Chapter 8: BANKING CONCEPTS
Type of Deposits
deposits: they are payable by the bank on demand from
the account holder. E.g. Savings in bank accounts, current
account, demand draft.
deposits: they have a fixed period of maturity. E.g.
fixed deposits, recurring deposits, cash certificates, staff
deposits are more than demand deposits in banks.
= net time and demand liabilities = time deposits + demand
stock of money in circulation with the public at any point of
time is called Money Supply.
of money supply:
= currency in circulation with public [CU] + demand deposits in
commercial banks [DD]
= M1 + saving
deposits held by post office banks
= M1 + net time deposits held in commercial banks.
= M3 + total deposits with post office banks[except national
M2 are narrow money and M3, M4 are broad money. Liquidity
increases from M4 to M1. M3 is the most popular measure of money
supply known as aggregate monetary resource.
Fig 1: Money supply
ratio: ratio of money held by public in currency to that they
hold as deposits in banks.
C.D.R = CU / DD.
ratio: proportion of total deposits banks keep in reserves.
ratio: fraction of the deposits banks must keep with RBI
ratio: fraction of the total demand and time deposits banks must
keep in liquid assets.
money or monetary base or reserved money [M0]: total liability
of the monetary authority of the country. It consists of
currency in circulation with public and vault cash with banks
and deposits of commercial banks and government of India with
multiplier = ratio of stock of money to the high powered money.
i.e. M3 / M0
all depositors of the bank want their money withdrawn the bank
will default. Hence in such situations the RBI acts as banker
to banks / lender of the last resort and extends loans to
ensure solvency of the latter.
also acts as banker to
the government. When governments can’t meet their expense
with their income, they print currency to meet the budget
deficit. In reality it involves selling of bonds to the RBI which issues currency to the
government in return. The money then ultimately comes in the
hands of the public and becomes a part of money supply.
Financing of budgets in this manner is called “deficit
financing from central bank borrowing”.
operations: RBI purchases or
sells government securities to the general public in the attempt
to increase or decrease liquidity or stock of high powered money
in the economy.
to save is the proportion of
the total additional income of the economy people wish to save
as a whole. Marginal
propensity to consume is the fraction of the total
additional income people wish to consume. It the people of the
economy increase the total proportion of income they save then
the total value of savings in the economy will either decrease
or remain same – paradox
the government deficits have to be financed by either borrowing,
taxation or financing. The government prefers to borrow thus
creating government debt.
economy: a country that trades with
other nations in goods and services and also in financial
assets. The degree of openness of an economy is the ratio of total foreign trade
[exports+ imports] to the country’s GDP.
Rates of RBI:
long term loan from RBI. No collateral needed.
standing facility: commercial banks can borrow from
RBI at this rate [Repo+1]%
and can use SLR securities as collateral. Limit is 0.75% of
rate: all clients can borrow from RBI for short
period at this rate but can’t use SLR securities as collateral.
No limit to borrowing.
Repo rate: RBI pays this to its clients for short
term loans [Repo – 1]%.
liquidity ratio: banks have to keep this much in
gold, securities, cash etc. It is decided by RBI.
ratio: have to deposit this much cash with RBI but no
both S.L.R, C.R.R are counted on net time and demand liabilities
[N.T.D.L = net time and
demand liabilities = time deposits + demand deposits].
To reduce inflation: tight
monetary policy, reduce money supply
To fight deflation: increase
money supply, easy monetary policy.
Monetary policy instruments with the RBI:
repo, repo, marginal standing facility, bank rate
ceiling of loans to specific sectors
loan to value – if customer wants to keep collateral of 1 kg
gold worth 1 lakh and the LTV is 60% then bank can loan him only
60% of 1 lac= 60,000.
Qualitative instruments are
selective and direct. Quantitative instruments are general and
During high inflation RBI
increases CRR, SLR and the rates and sells government securities
through open market operations [OMO] to reduce money supply.
During deflation RBI decreases CRR, SLR, rates and buys G-Secs
from public via OMO.
Monetary policy is currently
decided solely by RBI governor but to fix responsibility a
monetary policy committee needed with RBI governor [chairman] +
deputy governor [vice chairman] + executive director and 2
Priority sector lending [PSL]:
Indian banks, foreign banks with
more than 20 branches have to lend 40% of net loans given to
priority lending sector in that year.
Foreign banks with less than 20
branches must give 32% of their net loans given to PSL in a
PSL consists of agriculture [18%
out of 40% should go here], weaker sections [10% out of 40%] and
remaining to housing, education, micro & small enterprises,
retail trade, renewable energy, export credit. For foreign banks
with less than 20 branches no sector specific targets but should
In case the Indian banks or
foreign banks with 20+ branches don’t meet their target the
amount of shortfall must be given to rural infrastructure
development fund managed by NABARD. This is used to give loans
to states and bank earns interest on it decided by RBI.
For foreign banks with <20
branches the shortfall goes to small enterprises development
fund managed by SIDBI which is used to lend state industrial
finance corporations and bank earns interest on it.
PSL applies only to commercial
banks both public and private. It doesn’t apply to cooperative
banks, regional rural banks, NBFC.
It has four pillars:
payments through branches, ATM, cheques
at affordable rates
funds, pension plans
and non life insurance
mandates that banks should have 25% branches in rural areas.
To open branches in urban areas [metro / tier 1-3 cities] RBI
permission needed but no permission needed for tier 4-6 areas
or north east states and Sikkim.
PM Jan Dhan Yojana:
1: to divide country into sub service areas with 1000-1500
families within 5 km distance. Each family gets 1 account, 1
RuPay debit card, Rs. 1 lac worth accident insurance. Rs. 5000
overdraft if good credit history.
2: direct benefit transfer, sell micro insurance and credit
guarantee fund to cover losses.
Types of Banks:
Minimum capital. Large business houses and industrial houses
can’t apply. FDI and voting rights same as commercial banks.
a small area for deposit and loans. 50% loans to MSME, 25% rural
convert to it; even individuals with 10 yrs experience in
banking field can apply.
business correspondents but can’t become BC for other banks.
subsidiaries, NRI can apply, cooperative banks can’t. PSL target
must be met in 3 yrs.
have current and savings account but no time deposits.
loans, must put entire investment in G-Secs. Must give interest
more than 1 lac in account per customer.
mandatory but no PSL.
person in board has 1 vote. No profit no loss is motive.
the state registrar as a cooperative society. Regulator
urban or rural. In rural it could be state cooperative, district
or village cooperative.
only a few districts.
owns 50% + state 15% and sponsor bank 35%.
get registered under banking regulation act.
deposits less than Rs. 5 cr.
loans to only large corporate and infrastructure
+ CRR, SLR and PSL targets.
bank have less than 20 branches and for them no need for 25%
rural branches. They can’t act as bank saathi for other banks
banks have 20+ branches and they must have 25% rural branches.
They can act as bank saathi for other banks.
All India financial
export import bank. Loans, credit, finance to exporters and
importers. Promotes cross border trade and investment. It is
wholly owned by central government.
national bank for agriculture and rural development. Owned by
government 99.3% and RBI 0.7%. Regulatory authority for
cooperatives bank and regional rural banks. Helps state
cooperative banks and farmers, cottage industry.
apex institution for housing finance. 100% owned by RBI. Finance
to banks and NBFCs for housing projects. Publishes RESIDEX
[housing sector inflation]
owned by public sector banks and public sector insurance
companies. Finance to state industrial development corporations,
state finance corporations and banks.
Non banking finance corporation:
They are of two types: non
banking and financial company. They get license under company
act. Not all NBFC are regulated by RBI. Insurance NBFCs are
controlled by IRDA and merchant banks by SEBI. Deposit taking
NBFCs are allowed to take time deposit but not demand deposits.
No CRR but for deposit taking
NBFC SLR is 15%. No PSL and entry capital is 5 cr. They take
collateral as gold, bonds or shares. Only housing finance NBFC
have SARFAESI powers i.e. to auction land of borrowers who can’t
infrastructure finance , infrastructure debt fund, investment
companies, core investment companies, chit fund, loan company,
factoring company – regulated by RBI
– regulated by IRDA
companies – regulated by NHB
mutual fund, venture capital fund, merchant bank, investment
banks – regulated by SEBI
dept. Of corporate affairs.
5 cr., can’t lend more than 50000 per person, loans without
collateral, borrower fixes EMI, installments.
or bank saathi:
Banks can’t open branches in all
villages due to financial infeasibility. This creates hardship
to the villagers as they have to travel long distances for
accessing banking facilities.
Thus to act as a link between villagers and banks in
rural areas we have business correspondents.
BCA help villagers open account,
help them in performing transactions; they have an electronic
device which is used to process transactions. They also help
villagers with loan applications, access insurance and micro
A National asset reconstruction company is being considered to take over the bad assets of banks.The private ARC’s demand that bad assets be sold to them at a discount.
However banks don’t sell assets to ARC’s as they fear prosecution from government agencies. Thus in this situation a National ARC may be a good option.
Bank + Insurance = BankAssurance:
Banks can sell insurance policies under three models.
Insurance companies get office space in banks and insurance agents sell policies to people. Banks get a fixed fee from this.
Corporate Agent model.
One Bank can have a tie-up with a life, non life and a health insurance company. Bank can sell policies of only that company.
Banks sell policies of multiple insurance companies under one roof.
Note: NBFC's can sell insurance but only in Corporate Agent model. NBFC's with Rs. 100 crore funds and profit making in last three years can sell Mutual Funds. Banks can sell Mutual Funds but only after RBI's permission.
The FRDI Bill seeks to establish a Resolution Corporation which will monitor the risk faced by financial firms such as banks and insurance companies, and resolve them in case of failure.
Some provisions of the Bill allow for cancellation or writing down of liabilities of a financial firm (known as bail-in). There are concerns that these provisions may put depositors in an unfavourable position in case a bank fails. In this context, we explain the bail-in process below.
What is bail-in?
The Bill specifies various tools to resolve a failing financial firm which include transferring its assets and liabilities, merging it with another firm, or liquidating it. One of these methods allows for a financial firm on the verge of failure to be rescued by internally restructuring its debt. This method is known as bail-in.
Bail-in differs from a bail-out which involves funds being infused by external sources to resolve a firm. This includes a failing firm being rescued by the government.
How does it work?
Under bail-in, the Resolution Corporation can internally restructure the firm’s debt by: (i) cancelling liabilities that the firm owes to its creditors, or (ii) converting its liabilities into any other instrument (e.g., converting debt into equity), among others.
Bail-in may be used in cases where it is necessary to continue the services of the firm, but the option of selling it is not feasible. This method allows for losses to be absorbed and consequently enables the firm to carry on business for a reasonable time period while maintaining market confidence. The Bill allows the Resolution Corporation to either resolve a firm by only using bail-in, or use bail-in as part of a larger resolution scheme in combination with other resolution methods like a merger or acquisition.
Do the current laws in India allow for bail-in? What happens to bank deposits in case of failure?
Current laws governing resolution of financial firms do not contain provisions for a bail in. If a bank fails, it may either be merged with another bank or liquidated.
In case of bank deposits, amounts up to one lakh rupees are insured by the Deposit Insurance and Credit Guarantee Corporation (DICGC). The Bill has a similar provision which allows the Resolution Corporation to set the insured amount in consultation with the RBI.
Does the Bill specify safeguards for creditors, including depositors?
The Bill specifies that the power of the Corporation while using bail-in to resolve a firm will be limited.
When resolving a firm through bail-in, the Corporation will have to ensure that none of the creditors (including bank depositors) receive less than what they would have been entitled to receive if the firm was to be liquidated.
Further, the Bill allows a liability to be cancelled or converted under bail-in only if the creditor has given his consent to do so in the contract governing such debt.
Do other countries contain similar provisions ?
The Financial Stability Board, an international body comprising G20 countries (including India), recommended that countries should allow resolution of firms by bail-in under their jurisdiction.