RBI: The Reserve Bank of India was established on April 1, 1935 in accordance with the

provisions of the RBI Act, 1934. RBI was nationalized in 1949 and it is fully owned by the
Government of India. RBI was established on the recommendation of the Hilton Young
Commission.

RBI’s FUNCTIONS:
1. Issue of currency notes
2. Controlling the monetary policy
3. Regulator and supervisor of the financial system
4. Banker to other banks
5. Banker to the government
6. Granting licenses to banks
7. Control over NBFIs (Non Banking Financial Institutions)
8. Manager of Foreign Exchange of India (also known as FOREX)

RBI & Monetary Policy:

Monetary policy refers to the use of instruments under the control of the central bank to regulate the
availability, cost and use of money and credit.

The main objectives of monetary policy in India are:

 Maintaining price stability
 Ensuring adequate flow of credit to the productive sectors of the economy to support economic
growth
 Financial stability
There are several direct and indirect instruments that are used in the formulation and implementation of
monetary policy.

Direct instruments:
Cash Reserve Ratio (CRR): The share of net demand and time liabilities that banks must maintain as
cash balance with the Reserve Bank.
Statutory Liquidity Ratio (SLR): The share of net demand and time liabilities that banks must maintain
in safe and liquid assets, such as government securities, cash and gold.
Refinance facilities: Sector-specific refinance facilities (e.g., against lending to export sector) provided to
banks.

Indirect instruments
Liquidity Adjustment Facility (LAF): Consists of daily infusion or absorption of liquidity on a repurchase
basis, through repo (liquidity injection) and reverse repo (liquidity absorption) auction operations, using
government securities as collateral.
Open Market Operations (OMO): Outright sales/purchases of government securities, in addition to LAF,
as a tool to determine the level of liquidity over the medium term.
Market Stabilisation Scheme (MSS): This instrument for monetary management was introduced in
2004. Liquidity of a more enduring nature arising from large capital flows is absorbed through sale of short-
dated government securities and treasury bills. The mobilised cash is held in a separate government
account with the Reserve Bank.
Repo/reverse repo rate: These rates under the Liquidity Adjustment Facility (LAF) determine the corridor
for short-term money market interest rates. In turn, this is expected to trigger movement in other segments
of the financial market and the real economy.
Bank rate: It is the rate at which the Reserve Bank is ready to buy or rediscount bills of exchange or other
commercial papers. It also signals the medium-term stance of monetary policy.

Key financial terms

APR: It stands for Annual Percentage Rate. APR is a percentage that is calculated on the basis of the
amount financed, the finance charges, and the term of the loan.

ABS: Asset-Backed Securities. It means a type of security that is backed by a pool of bank loans, leases,
and other assets.

EPS: Earnings Per Share means the amount of annual earnings available to common stockholders as stated
on a per share basis.

CHAPS: Clearing House Automated Payment System. It‟s a type of electronic bank-to-bank payment system
that guarantees same-day payment.

IPO: Initial Public Offerings is defined as the event where the company sells its shares to the public for the
first time. (or the first sale of stock by a private company to the public.)

FPO: Follow on Public Offerings: An issuing of shares to investors by a public company that is already listed
on an exchange. An FPO is essentially a stock issue of supplementary shares made by a company that is
already publicly listed and has gone through the IPO process.

Difference: IPO is for the companies which have not been listed on an exchange and FPO is for the
companies which have already been listed on an exchange but want to raise funds by issuing some more
equity shares.

RTGS: Real Time Gross Settlement systems is a funds transfer system where transfer of money or
securities takes place from one bank to another on a “real time”. („Real time‟ means within a fraction of
seconds.) The minimum amount to be transferred through RTGS is Rs 2 lakh. Processing charges/Service
charges for RTGS transactions vary from bank to bank.

NEFT: National Electronic Fund Transfer. This is a method used for transferring funds across banks in a
secure manner. It usually takes 1-2 working days for the transfer to happen. NEFT is an electronic fund
transfer system that operates on a Deferred Net Settlement (DNS) basis which settles transactions in
batches. (Note: RTGS is much faster than NEFT.)

CAR: Capital Adequacy Ratio. It‟s a measure of a bank‟s capital. Also known as “Capital to Risk Weighted
Assets Ratio (CRAR)”, this ratio is used to protect depositors and promote the stability and efficiency of
financial systems around the world. It is decided by the RBI.

NPA: Non-Performing Asset. It means once the borrower has failed to make interest or principal payments
for 90 days, the loan is considered to be a non-performing asset. Presently it is 2.39%.
IMPS: Inter-bank Mobile Payment Service. It is an instant interbank electronic fund transfer service through
mobile phones. Both the customers must have MMID (Mobile Money Identifier Number). For this service, we
don‟t need any GPS-enabled cell phones.

BCBS: Basel Committee on Banking Supervision is an institution created by the Central Bank governors of
the Group of Ten nations.

RSI: Relative Strength Index.

IFSC code: Indian Financial System Code. The code consists of 11 characters for identifying the bank and
branch where the account in actually held. The IFSC code is used both by the RTGS and NEFT transfer
systems.

MSME and SME: Micro Small and Medium Enterprises (MSME), and SME stands for Small and Medium
Enterprises. This is an initiative of the government to drive and encourage small manufacturers to enjoy
facilities from banks at concessional rates.

LIBOR: London InterBank Offered Rate. An interest rate at which banks can borrow funds, in marketable
size, from other banks in the London interbank market.

LIBID: London Interbank Bid Rate. The average interest rate at which major London banks borrow
Eurocurrency deposits from other banks.

ECGC: Export Credit Guarantee Corporation of India. This organisation provides risk as well as insurance
cover to the Indian exporters.

SWIFT: Society for Worldwide Interbank Financial Telecommunication. It operates a worldwide financial
messaging network which exchanges messages between banks and other financial institutions.

STRIPS: Separate Trading for Registered Interest & Principal Securities.

CIBIL: Credit Information Bureau of India Limited. CIBIL is India‟s first credit information bureau.
Whenever a person applies for new loans or credit card(s) to a financial institution, they generate the CIBIL
report of the said person or concern to judge the credit worthiness of the person and also to verify their
existing track record. CIBIL actually maintains the borrower‟s history.

CRISIL: Credit Rating Information Services of India Limited. Crisil is a global analytical company providing
ratings, research, and risk and policy advisory services.

AMFI: Association of Mutual Funds of India. AMFI is an apex body of all Asset Management Companies
(AMCs) which have been registered with SEBI. (Note: AMFI is not a mutual funds regulator)

FCCB: Foreign Currency Convertible Bond. A type of convertible bond issued in a currency different from
the issuer‟s domestic currency.

CAC: Capital Account Convertibility. It is the freedom to convert local financial assets into foreign financial
assets and vice versa. This means that capital account convertibility allows anyone to freely move from local
currency into foreign currency and back, or in other words, transfer of money from current account to
capital account.

BANCASSURANCE: Is the term used to describe the partnership or relationship between a bank and an
insurance company whereby the insurance company uses the bank sales channel in order to sell insurance
products.

Balloon payment: Is a specific type of mortgage payment, and is named “balloon payment” because of
the structure of the payment schedule. For balloon payments, the first several years of payments are
smaller and are used to reduce the total debt remaining in the loan. Once the small payment term has
passed (which can vary, but is commonly 5 years), the remainder of the debt is due - this final payment is
the one known as the “balloon” payment, because it is larger than all of the previous payments.

CPSS: Committee on Payment and Settlement Systems

FCNR Accounts: Foreign Currency Non-Resident accounts are the ones that are maintained by NRIs in
foreign currencies like USD, DM, and GBP.

M3 in banking: It‟s a measure of money supply. It is the total amount of money available in an economy
at a particular point in time.

OMO: Open Market Operations. The buying and selling of government securities in the open market in
order to expand or contract the amount of money in the banking system. Open market operations are the
principal tools of monetary policy. RBI uses this tool in order to regulate the liquidity in economy.

Umbrella Fund: A type of collective investment scheme. A collective fund containing several sub-funds,
each of which invests in a different market or country.

ECS: Electronic Clearing Facility is a type of direct debit.

Tobin tax: Suggested by Nobel Laureate economist James Tobin, was originally defined as a tax on all spot
conversions of one currency into another.

Z score is a term widely used in the banking field.

POS: Point Of Sale, also known as Point Of Purchase, a place where sales are made and also sales and
payment information are collected electronically, including the amount of the sale, the date and place of the
transaction, and the consumer‟s account number.
LGD: Loss Given Default. Institutions such as banks will determine their credit losses through an analysis of
the actual loan defaults.

Junk Bonds: Junk bonds are issued generally by smaller or relatively less well-known firms to finance their
operations, or by large and well-known firms to fund leveraged buyouts. These bonds are frequently
unsecured or partially secured, and they pay higher interest rates: 3 to 4 percentage points higher than the
interest rate on blue chip corporate bonds of comparable maturity period.

ARM: Adjustable Rate Mortgage is basically a type of loan where the rate of index is calculated on the basis
of the previously selected index rate.

ABO: Accumulated Benefit Obligation, ABO is a measure of liability of pension plan of an organisation and is
calculated when the pension plan is terminated.

Absorption: A term related to real estate, it is a process of renting a real estate property which is newly
built or recently approved.

AAA: A type of grade that is used to rate a particular bond. It is the highest rated bond that gives
maximum returns at the time of maturity.

DSCR: Debt Service Coverage Ratio, DSCR is a financial ratio that measures the company‟s ability to pay
their debts.

FSDC: Financial Stability and Development Council, India‟s apex body of the financial sector.

ITPO: India Trade Promotion Organisation is the nodal agency of the Government of India for promoting
the country‟s external trade.

FLCC: Financial Literacy and Counseling Centres.

ANBC: Adjusted Net Bank Credit is Net Bank Credit added to investments made by banks in non-SLR
bonds.

Priority sector lending: Some areas or fields in a country depending on its economic condition or
government interest are prioritised and are called priority sectors i.e. industry, agriculture.

M0, M1, M2 AND M3: These terms are nothing but money supply in banking field.

BIFR: Bureau of Industrial and Financial Reconstruction.

FRBM Act 2003: Fiscal Responsibility and Budget Management act was enacted by the Parliament of India
to institutionalise financial discipline, reduce India‟s fiscal deficit, improve macroeconomic management and
the overall management of the public funds by moving towards a balanced budget.
The main objectives of FRBM Act are:-
1. To reduce fiscal deficit.
2. To adopt prudent debt management.
3. To generate revenue surplus.

Gold Standard: A monetary system in which a country‟s government allows its currency unit to be freely
converted into fixed amounts of gold and vice versa.

Fiat Money: Fiat money is a legal tender for settling debts. It is a paper money that is not convertible and
is declared by government to be legal tender for the settlement of all debts.

BCSBI: The Banking Codes and Standards Board of India is a society registered under the Societies
Registration Act, 1860 and functions as an autonomous body, to monitor and assess the compliance with
codes and minimum standards of service to individual customers to which the banks agree to.

OLTAS: On-Line Tax Accounting System.

EASIEST: Electronic Accounting System in Excise and Service Tax.

SOFA: Status of Forces Agreement, SOFA is an agreement between a host country and a foreign nation
stationing forces in that country.

CALL MONEY: Money loaned by a bank that must be repaid on demand. Unlike a term loan, which has a
set maturity and payment schedule, call money does not have to follow a fixed schedule. Brokerages use
call money as a short-term source of funding to cover margin accounts or the purchase of securities. The
funds can be obtained quickly.

Scheduled bank: Scheduled Banks in India constitute those banks which have been included in the
Second Schedule of RBI Act, 1934 as well as their market capitalisation is more than Rs 5 lakh. RBI in turn
includes only those banks in this schedule which satisfy the criteria laid down vide section 42 (6) (a) of the
Act.

FEDAI: Foreign Exchange Dealers Association of India. An association of banks specialising in the foreign
exchange activities in India.

PPF: Public Provident Fund. The Public Provident Fund Scheme is a statutory scheme of the Central
Government of India. The scheme is for 15 years. The minimum deposit is Rs 500 and maximum is Rs
70,000 in a financial year.

SEPA: Single Euro Payment Area.

GAAP: Generally Accepted Accounting Principles. The common set of accounting principles, standards and
procedures that companies use to compile their financial statements.

Indian Depository Receipt: Foreign companies issue their shares and in return they get the depository
receipt from the National Security Depository in return of investing in India.
Hot Money: Money that is moved by its owner quickly from one form of investment to another, as to take
advantage of changing international exchange rates or gain high short-term returns on investments.

NMCEX: National Multi-Commodity Exchange.

PE RATIO: Price to Earnings Ratio, a measure of how much investors are willing to pay for each dollar of a
company‟s reported profits.

CASA: Current Account, Savings Account.

CAMELS: CAMELS is a type of Bank Rating System. (C) stands for Capital Adequacy, (A) for Asset Quality,
(M) for Management ,(E) for Earnings, (L) for Liquidity and (S) for Sensitivity to Market Risk.

OSMOS: Off-site Monitoring and Surveillance System.

Free market: A market economy based on supply and demand with little or no government control.

Retail banking: It is mass-market banking in which individual customers use local branches of larger
commercial banks.

Eurobond: A bond issued in a currency other than the currency of the country or market in which it is
issued.

PPP: Purchasing Power Parity is an economic technique used when attempting to determine the relative
values of two currencies.

FEMA Act: Foreign Exchange Management Act, it is useful in controlling HAWALA.

Hawala transaction: It‟s a process in which large amount of black money is converted into white.

Teaser Loans: It‟s a type of home loans in which the interest rate is initially low and then grows higher.
Teaser loans are also called terraced loans.

ECB: External Commercial Borrowings, taking a loan from another country. Limit of ECB is $500 million, and
this is the maximum limit a company can get.

CBS: Core Banking Solution. All the banks are connected through internet, meaning we can have
transactions from any bank and anywhere. (e.g. deposit cash in PNB, Delhi branch and withdraw cash from
PNB, Gujarat)

CRAR: For RRB‟s it is more than 9% (funds allotted 500 cr) and for commercial banks it is greater than 8%
(6000 cr relief package).

NBFCs: NBFC is a company which is registered under Companies Act, 1956 and whose main function is to
provide loans. NBFC cannot accept deposit or issue demand draft like other commercial banks. NBFCs
registered with RBI have been classified as AssetFinance Company (AFC), Investment Company (IC) and
Loan Company (LC).

IIFCL: India Infrastructure Finance Company Limited. It gives guarantee to infra bonds.

IFPRI: International Food Policy Research Institute. It identifies and analyses policies for meeting the food
needs of the developing world.

Currency swap: It is a foreign-exchange agreement between two parties to exchange aspects (namely the
principal and/or interest payments) of a loan in one currency for equivalent aspects of an equal in net
present value loan in another currency. Currency swap is an instrument to manage cash flows in different
currency.

WPI: Wholesale Price Index is an index of the prices paid by retail stores for the products they ultimately
resell to consumers. New series is 2004 2005. (The new series has been prepared by shifting the base year
from 1993-94 to 2004-05). Inflation in India is measured on WPI index.

MAT: Minimum Alternate Tax is the minimum tax to be paid by a company even though the company is not
making any profit.

Future trading: It‟s a future contract/agreement between the buyers and sellers to buy and sell the
underlying assets in the future at a predetermined price.

Reverse mortgage: It‟s a scheme for senior citizens.

Basel 2nd norms: BCBS has kept some restrictions on bank for the maintenance of minimum capital with
them to ensure level playing field. Basel II has got three pillars:
Pillar 1- Minimum capital requirement based on the risk profile of bank.
Pillar 2- Supervisory review of banks by RBI if they go for internal ranking.
Pillar 3- Market discipline.

Microfinance institutions: Those institutions that provide financial services to low-income clients.
Microfinance is a broad category of services, which includes microcredit. Microcredit is provision of credit
services to poor clients.

NPCI: National Payments Corporation of India.

DWBIS: Data Warehousing and Business Intelligence System, a type of system which is launched by SEBI.
The primary objective of DWBIS is to enhance the capability of the investigation and surveillance functions
of SEBI.

TRIPS: Trade Related Intellectual Property Rights is an international agreement administered by the World
Trade Organisation (WTO) that sets down minimum standards for many forms of intellectual property (IP)
regulation as applied to nationals of other WTO Members.

TRIMs: Trade Related Investment Measures. A type of agreement in WTO.

SDR: Special Drawing Rights, SDR is a type of monetary reserve currency, created by the International
Monetary Fund. SDR can be defined as a “basket of national currencies”. These national currencies are
Euro, US dollar, British pound and Japanese yen. Special Drawing Rights can be used to settle trade
balances between countries and to repay the IMF. American dollar gets highest weightage.

LTD: Loan-To-Deposit Ratio. A ratio used for assessing a bank‟s liquidity by dividing the bank‟s total loans
by its total deposits. If the ratio is too high, it means that banks might not have enough liquidity to cover
any fund requirements, and if the ratio is too low, banks may not be earning as much as they could be.

CAD: Current Account Deficit. It means when a country‟s total imports of goods, services and transfers is
greater than the country‟s total export of goods, services and transfers.

LERMS: Liberalized Exchange Rate Management System.

FRP: Fair and Remunerative Price, a term related to sugarcane. FRP is the minimum price that a sugarcane
farmer is legally guaranteed. However sugar Mills Company gives more than FRP price.

STCI: Securities Trading Corporation of India Limited was promoted by the Reserve Bank of India (RBI) in
1994 along with Public Sector Banks and All India Financial Institutions with the objective of developing an
active, deep and vibrant secondary debt market.

IRR: Internal Rate of Return. It is a rate of return used in capital budgeting to measure and compare the
profitability of investments.

CMIE: Centre for Monitoring Indian Economy. It is India‟s premier economic research organisation. It
provides information solutions in the form of databases and research reports. CMIE has built the largest
database on the Indian economy and companies.

TIEA: Tax Information Exchange Agreement. TIEA allows countries to check tax evasion and money
laundering. Recently India has signed TIEA with Cayman Islands.

Contingency Fund: It‟s a fund for emergencies or unexpected outflows, mainly economic crises. A type of
reserve fund which is used to handle unexpected debts that are outside the range of the usual operating
budget.

FII: Foreign Institutional Investment. The term is used most commonly in India to refer to outside
companies investing in the financial markets of India. International institutional investors must register with
the Securities and Exchange Board of India to participate in the market.

P-NOTES: “P” means participatory notes.

MSF: Marginal Standing Facility. Under this scheme, banks will be able to borrow upto 1% of their
respective net demand and time liabilities. The rate of interest on the amount accessed from this facility will
be 100 basis points (i.e. 1%) above the repo rate. This scheme is likely to reduce volatility in the overnight
rates and improve monetary transmission.
FIU: Financial Intelligence Unit set by the Government of India on 18 November 2004 as the central
national agency responsible for receiving, processing, analysing and disseminating information relating to
suspect financial transactions.

SEBI: Securities and Exchange Board of India. SEBI is the primary governing/regulatory body for the
securities market in India. All transactions in the securities market in India are governed and regulated by
SEBI. Its main functions are:
1. New issues (Initial Public Offering or IPO)
2. Listing agreement of companies with stock exchanges
3. Trading mechanisms 4. Investor protection
5. Corporate disclosure by listed companies etc.

Note: SEBI is also known as capital regulator or mutual funds regulator or market regulator. SEBI also
created investors protection fund and SEBI is the only organization which regulates the credit rating
agencies in India. (CRISIL and CIBIL).

FINANCIAL REGULATORS IN INDIA: RBI, SEBI, FMCI (Forward Market Commission of India), IRDA etc.

ASBA: Application Supported by Blocked Amount. It is a process developed by the SEBI for applying to IPO.
In ASBA, an IPO applicant‟s account doesn‟t get debited until shares are allotted to him.

DEPB Scheme: Duty Entitlement Pass Book. It is a scheme which is offered by the Indian government to
encourage exports from the country. DEPB means Duty Entitlement Pass Book to neutralise the incidence of
basic and special customs duty on import content of export product.

LLP: Limited Liability Partnership, is a partnership in which some or all partners (depending on the
jurisdiction) have limited liability.

Balance sheet: A financial statement that summarises a company‟s assets, liabilities and shareholders‟
equity at a specific point in time.

TAN: Tax Account Number, is a unique 10-digit alphanumeric code allotted by the Income Tax Department
to all those persons who are required to deduct tax at the source of income.

PAN: Permanent Account Number, as per section 139A of the Act obtaining PAN is a must for the following
persons:-
1. Any person whose total income or the total income of any other person in respect of which he is
assessable under the Act exceeds the maximum amount which is not chargeable to tax.
2. Any person who is carrying on any business or profession whose total sales, turnover or gross receipts
are or are likely to exceed Rs. 5 lakh in any previous year.
3. Any person who is required to furnish a return of income under section 139(4) of the Act.
JLG: Joint Liability Group, when two or more persons are both responsible for a debt, claim or judgment.

REER: Real Effective Exchange Rate.

NEER: Nominal Effective Exchange Rate.

Contingent Liability: A liability that a company may have to pay, but only if a certain future event occurs.

IRR: Internal Rate of Return, is a rate of return used in capital budgeting to measure and compare the
profitability of investments.

MICR: Magnetic Ink Character Recognition. A 9-digit code which actually shows whether the cheque is real
or fake.

UTR Number: Unique Transaction Reference number. A unique number which is generated for every
transaction in RTGS system. UTR is a 16-digit alphanumeric code. The first 4 digits are a bank code in
alphabets, the 5th one is the message code, the 6th and 7th mention the year, the 8th to 10th mentions the
date and the last 6 digits mention the day‟s serial number of the message.

RRBs: Regional Rural Banks. As its name signifies, RRBs are specially meant for rural areas, capital share
being 50% by the central government, 15% by the state government and 35% by the scheduled bank.

MFI: Micro Finance Institutions. Micro Finance means providing credit/loan (micro credit) to the weaker
sections of the society. A microfinance institution (MFI) is an organisation that provides financial services to
the poor.

PRIME LENDING RATE: PLR is the rate at which commercial banks give loans to its prime customers
(most creditworthy customers).

BASE RATE: A minimum rate that a bank is allowed to charge from the customer. Base rate differs from
bank to bank. It is actually a minimum rate below which the bank cannot give loan to any customer. Earlier
base rate was known as BPLR (Base Prime Lending Rate).

EMI: Equated Monthly Installment. It is nothing but a repayment of the loan taken. A loan could be a home
loan, car loan or personal loan. The monthly payment is in the form of post dated cheques drawn in favour
of the lender. EMI is directly proportional to the loan taken and inversely proportional to time period. That
is, if the loan amount increases the EMI amount also increases and if the time period increases the EMI
amount decreases.

Basis points (bps): A basis point is a unit equal to 1/100th of a percentage point. i.e. 1 bps = 0.01%.
Basis points are often used to measure changes in or differences between yields on fixed income securities,
since these often change by very small amounts.

Liquidity: It refers to how quickly and cheaply an asset can be converted into cash. Money (in the form of
cash) is the most liquid asset.
Certificate of Deposit (CD) is a negotiable money market instrument and issued in dematerialised form
for funds deposited at a bank or other eligible financial institution for a specified time period.

Commercial Paper (CP) is an unsecured money market instrument issued in the form of a promissory
note. It was introduced in India in 1990. Corporates and the All-India Financial Institutions are eligible to
issue CP.

Indian Banking Structure

Types of banks in India

Central Bank (RBI)
Specialised banks
Commercial banks
Development banks
Co-operative banks

Central Bank:
As its name signifies, a bank which manages and regulates the banking system of a particular country. It
provides guidance to other banks whenever they face any problem (that is why the Central Bank is also
known as a banker‟s bank) and maintains the deposit accounts of all other banks. Central Banks of different
countries: Reserve Bank of India (INDIA), Federal Reserve System (USA), Swiss National Bank
(SWITZERLAND), Reserve Bank of Australia (AUSTRALIA), State Bank of Pakistan (PAKISTAN).

SpecialisedbBanks:

Those banks which are meant for special purposes. For examples: NABARD, EXIM bank, SIDBI, IDBI.

NABARD: National Bank for Agriculture and Rural Development. This bank is meant for financing the
agriculture as well as rural sector. It actually promotes research in agriculture and rural development.

EXIM bank: Export Import Bank of India. This bank gives loans to exporters and importers and also
provides valuable information about the international market. If you want to set up a business for exporting
products abroad or importing products from foreign countries for sale in our country, EXIM bank can provide
you the required support and assistance.

SIDBI: Small Industries Development Bank of India. This bank provides loans to set up the small-scale
business unit / industry. SIDBI also finances, promotes and develops small-scale industries. Whereas IDBI
(Industrial Development Bank of India) gives loans to big industries.

Commercial banks:

Normal banks are known as commercial banks, their main function is to accept deposits from the customer
and on the basis of that they grant loans. (Loans could be short-term, medium-term and long-term loans.)
 Commercial banks are further classified into three types.

(a) Public sector banks

(b) Private sector banks
(c) Foreign banks

(a) Public Sector Banks (PSB): Government banks are known as PSB. Since the majority of their stakes
are held by the Government of India. (For example: Allahabad Bank, Andhra Bank, Bank of Baroda, Bank of
India, Bank of Maharastra, Canara Bank, Central Bank of India etc).

(b) Private Sector Banks: In these banks, the majority of stakes are held by the individual or group of
persons. (For example: Bank of Punjab, Bank of Rajasthan, Catholic Syrian Bank, Centurion Bank etc).

(c) Foreign Banks: These banks have their headquarters in a foreign country but they operate their
branches in India. For e.g. HSBC, Standard Chartered Bank, ABN Amro Bank.

Development banks:

Such banks are specially meant for giving loans to the business sector for the purchase of latest machinery
and equipments. Examples: SFCs (State Financial Corporation of India) and IFCI (Indian Finance
Corporation of India).

Co-operative banks:

These banks are nothing but an association of members who group together for self-help and mutual-help.
Their way of working is the same as commercial banks. But they are quite different. Co operative banks in
India are registered under the Co-operative Societies Act, 1965. The cooperative bank is regulated by the
RBI.

Note: Co-operative banks cannot open their branches in foreign countries while commercial banks can do
this.

Types of bank accounts

 Savings bank account

 Current account
 Fixed Deposit account

1. Saving Bank Account: These accounts are maintained by individuals/ salaried peoples. Such account
offers interest on customer deposit. The interest on these accounts is regulated by Reserve Bank of India.
No Overdraft is allowed on such accounts.

2. Current Account: These accounts are used mainly by businessmen and are not generally used for the
purpose of investment. These deposits are the most liquid deposits and there are no limits for number of
transactions or the amount of transactions in a day. No interest is paid by banks on these accounts. One of
the prominent advantage of such account is that Overdraft is allowed.

3. Fixed Deposit Account: also known as term deposit account. All Banks offer fixed deposits schemes
with a wide range of tenures for periods from 7 days to 10 years. The term “fixed” in Fixed Deposits (FD)
denotes the period of maturity or tenor.

Prologue
 In the earlier articles, we saw
 What is financial intermediaries? Why are they important for
Economy?
 Then in part 1 of 3, we saw insurance sector
 In part 2 of 3, capital market
 In this third and final part, we‟ll see the banks and NBFCs.

Banks
 What do banks do? They collect deposits from savers and
lend it as loan to the borrowers, and earn Commission in
between. Hence they‟re one type of financial intermediaries.
 We already know that banks have to invest some of their
deposit money in govt. securities (and high rated corporate
bonds) under the statutory liquidity ratio (SLR).
 For past few years, this SLR rate has remained steady 23-
24%. Yet banks have invested more than 30% of their
deposits in Government securities.
 Recall that Government securities are “safe investments” and
if an investment is “safe” then it won‟t give much profit.
  So why are the bank investing more money in Government
securities, even above the SLR requirement?

1. because they think it is safer investment (compared to

lending it to the likes of Kingfisher) and or
2. because businessmen are not coming forward to take loans
and or
3. Consumers are also not coming forward for getting loans for
bike, car, or home loans (due to inflation).

Interest rate
 There are mainly three type of bank account:

Current Savings Term deposits/Fixed

Account account Deposit

Interest
Depends on how long you
paid by 0% 4-6*%
keep the money. 6-8*%
bank

 These rates change from bank to bank, ^these are just

approximate numbers for illustration.
 For banks Current account and savings account (CASA) are
most important. Why? Because on these deposits, bank has
to pay very low interest. So if bank gets lot money from CASA
source, and lends it as car/bike/home/business/personal
loans @12-18% =there is big profit margin.

Interest rate change

Deposit rates (bank pays to Lending rate (bank charging to

accounts holders) loan takers)

 RBI controls the interest  2012:

rates on foreign currency RBI deregulated the
non-resident account interest rate on loans
 (FCNR). given to exporters (in
 In 2011, foreign currency). This
RBI deregulated the was done to improve the
interest rates on savings exports.
deposits.  In 2012-13 period, RBI
 Still no public sector bank started reducing the repo
has increased its savings rate and consequently
deposit rate. (they just offer banks too lowered their
4%). Although private loan interest rates a bit.
sector banks offer higher.

Rural Banking: Background

During the British raj and the initial years after independence, the
banks (and insurance companies) only operated in the urban
areas. Why?

1. Staff/Manpower: easy availability of educated youth in cities.

2. Urban areas had better availability of electricity, telephone,
telegram, railways, office supplies etc.
3. Customers: Main Target audience of banks and insurance
companies= educated middle class, rich people and
businessmen. They live in cities.
4. At that time, Banks and insurance companies were controlled
by private players: they had only one motive=Profit. And city
folks have more surplus income compared to villagers.

Result:

 Villagers did not get facility of banking / insurance, and they

had to rely on the (evil) money lender who charged whatever
interest rate he wanted to.
 Sometimes they paid more money in interest, than the actual
principle they had borrowed.
 And thus villagers remained in debt and poverty forever.

Government’s action
Over the years, Government certain things to achieve following
objectives:

1. To help the villagers get easy loans for buying cows, buffalos,
diesel pump sets, seeds, fertilizers, digging wells and bores
in their farms etc.
2. increase the penetration of banking services in rural areas
3. To achieve financial inclusion in rural areas

Timeline: Banking in rural areas

50s Cooperative banks / societies

Birth of SBI and ICICI (although not related with rural

55
banking directly)

60s Bank nationalization (first round)

75 Regional rural banks were setup

NABAD was setup.+ Bank nationalization (second

80s
round)

Early
Self Help groups (SHG) and bank linking
90s

Late
Kisan Credit Card
90s

1. No-frills account
Mid- 2. Banking Business correspondence Agents (BCA)
2000s 3. Interest subvention scheme on crop loans

2011 Swabhiman scheme

Now let‟s fill in the details

 After independence
The structure looked like this (for rural banking)

1. RBI
2. State cooperative banks
3. Central cooperative banks (@District level.) || Urban
cooperative banks (in cities and small towns)
4. Primary Agriculture Credit societies (PCAS) (@village level)

Then came RRB and NABARD.

Why RRB?
 1975: Government appointed MM Narsimhan Committee to
look into rural banking.
 Narsimhan observed that Commercial banks (such as SBI,
BoB) have high cost structure (building, staff etc.) so they
prefer to open branches in cities rather than villages-
Because city branches make more profit.
 The staff of commercial banks= expert in banking and
financial matters but not aware of the problems of rural
people.
 On the other hand, the Primary agriculture Cooperative
societies have members from the villagers themselves, so
they are more aware of the needs and problems of the
villagers.
 Therefore, we need to create a hybrid institution that has
positive characters of both

1. Financial strength and expertise of commercial banks) +

2. Grassroot problem awareness of cooperative society).

 Thus, Regional rural banks were born.

RRB provides loan and savings facilities to villagers. These

villagers include

1. farmers (small and marginal)

2. agri laborers
 3. rural artisans
4. rural entrepreneurs
5. cooperative societies
6. primary agriculture credit societies

 RRBs are sponsored by Commercial banks.

 The Sponsor bank provides training to the staff of Regional
rural bank.
 The sponsor bank also provides initial capital to setup the
regional rural bank.
 According to the RRB Act, the paid up capital is Central
Government : State Government : Sponsor bank = 50 : 15 :
35

How is RRB different from commercial banks?

Commercial Bank RRB

 Huge.  Small.

 Whole India
Area of (although mainly
operation  One or a few districts.
concentrated in
(rural)
urban areas and
small towns)

 Borrowing from
NABARD, SIDBI.
 Savings accounts,
 They also have
Source of fixed deposit etc.
savings account of
finance  Borrowing from RBI
villagers, but it is not
and other sources
sufficient to cover the
loan demands.

 Apart from RRBs, villagers also get services from cooperative

credit societies, Microfinance institutions;
 Even commercial banks such as SBI also serve the villagers
via BCA (Banking correspondence agents).
 And the urban-rural geographical breakup has changed a lot
since the birth of RRBs. (Many places that were villages in
70s have now become small towns).
 In this context, it was necessary to consolidate/merge various
RRBs- to reduce their overhead expenses and make them
more competitive
 Therefore in 2005: Government of India started
amalgamation of RRB. So now the number of RRBs have
decreased.
 Till 1 January 2013, 22 RRBs had already been
amalgamated into 9 RRBs.

Rural Infrastructure Development Fund (RIFD)

 Started in mid 90s.
 NABARD operates the Rural Infrastructure Development
Fund (RIDF).
 This fund provides cheap loans to states and state-owned
corporations
 So they can quickly complete projects related to

1. medium and minor irrigation,

2. soil conservation,
3. watershed management
4. Flood Protection;
5. Forest Development;
6. Cold storage
7. Community Irrigation wells for the village as a whole;
8. Village Knowledge Centres;
9. Desalination plants in coastal areas;
10. Building schools, Anganwadi Centres etc.
11. Building toilet blocks in existing schools, specially for
girls
12. Rural Roads, Bridges
13. and other forms of rural infrastructure.
Banks who do not meet their Priority sector lending requirements,
provide money to this rural infrastructure development fund.

Financial Inclusion
 Financial inclusion = getting all poor people in the banking,
insurance, pension net. So they don‟t become victims of evil
money lenders who charge 36% compound interest rates (or
even more).

Swabhimaan scheme
 We‟ve already discussed this scheme and Banking business
correspondents (BCs) in earlier article. Click me
 Budget 2012, Chindu Pranab had announced that
Swabhimaan would be extended to habitations with
population more than 1,000 in the north-eastern and hilly
states and population more than 1,600 in the plains areas as
per Census 2001.

Ultra Small Branches

 Ultra small branches (USBs) are being set up in all villages
covered through Banking Correspondence Agents. (We‟ve
already discussed Banking business correspondents in
earlier article. Click me)
 These Ultra small branches (USBs) will have a small area of
100-200 sq. feet.
 A bank officer will be available here with a laptop on pre-
determined days.
 The Banking Correspondence agents will offer cash service
to villagers (e.g. depositing or taking out money),
 This bank officer (in Ultra small branch) will offer other
services, undertake field verification (for loan applications),
and follow up banking transactions.
 A total of over 40,000 Ultra small branches (USBs) have so
far been set up in the country.

SHG Bank linkage program

Self-Help Group (SHG)-Bank Linkage Programme started in early
90s.
Under this programs, self-help group open savings account in the
bank. They get loans for their projects, deposit money from
members (and NGOs earn commission in between).
It is being implemented by

1. commercial banks,
2. regional rural banks (RRBs)
3. Cooperative banks.

Development Banks/AIFI
They can be further classified based on their target audience

Import-
Agro Housing Industry
export

1. SIDBI
2. IDBI
National Housing 3. ICICI
NABARD EXIM bank
Bank 4. IFCI
5. IIBI

 Out of ^them, names highlighted in bold (NABARD, NHB,

SIDBI, EXIM) = All Indian financial institutions (AIFI). Rest are
development banks.

Industrial Development Bank?

First question: How is industrial development bank different from
regular (commercial) banks such as SBI, PNB etc.?

Industrial Commercial Bank

development
 bank

Public Sector
1. ICICI* 1. SBI
2. IDBI 2. PNB
3. SIDBI 3. BoB
Examples (AIFI)
4. IFCI Pvt.Sector
5. IIBI
1. ICICI*
2. HDFC

Accept
deposit
No Yes
from
public?

Provide
Provide short/medium/long term
medium/long
finance to both common men
Job? term finance to
(car/bike/home/education/personal
ONLY
loans) + to industries.
industries.

*The ICICI started in 1955 to provide finance to industries. In 1994

they also started ICICI Bank. And in 2002, the original parent
(ICICI) was merged with ICICI Bank Ltd.
how do Industrial development banks provide finance to
industries?

1. By directly giving loans to a company.

2. By buying shares and bonds of a company.
3. By underwriting new IPOs.

In the beginning, these organizations started as “All India

financial institutions”, their job was to provide medium / long term
finance to companies.
 But after the LPG reforms in the 90s, capital market become
popular. Now businessmen had more options to arrange for
finance (via IPOs, bonds). So these All India financial
institutions (AIFI) lost their original glamour and government
converted them into Development banks (as per Narsimhan
Committee‟s recommendation).

 Now only four AIFI left: NABARD, SIDBI, EXIM and NHB.
They areregulated by RBI.
 In the (part 2 of 3), we had seen that now SIDBI and NHB are
allowed to borrow via external commercial borrowing (ECB)
route.

 Full name: Industrial Credit and Investment

Corporation of India.
 Private sector development bank
1.ICICI
 Setup in „55. (same year SBI was also born).
 2002: Merged it with ICICI Bank ltd.

 Small industries development bank of India

 Started in 1990.
 SIDBI helps the micro, small and medium
enterprises (MSME).
 It provides finance to State Industrial
Development Corporation (SIDC), State
2.SIDBI
finance corporations, Commercial banks,
cooperative banks and regional rural banks.
And then those organizations deliver
loans/finance to the ultimate target group
(MSME industries).

 Industrial development bank of India

 UTI is a subsidiary of IDBI
 It borrows money by issuing bonds (and then
3.IDBI
lends that money to industries at a higher
interest rate.)
  Industrial finance corp. of India
 Setup in 1948: that makes it the first industrial
4.IFCI
financial institution in India.

 Industrial investment Bank of India.

5.IIBI
 NABARD = National bank for Agriculture and
rural development
 It was setup in early 80s. (Regional rural
banks (RRB) were started in „75, that means
first RRB came and then NABARD came).
 It acts as the regulatory authority
for cooperative banks and regional rural
banks
 NABARD lends it downwards to State
6.NABARD
cooperative banks (SCB), Regional Rural
banks (RRBs), Microfinance institutions,
cooperative credit societies etc.
 That‟s how farmers, villagers,
cottage/handicraft, self help group (SHG) get
loans at reasonable interest rate.
 NABARD operates the Rural Infrastructure
Development Fund (RIFD)

 National Housing Bank (NHB)

 Started in late 80s
 As the subsidiary of RBI
7.NHB  It is the apex institution for housing finance in
India (just like how NABARD is for rural /
agri).

Reverse Mortgage product

 Launched by National Housing bank.
 For senior citizen
 The senior citizen can mortgage his house and he‟ll be given
monthly income.
 He doesn‟t need to repay loan or pay any EMIs, but when he
dies, bank will take over his house and auction it to recover
the loan money. (and if house fetches more than loan dues,
then bank will give that extra money to heirs of the dead
person.)
 Punjab National bank also has a scheme like that, called
“PNB Baghban”.

FINANCIAL PERFORMANCE OF BANKS

 NPA = Non performing asset, in crude term, bank gave loan
to someone but he is not repaying it back on time.
 Reasons for rising NPAs

1. current macroeconomic situation in the country;

2. increased interest rates in the recent past;
3. lower economic growth;
4. aggressive lending by banks in earlier good economic times
(i.e. prior to 2007). And now some of those businessmen /
salaried individuals are not earning enough due to slow
down, hence unable to repay the loans.
5. Our banks had also loaned to some State electricity boards
and airline companies (but they are not paying back on time)
so the banks‟ NPA increased.
6. switchover to system-based identification of NPAs by Public
Sector Banks

Capital Adequacy Ratio

 A measure of a bank‟s ability to absorb losses.
 Formula: value of its capital divided by the value of risk-
weighted assets.
 To put this crudely : CAR= bank‟s capital / bank‟s risky
assets.
 A low capital adequacy ratio (CAR) = bank has a limited
ability to absorb losses (meaning bank is more likely to
collapse if people start defaulting on their loans.)
 High CAR= bank has good ability to absorb losses.
  In public sector banks, government of India (GoI) has
regularly infused capital to keep the CAR high. But over the
years, GoI too is running low on cash (thanks to fiscal deficit),
so government had formed a committee, and committee
recommended that
 Government should create a new financial holding company.
This company will raise money from domestic and
international sources and then infuse it as equity in public
sector banks.

NPA: steps taken to reduce it

1. SARFAESI act and asset reconstruction companies (ARCs)
(already discussed, click me)
2. nodal officers in banks for each Debts Recovery Tribunal
(DRT);
3. close watch on NPAs

RBI has also announced the following remedial measures:

1. sanction of fresh loans/ad-hoc loans from 1st Jan 2013 will

be made on the basis of sharing of information among banks;
2. banks will conduct sector- /activity-wise analysis of NPAs;
3. banks will put in place a robust mechanism for early detection
of sign of distress, amendments in recovery laws, and
strengthening of loan appraisal and post credit monitoring.

Chindu’s Budget speech

Interest subvention scheme

 It was started in 2006

 Govt. will continue this scheme for 2013-14 also.
 Given for short term crop loans
 For loan Upto Rs.3 lakh
 Time period: 1 year.
 Under this scheme, farmer can get loan @7% interest rate.
  But if he repays the loan on time, then he will get additional
4% interest subvention. (meaning loan would cost him 7-
4=3% interest rate only.)
 So far, the scheme has been applied to loans taken from
public sector banks, RRBs and cooperative banks.
 Chindu proposed to extend this scheme to crop loans
borrowed from private sector scheduled commercial banks as
well.

In case you wonder “WHY”? Why is govt. giving 3% interest

subversion to farmer who repay the loans on time? Earlier the
interest subvention was 1% (2009), It was increased to 2% (2010)
and 3%(2011).

 Because, in 2009, govt. had launched debt waiver scheme.

(Meaning farmers didn‟t have to repay the loans they had
taken earlier.) Govt. say they are doing it to prevent „farmers‟
suicides‟, but experts believe it was more of an election
gimmick.
 It hurt the economy in two ways

1. It increased fiscal deficit of the government.

2. The farmers who had been regularly repaying loan, felt
cheated. Now they also don‟t repay the loans on time,
thinking sooner or later govt. would announce another debt-
waiver.

Thus, banks, particularly regional rural banks (RRBs) are facing

really hard time recovering the loan money. That‟s why Chindu is
doing two things

1. On one hand, he offers additional interest subersion to

farmers who repay loans on time.
2. On the other hand, he is also working for amalgation of
RRBs.

More cash to NABARD

 Govt. will provide Rs. 5000 crore to NABARD
  NABARD will give it as loan for construction of warehouses,
godowns, silos and cold storage units both in the public and
the private sectors.
 Panchayats can also use this money for construction of
godowns to help farmers to store their produce.

Multilateral Development banks: Roads in NE

 These banks operate at international level. They are formed
by group of countries.
 Examples of MDB= Word Bank, Asian Development Bank
(ADB), African development bank.
 Chindu wants to get loan from both World Bank and the
Asian Development Bank to build roads connecting North
East India with Myanmar. This will help in our “look east”
policy and improve the economic prosperity of north eastern
States of India.

Bank for Women?

 At present, there is no bank that exclusively serves women.
 Chindu porposed that we should have have a bank that

1. lends mostly to women and women-run businesses,

2. supports women SHGs and women‟s livelihood,
3. employs predominantly women,
4. addresses gender related aspects of empowerment and
financial inclusion

for this,

 MBN Rao committee = they‟ll prepare the blueprint for the

country‟s first women‟s bank.
 Govt. shall provide Rs 1,000 crore as initial capital to start
this bank.
 Chindu hopes RBI will give banking license to this by
October, 2013.

Urban housing fund

 There is already Rural Housing Fund set up through the
National Housing Bank.
 In this system, govt. gives cash to NHB. And NHB lends it to
other banks operating in rural areas >> finally those bank
lend it to villagers to construct houses.
 Chindu has proposed to start similar fund for Urban housing
under National housing bank.

Banking
1. Govt. will provide capital infusion to public sector banks and
make sure they meet BASEL III norms.
2. All scheduled commercial banks and all RRBs are on core
banking solution (CBS) and on the electronic payment
systems (NEFT and RTGS).
3. Public sector banks have assured Chindu that we‟ll set up
ATM in all our branches by the end of March 2014
4. We are working with RBI and NABARD to bring all other
banks, including some cooperative banks, on CBS and e-
payment systems by the end of December 2013.

What is Core Banking Solution (CBS)?

 Core banking solution= Bank integrates all of its branches in
a single IT network.
 Whenever you take out money or deposit money from your
account, the database is updated in the central server
directly.
 Any branch of the bank, can access this date from the central
server.
 Thus Core banking solution helps customers to operate their
accounts, and avail banking services from any branch of the
Bank on CBS network, regardless of which branch he had
opened the account.
 The customer is no more the customer of a Branch. He
becomes the Bank‟s Customer.
 Thus CBS = Anywhere and Anytime Banking.
 You can deposit money in any branch-office, you can give
cheque, you can take out money, you can get your account
 statement, etc.…..as long as that branch is part of the core
banking solution.
 CBS branch is like a Sales & Service Delivery Center.
Internet banking, mobile banking, ATM are all interconnected
in Core banking solution.

Why is CBS in news?

Because of two reasons
#1: Chindu’s budget speech

 All scheduled commercial banks and all RRBs are on core

banking solution (CBS) and on the electronic payment
systems (NEFT and RTGS).
 We are working with RBI and NABARD to bring all other
banks, including some cooperative banks, on CBS and e-
payment systems by the end of December 2013.

#2: RBI’s notice to UCB

 in March 2013, RBI issued a notice that

 Many Urban Co-operative Banks (UCBs) haven‟t
implemented the core banking solutions (CBS) yet. We‟re
giving them deadline: Dec 2013.
 If they do not implement core-banking solutions by that time,
then we (RBI) could deny them various approvals (e.g.
permission to open new branch etc.)

Why UCBs haven’t implemented CBS?

 All the state-owned commercial banks have implemented
CBS system already.
 But other Urban cooperative banks at district level are unable
do it due Lack of funds (takes lot of money to setup server,
buy licensed softwares, intenet bill etc).
 Although RBI maintains that in long term, use of Information
technology and CBS will reduce the cost of operation so it‟s
a win-win situation if UCBs implemented the CBS.
Finally, conclusion, summary, what do we get from fifth chapter?

Conclusion
 Indian Government started reforming the financial markets
under LPG reforms in 90s.
 The results of these reforms have been encouraging.
 Today, India has one of the most vibrant and transparent
capital markets in the world.
 But still there are certain challenges before Indian capital
market becomes an important avenue for investors – both
foreign and domestic.
 1) Our corporate sector requires long term funds (@low cost),
and
 2) we need lot of money for infrastructure project.

To help ^these two, we need three things

1. Well developed Banking system…already present

2. Well developed equity market….already present.
3. Well developed corporate bond market…yet to develop.

So, Government needs to take policy initiatives for developing a

robust corporate bond market. These policy initiatives include:

1. Need to strengthen the legal, regulatory framework for

corporate debt market.
2. Legal regulatory framework for financial products which is
new or still in nascent stage e.g. municipal bonds, credit
default swaps.
3. At present our public sector organizations related to pension-
insurance sector (LIC, EPFO) cannot invest lot money in
corporate debts. Government needs to relax their investment
guidelines.

Infrastructure development funds (IDF)

 IDF are already discussed in earlier article click me

 Infrastructure Development funds will financing the long term
infrastructure projects @cheaper cost.
  However, for the IDF to become effective, Government needs
to take policy initiatives. (allowing public sector insurance and
pension funds to invest in them).

Financial literacy

 Investment will not come just by relaxing the legal/regulatory

framework.
 You need to encourage people to invest in capital market.
(and to prevent them from investing all their money in gold-
because gold purchase increases current account deficit and
creates more problems for Indian economy).
 Govt also tried to give the “carrot” of RGESS. But challenge :
much of the target audience doesn‟t have PAN card and
DEMAT account.

Banks

 Banking Laws (Amendment) Act 2012 already discussed click

me
o This will give more regulatory and supervisory to RBI
and
o help banks in raising funds from the capital market for
expanding their banking business.
 SARFAESI act amendment help banks reduce their NPAs.
 Other issues related to RRBs, NABARD etc given in this
article itself.

Pension
Pension reforms in India

1. Will facilitate the flow of long-term savings for development

2. Will help establish a credible and sustainable social security
system in the country

But challenge: NPS is not popular due to low commission, bill

pending in parliament. More explained earlier, click me
Insurance
  Chindu gave revival package.
 Challenge: Less insurance penetration, FDI Bill pending in
parliament

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 victims in the hands of local
moneylender cum thugs.

Three important initiatives taken by RBI for financial inclusion:

 Lead banking scheme (LBS).

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

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

 Business Correspondents (BC) system. Discussed in

2006 this article.

Why Business Correspondents system?

 If Financial inclusion means “open bank accounts for poor
people.” Then what‟s the big deal, 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 money deposited, 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 comes the 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 to ask 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 do with regular customers.
 So, he may have to wait for many hours, move from this table
to that table, before he gets his 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 or fertilizers.
 One the other hand, local money lenders in his village, give
money quickly, without asking many questions or requiring
him to fillup two dozen application forms. (but then they
extract 36% compound interest from this poor man, thus
making his life a living hell.)

Ultimately

1. Banks We can‟t open branches @every village,

because it‟s not profitable.
2. poor We can‟t make trip to nearest town to access
people banking facilities, because it is inconvenient.

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 savings account, 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-Governmental 8. farmers‟ clubs
Organisations(NGOs) 9. Community based
2. Self Help Groups (SHGs), organisations
3. Micro Finance Institutions 10. Cooperatives
(MFIs) societies
4. Post Offices 11. Village Knowledge
5. Insurance agents Centres,
6. Panchayats 12. Agri Clinics/ Agri
7. Civil Society Organisations Business Centers,
(CSOs) 13. Krishi Vigyan
Kendras
14. Khadi and Village
Industries units
15. 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/manage loans.
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.

Swabhimaan
 Initiative by the Finance Ministry + Indian Banks‟ Association
 launched in 2011
 To bridge economic gap between rural and urban India.

Objectives
 Make banking facilities available to every habitat with a
population >2000 (by March 2012.)
 Banks will provide basic services like deposits, withdrawal,
Kisan Credit Card (KCCs) etc via 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 to beneficiary‟s account.
 Beneficiary can withdraw the money from the Business
Correspondents (BCs) in their village 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 BC
 Last 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 service delivery.)
 Reserve Bank of India (RBI) has permitted all business
correspondents (BCs) working for one 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 like LIC.
 Last year, FINO become the common Business
Correspondents company for all public sector banks
operating in Jharkhand.

NREGA payment

Old system New system

 1. All accounts will be
maintained by core banking
1. A villager earns some
system.
cash under MNREGA.
2. So, cash directly goes from
2. Government gives cash
Government > Bank
to bank.
>MNREGA worker‟s bank
3. Bank gives it to B.C.
account.
4. B.C. deposits it into
3. Villagers will have the
MNREGA worker‟s
freedom to make their
account.
withdrawals from any BC they
choose.

Kiosk Banking
 The 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 the time they just gather dust.
 Therefore, technology-based „self-service‟ model (e.g ATM,
internet kiosks) is not useful at this stage.
 And hence we need Personnel (these Business
Correspondents=middlemen). Because often villagers are
illiterate, so they can‟t even fill up the forms for opening bank
accounts or loan-application or filling the deposit slips etc.
Business Correspondents are essential at this stage.
 But again problem: The cost per transaction remains high.
(Because Bank has to pay commission 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 ATM machines+ 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 in detail, 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 ~75,000 villages have a bank branch
or business correspondent agents (BCA). So for the poor
people in remaining ~525000 villages still face the problems
we saw` in MNREGA payment withdrawl.
 So Direct Cash Transfer will be #EPICFAIL unless each and
every village is covered under banking services.
 Therefore, recently Chindu asked the banks to have at least
one bank branch or business correspondent agents (BCA) for
every village or group of villages with 1,000 to 1,500
households.
 In the villages without BCA, Department of Electronics and
Information Technology will install Common Service Centre
(CSC).
 This CSCs will serve as the BCA.
 Right now, CSC will used only for opening new accounts of
beneficiaries under the scheme for direct cash transfer.
 Only after banks install the software and complete other
technical requirements for cash transactions, the CSC will
allow villagers to withdraw cash from their accounts.

Liquidity?
 Liquidity is a relative term.
 For assets: Rs.1 crore worth gold is more liquid than Rs.1
crore worth farmhouse. Because you can quickly sell the gold
in a few days, but for selling farmhouse you‟ll have to deal
with so many prospective customers, real-estate agents,
paper work, stamp duty etc., this would take more than 15
days= not so liquid.
 For banking: if yesterday SBI had Rs.100 to give as loan
 today SBI has Rs.200 to give as loan, then we say liquidity
has increased. (And vice versa).
 In winter, supply of green vegetables increases (compared to
summer) so selling price of green vegetables decreases in
winter (compared to summer).
 Similarly when liquidity (money supply) increases, the cost of
borrowing (=interest rates) goes down.
 Very high liquidity can create demand pull inflation=bad. for
more, click me
 Very less liquidity=cost of borrowing is extremely high for
businessman = bad because he cannot easily start or expand
his business=less people get employment.
 So one of the job of RBI= control this “liquidity” in banking
system.
 RBI mainly uses following tools to control this liquidity /
money supply in the banking system.

1. Cash reserve Ratio (CRR)

2. Statutory Liquidity Ratio (SLR)
3. Liquidity Adjustment Facilities (LAF) (Repo and reverse repo)
4. Open market operations (OMO)

What is Cash reserve ratio (CRR)?

 For the sake of simplicity, let‟s assume there are only four
people in India: 1) common men and 2) businessmen 3)
Commercial banks (like SBI) 4) Central Bank (RBI.)
 Now the Question: How do commercial banks make money?
 Common men save their money in bank. Bank gives them
say 7% interest rate on savings.
 Then Bank gives that money as loan to businessmen and
charges 12% interest rate. So 12-7=5% is the profit of Bank.
Although that‟s technically incorrect, because we‟ve not
counted bank‟s input cost=staff salary, telephone-internet-
electricity bill, office rent, xerox machine etc. So actual profit
will be less than 5%.
 But anyways, first let‟s construct a technically incorrect
model.
1. SBI has only one branch in a small town. It was opened on
Monday.
2. On the very same day, Total 100 common men deposited 1
lakh each in their savings accounts here (=total deposit is 1
crore)
3. and SBI offered them 7% interest rate per year on their
savings

WHY CRR: Cash reserve ratio?

 On Tuesday, SBI Branch manager gives away entire 1 crore
to a businessman as loan for 12% interest rate for 5 years.
 From SBI‟s point of view, sounds very good right? 12-7=5%
profit!
 But we‟ve not considered the fact that on Wednesday, some
of those common men (account holders) will need to take out
some money from their banks savings account- to pay for
gas, electricity, mobile bills, college fees, writing cheques and
demand drafts etc.
 But SBI‟s office doesn‟t have a single paisa left! = problem,
protest, rioting, suicides.
 So condition #1: Banks must not give away all of the deposit
money to businessmen for loans. Banks must keep some
money with aside.
 Ok but who‟ll decide how much minimum cash should a bank
keep aside? Ans. RBI via CRR.(Cash reserve ratio).
 But banks donot like high CRR. We already saw that in the
CRR controversy article: click me

WHY SLR: Statutory liquidity ratio?

 Continuing the same example. SBI got 1 crore on Monday.
 But suppose, RBI gave him order, “you must keep Rs.10
lakhs aside. (CRR)”
 Thus, SBI is left with only 1 crore – 10 lakhs = 90 lakh
rupees.
 So SBI manager decides to get maximum profit out of
remaining money. Suppose ongoing rate for business loans
is 12%.
  But there is one businessman Mr.Parajay.
 No bank is offering him loan, because his past track record is
not good: his earlier business adventures were epic fail.
 This Mr.Parajay comes to SBI

I desperately need loan for my business. but no

other bank is giving me loan. Tell you what, give
me all of those 90 lakh rupees as loans, I‟m
ready to pay 36% interest rate on it! And trust
Mr.Parajay, the
me, I‟m going to make lot of money in my new
businessman
business project. And I‟m ready to mortgage all
of my factories, cars, farmhouses. So if I can‟t
repay loan, you can auction them and recover
your money.

SBI manager Good! I‟ll give you all of my 90 lakhs as loan!

 After six months, Mr. Parajay‟s new business project = also

#EPICFAIL.
 He cannot pay back the EMIs.
 Although SBI can attach his assets and auction them to
recover the money. But it‟ll take lot of time.
 In the mean time, common-men also read this story in local
newspapers and they panic that SBI will collapse and bank
manager will shut down the office and run away.
 So all the common men line up in front of bank and demand
back their money. Recall that SBI still has 10 lakh left in CRR.
But people want total 1 crore back!
 Again money of account holders (common men) is stuck
=problem, protest, rioting, suicides.
 So, Condition #2: Bank must not give away all its loans to
risky loan takers. Banks must invest part of its money in “safe
and liquid” investment. So during emergency, bank can sell
those “liquid” investments and take out the money.
 For example, Government securities, gold, corporate bonds
of reputed companies like Infosys, reliance, TCS. These are
“safe” investments.
 These are also “liquid”, because you can sell them quickly
whenever you want. (recall that SBI could also auction
Mr.Parajay‟s properties, but it‟ll take lot of time in paperwork,
legal issues etc.)
 Ok so, bank should invest part of common-men‟s money in
“safe” investments like Government securities, gold and
corporate bonds of highly reputed companies.
 BUT who will decide how much money should be
invested in this sector?Ans. RBI via SLR (Statutory liquidity
ratio). In earlier article, we‟ve already seen SLR in
detail. click me
 Let‟s assume RBI ordered SBI to keep Rs.25 lakhs under
SLR.
 Thus, out of original Rs.1 crore that SBI had, 10 lakhs (CRR)
+ 25 lakhs (SLR) are gone.

Bank Runs: SLR+CRR

 Suppose a rival bank of SBI, hires some people to spread
rumors against SBI.
 The rumor is something like this= “SBI invested lot of money
in sharemarket but sharemarket is crashed so now SBI
doesn’t have any money left. They’re going to shut down the
office and run away.”
 ^this is totally ridiculous rumor because according to RBI
rules, banks cannot invest depositor‟s money in the
sharemarket in the first place!
 Anyways, out of the 100 SBI account holders (common
men), 30 common men believe in this rumor and run to the
SBI office.
 They demand SBI to return their entire savings deposit. Such
panic movement of bank customers is known as “bank run”.
 Thankfully, SBI has total 10 lakh (CRR), so they can directly
give it back. SBI also has set aside Rs.25 lakhs under (SLR),
so SBI can sell away those Government securities, gold
worth 25 lakhs and give that money back to account holders.
 Thus, SLR+CRR protects a bank against Bank runs.
 However in case of a “totally awesome” bankrun, nothing can
protect a bank. (i.e. when all of the account holders
 simultaneously demand all of their money on the same day!)
anyways back to the topic:

WHY Priority Sector lending?

So far, You know what is CRR and SLR.
Now SBI manager start making calculation, how much money is
left with him?

Money received from common men 1 crore=100 lakh

Money set aside in CRR MINUS 10 lakh

Money invested in SLR MINUS 25 lakh

Money left 100-10-25=Rs.65 lakh.

 Out of that 65 lakhs, let‟s assume SBI manager has to keep

aside 15 lakh for Administrative costs, salaries of employees,
electricity bill, internet bill, Xerox machine etc. So he has only
50 lakh left for providing “loan” to needy people.
 Now loan-takers line up in front of SBI office

Give us loans of 1 lakhs each for buying seeds

and fertilizers. However, given the vagaries of
50 farmers
monsoon and low profit margin in agriculture, we
cannot pay more than 5% interest rate.

Give us loans of 2 lakhs each to setup small retail

25 Small shops / car mechanic / hair saloon etc. We offer
businessman 11% interest rate. we cannot offer a penny more
because our profit margin isnot good.

2 Students Sir please give us loan of Rs.25 lakhs each, for

paying self-financed medical college. We can pay
 atmost 9% interest rate.

Give me those 50 lakhs. In a few months, Diwali

1 Big
is coming and I want to setup a new firecracker
businessman
factory. I offer you 15% interest rate.

 if SBI is run from purely profit point of view, then farmers,

small businessmen, students and weaker sections of the
society will never get any loan.
 Because SBI manager would want to give loan to a person
that offers him highest interest rate.
 Then who is going to protect those weak people? Who is
going to help them get loans at reasonable rates? Ans. RBI.
 Suppose RBI tells the SBI manager, “40% of the money you
lend, must go to priorities sectors viz. agriculture, small scale
business, housing and education.” (=40% of 50 lakh=20lakh).
 ^This is the basic funda of priority sector lending. More
details are given on page 15.12 of Ramesh Singh.

What is NDTL?
 So far, We know that Banks have to comply with the CRR,
SLR and priority sector lending rules of RBI.
 CRR, SLR is counted on amount of money a bank receives.
But bank receives lot of money,

1. from depositors,
2. from loan takers who‟re re-paying EMI,
3. (fraudulent) hidden charges imposed on credit cards
4. Commission charged on giving demand draft
5. Commission charged on online money transfer
6. Commission charged on foreign currency conversion
etc.etc.etc.

 So how does bank exactly count CRR, SLR requirements? =

Net Demand and Time Liabilities (NDTL)
 Main example (list not exhaustive)

1. Money deposited in Fixed deposits (FD)

2. Cash certificates
Time 3. gold deposits.
liabilities 4. Staff security deposit. E.g. in some banks when
you join as Probationary officer, you‟ve to sign
bond worth RS.1-2 lakh rupees.

1. Money deposited in savings account

Demand 2. Money deposited in current account
liabilities 3. Demand drafts
4. unclaimed deposits;

 I‟m not going into minute nitty-gritty involved in computing

NDTL because that‟s irrelevant from exam point of view. So
long story cut short, CRR and SLR are calculated on this
NDTL number with some caveats.
 And banks have to send reports to RBI on fortnight basis
that “our NDTL is xyz and we are maintaining xyz SLR and
CRR on it as per your direction.”
 Now here comes the problem: In our example, SBI followed
SLR, CRR and 50 lakh rupees left for loaning.
 However in the given period, priority sector loan takers
(farmers, students etc.) and regular loan taker (businessmen,
car/bike loans)….all of them together take total loans worth
only Rs.30 lakhs.
 so SBI is left with 50-30=surplus of 20 lakh rupees.
 These 20 lakhs are just gathering dust in the office. Nobody
is coming to take new loans! What should SBI do? because
SBI has to give 7% interest even on these 20 lakh rupees, so
SBI cannot afford to let this money gather dust!
 Now comes the Liquidity adjustment facilities, Repo Rate and
reverse repo rate.
 Let‟s start with reverse repo rate.

Reverse repo rate?

  The book definition of Reverse repo rate = “it is interest rate
paid by RBI to itsclients for short term loans.” Ok but who
are the clients of RBI?

1. Central Government
2. State Government
3. Banks (commercial, regional rural banks, cooperative banks)
4. Non-banking financial institutions etc.etc.etc.

 anyways, Reverse repo rate in crude words= when SBI parks

its surplus money in RBI for short term, SBI makes ^this
much profit.
 But actually reverse repo rate works in a bit complicated
manner= via selling and repurchase of Government
securities.
 You‟re aware of Government securities: when Government
wants to borrow money from market, Government security /
Government bond is issued.
 Basically it‟s a piece of paper. It has agreement something
like: “whoever gives me Rs.100 will get 8% interest rate for
10 years and then principle will be repaid”.
 For the purpose of understanding Reverse repo, let‟s
construct a simplified technically incorrect model:

1. RBI has Government securities worth Rs.100 lakhs.

2. SBI has surplus Rs.100 lakhs and nobody is taking them as
loans. But SBI is sure more people will come to take loans
before Diwali. So SBI just wants to park this surplus 100
lakhs somewhere for the short-term.
3. SBI enters into Reverse Repo agreement with RBI.
4. The agreement reads “I (SBI) will give buy Government
securities worth Rs.100 lakhs from the RBI, and RBI
promises to buy back those securities from me after 6 months
@Rs.106 lakhs.

Read it carefully:

 Time: after 6 months,

 SBI‟s investment: Rs.100 lakhs
  After 6 months, SBI gets: Rs.106 lakhs.
 So profit of SBI (or interest earned by SBI or interest paid by
RBI)=(106-100)/100 = 6%. This is reverse repo rate.

Tied to repo rate

In 2011, under RBI made following rule:

1. reverse repo rate would not be announced separately but will

be linked to repo rate.
2. The reverse repo rate will be 100 basis points below repo
rate.(=minus 1%)

So if RBI declares “Repo rate=8%” then reverse repo-rate is

automatically 8-1=7%.But now comes the question:

What is repo rate?

Common sense says, it has to be reverse of “reverse repo rate”
right? Yes that is right.
Textbook definition says

 Repo rate is the rate RBI charges on its clients for short term
loans.
 To put this crudely, when SBI wants to borrow money from
RBI for short term, SBI will have to pay ^this much interest
rate.
 (again) For the purpose of understanding repo rate, let‟s
construct a simplified technically incorrect model:

1. RBI has cash of Rs.100 lakhs.

2. SBI has Government securities worth Rs.100 lakhs.
3. SBI enters into Repo agreement with RBI.
4. The agreement reads “I (SBI) am selling my Government
securities worth Rs.100 lakh to RBI and I (SBI) promise to
buy back(repurchase) those securities from RBI after 6
months @Rs.107 lakhs.

Read it carefully:
1. Time: after 6 months.
2. RBI‟s investment: Rs.100 lakhs
3. After 6 months, RBI gets: Rs.107 lakhs from SBI.
4. So profit of RBI (or interest earned by RBI or interest paid by
SBI)=(107-100)/100 = 7%. This is Repo rate.

Question:

 Why all this gadhaa majoori (donkey labour), involving

Government security? Why can‟t RBI and SBI give money to
eachother without involving Government securities just like
the normal people borrow and lend to each other?
 Answer= Because Government security acts as “collateral”.
So if first party doesn‟t honor the agreement (of repurchase),
then second party can sell away the Government security to
a third party and recover its money.
 Just like pawning your jewelry in Muthoot finance or
Mannapuram gold loans.

Repo rate vs Bank rate?

Repo RBI lends money to banks for short term loans @this
rate interest rate.

Bank RBI lends money to its clients for long term loans @this
rate interest rate.

What is LAF?
 liquidity adjustment facilities (LAF).
 Recall that one of the main task of RBI is to control money
supply in the economy.
 RBI controls money supply via monetary policy. For this RBI
uses various “tools” e.g. SLR and CRR.
 Liquidity adjustment facilities (LAF) is also a tool used by RBI
to control short-term money supply.

LAF timeline
 Narsminam Committee on banking rector reforms,
1998
recommends LAF

1999 RBI introduces interim LAF

2000 RBI introduces full-fledged LAF.

 In the old Bollywood movies, international smugglers often

come to main villain‟s hideout with suitcases loaded with
cash. Then main villain will auction some ancient Indian
statues to them. Something similar happens under LAF.
 LAF helps banks to quickly borrow money incase of any
emergency or for adjusting in their SLR/CRR requirements.
 Under LAF, RBI auctions Government securities, starting at
the repo and reverse repo rate. Minimum bidding amount is
Rs.5 crore.
 So LAF is a tool used by RBI to control short-term liquidity /
money supply in the market.
 In LAF, money transaction is done via RTGS. (RTGS is an
online money transfer method). So in this auction, players
don‟t need to bring suitcases loaded with cash.

What is RGTS?
 RTGS, NEFT=These are online facilities for transferring
money within the country.

Real Time Gross Settlement National Electronic Fund

(RTGS) Transfer (NEFT)

Fast (immediate money transfer) Slow (done on hourly basis)

Can be used only if money Can be used for any amount.

transfer amount is minimum 2 lakh There is no minimum or
rupees or more. maximum limit.
 What is Marginal Standing facility (MSF)?
 RBI started this thing in 2011.
 Under MSF, Scheduled Commercial Banks can borrow
money from RBI @1% higher than the ongoing Repo rate
under liquidity adjustment facility (LAF.)
 Although, the system of lending remains same just like under
repo. = SBI sells Government security to RBI, and promises
to buy it back after sometime, at a higher rate. Difference in
selling and purchase = interest rate earned by RBI.
 we can memorize it like

1. Repo rate = reverse repo + 1%

2. MSF rate= repo rate + 1%

Difference between LAF and MSF

LAF MSF

Liquidity adjustment facility Marginal standing facility

Minimum bidding amount is 5 cr. 1 cr.
Only scheduled commercial
All clients of RBI are eligible to bid.
banks can bid.
Bank cannot sell Government bank can sell the Government
security to RBI that is part of security from its SLR quota to
bank‟s SLR quota. RBI.
Bank can borrow any amount of
Bank can maximum borrow
money as long as it has the
upto 2% of its NDTL.
securities to sell.
MSF lending rate is always
Suppose repo rate is “r%”
(r+1)%

Food for thought

 Let‟s take some approx. numbers based on past few months.
 Repo rate has been around 8%. That means reverse repo is
around 7% and MSF is 9%.
  SBI offers 0% interest on current account, 4% on savigns
account, around 7% interest rate on term deposits.
 SBI charges around 10% on home loans, 12% on car loans
and 18% on bike loans.
 Now consider what If SBI parks its money in RBI (via reverse
repo rate). Well RBI‟s reverse repo is also around 7%! may
be a few 0.25-0.75% higher than SBI‟s term deposit interest
rate. Point being, SBI is better off finding more loan takers
than parking money in Reverse repo rate because it can earn
more profit that way.

Open market operations?

 Open market operation= when RBI buys/sells securities in
open market.
 How is it different from LAF or MSF?
 Well in LAF or MSF, one party buys Government security
from second party. But second party has agreed to buy back
(repurchase) the same security from first party after some
time. So Government security is not “permanently” sold, it is
only used as a collateral= that‟s like pawning your jewelry in
Muthoot finance company.
 But in case of OMO, first party permanently sells the
Government security to second party. Second party is free to
do whatever it wants with that security.
 When RBI purchases Government securities =liquidity
increased (because RBI is paying that party some money to
buy that security, right? so RBI is pouring additional money
into the system.)
 On reverse, when RBI sells Government securities= liquidity
is decreased. (because those players are giving their cash to
RBI to purchase the securities= money is sucked out of the
system by RBI).

Summary

From SBI manager‟s point of view

 I must keep this much money aside. I cannot give it
CRR as loan to anyone. I will not earn any interest rate on
it.

I‟ve to invest this much money in gold, Government

SLR securities (G-sec) and RBI approved corporate
bonds.

If I borrow money from RBI for short term, I‟ll have to

Repo rate
pay them this much interest rate.

Reverse If I park my money in RBI, they‟ll pay me this much

repo rate interest rate.

If I borrow money from RBI for long term, I‟ll have to

Bank rate
pay this much interest rate.