Basic Concepts

Annual Financial Statement

Article 112 of the Constitution requires the government to present to
Parliament a statement of estimated receipts and expenditure in respect of
every financial year April 1 to March 31.
This statement is the annual financial statement.
The annual financial statement is usually a white 10-page document.
It is divided into three parts, consolidated fund, contingency fund and public
account.
For each of these funds, the government has to present a statement of
receipts and expenditure.
Consolidated Fund
This is the most important of all government funds.
All revenues raised by the government, money borrowed and receipts from
loans given by the government flow into the consolidated fund of India.
All government expenditure is made from this fund, except for exceptional
items met from the Contingency Fund or the Public Account.
Importantly, no money can be withdrawn from this fund without the
Parliaments approval.
Contingency Fund
As the name suggests, any urgent or unforeseen expenditure is met from this
fund.
The Rs 500-crore fund is at the disposal of the President.
Any expenditure incurred from this fund requires a subsequent approval from
Parliament and the amount withdrawn is returned to the fund from the
consolidated fund.
Public Account
This fund is to account for flows for those transactions where the government
is merely acting as a banker.
For instance, provident funds, small savings and so on.
These funds do not belong to the government.
They have to be paid back at some time to their rightful owners.
Because of this nature of the fund, expenditure from it are not required to be
approved by the Parliament.
For each of these funds the government has to present a statement of
receipts and expenditure.
It is important to note that all money flowing into these funds is called
receipts, the funds received, and not revenue.
Revenue in budget context has a specific meaning.
The Constitution requires that the budget has to distinguish between receipts
and expenditure on revenue account from other expenditure.
So all receipts in, say consolidated fund, are split into Revenue Budget
(revenue account) and Capital Budget (capital account), which includes non-
revenue receipts and expenditure. For understanding these budgets
Revenue and Capital it is important to understand revenue receipts,
revenue expenditure, capital receipts and capital expenditure.
Revenue receipt/Expenditure
All receipts and expenditure that in general do not entail sale or creation of
assets are included under the revenue account.
On the receipts side, taxes would be the most important revenue receipt.
On the expenditure side, anything that does not result in creation of assets is
treated as revenue expenditure.
Salaries, subsidies and interest payments are good examples of revenue
expenditure.
Capital receipt/Expenditure
All receipts and expenditure that liquidate or create an asset would in general
be under capital account.
For instance, if the government sells shares (disinvests) in public sector
companies, like it did in the case of Maruti, it is in effect selling an asset.
The receipts from the sale would go under capital account.
On the other hand, if the government gives someone a loan from which it
expects to receive interest, that expenditure would go under the capital
account.
In respect of all the funds the government has to prepare a revenue budget
(detailing revenue receipts and revenue expenditure) and a capital budget
(capital receipts and capital expenditure).
Contingency fund is clearly not that important.
Public account is important in that it gives a view of select savings and how
they are being used, but not that relevant from a budget perspective.
The consolidated fund is the key to the budget. We will take that up in the
next part.
As mentioned in the first part, the government has to present a revenue
budget (revenue account) and capital budget (capital account) for all the
three funds.
The revenue account of the consolidated fund is split into two parts, receipts
and disbursements simply, income and expenditure.
Receipts are broadly tax revenue, non-tax revenue and grants-in-aid and
contributions.
The important tax revenue items are listed below.
Direct Tax
Traditionally, these are taxes where the burden of tax falls on the person on
whom it is levied.
These are largely taxes on income or wealth.
Income tax (on corporates and individuals), FBT, STT and BCTT are direct
taxes. Indirect Tax
In case of indirect taxes, the incidence of tax is usually not on the person who
pays the tax.
These are largely taxes on expenditure and include Customs, excise and
service tax.
Indirect taxes are considered regressive, the burden on the rich and the poor
is alike.
That is why governments strive to raise a higher proportion of taxes through
direct taxes.
Moving on, we come to the next important receipt item in the revenue
account, non-tax revenue.
Non-tax revenue
The most important receipts under this head are interest payments (received
on loans given by the government to states, railways and others) and
dividends and profits received from public sector companies.
Various services provided by the government police and defence, social
and community services such as medical services, and economic services
such as power and railways also yield revenue for the government.
Though Railways are a separate department, all its receipts and expenditure
are routed through the consolidated fund.
Corporation Tax Tax on profits of companies.
Taxes on Income
Income tax paid by non-corporate assesses, individuals, for instance.
Fringe benefit tax (FBT)
The taxation of perquisites or fringe benefits provided by an employer to
his employees, in addition to the cash salary or wages paid, is fringe benefit
tax.
It was introduced in Budget 2005-06.
The government felt many companies were disguising perquisites such as
club facilities as ordinary business expenses, which escaped taxation
altogether.
Employers have to now pay FBT on a percentage of the expense incurred on
such perquisites.
Securities transaction tax (STT)
Sale of any asset (shares, property) results in loss or profit.
Depending on the time the asset is held, such profits and losses are
categorised as long-term or short-term capital gain/loss.
In Budget 2004-05, the government abolished long-term capital gains tax on
shares (tax on profits made on sale of shares held for more than a year) and
replaced it with STT.
It is a kind of turnover tax where the investor has to pay a small tax on the
total consideration paid / received in a share transaction.
Banking cash transaction tax (BCTT)
Introduced in Budget 2005-06, BCTT is a small tax on cash withdrawal from
bank exceeding a particular amount in a single day.
The basic idea is to curb the black economy and generate a record of big cash
transactions.
Customs
Taxes imposed on imports.
While revenue is an important consideration, Customs duties may also be
levied to protect the domestic industry or sector (agriculture, for one), in
retaliation against measures by other countries.
Union Excise Duty
Duties imposed on goods made in India.
Service Tax
It is a tax on services rendered.
Telephone bill, for instance, attracts a service tax.
While on taxes, let us take a look at an important classification: direct tax and
indirect tax.
Grants-in-aid and contributions
The third receipt item in the revenue account is relatively small grants-in-aid
and contributions.
These are in the nature of pure transfers to the government without any
repayment obligation. We now look at the disbursements section of the
revenue account of the consolidated fund.
It lists all the revenue expenditures of the government.
These include expense incurred on organs of state such as Parliament,
judiciary and elections.
A substantial amount goes into administering fiscal services such as tax
collection.
The biggest item is interest payment on loans taken by the government.
Defence and other services like police also get a sizeable share. Having
looked at receipts and expenditure on revenue account we come to an
important item, the difference between the two, the revenue deficit.
Revenue Deficit
The excess of disbursements over receipts on revenue account is called
revenue deficit.
This is an important control indicator.
All expenditure on revenue account should ideally be met from receipts on
revenue account; the revenue deficit should be zero.
When revenue disbursement exceeds receipts, the government would have to
borrow.
Such borrowing is considered regressive as it is for consumption and not for
creating assets.
It results in a greater proportion of revenue receipts going towards interest
payment and eventually, a debt trap.
The FRBM Act, which we will take up later, requires the government to reduce
fiscal deficit to zero by 2008-09.
Receipts in the capital account of the consolidated fund are grouped under
three broad heads public debt, recoveries of loans and advances, and
miscellaneous receipts.
Public debt
Public debt receipts and public debt disbursals are borrowings and
repayments during the year, respectively. The difference is the net accretion
to the public debt.
Public debt can be split into internal (money borrowed within the country) and
external (funds borrowed from non-Indian sources).
Internal debt comprises treasury bills, market stabilisation schemes, ways and
means advance, and securities against small savings.
Treasury bills (T-bills)
These are bonds (debt securities) with maturity of less than a year.
These are issued to meet short-term mismatches in receipts and expenditure.
Bonds of longer maturity are called dated securities.
Market stabilisation scheme
The scheme was launched in April 2004 to strengthen RBIs ability to conduct
exchange rate and monetary management.
These securities are issued not to meet the governments expenditure but to
provide RBI with a stock of securities with which it can intervene in the
market for managing liquidity.
Ways and means advance (WMA)
One of RBIs roles is to serve as banker to both central and state
governments.
In this capacity, RBI provides temporary support to tide over mismatches in
their receipts and payments in the form of ways and means advances.
Securities against small savings
The government meets a small part of its loan requirement by appropriating
small savings collection by issuing securities to the fund.
Budget at a glance
This is a snap shot of the budget for easy understanding. Nonetheless, it
introduces some new concepts.
While receipts are broken down into revenue and capital, unlike the
consolidated fund, it shows the centre's net tax revenues.
This is because a decent part of the gross tax revenue, as decided by the
relevant Finance Commission, flows to the state governments.
Budget at a glance also segments expenditure into plan and non-plan
expenditure, instead of splitting into revenue and capital.
Each of these is then split into revenue account and capital account.
Before discussing plan and non-plan expenditure it is important to discuss the
concept of the central plan.
Central plan
Central or annual plans are essentially Five Year Plans broken down into
annual instalments.
Through these plans, the government achieves the objectives of the Five Year
Plans.
The central plans funding is split almost evenly between government support
(from the budget) and internal and extra budgetary resources of public
enterprises.
The governments support to the central plan is called budget support.
We will take up plan and non-plan expenditure in the next part.
Plan expenditure
This is essentially the budget support to the central plan and the central
assistance to state and union territory plans.
Like all budget heads, this is also split into revenue and capital components.
Non-plan expenditure
This is largely the revenue expenditure of the government.
The biggest items of expenditure are interest payments, subsidies, salaries,
defence and pension.
The capital component of the non-plan expenditure is relatively small with the
largest allocation going to defence. Defence expenditure is non-plan
expenditure.
Budget Deficit
The figure that results by subtracting the total expenditures (on revenue and
capital accounts) from the total receipts (on revenue and capital accounts) of
the Government of India.
The budget deficit is financed through the issue of Ad hoc TREASURY BILLS
and/or by drawing down cash balances with the Reserve Bank of India.
Fiscal Deficit
When the governments non-borrowed receipts fall short of its entire
expenditure, it has to borrow money from the public to meet the shortfall.
The excess of total expenditure over total non-borrowed receipts is called the
fiscal deficit.
Primary deficit
The revenue expenditure includes interest payments on governments earlier
borrowings.
The primary deficit is the fiscal deficit less interest payments.
A shrinking primary deficit indicates progress towards fiscal health.
The Budget document also mentions deficit as a percentage of GDP.
This is to facilitate comparison and also get a proper perspective. Prudent
fiscal management requires that government does not borrow to consume in
the normal course.
FRBM Act
Enacted in 2003, Fiscal Responsibility and Budget Management Act require
the elimination of revenue deficit by 2008-09.
Hence, from 2008-09, the government will have to meet all its revenue
expenditure from its revenue receipts.
Any borrowing would only be to meet capital expenditure.
The Act mandates a 3% limit on the fiscal deficit after 2008-09.
Resources transferred to the states
A part of the Centres gross tax collection goes to state governments.
In the Budget 2007-08, the states were to receive nearly 27% of the gross
tax collections.
The Centre also transfers funds to states by way of support to their plans.
It also gives large grants to manage centrally-sponsored schemes.
The government counts small savings transfers to state governments, which
are in the nature of borrowings, as resources transferred to states.
Before March 31, 1999, the Centre used to borrow net accretions to small
savings and lend them to the states.
From April 1, 1999, states started receiving 75% of net small savings directly;
the balance was invested in special government securities during 1999-2000
to 2001-2002.
The sums received in the NSS fund on redemption of special securities are
being reinvested in special G-secs. From April 2002, the entire net collection
under small saving schemes in each state and UT are advanced to the
concerned state/UT government as investment in its special securities.
The expenditure and receipts Budget take up the respective heads in greater
detail.
Value-Added Tax (VAT) and GST
VAT helps avoid cascading of taxes as a product passes through different
stages of production/value addition.
The tax is based on the difference between the value of the output and inputs
used to produce it.
The aim is to tax a firm only for the value added by it to the inputs it is using
for manufacturing its output and not the entire input cost.
VAT brings in transparency to commodity taxation.
In this concluding part we take a look at some of the important terms that
figure in the Budget
CESS
This is an additional levy on the basic tax liability.
Governments resort to cess for meeting specific expenditure. For instance,
both corporate and individual income is at present subject to an education
cess of 2%.
In the last Budget, the government had imposed another 1% cess
secondary and higher education cess on income tax to finance secondary
and higher education.
COUNTERVAILING DUTIES (CVD)
Countervailing duty is a tax imposed on imports, over and above the basic
import duty.
CVD is at par with the excise duty paid by the domestic manufacturers of
similar goods.
This ensures a levelplaying field between imported goods and locally-
produced ones.
An exemption from CVD places the domestic industry at disadvantage and
over long run discourages investments in affected sectors.
EXPORT DUTY
This is a tax levied on exports.
In most instances, the object is not revenue , but to discourage exports of
certain items.
In the last Budget, for instance , the government imposed an export duty of
Rs 300 per metric tonne on export of iron ores and concentrates and Rs 2,000
per metric tonne on export of chrome ores and concentrates.
FINANCE BILL
The proposals of government for levy of new taxes, modification of the
existing tax structure or continuance of the existing tax structure beyond the
period approved by Parliament are submitted to Parliament through
this bill.
It is the key document as far as taxes are concerned.
FINANCIAL INCLUSION
Financial inclusion is universalising access to basic financial services (to have
a bank account , timely and adequate
credit) at an affordable cost.
Exclusion from financial services imposes costs on those excluded ; these are
typically the disadvantaged and low-income group.
Exclusion forces them into informal arrangements such as borrowing from
local money lenders at high rates.
Financial inclusion remains a serious issue in India.
The government has proposed a no-frills account to provide cheap banking.

MINIMUM ALTERNATE TAX (MAT)

This tax on corporate profits was introduced in 1996-97 and has been
modified since.
If the tax payable by a company is less than 10% of its book profits, after
availing of all eligible deductions , then 10% of book profits is the minimum
tax payable.
Book profits are profits calculated as per the Companies Act, while profits as
per the Income-Tax Act could be significantly lower, thanks to various
exemptions and depreciation.
PASS-THROUGH STATUS
A pass-through status helps avoid double taxation. Mutual funds, for
instance , enjoy pass-through status.
The income earned by the funds is tax free.
Since mutual funds income is distributed to unitholders, who are in turn
taxed on their income from such investments , any taxation of mutual funds
would amount to double taxation.
Essentially , it means the income is merely passing through the mutual funds
and, therefore, should not be taxed.
 The government allows venture funds in some sectors pass-through status to
encourage investments in start-ups .
SUBVENTION
The term subvention finds a mention in almost every Budget.
It refers to a grant of money in aid or support, mostly by the government.
In the Indian context, for instance, the government sometimes asks
institutions to provide loans to farmers at below market rates.
The loss is usually made good through subventions.
SURCHARGE
As the name suggests, this is an additional charge or tax. A surcharge of 10%
on a tax rate of 30% effectively raises the combined tax burden to 33%.
In the case of individuals earning a taxable salary of more than Rs 10 lakh a
surcharge of 10% is levied on income in excess of Rs 10 lakh.
Corporate income is levied a flat surcharge of 10% in the case of domestic
companies and 2.5% for foreign companies.
Companies with revenue less than Rs 1 crore do not have to pay this
surcharge.
ADR An acronym for American Depository Receipt.
It is an instrument traded at U.S. exchanges representing a fixed number of
shares of a foreign company that is traded in the foreign country.
By trading in ADRs, U.S. investors manage to avoid some of the problems of
dealing in foreign securities markets.
The ADR route enables companies to raise funds in the U.S. financial
markets, provided they meet the stringent regulatory norms for disclosure
and accounting.
Arbitrage
The simultaneous purchase and sale transactions in a security or a
commodity, undertaken in different markets to profit from price differences.
For example, an arbitrageur may find that the share of The Tata Iron and Steel
Company (TISCO) is trading at a lower price, at the Vadodara Stock Exchange
compared to the exchange at Bombay.
Hence, he may simultaneously purchase TISCO stock in Vadodara at, say
Rs.250, and sell in Bombay at a higher price, say Rs.256, making a profit of
Rs.6 per share less expenses.
At-the-Money
The term relates to trading in listed OPTIONS.
An option is said to be trading at-the-money when the STRIKING PRICE and
the market price of the underlying share are equal.
Badla System
An Indian term for a trading system with a mechanism for deferring either
payment for shares purchased or delivery of shares sold.
The system, discontinued by the Securities and Exchange Board of India
(SEBI), from March 1994, was applicable to A group or Specified shares.
For carrying forward a purchase transaction from one settlement period to the
next, the buyer normally paid the seller a charge termed badla or Contango.
This consideration would be fixed in the badla session.
When buyers could not take delivery, badla financiers would step in and help
out the buyers
Balance of Payments
A statement that contains details of all the economic transactions of a
country with the rest of the world, for a given time period, usually one year.
The statement has two parts: the Current Account and the Capital Account.
The Current Account gives a record of a countrys:
(a) Trade Balance which shows the difference of exports and imports of
physical goods such as machinery, textiles, chemicals and tea, (b) Invisibles
that comprise services (rendered and received) such as transportation and
insurance and certain other flows, notably private transfers by individuals.
When imports of goods exceed exports, it is referred to as a Trade Deficit.
However, the overall current account position depends on both the trade
balance and the performance of Invisibles.
The Capital Account contains details of the inward and outward flows of
capital and international grants and loans.
Examples of such flows are external assistance, foreign (direct and
PORTFOLIO) investments, subscription to Global Depository Receipts or
EUROCONVERTIBLE BONDS and deposits of non-residents.
Inflows on the capital account are helpful in financing a current account
DEFICIT.
Any gap that remains is covered by drawing on exchange or gold reserves, or
by credit from the International Monetary Fund.
Depending on the nature of imports, a deficit on the current account indicates
an excess of investment over domestic saving in an economy.
So long as this deficit is kept in check (evaluated as a percentage of the
CROSS DOMESTIC PRODUCT), the DEBT SERVICE RATIO would remain within
manageable limits.
Bank Rate
The rate of interest charged by the Reserve Bank of India (RBI) on financial
accommodation extended to banks and FINANCIAL INSTITUTIONS.
The support is provided in the form of a bills rediscounting facility and
advances or REFINANCE against specified ASSETS (e.g.
TREASURY BILLS and DATED SECURITIES) or PROMISSORY NOTES.
The intent behind changing the Bank Rate at certain junctures is to raise or
lower the cost of funds that banks obtain from the RBI.
This, in turn, would alter the structure of banks interest rates and thereby
serve to curb or encourage the use of credit. However, the Bank Rate is a
relatively passive instrument of credit control.
In the wake of the East Asian currency crisis, the RBI used the Bank Rate in
conjunction with the CASH RESERVE RATIO and other measures to stabilize
the exchange rate of the Rupee.
Bear
A person who expects share prices in general to decline and who is likely to
indulge in SHORT SALES.
Bear Market
A long period of declining security prices.
Widespread expectations of a fall in corporate profits or a slowdown in
general economic activity can bring about a bear market.
Beta
(b) A measure of the volatility of a stock in relation to the market. More
specifically, it is the index of SYSTEMATIC RISK, indicating the sensitivity of
return on a security or a PORTFOLIO to return from the market.
 It is the slope of the regression line, known as the CHARACTERISTIC LINE,
which shows the relationship of an ASSET with the market. For measuring
market returns, a proxy such as a broad-based index is used.
Thus, if b exceeds 1, the security is more volatile than the market, and is
termed an Aggressive Security.
For example, a beta of 1.3 implies that a securitys return will increase by 13
percent when the return from the market goes up by 10 percent. An asset
whose beta is less than 1 is termed a defensive security.
Based on this, an aggressive growth strategy would be to invest in high beta
stocks when the market is poised for an upswing; similarly, a switchover to
low beta stocks is recommended when a downswing is imminent.
Bills of Exchange
A credit instrument that originates from the creditor (drawer) on which the
DEBTOR (drawee) acknowledges his LIABILITY; after such acceptance, the
drawer may get the bill discounted, so as to realize the proceeds immediately.
Blue Chip
A share of a company that is financially very sound, with an impressive track
record of earnings and DIVIDENDS, and which is highly regarded for its
competent management, quality products and/or services.
Examples in India are Hindustan Lever, Gujarat Ambuja Cements, and Reckitt
& Colman among others.

Bond
A long-term debt instrument on which the issuer pays interest periodically,
known as Coupon.
Bonds are secured by COLLATERAL in the form of immovable property.
While generally, bonds have a definite MATURITY, Perpetual Bonds are
securities without any maturity.
In the U.S., the term DEBENTURES refers to long-term debt instruments which
are not secured by specific collateral, so as to distinguish them from bonds.
Book Value
It is the amount of NET ASSETS that would be available per EUQUITY SHARE,
after a company pays off all LIABILITES including PREFERENCE SHARES from
the sale proceeds of all its ASSETS liquidated at BALANCE SHEET values.
Budget
A financial plan that projects receipts and payments of an entity covering a
specific period of time, usually one year.
Its primary purpose is to achieve financial control. Budgets could be
distinguished on the basis of time span, function and flexibility.
For instance, budgets may be short-term or long-term; similarly, there are
Sales Budgets, Cash Budgets, Capital Expenditure Budgets and other to cover
different functions.
Bull
A person who expects share prices in general to move up and who is likely to
take a long position in the stock
Call Money
A term used for funds borrowed and lent mainly by banks for overnight use.
This is a market, which banks access in order to meet their reserve
requirements or to cover a sudden shortfall in funds and the interest rate is
determined by supply and demand conditions.
Capital Adequacy Ratio
A requirement imposed on banks to have a certain amount of capital in
relation to their ASSETS, i.e., loans and investments as a cushion against
probable losses in investments and loans.
In simple terms, this means that for every Rs.100 of risk-weighted assets, a
bank must have Rs. X in the form of capital.
Capital is classified into Tier I or Tier II.
Tier I comprises share capital and disclosed reserves, whereas Tier II includes
revaluation reserves, hybrid capital and subordinated debt.
Further, Tier II capital should not exceed Tier I capital
Capital Reserves
The reserves created in certain ways, that include the sale of FIXED ASSETS
at a profit.
These amounts are regarded as not available for distribution as DIVIDENDS
Cash Reserve Ratio (CRR)
A legal obligation on all SCHEDULED COMMERCIAL banks excluding REGIONAL
RURAL BANKS to maintain certain reserves in the form of cash with the
Reserve Bank of India (RBI).
The reserves, to be maintained over a fortnight, are computed as a
percentage of a banks net demand and time LIABILITIES.
Banks earn interest on eligible cash balances thus maintained and it
contributes to their profitability.
Central Bank
The premier bank in a country that discharges the responsibilities of issuing
currency, managing MONEY SUPPLY by appropriate measures in order to
maintain price stability and economic growth, maintaining the exchange
value of the domestic currency, superintendence and regulation of the
commercial banks, etc. In India, the Reserve Bank of India (RBI) is the Central
Bank.
Commercial Paper
A short-term, unsecured PROMISSORY NOTE issued by BLUE CHIP companies.
Like other MONEY MARKET instruments, it is issued at a DISCOUNT on the
FACE VALUE and is freely marketable.
Commercial Paper may be issued to any person including individuals, banks
and companies.
Commodity Futures
A standardized contract guaranteeing delivery of a certain quantity of a
commodity (such as wheat, soybeans, sugar or copper) on a specified future
date, at a price agreed to, at the time of the transaction.
These contracts are standardized in terms of quantity, quality and delivery
months for different commodities.

Corporate Governance
The manner in which a company is managed. The term, Corporate
Governance connotes the importance of responsibility and accountability of a
companys management to its shareholders and other stakeholders, viz.,
employees, suppliers, customers and the local community.
Hence it calls for ethics, morals and good practices in running a company.
Credit Rating
The exercise of assessing the credit record, integrity and capability of a
prospective borrower to meet debt obligations.
Credit rating relates to companies, individuals and even countries.
The rating agencies in India are Credit Rating and Information Services of
India Limited (CRISIL), ICRA, and Credit Analysis and Research (CARE).
Cross Currency Option
An instrument that confers a contractual right on the purchaser of the OPTION
to buy (call) or sell (put) a currency against another currency, e.g., Yen for
U.S. dollar.
For this privilege, the purchaser pays a cost termed PREMIUM.
Debenture
A debt security issued by companies, having a certain MATURITY and bearing
a stated COUPON RATE.
Debentures may be unsecured or secured by ASSETS such as land and
building of the issuing company.
Debenture holders have a prior claim on the earnings (coupon) and ASSETS in
the event of liquidation
Debt-Equity Ratio
This ratio is used to analyze FINANCIAL LEVERAGE.
It is a structural ratio that gauges the level of debt financing, and is worked
out by dividing total debt, short-term and long-term, by NET WORTH.
The denominator would comprise total equity of common stockholders and
PREFERENCE capital.
Disinvestments
The sale of shareholding by an individual or institution in order to raise cash

Dividend
The payment made by a company to its shareholders.
Legal and financial considerations have a bearing on the level of dividend to
be paid.
Dumping
The sale of goods in a foreign market at a price that is below the price
realized in the home country, after allowing for all costs of transfer including
transportation charges and duties.
The motive may be to enhance revenues, offload surplus stocks or a
predatory intent of killing foreign competition.
Escrow Cash
securities or other valuable instruments that are held by a third party to
ensure that the obligations under a contract are discharged.
The escrow mechanism is a technique of mitigating the risk to lenders and it
is used typically in infrastructure projects such as power, roads or telecom.
For example, an escrow account can be set up at a bank for depositing the
payments of electricity bills.
Financial Institution
A non-banking financial intermediary (company corporation or co-operative
society) carrying on any of the activities specified in the relevant section of
the Reserve Bank of India Act.
These activities include lending, investing in shares and other securities,
HIRE-PURCHASE, insurance and CHIT FUNDS.
In general, this term refers to the Development Finance Institutions such as
IDBI and IFCI, as well as the Unit Trust of India (UTI) and the Life Insurance
Corporation of India (LIC).
However, a more specific classification could be as shown below :

The Money Market is that segment of the financial markets wherein financial
instruments having maturities of less than one year are traded. These
different instruments are listed below :

Instrument
Typical MATURITY (in days)

CALL MONEY and NOTICE MONEY

1 and up to 14

REPOS
14

INTER-BANK TERM MONEY

15 TO 90

BILL OF EXCHANGE
90

TREASURE BILL
91 AND 364

INTER-BANK PARTICIPATION

CERTIFICATE
91 TO 180

CERTIFICATE OF DEPOSIT
90 TO 364

COMMERCIAL PAPER
30 TO 364

INTERCORPORATE DEPOSIT
90

The money market is useful to any entity, whether a government, bank,

business or wealthy individuals having a temporary surplus or DEFICIT. Hence,
it may be viewed as a forum for adjusting their short-term LIQUIDITY
positions.
The Capital Market
The Capital Market is that segment of the financial markets in which securities
having maturities exceeding one year are traded.
Examples include DEBENTURES, PREFERENCE shares and EQUITY SHARES.
Fiscal Policy
The use of tax and expenditure powers by a government. Government all over
the world, are vested with the task of creating infrastructure (e.g., roads,
ports, power plants, etc.) and are also required to ensure internal and external
security.
These responsibilities entail government expenditures on various fronts
capital outlays, the defense forces, police, the administrative services and
others.
Taxes are a major source of revenue to meet these outflows. Thus, the Union
Government collects income tax, EXCISE DUTY, customs duty, etc., through
its different arms.
Forward Contract
A transaction which binds a seller to deliver at a future date and the buyer to
correspondingly accept a certain quantity of a specified commodity at the
price agreed upon, which is known as the Forward Rate.
A forward contract is distinct from a futures contract because the terms of the
former can be tailored to ones needs whereas, the latter ias standardized in
terms of quantity, quality and delivery month for different commodities.
In other words, forward contracts are customized contracts that enable the
parties to choose delivery dates and trading units to suit their requirements.

Futures Market
A market in which contracts for future delivery of certain commodities or
securities are traded.
GDR
An acronym for Global Depository Receipt.
It is an instrument denominated in foreign currency that enables foreign
investors to trade in securities of alien companies not listed at their
exchanges.
Gilt-edged
Securities A term often used to refer to GOVERNMENT SECURITIES signifying
that the securities have the highest degree of reliability.
They are, however, vulnerable to INTEREST RATE RISK and INFLATION RISK.
Gross Domestic Product (GDP)
This is a comprehensive measure of the economic activity that takes place in
a country during a certain period.
It is the total value of final goods and services produced in an economy in a
year.
The computation is on the basis of value added the contribution of a
producing enterprise is the difference between the value of its finished
product and the cost of materials used.
Hence, national output is the total value added by all producing enterprises.
More specifically, gross domestic product is expressed as
C + I + G + (X M)
Where
C stands for consumption, which is the expenditure by consumers on
consumption goods and services.
I is Gross private Domestic Investment representing the acquisition of new
capital goods (e.g., plant and machinery) and inventory additions by business
enterprises, as well as construction of factories, houses, etc.
G denotes government expenditure on goods and services.
(X-M) represents the difference between exports (S) and imports (M) of goods
and services.
Havala Transaction
An Indian term which refers to a mode of transfering of funds out of India or
into the country, bypassing official and legal channels.

Hedging
The action of combining two or more transactions so as to achieve a risk-
reducing position.
The objective, generally, is to protect a profit or minimize a loss that may
result on a transaction.
Hot Money
This refers to large amount of short-term funds held internationally by banks,
institutions and wealthy individuals which quickly move out of or into a
country, usually, in anticipation of exchange rate movements or interest rate
changes.
Hot Money is, therefore, an unstable source of funds.
ICRA
An acronym for the credit rating institution. Investment Information and Credit
Rating Agency of India Limited, which has subsequently been rechristened as
ICRA Limited.
The agency has been promoted by various financial institutions including
Industrial Finance Corporation of India, State Bank of India and Unit Trust of
India.
The role of this agency like Credit Rating and Information Services of India
Limited (CRISIL), is to assist investors in assessing the credit risk of various
securities such as BONDS and COMMERCIAL PAPER, by assigning letter
ratings.
In-the-Money
An expression used to indicate that an OPTION has an immediate tangible
value because of the difference between the current market price of the share
and its exercise price. For example, if a companys share is trading at Rs.110
while its call has an exercise price of Rs.100, the option is said to be in the
money.
Junk Bonds
The debt securities of companies bearing a considerable degree of risk that is
reflected in their mediocre or poor CREDIT RATINGS.
Alternatively referred to as Low-grade or High-risk BONDS.
Letter of Credit
A financial instrument issued by a bank on behalf of a purchaser of goods,
undertaking responsibility to pay a certain amount during a specified period,
for goods delivered.
LIBOR
An abbreviation for London Inter Bank Offer Rate, which is an average of the
interest rates at which leading international banks are prepared to offer term
EURODOLLAR DEPOSITS to each other.
The interest rate differs according to the deposit MATURITY and the
soundness of borrowing banks.
Libor is also used as a reference rate in quoting interest rates on various
other loans.
Lock-box
A facility used in the U.S. and elsewhere for speeding up collections.
A bank collects and arranges for clearance of cheques that are sent by
customers to a designated post office box.
The advantage of this cash management system is that it eliminates the
clerical functions prior to the deposit of the cheques. The company is thereby
able to reduce FLOAT and realize sale proceeds faster.
M1
A measure of the stock of money in India, which is also referred to as Narrow
Money.
M1 is calculated by adding the net demand deposits of banks and Other
deposits with the Reserve Bank of India (RBI) to the sum of currency notes
and coins held by the public.
Net demand deposits comprise current account deposits and a portion of the
savings deposits considered as a demand LIABILTY, all held by the public;
Other deposits with RBI refers to funds held by certain institutions like the
Industrial Development Bank of India and International Monetary Fund,
foreign governments and CENTRAL BANKS, (See also REDDY COMMITTEE.)
M2
The sum of M1 and post office savings bank deposits.
M3
A measure of the stock of money in the nation with reference to which
monetary targets are set by the Reserve Bank of India.
It is the sum of M1 and the net TIME DEPOSITS (together with the portion of
savings deposits no included in M1) with banks.
It is also called Broad Money.
M3 is a function of RESERVE MONEY. (See also CHAKRAVARTY COMMITTEE)

M4
The sum of M3 and total post office deposits.
MIBOR
An acronym for the Mumbai Inter Bank Offer Rate, which is the weighted
average interest rate of the rates at which certain banks/ institutions in
Mumbai belonging to a representative panel are prepared to lend CALL
MONEY.
Non-Banking Financial Company (NBFC)
A financial intermediary that is engaged in certain financing activities other
than banking.
These activities are specified in the Non-Banking Financial Companies
(Reserve Bank) Directions, 1977 and amendments thereto.
They include equipment leasing, HIRE-PURCHASE, housing finance and
investments in financial securities
Open-Market Operations (OMO)
The purchase or sale of securities, by the CENTRAL BANK of a country to
expand or contract the reserves with the banking system.
Open Market Opertions serve as an instrument of PUBLIC DEBT management
and also of monetary control, besides the CASH RESERVE RATIO and
STATUTORY LIQUIDITY RATIO.
Through OMO, the Reserve Bank of India (RBI) is able to absorb liquidity from,
or inject the same into, the banking system.
Since it is envisaged that OMO will become the dominant tool of monetary
control in India, the government and RBI have initiated a series of measures
to deepen and widen the market for GOVERNMENT SECURITIES.
These actions, which will enhance the effectiveness of OMO, are as follows :
A shift to market rates of interest on Government Securities.
The promotion of new institutions viz., DISCOUNT AND FINANCE HOUSE OF
INDIA and SECURITIES TRADING CORPORATION OF INDIA.
The appointment of PRIMARY DEALERS to intensify the participation of
intermediaries.
The introduction of the
Delivery versus Payment system.
Promotion of the MARKING-TO-MARKET basis for the valuation of APPROVED
SECURITIES held by banks.
Permitting banks to trade in Government Securities, in order to promote the
retail market segment.
Opportunity Cost
The value or benefit from an alternative proposal, e.g., investment decision,
that is foregone in favour of another.
Primary Market
The segment of FINANCIAL MARKETS in which securities are originated.
Thus, the transactions for fresh offerings fo EUQUITY SHARES, DEBENTURES,
PREFERNENCE SHARES, and other securities are collectively referred to as the
primary market.
Prime Lending Rate (PLR)
The rate of interest charged by banks on WORKING CAPITAL and short term
loans to their most credit-worthy borrowers.
The prime rate serves as a benchmark for deciding on the interest rate to be
charged to other borrowers.
Accordingly, major banks and also FINANCIAL INSTITUTIONS in India
periodically announce their PLRs depending on their cost of funds and
competitive lending rates.
From October 1997, the Reserve Bank of India has decided to permit banks to
announce separate Prime Term Lending Rates on term loans of three years
and beyond.
More recently, banks have been given the freedom to have different PLRs for
different maturities.
Public Debt
The debt obligations of the Government of India comprising external debt,
i.e., loans from foreign countries, international FINANCIAL INSTITUTIONS, etc.
and internal debt that includes market loans, TREASURY BILLS, special bearer
BONDS and special loans and securities outstanding.
A very large portion of the internal debt obligations is held by the Reserve
Bank of India.
In a broader sense, public debt includes the debt of Central, State and Local
governments and also Government-owned entities.
Refinance
The system of borrowing by a bank or other financial intermediary from an
apex institution or the CENTRAL BANK of a country, on the strength of its
loans or financial ASSETS.
Thus, for instance, IDBI and NABARD provide refinance to a host of banks and
institutions vis--vis the loans made by the latter to ultimate borrowers.

Secondary Market
The segment of FINANCIAL MARKETS in which securities that have already
been issued are traded.
Thus the secondary market comprises security exchanges and also
transactions taking place elsewhere
Seed Capital
The financial assistance towards a promoters equity contribution.
Seed Capital, alternatively called Equity Support, is to enable promising
entrepreneurs with inadequate capital to set up their enterprises.
The assistance is usually in the form of a loan at very generous terms
Sensitive Index
A statistical measure of the prices of 30 selected stocks traded on the
Bombay Stocks traded on the Bombay Stock Exchange.
Service Tax
A levy on the value of taxable services provided to any person.
Based on the recommendations of the CHELLIAH COMMITTEE on tax reforms,
a beginning was made with the Union Budget for 1994-95 to impose a 5
percent service tax on stock-brokerage, general insurance and telephone
connection.
Its administration is the responsibility of the Central Excise Department
Statutory Liquidity Ratio (SLR)
The portion of net demand and time LIABILITIES that SCHEDULED commercial
banks (excluding REGIONAL RURAL BANKS) must invest in specified financial
ASSETS such as TREASURY BILLS and GOVERNMENT SECURITIES.
The SLR indirectly serves as an instrument of credit control, by reducing the
monetization of the DEFICIT that would have taken place if funds from the
banking system were not statutorily pre-empted by the government sector.
Sweat Equity
Equity shares allotted to certain employees of company either on discount or
for consideration other than cash, as a reward for providing know-how or
sharing intellectual rights or some other value addition to the company.

Treasury Bill (T-Bill)

A short-term debt instrument of the Government of India.
This security bears no DEFAULT RISK and has a high degree of LIQUIDITY and
low INTEREST RATE RISK in view of its short term.
The instrument is negotiable and is issued at a discount from the FACE VALUE.
At MATURITY, the investor receives the face value and hence the increment
constitutes the interest earned.
Two types of T-Bills were issued in India, by the Reserve Bank of India (RBI),
on behalf of the government :
Ad-hoc T-Bills (or Ad-hocs) of 91 days maturity (which were non-marketable)
to the RBI to replenish the Central Governments cash balance.
Ordinary T-Bills on tap that are taken up mainly by banks, for short-term
investment or to comply with statutory requirements.
Zero-base Budgeting
A rigorous method of drawing up BUDGETS in which the premise is that
expenditures will be zero, and so allocations are made thereafter, only upon a
justification of the true requirements. Thus, this method does not consider the
previous years allocation, but instead, imposes an onerous burden of
justifying any expenditure whose approval is sought.
In the process, it forces administrators or managers to critically appraise
ongoing programmes and activities; this review could lead to considerable
economy in inessential expenditure.
Zero-coupon Bond
A BOND that bears a zero COUPON RATE and hence is issued at a price
substantially below its FACE VALUE
At MATURITY, an investor receives the face value.
So, the return consists of the DISCOUNT, i.e., the excess of face value over
the issue price.
Thus, zero-coupon bonds are a sub-set of the group of DEEP DISCOUNT
BONDS.
The advantage with this security to an investor is that, he does not have to
worry about reinvestment, since there are no periodic inflows.
Similarly, a company need not bother about meeting interest obligations at
regular intervals, and yet would obtain tax deduction.
Basis Point
One hundredth of 1%.
A measure normally used in the statement of interest rate e.g., a change from
5.75% to 5.81% is a change of 6 basis points.
Blue Chips
Blue chips are unsurpassed in quality and have a long and stable record of
earnings and dividends.
They are issued by large and well-established firms that have impeccable
financial credentials.
Capital Gain
The amount by which the proceeds from the sale of a capital asset exceed its
original purchase price.

Certificate of Deposits (CDs)

Savings instrument in which funds must remain on deposit for a specified
period, and premature withdrawals incur interest penalties.
Face Value/ Nominal Value
The value of a financial instrument as stated on the instrument.
Interest is calculated on face/nominal value.
Privatization
The sale of government-owned equity in nationalized industry or other
commercial enterprises to private investors.
Capital Funds
Equity contribution of owners.
The basic approach of capital adequacy framework is that a bank should have
sufficient capital to provide a stable resource to absorb any losses arising
from the risks in its business.
Capital is divided into different tiers according to the characteristics / qualities
of each qualifying instrument.
For supervisory purposes capital is split into two categories: Tier I and Tier II.
Tier I Capital
A term used to refer to one of the components of regulatory capital.
It consists mainly of share capital and disclosed reserves (minus goodwill, if
any).
Tier I items are deemed to be of the highest quality because they are fully
available to cover losses Hence it is also termed as core capital.
Tier II Capital
Refers to one of the components of regulatory capital.
Also known as supplementary capital, it consists of certain reserves and
certain types of subordinated debt.
Tier II items qualify as regulatory capital to the extent that they can be used
to absorb losses arising from a bank's activities.
Tier II's capital loss absorption capacity is lower than that of Tier I capital.

Leverage
Ratio of assets to capital
Capital reserves
That portion of a company's profits not paid out as dividends to shareholders.
They are also known as undistributable reserves and are ploughed back into
the business.
BASEL Committee on Banking Supervision
The BASEL Committee is a committee of bank supervisors consisting of
members from each of the G10 countries.
The Committee is a forum for discussion on the handling of specific
supervisory problems.
It coordinates the sharing of supervisory responsibilities among national
authorities in respect of banks' foreign establishments with the aim of
ensuring effective supervision of banks' activities worldwide.
BASEL Capital accord
The BASEL Capital Accord is an Agreement concluded among country
representatives in 1988 to develop standardised risk-based capital
requirements for banks across countries.
The Accord was replaced with a new capital adequacy framework (BASEL II),
published in June 2004.
BASEL II is based on three mutually reinforcing pillars hat allow banks and
supervisors to evaluate properly the various risks that banks face.
These three pillars are:
Minimum capital requirements, which seek to refine the present
measurement framework
 supervisory review of an institution's capital adequacy and internal
assessment process;
market discipline through effective disclosure to encourage safe and sound
banking practices
CRAR(Capital to Risk Weighted Assets Ratio)
Capital to risk weighted assets ratio is arrived at by dividing the capital of the
bank with aggregated risk weighted assets for credit risk, market risk and
operational risk.
The higher the CRAR of a bank the better capitalized it is.
Credit Risk
The risk that a party to a contractual agreement or transaction will be unable
to meet its obligations or will default on commitments.
Credit risk can be associated with almost any financial transaction.
BASEL-II provides two options for measurement of capital charge for credit
risk
1.standardised approach (SA) - Under the SA, the banks use a risk-weighting
schedule for measuring the credit risk of its assets by assigning risk weights
based on the rating assigned by the external credit rating agencies.

2. Internal rating based approach (IRB) - The IRB approach, on the other hand,
allows banks to use their own internal ratings of counterparties and
exposures, which permit a finer differentiation of risk for various exposures
and hence delivers capital requirements that are better aligned to the degree
of risks. The IRB approaches are of two types:
a) Foundation IRB (FIRB): The bank estimates the Probability of Default (PD)
associated with each borrower, and the supervisor supplies other inputs such
as Loss Given Default (LGD) and Exposure At Default (EAD).
b) Advanced IRB (AIRB): In addition to Probability of Default (PD), the bank
estimates other inputs such as EAD and LGD.
The requirements for this approach are more exacting.
The adoption of advanced approaches would require the banks to meet
minimum requirements relating to internal ratings at the outset and on an
ongoing basis such as those relating to the design of the rating system,
operations, controls, corporate governance, and estimation and validation of
credit risk components, viz., PD for both FIRB and AIRB and LGD and EAD for
AIRB.
The banks should have, at the minimum, PD data for five years and LGD and
EAD data for seven years.
In India, banks have been advised to compute capital requirements for credit
risk adopting the SA.
Market risk
Market risk is defined as the risk of loss arising from movements in market
prices or rates away from the rates or prices set out in a transaction or
agreement.
The capital charge for market risk was introduced by the BASEL Committee on
Banking Supervision through the Market Risk Amendment of January 1996 to
the capital accord of 1988 (BASEL I Framework).
There are two methodologies available to estimate the capital requirement to
cover market risks:
The Standardised Measurement Method: This method, currently implemented
by the Reserve Bank, adopts a building block approach for interest-rate
related and equity instruments which differentiate capital requirements for
specific risk from those of general market risk.
The specific risk charge is designed to protect against an adverse movement
in the price of an individual security due to factors related to the individual
issuer.
The general market risk charge is designed to protect against the interest
rate risk in the portfolio.
2) The Internal Models Approach (IMA): This method enables banks to use
their proprietary in-house method which must meet the qualitative and
quantitative criteria set out by the BCBS and is subject to the explicit approval
of the supervisory authority.
Operational Risk
The revised BASEL II framework offers the following three approaches for
estimating capital charges for operational risk:
1) The Basic Indicator Approach (BIA): This approach sets a charge for
operational risk as a fixed percentage ("alpha factor") of a single indicator,
which serves as a proxy for the banks risk exposure.
2) The Standardised Approach (SA): This approach requires that the institution
separate its operations into eight standard business lines, and the capital
charge for each business line is calculated by multiplying gross income of that
business line by a factor (denoted beta) assigned to that business line.
3) Advanced Measurement Approach (AMA): Under this approach, the
regulatory capital requirement will equal the risk measure generated by the
banks internal operational risk measurement system.
In India, the banks have been advised to adopt the BIA to estimate the
capital charge for operational risk and 15% of average gross income of last
three years is taken for calculating capital charge for operational risk.

Internal Capital Adequacy Assessment Process (ICAAP)

In terms of the guidelines on BASEL II, the banks are required to have a
board-approved policy on internal capital adequacy assessment process
(ICAAP) to assess the capital requirement as per ICAAP at the solo as well as
consolidated level.
The ICAAP is required to form an integral part of the management and
decision-making culture of a bank. ICAAP document is required to clearly
demarcate the quantifiable and qualitatively assessed risks

The ICAAP is also required to include stress tests and scenario analyses, to be
conducted periodically, particularly in respect of the banks material risk
exposures, in order to evaluate the potential vulnerability of the bank to some
unlikely but plausible events or movements in the market conditions that
could have an adverse impact on the banks capital.
Supervisory Review Process (SRP)
Supervisory review process envisages the establishment of suitable risk
management systems in banks and their review by the supervisory authority.
The objective of the SRP is to ensure that the banks have adequate capital to
support all the risks in their business as also to encourage them to develop
and use better risk management techniques for monitoring and managing
their risks.
Market Discipline
Market Discipline seeks to achieve increased transparency through expanded
disclosure requirements for banks.
Derivative
A derivative instrument derives its value from an underlying product. There
are basically three derivatives
a) Forward Contract- A forward contract is an agreement between two parties
to buy or sell an agreed amount of a commodity or financial instrument at an
agreed price, for delivery on an agreed future date.
Future Contract- Is a standardized exchange tradable forward contract
executed at an exchange.
In contrast to a futures contract, a forward contract is not transferable or
exchange tradable, its terms are not standardized and no margin is
exchanged.
The buyer of the forward contract is said to be long on the contract and the
seller is said to be short on the contract.
b) Options- An option is a contract which grants the buyer the right, but not
the obligation, to buy (call option) or sell (put option) an asset, commodity,
currency or financial instrument at an agreed rate (exercise price) on or
before an agreed date (expiry or settlement date).
The buyer pays the seller an amount called the premium in exchange for this
right.
This premium is the price of the option.
c) Swaps- Is an agreement to exchange future cash flow at pre-specified
Intervals.
Typically one cash flow is based on a variable price and other on affixed one.
Non Performing Assets (NPA)
An asset, including a leased asset, becomes non performing when it ceases to
generate income for the bank.
Net NPA
Gross NPA (Balance in Interest Suspense account + DICGC/ECGC claims
received and held pending adjustment + Part payment received and kept in
suspense account + Total provisions held)
Doubtful Asset
An asset would be classified as doubtful if it has remained in the substandard
category for a period of 12 months. A loan classified as doubtful has all the
weaknesses inherent in assets that were classified as substandard, with the
added characteristic that the weaknesses make collection or liquidation in
full, - on the basis of currently known facts, conditions and values - highly
questionable and improbable.
Liquid Assets
Liquid assets consists of: cash, balances with RBI, balances in current
accounts with banks, money at call and short notice, inter-bank placements
due within 30 days and securities under held for trading and available for
sale categories excluding securities that do not have ready market.
Banking Book
The banking book comprises assests and liabilities, which are contracted
basically on account of relationship or for steady income and statutory
obligations and are generally held till maturity.
Venture Capital Fund
A fund set up for the purpose of investing in startup businesses that is
perceived to have excellent growth prospects but does not have access to
capital markets.

Stress testing
Stress testing is used to evaluate a banks potential vulnerability to certain
unlikely but plausible events or movements in financial variables.
The vulnerability is usually measured with reference to the banks profitability
and /or capital adequacy.
Basis Point
Is one hundredth of one percent.
1 basis point means 0.01%. Used for measuring change in interest rate/yield.
Special Purpose Vehicle (SPV)
An entity which may be a trust, company or other entity constituted or
established by a Deed or Agreement for a specific purpose.
Banking Ombudsman
Scheme enables an expeditious and inexpensive forum to bank customers for
resolution of complaints relating to certain services rendered by banks.
The Banking Ombudsman Scheme is introduced under Section 35 A of the
Banking Regulation Act, 1949 by RBI with effect from 1995.
The Banking Ombudsman is a senior official appointed by the Reserve Bank of
India to redress customer complaints against deficiency in certain banking
services.
All Scheduled Commercial Banks, Regional Rural Banks and Scheduled
Primary Co-operative Banks are covered under the Scheme
Repo transaction
The term Repo has been derived from the word repurchase which literally
means selling today and buying back at a later date.
To be specific, in money market terms, it means a repo trader sells securities,
gets funds for a certain specified time, and after this time period, purchases
back the securities by paying the previously taken (read borrowed) funds
along with some interest for the said period.
The securities in question basically act as an insurance against borrowers
default. A forex money market also repo works on similar terms.
Repo rate
In the above transaction, if the lender of the funds is RBI, it I termed as a repo
transaction with RBI. Following may be noted-
Whenever the banks have any shortage of funds they can borrow it from RBI.
Repo rate is the rate at which banks borrow rupees from Reserve Bank of
India (RBI).
A reduction in the Repo rate will help banks to get money at a cheaper rate.
When the Repo rate increases borrowing from RBI becomes more expensive.
The rate charged by RBI for its Repo operations is 5.25%.
When RBI lends money to bankers against approved securities for meeting
their day to day requirements or to fill short term gap, it takes approved
securities as security and lends money.
These types of operations are generally for overnight operations.
Repo rate is the medium through which RBI infuses funds in the system.
Recently, in view of the decreased (read tightening) liquidity conditions, RBI
has allowed a second Repo facility which means that RBI is giving banks to
borrow money from RBI and thus RBI is looking to infuse more money into the
system
A banks money market trader typically can use RBIs LAF and money market
for arbitrage opportunities sometimes
Reverse repo rate
If the borrower of the funds is RBI, it is termed as reverse repo transaction.
Reverse Repo rate is the rate at which RBI absorbs money from the system.
Banks are always happy to lend money to RBI since their money is in safe
hands with a good interest.
An increase in Reverse Repo rate can cause the banks to transfer more funds
to RBI due to attractive interest rates.
It can cause the money to be drawn out of the banking system.
The rate charged by RBI for its Reverse Repo operations is 3.25%.