Indian Monetary policy, Policy Rates, Reserve Ratios, Lending/Deposit Rates, Bank Liabilities/Assets

Monetary Policy
Monetary policy is the process by which the government, central bank, or monetary authority manages the supply of money in the economy of the country.
Aim of the monetary policy is either to increase the total supply of money in the economy by lowering interest rates or to decrease the supply by increasing the interest rates.

What are the objectives of Indian Monetary policy?
· Maintain price stability
· flow of credit to the productive sectors of the economy
· stability for the national currency
· Growth in employment and income.

Tools of Indian Monetary Policy
· Open Market Operations (OMO)
· Cash Reserve Ratio (CRR)
· REPO/Reverse Repo
· Statutory Liquidity Ratio (SLR)

Open market operations
Sales or purchases of government debt instruments (treasury bonds, treasury bills, treasury notes) on the open financial markets by a country's central bank as part of its efforts to influence the size of the money supply and the levels of interest rates.

Central bank decisions to buy up government debt instruments make for an expansionary (increase) monetary policy, while sales of government debt instruments by the central bank represent a contractionary (tightening) monetary policy.

Different Policy Rates:

Repo-Bank Rate is the rate at which banks borrow money from the RBI, When Repo-Bank Rate is increased money supply in the economy decreases. It is 7.75% as of today in India.

Reverse-repo rate is the rate at which the RBI absorbs liquidity from the system, or the interest rate paid to banks for RBI's borrowings from them. It is 6% as of today in India.

Bank-Discount Rate is the Rate at which Banks borrow money from the Central Bank (RBI). It is 6% as of today in India.

Reserve Ratios:
CRR – Cash Reserve Ratio, the portion or percentage of Depositor’s balances banks must have on hand as cash. It is a requirement determined by country’s Central Bank. It Affects money supply in a country.
for e.g.: if CRR in India is set at 7.5% (this is current CRR rate in India) and Banks total deposits are in tune of Rs 100 Cr then Rs 7 Cr is required to be kept as reserve.

SLR – Statutory Liquidity Ratio is that amount which a bank has to maintain in the form of cash, gold or approved securities. The ratio is derived broadly on the total demand and time liabilities of a bank. It is 25% as of today in India.

Lending/Deposit Rates:

Prime Lending Rate (PLR) is that rate of interest at which a bank lends to its best customers. It is 12.75 to 13.25 % as of today in India.

Savings Bank Rate – is the interest rate offered by banks for the money kept in Savings account. It is 3.5% as of today in India.

Deposit Rate – is the rate interest rate offered by banks for short-long term deposits with the banks. It is 7.5 to 9.6 % depending on tenure as of today in India.

Capital Markets:
BSE Sensex
S&P CNX Nifty

Government Securities Market:
T Bills (91/182/364 Days) : T-Bills are treasury bills issued by the government of a country and are exchangeable (redeemable) in less than a year.

Money Markets:
Call Rates – is the overnight inter-bank interest rate. It is 6.65 to 8.05% as of today in India.

LIABILITIES for a Bank

1. Capital
2. Reserves & Surplus
3. Deposits
3.1 Demand Deposits
3.2 Savings Bank Deposits
3.3 Term Deposits
4. Borrowings
5. Other Liabilities and Provisions

ASSETS of a Bank

1. Cash & balances with RBI
2. Balances with banks and money at call & short notice
3. Investments
3.1 Govt. Securities
3a. In India
3b. Outside India
3.2 In other approved securities
3.3 In non-approved securities
4. LOANS & ADVANCES
4.1 Bills purchased & discounted
4.2 Cash credit, Overdrafts etc.
4.3 Term loans
5. Fixed Assets
6. Other assets

Basel II, 3 Pillars

Basel II mainly talks about guidelines for supervisory bodies for proposing revisions in maintenance of adequate capital by banks active in international capital markets.

It Specifies Framework for measuring Capital adequacy/sufficiency and the minimum standard to be achieved which the national supervisory authorities will propose for adoption by the banks in respective countries.

This framework and standards has been endorsed by Central Bank Governors and Heads of

Banking supervision of G-10 countries.
Expanded list [Belgium, Canada, France, Germany, Italy, Japan, Luxembourg, the Netherlands, Spain, Sweden, Switzerland, the United Kingdom, and the United States.]

Basel II promotes/Advocates:
Adoption of stronger risk management practices by the banking industry.
Assessment of Risk provided by banks internal systems as inputs to capital Calculations
To ensure that bank systems and controls are adequate enough and comply with minimal requirements to serve as the basis for capital calculations.
Provides a range of options for determining the capital requirements for Credit risk, Market Risk and Operational risk
Allows limited degree of national discretion for implementation of framework
Changes in the approach to the treatment of Expected Losses and Un Expected Losses (UL) and to the treatment of securitization exposures.
Treatments of Credit Risk Mitigation and revolving retail exposures.

Some of the Activities in scope which financial entities are involved in are:
Financial Leasing
Issuing Credit Cards
Portfolio Management
Investment Advisory
Custodial and Safe Keeping Services

3 Pillars on which the Framework is based on:

1. Minimum Capital Requirements
a. Banks to asses the minimum capital requirements for Credit, Market, Operational Risks, Interest Rate risk in the banking book, Liquidity Risk etc.
b. The Capital Ratio is calculated using definition of Regulatory Capital and risk-weighted assets.
c. The total Capital Ratio should not be lower than 8%

2. Supervisory Review
a. Review of Assessments done in pillar I
b. Set Guidelines to ensure that Banks have sufficient capital to support their business.
c. Recognizes the responsibility of bank management in developing an internal capital assessment process and setting capital targets that are commensurate with the bank’s risk profile and control environment.

3. Market Discipline
a. Disclosures and Effective complement of above 2 pillars
b. Encourage market discipline by developing a set of disclosure requirements which will allow market participants to asses key pieces of information on the scope of application capital risk exposures, risk assessment processes and hence the capital adequacy of the institution.

Basel Framework is an Extension to 1988 Accord Capital Adequacy Framework

Banks to hold capital equivalents of 8% of its Risk-Weighted assets. (As per 1996 Market Risk Amendment.)

Tier - 1,2,3 Capital, Risk

The Capital Adequacy Ratio (CAR) is the percentage of a bank's capital to its risk-weighted assets.
It’s a measure of a bank's capital. It is expressed as a percentage of a bank's risk weighted credit exposures.
This ratio is used to protect depositors and promote the stability and efficiency of financial systems around the world. Two types of capital are measured: tier one capital, which can absorb losses without a bank being required to cease trading, and tier two capital, which can absorb losses in the event of a winding-up and so provides a lesser degree of protection to depositors.

Tier 1 Capital
A term used to describe the capital adequacy of a bank. Tier I capital is core capital; this includes equity capital, disclosed reserves, common stock, preferres stock.

Tier I capital is the most reliable Capital for Banks.
This is the amounts paid up to originally purchase the stock (or shares) of the Bank

Tier 2 Capital
Tier II capital is secondary/Supplementary bank capital.

There are following classifications of tier two capitals:
Undisclosed reserves,
Revaluation reserves,
General provisions,
Hybrid instruments and
Subordinated term debt.

An Asset is a resource controlled by the enterprise as a result of past events and from which future economic benefits are expected to flow to the enterprise

Risk: The chance that an investment's actual return will be different than expected. This includes the possibility of losing some or all of the original investment. It is usually measured by calculating the standard deviation of the historical returns or average returns of a specific investment.

Risk Comprises two components: uncertainty and exposure.

Credit risk is the risk of loss due to a debtor's non-payment of a loan or other line of credit (either the principal or interest (coupon) or both.
Credit risk due to uncertainty in a counterparty's ability to perform on an obligation.
Legal risk from uncertainty due to legal actions or uncertainty in the applicability or interpretation of contracts, laws or regulations.

Market risk is the risk that the value of an investment will decrease due to moves in market factors. The four standard market risk factors are:

Equity risk or the risk that stock prices will change.

Interest rate risk or the risk that interest rates will change.
Currency risk or the risk that foreign exchange rates will change.
Commodity risk or the risk that commodity prices (i.e. grains, metals, etc.) will change.
Sometimes, a fifth risk factor is also considered:

Equity index risk, or the risk that stock or other index prices will change

Interest rate risk is the risk that the relative value of an interest-bearing asset, such as a loan or a bond, will worsen due to an interest rate increase. In general, as rates rise, the price of a fixed rate bond will fall, and vice versa

Liquidity risk is the risk that arises from the difficulty of selling an asset. An investment may sometimes need to be sold quickly. Unfortunately, an insufficient secondary market may prevent the liquidation or limit the funds that can be generated from the asset. Some assets are highly liquid and have low liquidity risk (such as stock of a publicly traded company), while other assets are highly illiquid and have high liquidity risk (such as a house).

Financial Markets - Primary, Secondary, Debt, Equity, Call Money

Structure of the Financial Markets

· Debt and Equity Market
-- A firm or individual can obtain funds in financial markets in two ways; issue of bonds or issue of equities.
· Bonds: A contractual agreement by the borrower of the fund to pay the holder of the instrument fixed amount at regular interval (int. payments and principal) until a specified time (maturity period).
· Equity: Claims to the share in the net income (income after expenses and taxes) and the assets of a business.

· Primary and Secondary Market
· A primary market is a financial market in which new issues of a security such as bond or stocks are sold to initial buyers by the corporations or Government.
· Secondary markets deals with securities that previously issued. These securities are resold in these markets.
· Exchanges and Over-the-Counter Markets
· Secondary markets can be organized in two ways; one is to organize exchanges, where the buyers and sellers or their agents or brokers meet at central location to conduct trades. - BSE
· The other method of organizing a secondary market is to have an over-the-counter(OTC) market, in which dealers at different locations who have inventory of securities stand ready to buy and sale securities over the counter – local stock exchanges.
· Money and Capital Markets:
· MM: Money market is a financial market in which only short-term debt instruments are traded. Generally, those instruments are maturity less than one year.
· Money market securities are usually less fluctuating. Corporations use money market instruments to earn money.
· Money market is a market for very short term
· CM: Capital market is the market in which longer term debt and equity instruments are traded(maturity greater than one year).
· Capital market instruments are generally held by financial intermediaries, insurance companies and pension funds.

Segments of Money Market:
· Call Money Market
· Acceptance Market
· Bill discount Market
· Collateral loan market.

· Call money market deals in loans at call and short notices.
· Deals with extreme form of short term loans; 24 hours, 7-15 days maturity.
· They can be recalled on demand or shortest possible notice.
· Call Money Rate is the interest rate at which money is lended in the market.
· Normally, collaterals are not insisted upon.
· In India, CMM provides facilities for inter-bank tending.

Types of Credit Market Instruments

Simple loans:
Lender provides the borrower with an amount of funds, which must be repaid to the lender at the maturity date along with an additional payment for the interest.
Fixed Payment Loans:
Lender provides the borrower with an amount of funds, which must be repaid by making the same payments every year/month, consisting of part of principal and interest for a set number of years.

Coupon Bond:
Coupon bond pays the owner of the bond a fixed interest payment (coupon payment) every year until the maturity date, when a specified final amount (face/par value) is repaid.
Discount Bond:
It is also called zero coupon bond. It is bought at a price below its face value (at a discount) and the face value is repaid at the maturity date.

Reserve Bank of India - RBI

Reserve Bank of India (RBI) is India’s Central Bank. RBI was established in 1935 as per Reserve Bank of India Act, 1934.
It was nationalized in 1949. It has approximate 22 Regional Offices across India.

RBI’s main Objectives:

Monetary Authority
· Formulates implements and monitors the monetary policy.
Why?
To maintain price stability and to ensure adequate flow of credit to productive sectors. In simple terms RBI decides how much money should float in the market in order to keep the inflation within reasonable limits in line with the economic growth.

Regulator and supervisor of the financial system.
· By prescribing broad parameters of banking operations
Why?
To maintain public confidence in the Banking system, protect depositor’s interest and to provide cost-effective banking services to the public.

Manager of Exchange Control
· Manages the Foreign Exchange Management Act, 1999.
Why?
To facilitate external trade and payment and promote orderly development and maintenance of foreign Exchange market in India.
Predominantly this means managing or monitoring the Exports and Imports of the country as a whole.

Issuer of currency – Note Issuing Authority
· Issues and exchanges currency or destroys currency and coins not fit for circulation. That is why we see the name “Reserve Bank of India” on our currency notes with the promise by the RBI Governor.

Some other major Roles of RBI are:
· Banker to Government of India.
· Gold Trade Regulator.
· Buys and sells foreign currencies to maintain exchange rates.

Term of the Day Ombudsman

An Ombudsman is usually an official appointed by government or parliament who is charged with representing the interests of the public by investigating and addressing complaints reported by individual citizens. Similarly on these lines a banking Ombudsman is very much prevalent in India to act as a redressal forum for customer complaints on banking industry.

Did You know?
RBI was set up on Recommendation of the Report submitted by Hilton Young Commission in 1926.
RBI’s Central Board of Directors has Azim Premji and Kumar Mangalam Birla.

Mutual Funds an Introduction

A Mutual Fund is a vehicle to pool money from investors, with a promise that money would be invested in a particular manner, by professional managers who are expected to honour the promise.

Mutual funds in India are governed by regulations of Securities and Exchange Board of India (SEBI).

Organisations managing the investments are called Asset Management Company

A mutual fund scheme typically has an:
Investment Portfolio (Portfolio Statement)
Account of Income and Expenditure (Revenue Account)
Account of Assets and Liabilities (Balance Sheet)

Trustees are the people with mutual fund organization who are responsible for ensuring that investors interests in a scheme are properly taken care of, in return for their services they are paid trustee fees, normaly charges to the scheme.

Load : Is an expense bared by investor in different ways like Entry/Exit Load, Administrative load etc.

Open-Ended Schemes:
- Schemes that do not have a fixed maturity
- More liquidity with lesser loads
Closed-End Schemes:
- Have fixed maturity
- Lesser liquidity with more loads
Schemes by Asset Class:
-Securities
1. Equity Schemes
- Invests primarily in shares.
2. Debt or income schemes
a. GILT schemes
- Invests in government securities
- Most liquid
b. Bond Schemes
- Invests in bond securities issued primarily by government or any other issuer
c. Money Market and Liquid Schemes
- Invests in short term debt instruments
- Less volatile
3. Balanced Schemes
- Mix of Equity and Debt
4. Capital Protected Schemes
- Are Closed-End Schemes. Let us learn by eg:
eg: An investment in GILTs for 5 years gives 7% return, so a 5 year closed-end
scheme can collect Rs 100 from investor and invest it as follows:
Rs: 71.30 in guilt for 5 years maturity
Rs: 18.70 in shares.
At the end of 5 years Rs 71.30 will grow to Rs 100 equivalent to amount invested.
So even if investments in shares is wiped out(remote possibility) investors capital is still protected.

Mutual funds can also invest in physical assets like real estate, precious metals like Gold, Silver, Oil another commodities.

NAV: Net Asset Value is the total value of the fund's portfolio less liabilities.

Total mutual fund assets under management in India are above Rs 4 Lakh crore, which is approx. 12% of total deposits in the banking systems in India.

Future topics -- Schemes by Position like sector funds, Exchange traded funds, Hedge Funds. Also to follow Derivates, Futures, Options.