Class 4

Class 4

Why Regulators are required

· Banks have public’s money which needs to be protected. On a bank’s Balance sheet, their own capital (around 6%) is very low compared to public deposits (liabilities)

· Also, banks duty is to pay deposits as and when it is due, irrespective customer demands it or not

· Regulator creates deposit insurance agency to avoid failure of the banks

· Regulator gets hidden info form the bank (apart from Balance sheet figures)

· Creation of Money (Bank notes)

M3

· Currency in circulation (8% - 9% of Money Supply)

· Demand & time liabilities of a bank (90% of Money Supply)

· Other deposits with central bank (for international settlement)

Hence, to control money supply, control deposits. M3 is calculated on a weekly basis. Published on every Wednesday indicating position of previous Friday.

Tools of Central Bank

· Bank Rate

· Variable Cash Reserve

· Open Market Operations

· Exchange Rate Management

· Liquidity adjustment facility

· Moral suasion

Bank Rate

RBI lends to commercial banks, which covers both short term as well as long term period loans

Why Banks Fail

· Because exports get affected

· Loan payment default

Banking Regulations act – 1949

RBI Act – Controls SLR, CRR

RBI – It is a banker to the government. A cheque issued by central government is never returned. Central government’s account may not have sufficient balance due to slow tax collection. Hence, when Central government’s account has less money than cheques issued, RBI can cater to clearing of cheques via CRR / SLR deposited by banks or it will print money or will issue Treasury bill to itself.

PLR – Rate at which banks lend to AAA rated companies.

PLR + Cost of deposit + CRR Loss + Interest lost for lending to government + Profit margin of bank = New Base Rate

Hence, no bank can lend below base rate

Bankers to Banks - Banks can borrow from RBI. Transfer of bank’s funds - From Central RBI to different locations – Free of charge, maximum 3 times per week

RBI is lender of last resort – RBI can lend to individuals, but has not done it till today

RBI floats public issues (issued by Central Government)

It advices Central Government when and how much to borrow

Public Debt management – Government never borrows (issues bonds) when an IPO is coming. It may happen that IPO subscription will get affected because of government’s public issue

Vimal Jalan (Ex RBI Governer) – RBI needs to act in favor of the market

Subordinated debt – Debt (securitized, debenture) is created on the basis of underlying security

· Issued Capital >= 50% of Authorized Capital

· Paid Up Capital >= 50% of Issued Capital

Why tier 2 – To support Tier 1 Capital in order to maintain minimum level of capital adequacy

External borrowing of the bank is restricted to 15% of Tier 1 capital (More regulated)

Contingent Liability – Liability incurred as and when they arise.

Cash is certain; Profit is a matter of Opinion