

 Boom period – more production – more

velocity.
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MONEY MULTIPLIER

The amount of money banking system

generates with each rupee
Money multiplier inversely proportional
to CRR
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Money multiplier

Increases with decrease in CRR

improves as banking penetration

increases
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The money multiplier in an economy increases with which one of the

following?
• A. Increase in the cash reserve ratio
• B. Increase in the banking habit of the population
• C. Increase in the statutory liquidity ratio
• D. Increase in the population of the country

Monetary policy

Usually decided bi-monthly at present

But RBI can intervene and change the

rates any time based on it’s discretion.
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1>Repo rate

Currently The rate at which RBI lends money to

4.40%(Dec commercial banks
2020)
Generally with government securities as
collateral
5.15% Increase will lead to reduction in
(oct 2019) inflation

2>Reverse repo rate

Currently The rate of interest which RBI pays for
3.75% (Dec borrowing money from banks
2020)
With government securities as collateral

(Oct 2019) Increase will lead to reduction in

– 4.90% inflation
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Open market operations

In the Use of Repo and reverse repo rates to

medium manage liquidity
to long
Is together called as open market
term
operations
Selling and buying of govt securities

Liquidity adjustment facility

Short Use of Repo and reverse repo rates to

manage
term
Mismatches of liquidity in banks in the
(day short term
to Using securities as collateral
day)
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• If RBI purchases Government securities via open market operations,

then liquidity _______.
• increases
• decreases
• Stays the same.
• None of above.

Monetary policy corridor

earlier The difference between Repo and

reverse repo rate
Controls the rate of interest of loans
between banks
Regulates inter bank lending
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Monetary policy corridor

Changes The repo rate was placed in the middle of the corridor
that have while the reverse repo rate and the MSF rate were placed
above and below
happened
MSF – Repo – Reverse repo

4.65 – 4.40 – 3.75

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(Money at call and short notice)

Money at call – 24 hr money market

Short notice – 7 and 14 days

MIBOR(Mumbai interbank offer rate),

LIBOR

3> Bank rate

4.65% Rate at which RBI provides

at
present loans to banks
No collateral required
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Bank rate

Used Earlier -- Pledging of commercial bills

as mostly, sometimes G-secs also
penalty Not used as the primary instrument by
rate RBI
Interest is relatively high, so banks don’t
prefer it either

Repo rate vs Bank rate

Repo Bank
rate With collateral rate Without
collateral
Short term Longer term

Always lower Always higher

than bank rate than Repo rate
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Repo rate vs Bank rate

Repo Not used as penalty Bank Used as penalty rate

rate rate rate

Primary instrument of Not primarily used in

RBI in controlling controlling inflation
inflation
Banks prefer repo rate Banks don’t prefer bank
as far as possible rate (as it is higher)

4> Cash reserve ratio

Currently Ratio of average daily balance of DTL of bank, which a

bank has to necessarily keep with the central bank in cash
3%
RBI does not pay any interest on it

Mandated under RBI act

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Cash reserve ratio

During demonetization, RBI temporarily prescribed
Incremental CRR of 100% to drain excess liquidity in
banks & prevent crashing of loan interest rates
All Scheduled Commercial Banks (SCB) must keep CRR
however

RBI may prescribe separate norms/ slabs for RRBs and

Cooperative Banks

In which of the following, Bank will not be making any money?

• Meeting CRR requirement.
• Meeting SLR requirement.
• Parking money in RBI under Reverse repo.

• A. Only 1 and 3
• B. Only 2 and 3
• C. Only 1
• D. All of them
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5>Statutory liquidity ratio

18% Banks must keep some amount of deposits

currently in liquid assets such as cash, gold, G-Sec,

If banks buy G-secs, they get interest

Will be reduced to 18% in a phased

manner by 2020

Statutory liquidity ratio

All Scheduled commercial banks must

hold SLR
This way government gets loans

And Also, stability of the banking system

is maintained
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CRR + SLR

CRR-SLR are counted on fortnightly basis.

If not maintained, bank will have to pay penalty

interest rate to RBI which is linked with Bank Rate.

They help in maintaining monetary stability

If RBI wants to inject more liquidity in the system, it should

• A. Increase the CRR rate
• B. Increase the SLR rate
• C. Decrease the Reverse repo rate.
• D. Decrease the repo rate.
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How monetary stability?

CRR 1) CRR assists in money multiplier

effect
+
SLR 2) CRR+SLR provide
buffer/protection during a Bank Run

CRR + SLR

Can be used to control inflation, but not used in

general

CRR is an extreme measure to use for inflation

control

SLR is not a primarily inflation control tool, but if

RBI doesn’t pass the money to govt, can be used
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For example, Market stabilization scheme

Bonds issued by govt, sold by RBI

But money kept in separate account

under RBI, govt cannot spend it.
But govt has to pay interest on these
bonds (cost of maintaining price stability)

UPSC CDS 2011

• Q. Find correct statements about Statutory Liquidity Ratio (SLR)
• 1. To meet SLR, Commercial banks must keep cash only.
• 2. SLR is maintained by the banks with themselves.
• 3. SLR restricts the banks leverage in pumping more money into the
economy.
Answer codes:
(a) 1, 2 and 3
(b) 1 and 3
(c) 2 and 3
(d) only 2
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UPSC (2015)
Q. When the Reserve Bank of India reduces the Statutory Liquidity
Ratio by 50 basis points which of the following is likely to happen?
• (a) India's GDP growth rate increases drastically.
• (b) Foreign Institutional Investors may bring more capital into our
country.
• (c) Scheduled Commercial Banks may cut their lending rates.
• (d) It may drastically reduce the liquidity to the banking system.

Marginal standing facility

Currently Marginal standing facility (MSF) is a window for banks to borrow from the
Reserve Bank of India in an emergency situation when inter-bank liquidity
– 4.65% dries up completely.

Need collateral of G-secs

(25 basis
points
above Only up to 24 hours

repo and
equal to Only up to 2% NDTL (as of now)
bank rate)
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MSF

G-secs can be used even in violation of

SLR, CRR for MSF
But not for repo or any other instrument

Qualitative measures

Rationing RBI may impose limits on loans given or impose

of credit obligations on banks to give particular loans.
Quotas of loans may be created.

In India we have Priority sector lending

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Priority sector lending

way to provide higher priority to certain economic sectors
PSL in our country.

Giving them better access to credit/loans as usually these

sectors may not automatically be attractive for banks
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Adjusted Net bank credit

Net bank
credit +
Bank credit  loans given by the bank
investments (assets)
in non SLR
category Net bank credit  assets – loans taken
(held to from other banks
maturity)
Adjusted  Subtracting bonds held
under obligation like SLR.
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Qualitative measures
Margin Margin means that proportion of the value of security
requirements against which loan is not given
-- to reduce
hoarding and
black Higher the margin lesser will be the loan sanctioned.
marketing
also
When RBI wants more loans to flow to particular sectors
– housing, auto, agri they reduce margins and vice versa
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Qualitative measures
Regulating
consumption Direct loans to productive purposes
loans

Too much consumption without

production increases inflation

Qualitative measures

Moral Persuade an erring bank to follow rules

suasion – first informally
Then formally, by sending notices

Combination of persuasion and pressure

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Qualitative measures

Direct Penal action -- penalty

action Stop repo and other operations

Moratorium imposed on banking operations

Cancelling of licenses

DRI scheme
Agri, allied, Differential rate of interest scheme – loans at concessional
self interest rate of 4%
employment
SC/ST, minorities and physically handicapped persons

Family income not exceeding Rs.18, 000/- p.a. in rural areas

and Rs.24, 000/- p.a. urban / semi urban areas.
Land holding does not exceed 1 acre irrigated or 2.5 acres in
case of un-irrigated land. (land criteria doesn’t apply to
SC/STs)
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Lead bank scheme

Bank with good branch network + financial + manpower resources
in a district is considered as lead bank for that district

1>coordinating the activities of banks and other developmental

agencies

2>To enhance credit to the priority sector and other sectors

3>and to promote banks' role in the overall development of the

rural sector
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UPSC 2013
• Priority Sector Lending by banks in India constitutes the
• lending to

• (a) Agriculture
• (b) Micro and small enterprises
• (c) Weaker sections
• (d) All of the above

New developments
Standing Banks parks funds in RBI for short-term to earn interest.

Deposit
Facility No G-sec / collateral, unlike Reverse Repo.
(SDF)
[proposed]
This helps RBI absorb excess liquidity for short term in situations like
demonetization when RBI may not have enough G-Secs to pledge as
collaterals.

Urjit Patel Committee on Monetary policy (2013) proposed this, budget 2018
has accepted this proposition.
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• Which of the following is not an instrument of Selective Credit

Control? (UPSC 1995)
• a) Regulation of consumer credit
• b) Rationing of credit
• c) Margin requirements
• d) Cash reserve ratio

UPSC (2013)
• Q. An increase in the Bank Rate generally indicates that _ _ _
• a) Market rate of interest is likely to fall.
• b) Central Bank is no longer making loans to commercial banks.
• c) Central Bank is following an easy money policy.
• d) Central Bank is following a tight money policy.
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UPSC (2015)
• Q. Consider the following:
• 1) Bank rate 2) Open market operations
• 3) Public debt 4) Public Revenue
• Which of them is/are part of Monetary Policy?
• (a) 1 only
• (b) 2, 3 and 4
• (c) 1 and 2
• (d) 1, 3 and 4

UPSC(2013)
• Q. 'Open Market Operations' refers to:
• (a) borrowing by banks from the RBI
• (b) lending by commercial banks to industry and trade
• (c) purchase and sale of government securities by the RBI
• (d) None of the above
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Three predominant types of monetary policy

1> Exchange rate stability as the main concern ex:

Singapore and other export led economies

2> Multiple indicators – growth, inflation,

employment, exchange rate ex: India before 2016

3> Inflation targeting as the main concern ex:

India at present (after Urjit patel committee)

Limitations of monetary policy

1> Indian Banks don’t immediately pass on the RBI rate
cuts to customers, citing NPA/Bad loans / profitability
problem
2> Supply Side Issues: El-Nino/Poor monsoon hurting
crop production, geopolitical issues increasing global
crude oil & raw material prices. RBI can’t control
3> sometimes fiscal policy affects monetary policy – loan
waivers, huge subsidies, leakage of subsidies
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Limitations of monetary policy

4> RBI cannot control direct lending through bond

sale by businesses

5> RBI has no control over moneylenders,

informal economy which do not depend on loans

Non Performing Assets

Definition (NPA) is a loan for which the principal or interest payment

remained overdue for a period of 90 days.

Agriculture / Farm Loans; the NPA is defined as under:

 For short duration crop agriculture loans such as paddy,
Jowar, Bajra etc. if the loan (installment / interest) is not
paid for 2 crop seasons
 For Long Duration Crops, the above would be 1 Crop
season from the due date.
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Some terms about loans

Standard Asset: If the borrower regularly pays his dues and on time;

secured loan: borrower pledges some asset (e.g. a car or property) as

collateral for the loan

Unsecured loan: without the use of property as collateral for the loan, and
it is also called a signature loan or a personal loan.

Provisioning: For every loan given out, the banks keep aside some extra
funds to cover up losses if something goes wrong with those loans.
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Provisioning requirements
Substandard
asset
Sub-standard – NPA but less than 12
provisioning months
o 15% of outstanding amount in case of
Secured loans
o 25% of outstanding amount in case of
Unsecured loans
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Provisioning requirements
Doubtful Sub-standard asset remains so for a period of 12 more months; it would
be termed as “Doubtful asset”. This remains so till end of 3rd year.
asset
provisioning
o Up to one year: 25% of outstanding amount in case of Secured loans;
100% of outstanding amount in case of Unsecured loans

o 1-3 years: 40% of outstanding amount in case of Secured loans; 100% of

outstanding amount in case of Unsecured loans

o more than 3 years: 100% of outstanding amount in case of Secured

loans;100% of outstanding amount in case of Unsecured loans.

Gross and net NPAs

Gross NPA is just the sum

of all NPAs of the bank
Net NPA is Gross NPA
minus provisioning
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Why NPAs?

1> Due diligence not done by the bank – ex: Loan

disbursed for a road even before land acquisition

2> Poor monitoring by the bank post

disbursement

3> Diversion of funds by companies for purposes

other than for which loans were taken

Why NPAs?
4> Earlier – used to do restructuring of NPAs to avoid
provisioning, now RBI made it strict – sudden rise in NPAs
seen.
5> Economic downturn since 2008

6> Export decline due to low global demand (double dip

recession, now trade wars)
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Why NPAs?

7> Policy paralysis, especially seen in UPA2

– delay in decision making

8> Crony capitalism – Banks are forced by

government to lend to certain corporates.

9> Poor bankruptcy provisions – exit

barriers led to piling up of bad loans

Impact of NPAs

1>Provisioning norms – reduce profits

for the banks
2>Increase in interest rates to
compensate
3>Evergreening of NPAs
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Impact of NPAs

4> Twin balance sheet syndrome hurts

growth
5> banks become cautious in lending –
reduced loans
6> Monetary transmission issues arise

Monetary transmission issues

Banks 1> Rising NPAs impact profits, so banks

not don’t reduce rates
passing 2> competition from small savings
on rate instruments
cut
Ex: National savings certificates, Kisan
vikas patra, Sukanya samriddhi yojna etc
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Benchmark prime lending rate(BPLR )

up Benchmark Prime Lending Rate (BPLR) was the

rate at which commercial banks charge their

to customers who are most credit worthy. Banks can

fix the BPLR with the approval of their Boards.

2010 Under BPLR, banks could lend even below BPLR.

Ultimately one borrower getting cheaper loan
than the other was a major problem. Hence base
rate was introduced

Base Rate
Base Rate is the interest rate below which Scheduled
2010 Commercial Banks (SCBs) will lend no loans to its customers

to 1) Cost for the funds (interest rate given for deposits+ loans
taken),

2016 2) Operating expenses,

3) Minimum rate of return (profit or margin), and

4) Cost for the CRR (for the four percent CRR, the RBI is not
giving any interest to the banks)
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Marginal cost of funds based lending rate

(MCLR)
2016 Marginal – new funds that are coming in
onwards (deposits, loans)
Changed formula to calculate interest rates of
banks

Ex: Housing = MCLR +1%;

Auto = MCLR +2%

MCLR
1>Marginal cost of funds: (interest for new deposits
MCLR and interest on new loans)
2>cost of holding CRR

3> Operating cost: rents, salaries etc

4> Tenor premium: Higher interest can be charged for

long term loans
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Impact of MCLR

Better monetary transmission

Lower interest rates for borrowers

Less discretion for banks in deciding

interest rates

Measures taken to resolve NPAs

1>Debt Courts took 6-8 years

recovery
tribunals
Separate tribunals established to reduce
time taken
But huge lag developed in tribunals also
– they were insufficienct
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Measures taken to resolve NPAs

2>SARFAESI The Securitization and Reconstruction of Financial
Act – 2002 Assets and Enforcement of Security Interest

If more than 25% of bank loans are NPA’s, no

need to go to court or tribunal

They can send a notice and auction the collateral.

Can buy loans to reach 25% mark.

Measures taken to resolve NPAs

3> Asset
reconstruction Loans sold to these companies and then
companies converted to equity
(ARCs)
Banks cannot hold equity beyond a point
– it creates more risk in the economy
So, ARCs were created.
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2015 – mission Indradhanush

Mission Indradhanush

Appointments -- separate post of Chairman

and Managing Director and the CEO

Bank Board Bureau – will focus on

appointments without political interference

Capitalization – 1.8 lakh cr required for banks

upto 2019, 70kcr will be provided by govt
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Mission Indradhanush

Destressing – strengthening risk control measures

Employment – government will not interfere in

hiring and firing decisions

Framework for accountability – Key performance

indicators linked to performance incentives

Mission Indradhanush

Governance Reforms – PJ nayak committee

recommended governance reforms

PJ nayak – setup Bank Investment Company as a

holding company, BBB (done), repeal acts which
require 50%+ stockholding of government in PSBs
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2018 – RBI abolished a lot of measures

Called SDR, CDR, S4A, JLF

them as
alphabet
Said they give too much lenience, perpetuating the
soup problem of NPAs

Increased reporting requirements for NPAs –

Special mention accounts (to prevent evergreening)

Project Sashakt

Proposed 1> Bad loans of up to ₹ 50 crore will be managed at the

bank level, with a deadline of 90 days
by Sunil
Mehta
2> 50-500 crore, banks will enter an inter-creditor
panel agreement, authorizing the lead bank to implement a
resolution plan in 180 days, or refer the asset to NCLT
3> For loans above ₹ 500 crore, the panel recommended
an independent AMC, supported by institutional funding
through the AIF.
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AMC – asset management company

An asset management company (AMC) is a company

that invests its clients' pooled funds into securities.

Asset management companies provide investors with

more diversification and investing options such as
mutual funds, hedge funds and pension plans, and
these companies earn income by charging service
fees or commissions to their clients.

What are AIFs?

SEBI AIFs refer to any privately pooled investment fund, (whether from Indian
or foreign sources), in the form of a trust or a company or a body
definition corporate or a Limited Liability Partnership (LLP).

AIF does not include funds covered under the SEBI (Mutual Funds)
Regulations, 1996, SEBI (Collective Investment Schemes) Regulations,
1999 or any other regulations of the Board to regulate fund
management activities.

Hence, in India, AIFs are private funds which are otherwise not coming
under the jurisdiction of any regulatory agency in India.
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Basel requirements
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Basel is a place in Switzerland

1974 – Herstatt, a German bank failed

G10 countries + Spain and Luxemburg

wanted to prevent such incidents

Some regulations must be developed

Basel committee for banking supervision

formed (BCBS)
Banks do a lot of innovations every year
– so rules need to change too
So, we have 3 sets of Basel norms
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For all multinational banks in the world

Basel 1 -- 1988
Basel 2 -- 2004
Basel 3 -- 2008

In India,

They are automatically applicable on

multinational banks
Domestic banks were not following for a
while,
But later implemented. Currently under
basel 2, going to implement basel 3
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Basel norms focus on

1> Minimum capital requirement

2> supervisory review (supervision to

meet norms)
3> Market discipline (disclosure norms)

Minimum capital requirement

Measured by capital adequacy ratio

Must be at least 8%

But RBI says 9% for India

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Capital adequacy ratio

Measure of bank’s financial strength to ensure

that banks have enough cushions to absorb losses
before becoming insolvent and losing depositors’
funds.

CAR is required to be 9% by RBI (based on BASEL

III norms), where 7% has to be met by Tier 1
capital while the remaining 2% by Tier 2 capital.
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Tiers of capital of a bank

Tier 1 capital consists of shareholders'

equity and retained earnings. (permanent)

Tier 2 capital includes revaluation reserves,

hybrid capital instruments and debt. (Temporary)

Risk weighted assets

Assets of a bank -- loans

Given weight according to their risk

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Capital adequacy ratio (CAR)

(Tier I + Tier II
Capital)/ X 100
Risk Weighted
Assets
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Capital conservation buffer

The capital conservation buffer is

a capital buffer of 2.5% of a bank's
total exposures that needs to be
met with an additional amount of
Common Equity Tier 1 capital.
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Domestic systematically important banks (D-

SIBS)
Very big banks need to be more cautious

If they fail, economy fails

So need to take extra measures

Basel 3 says (for D-sibs)

4 factors 1> Size(40%)

based
on 2> Interconnectedness
which
we 3> Complexity in operations
choose
D-sibs 4> substitutability(20% each)
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RBI

If 2% GDP, then sufficient size

RBI declared  SBI, ICICI, HDFC

Too big to fail banks

Prompt corrective action

set of guidelines for banks that are weak

in terms of identified indicators including
– poor asset quality, insufficient capital
and insufficient profit or losses.
It is an early intervention package or
resolution guideline
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Banks under PCA

Jan 2018 – there were 12 banks under PCA

Govt recapitalized and took several measures

By March 2018 only 6 banks

2021 feb – 3 banks under PCA

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Leverage?

Leverage ratio -- ratio of tier 1 capital to

total assets
Was suggested in basel 3

Now RBI using in PCA

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NBFCs

A Non-Banking Financial Company (NBFC) is a

company registered under the Companies Act,

engaged in the business of loans and

advances, acquisition of
shares/stocks/bonds/debentures/securities
issued by Government or local authority or
other marketable securities

Who can be an NBFC?

50:50 Financial activity as principal business is

when a company’s financial assets constitute
test more than 50 per cent of the total assets

and income from financial assets constitute

more than 50 per cent of the gross income.
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Regulation of NBFCs

Multiple regulators
Based on their operation
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Systematically important NBFCs

NBFCs whose asset size is of ₹ 500 cr or more

as per last audited balance sheet are
considered as systemically important NBFCs.

The rationale for such classification is that the

activities of such NBFCs will have a bearing on
the financial stability of the overall economy.

Are they same as banks?

Majorly NBFCs cannot accept demand deposits

yes, but
some NBFCs are not a part of the payment and settlement system
exceptions
NBFCs cannot issue cheques drawn on itself

NBFC depositors do not have deposit insurance facility of the

Deposit Insurance and Credit Guarantee Corporation, unlike banks
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RBIs Internal working group suggestions

Nov 1> large corporates should be allowed as promoters of

banks – cap on promoters stake can be increased from
2020 current 15% to 26%
Revise 2> Initital paid up capital required to setup a bank to be
licensing increased to 1000 cr for full fledged banks

norms
3> Big NBFCs (50kcr+ assets, 10+ years of operation) to be
for considered for conversion to banks
banks
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RBIs Internal working group suggestions

Positives 1> Bring more capital to banking sector,

of reduce pressure on govt
corporates
as bank 2> better competition in the banking
promoters
sector
3> More choices available for people –
to deposit, take loans

RBIs Internal working group suggestions

Negatives Connected banking – Corporates as promoters

of of banks give loans to their own companies
corporates
as bank Circular banking – Quid pro quo to bypass
promoters regulations and go for connected banking

Destabilization of banking sector is possible –

due to increased risk transfer
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