1

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 ABOUT ME
ü Mentoring, guiding and teaching
UPSC students since 8 years

ü Polity, Indian Economy, Essay,

Internal Security & Post
Independence India
ü Teaching Political Science Optional

GS by Kapil Sikka (https://t.me/kapillive)

@kapilsikkaa
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• Comprehensive
Coverage

• Must for UPSC/SSC/

Banking Exams

• Doubts Clearing

• PDFs
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 Chapter -12

BANKING IN INDIA

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 Bank Rate
• Bank rate is the rate charged by the central bank for lending
funds to commercial banks
• In this case, there is no repurchasing agreement signed, no
securities sold or collateral involved.
• Banks borrow funds from the central bank and lends the
money to their customers at a higher interest rate, thus,
making profits.
• Bank Rate is usually higher than Repo Rate as it is an
important tool to control liquidity.
• Used for Long term lending
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• Government of India, state governments, banks, financial
institutions, co-operative banks, NBFCs, borrow through
this route

• The rate has been realigned with the MSF (Marginal

Standing Facility) by the RBI in February 2012.

• Interest rate is 1 per cent higher than the current repo rate.

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 Liquidity Adjustment Facility
• Monetary policy operating framework of the RBI since 2000.
• To meet the Funds mismatch of Day to Day basis
• LAF has two components -- repo (repurchase agreement) and
reverse repo.
• When banks need liquidity to meet its daily requirement, they
borrow from RBI through repo.
• The rate at which they borrow fund is called the repo rate.
• When banks are flush with fund, they park with RBI through the
reverse repo mechanism at reverse repo rate.
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 LAF

Reverse.
REPO
REPO
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WHAT IS REPO RATE

FUNDS

SECURITIES & COLLATERALS

10
WHAT IS REVERSE REPO RATE

SECURITIES & COLLATERALS

FUNDS

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• Repurchase Options or Repo, is a money market instrument, which
enables collateralised short term borrowing and lending through
sale/purchase operations in debt instruments.

• Bank A is taking a loan of Rs.100 Crores from RBI for 1 day and
putting Government Bonds of same value as security with a promise
that they will buy these government securities back after 1 day.

• After one day, Bank A return (Rs.100 Crores + interest amount) to RBI
and get back his securities.

• Repo is thus, a money market instrument combining elements of two

different types of transactions viz., lending-borrowing and sale-
purchase.

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• The interest rate at which the RBI borrows money from banks for
the short term is defined as Reverse Repo Rate.

• The Reverse Repo Rate helps the RBI get money from the banks
in times of need. In return, the RBI offers attractive interest rates
to them.

• The banks also voluntarily park excess funds with the central bank
as it provides them with an opportunity to earn higher interest on
surplus money lying idle.

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 Reverse
Repo
Repo

High Rate

Low Rate Regulates

Liquidity

Sucks Liquidity Regulates

Inflation

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Increase in Decrease in
Repo Repo

Less More
Borrowing Borrowing

Reduces Increase
Money Money
Supply Supply

Reduces Increases
Inflation Inflation

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 Urijit Patel Committee Recommendations

• Term Repo & Term Reverse repo

• A term repo is a repo of more than one-day

duration.

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• A term repo is a repo of more than one-day duration.

• The word term denotes longer period (7, 14, 28).

• Interest rate is determined through the auction (above repo)

• the loan seeking bank should submit securities to the RBI.

• Since the loan is for more duration, the bank should give
higher interest than the repo rate.

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 Long Term Repo
• Since 2020
• RBI provides longer term (one- to three-year) loans to banks at
the prevailing repo rate.

• As banks get long-term funds at lower rates, their cost of funds

falls. In turn, they reduce interest rates for borrowers.

• LTRO helped RBI ensure that banks reduce their marginal cost
of funds-based lending rate, without reducing policy rates.
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 Marginal Standing Facility
• Under the MSF window, banks can borrow overnight by dipping up to 2%
into the statutory liquidity ratio (SLR).

• The MSF would be the last resort for banks once they exhaust all borrowing
options including the liquidity adjustment facility by pledging government
securities, where the rates are lower in comparison with the MSF.

• The MSF would be a penal rate for banks and the banks can borrow funds
by pledging government securities within the limits of the statutory liquidity
ratio.
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 Other Tools
• Call Money Market: Important segment of the money market
where borrowing and lending of funds take place on short
term usually over night basis.

• Scheduled commercial banks (SCBs) regional rural banks,

excluding cooperative banks (other than land development
banks), insurance are borrowers in this market
• Banks are allowed to borrow based upon NDTL

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21
22
Call Money
Market?

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Call money market (CMM) the market where
overnight (one day) loans can be availed by
banks to meet liquidity

It is market oriented mechanism to meet the

liquidity requirements of banks

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 Notice Money Market

In case bank needs funds for more days, it can avail money
through notice market.

Here, the loan is provided from two days to fourteen days.

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 Open Market Operations (OMOs)
• Open Market Operations (OMOs) are market operations conducted by
RBI by way of sale/purchase of government securities to/from the
market with an objective to adjust the rupee liquidity conditions in
the market on a durable basis.
• If there is excess liquidity, RBI resorts to sale of securities and sucks
out the rupee liquidity.
• Similarly, when the liquidity conditions are tight, RBI buys securities
from the market, thereby releasing liquidity into the market.
• It is one of the quantitative (to regulate or control the total volume
of money) monetary policy tools which is employed by the central
bank of a country to control the money supply in the economy. 26
Source: HSBC Global

What is Bond

• Borrowing
instrument

• Can be
issued by
Government
or Corporate

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 Why Operation Twist

• Whenever there is a long-term investment deficit in the country

and the investors are hesitant to make long-term investments
in the economy,

• The government jumps in to revive growth by lowering the

interest rate for long-term investment ventures.
 Operation Twist
• Operation Twist' is RBI's simultaneous selling of short-term
securities and buying of long term securities through open market
operations (OMO).
• Under this mechanism, the short-term securities are transitioned
into long-term securities
• Buying and selling government securities brings down long-term
interest rates and bolster short-term rates.
• There is an inverse relationship between the bond prices and their
yields.
• As the central bank buys long-term securities (bonds), their demand
rise which in turn pushes up their prices.
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 Operation Twist

• However, the bond yield comes down with an increase in

prices.
• Yield is the return an investor gets on his (bond)
holding/investment.
• The interest rate in an economy is determined by yield.
• Thus, lower long-term interest rates mean people can avail
long-term loans (such as buying houses, cars or financing
projects) at lower rates.
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 Price Yield Relation
• A bond’s interest rate, or coupon, determines the amount of
income earned annually from holding the bond.

• A bond’s current yield reflects that income as a percentage of

the bond’s price.

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 Yield Inverted Curve
• In a normal yield curve, the short-term bills yield less than the
long-term bonds.

• When a yield curve inverts, it's because investors have little

confidence in the near-term economy.

• They demand more yield for a short-term investment than for a

long-term one.

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Market Stabilisation Scheme (MSS):
• Market Stabilisation Scheme or MSS is a tool used by the Reserve
Bank of India to suck out excess liquidity from the market through
issue of securities like Treasury Bills, Dated Securities etc. on
behalf of the government.

• The money raised under MSS is kept in a separate account called

MSS Account and not parked in the government account or
utilised to fund its expenditures.
• It has features of both SLR and CRR

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 Standing Deposit Facility Scheme (SDFS)
• This concept, first recommended by the Urjit Patel committee
report in 2014

• Standing Deposit Facility allows the RBI to absorb liquidity

(deposit) from commercial banks without giving government
securities in return to the banks (alternative to R-Repo)

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 Benchmark Prime Lending Rate
• The Benchmark Prime Lending Rate was introduced by the Reserve
Bank of India in the year 2003 with the aim of introducing
transparency and ensuring appropriate pricing of loans, wherein the
lending rates truly reflect the actual costs.
• It was envisaged as a reference rate and was to be computed taking
into consideration
(i) cost of funds;
(ii) operational expenses; and
(iii) a minimum margin to cover regulatory requirements of
provisioning and capital charge, and profit margin.

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 BPLR
• Banks had authority to lend below BPLR

• Hence, Bank Rate was introduced in 2010

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 BASE RATE
• Base rate is the minimum rate set by the Reserve Bank of India
below which banks are not allowed to lend to its customers.
• Floor rate of interest
• Base rate is decided in order to enhance transparency in the credit
market and ensure that banks pass on the lower cost of fund to their
customers.
• Loan pricing will be done by adding base rate and a suitable spread
depending on the credit risk premium.

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 MCLR
• The marginal cost of funds-based lending rate (MCLR) is the
minimum interest rate that a bank can lend at.
• MCLR is a tenor-linked internal benchmark, which means the rate is
determined internally by the bank depending on the period left for
the repayment of a loan.
• MCLR is closely linked to the actual deposit rates and is calculated
based on four components: the marginal cost of funds, negative
carry on account of cash reserve ratio, operating costs and tenor
premium.
• It replaced the base rate structure, which had been in place since July
2010.
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 Features of MCLR
• tenor linked internal benchmark to be reset on annual basis.
• Actual lending rates will be fixed by adding a spread to the
MCLR.
• To be reviewed every month on a pre-announced date.
• Existing borrowers will have the option to move to it.
• Banks will continue to review and publish ‘Base Rate’ without
fail

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 New Initiatives
• bi-monthly monetary policy cycle
• glide path for disinflation
• term repos for three set of tenors 7, 14 and 28 days.

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 New Floating Rate Regime
• April 2019, External Benchmarks were taken into
consideration
– Repo rate,
– 91-day Treasury Bill yield
– 182-day Treasury Bill yield
– Any other benchmark produced by the FBIL

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 Financial Benchmark India Private Ltd
• Its aim is to develop and administer benchmarks relating to money
market, government securities and foreign exchange in India.
• It is responsible for all the aspects relating to the benchmarks to be
issued by it, namely, collection and submission of market data and
information including polled data, formulation, adoption and periodic
review of benchmark calculation methodologies, calculation, publication
and administration of benchmarks confirming to the highest standards
of integrity, transparency and precision.
• The FBIL is committed to providing financial benchmarks that are
(i) free from bias,
(ii) backed by robust data driven research and
(iii) compliant with global best practices.
 MONETARY TRANSMISSION
• Transmission has been weak on all 3 accounts
• Rate Structure (Average Lending Rate)
• Term structure (Short Term Rate vs Long Term Rate)
• Credit Growth (13.5% – 7.5%)

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 Emergence of Nationalised Banks
• Banking Nationalisation Act, 1969
• 14 banks & 6 banks

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 Regional Rural Banks
• Since 1957
• Credit to Weaker Section
• Mobilise savings in rural areas
• Kelkar Committee -1987- Stopped New RRBs
• Bhandari Committee (1994–95) and the Basu Committee
(1995–96): Concessional Loans abolished
• Now Small Finance Banks

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 CO-OPERATIVE BANKS
• Banks classified under two heads—commercial banks and co-
operative banks.
• Commercial banks are nationalised banks, private sector banks,
foreign banks and RRBs
• They account for a majority share of the banking
• On the other hand co-operative banks plays an important role
in local development
• They provide money support to agriculture and allied activities,
rural-based industries
• Also provide support to urban centres 49
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 A three tier Structure
• Primary Credit Societies-PCSs (agriculture or urban),

• District Central Co-Operative Banks-DCCBs, and

• State Co-Operative Banks-SCBc (at the apex level).

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 Urban co-operative banks
• The term Urban Co-operative Banks (UCBs), though not
formally defined, refers to primary cooperative banks located in
urban and semi-urban areas

• These banks, till 1996, were allowed to lend money only for
non-agricultural purposes

• They are registered and governed under the co-operative

societies acts of the respective states and are covered by the
Banking Regulation Act, 1949

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• At present we have 29 UCBs
• DCCBs & SCBs operate at the district and state levels.

• A district can have only one DCCB reporting to the SCB.

• They were under supervision of the RBI—later on this function

was delegated to the NABARD.

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 Problems of these Banks
• Regulatory issues under dual regulatory control
• UCBs are under the RBI and the Registrar of Co-operative Societies
(RCS) of the respective states while the DCCBs and SCBs come under
the NABARD, the RBI and the RCSs.
• Political intervention at state level
• Cooperative banks are lacks skill and expertise.
• Recruitments are politicised.
• Co-operative banks have been in news always for frauds.
• Government of India decided (in the Union Budget 2017–18) to
bring the co-operative banks into the ambit of the ‘core banking’
structure.
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 Financial Sector Reforms
• In wake of crisis of 1991
• A high level committee on Financial System (CFS) 1991 was
setup
• to examine all aspects relating to structure, organisation,
function and procedures of the financial system

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Narsimhan Committee I (Committee
on Financial Systems)
• Banking sector is the backbone, hence a trusted environment
is the need of the hour
• operational flexibility of Banks;
• Decision Making autonomy for public sector banks
• High degree of professionalism in banking operation.

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 Recommendation of CFS
• The RBI was advised not to use the CRR as a principal
instrument of monetary and credit control, and focus in
Increasingly

• Progressive reduction of CRR 15% to 3 to 5%

• Interest on CRR
 Interest Rates
• Determined by market forces
• No controls on interest rates on deposits and lending
• Subsidies should be phased out;
• Bank rate to be the anchor rate and all other interest rates to
be closely linked to it
• The RBI to be the sole authority to simplify the structure of
interest rates.

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 Priority Sector Lending
1. What are the different categories under priority sector?
Priority Sector includes the following categories:
(i) Agriculture
(ii) Micro, Small and Medium Enterprises
(iii) Export Credit
(iv) Education
(v) Housing
(vi) Social Infrastructure
(vii) Renewable Energy
(viii) Others
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 NPAs and Stressed Assets
• They are the bad loans of the banks.
• Criteria has changed from time to time
• Since 2004 RBI has standardized the process of declaring NPAs
based upon international standards.
• As per the definition a loan is considered NPA if it has not been
serviced for one term (i.e., 90 days).
• This is known as ‘90 day’ overdue norm.
• Agricultural advances whose interest or principal installment
payments remain overdue for two crop/harvest seasons for short
duration crops or overdue one crop season for long duration crops
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 Classification
NPAs were classified into three types:
• Sub-standard NPA: remaining NPAs for less than or equal to 12
months;
• Doubtful NPA: remaining NPAs for more than 12 months; and
• Loss Assets: where the loss has been identified by the bank or
internal/external auditors or the RBI inspection, but the amount
has not been written off.

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66
 Recent Upsurge in NPAs
• Reserve Bank of India's Financial Stability Report, released in January
this year, showed that gross non-performing assets (NPAs) of banks may
rise to 13.5 per cent by September 2021
• Economic Survey 2019-20 says that the Gross NPA ratio of SCBs
remained static @ 9.1 per cent between March and September 2019.
• The PSBs are worst affected by NPA crisis
• These NPAs have hit the general credit expansion
• Insolvency proceedings have helped the banks to recover around ₹1.58
lakh crore by December 2019,
• Hair cuts in the valuation of the assets have been also very high.

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68
 Reasons of NPAs
• Global and Domestic Changes
• Macro-economic Instabilities
• Slowdown in economies
• Red tapism and delay in project approvals resulting into high cost over-
runs. (impacts loan servicing capability of the borrowers )
• Aggressive lending to high corporate leverage.
• High incidences of ‘wilful defaults’.
• Loan frauds.
• Corruption and collusion in the banking institutions.

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 Resolution of the NPAs
• RBI has implemented various schemes for addressing the problems
of NPA

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 5/25 Refinancing:
• Revival of stressed assets in the infrastructure sectors and 8 core
industries.
• Lenders were allowed to extend the tenure of loans to 25 years
with interest rates adjusted every 5 years,
• Helped to improve the credit profile and liquidity position of
borrowers,
• Banks can also maintain clean loan books
• It aimed to reduce the provisioning costs against NPAs.
• Longer amortization might result into ever-greening of loans
• Ultimately the burden got shifted to future
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 ARCs (Asset Reconstruction
• Companies):
ARCs were introduced under the SARFAESI Act (2002),
• Specialized agencies to resolve the burden of NPAs.
• Majority of them are Private organisation
• Hence want loans at cheap prices
• Banks were not interested in such sales
• Since 2014 ARCs were directed to pay higher fee for their
purchases, hence only 5% of NPAs cases were resolved
SDR (Strategic Debt Restructuring):
• Since 2015 RBI, this scheme provide an opportunity to banks to
convert debt of companies
• This applies to those companies whose stressed assets were
restructured but which could not finally fulfil the conditions
attached to such restructuring
• The equity will be converted to 51 per cent equity
• Further they will be sold to the highest bidders—ownership
change takes place in it.
• By end-December 2016, only 2 such sales had materialized,
because of financial viability
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74
AQR (Asset Quality Review):

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 S4A (Scheme for Sustainable
Structuring
• Since June of
2016,Stressed
a restructuring Assets)
agency is hired by Bank
to decide sustainable and unsustainable component of
stressed debt
• The unsustainable component is converted into equity and
preference shares.
• Different from the SDR arrangement
• This process involves no change in the ownership of the
company.
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 PUBLIC SECTOR ASSET
REHABILITATION AGENCY (PARA)
• The Economic Survey 2016-17 called for a need to set up a
government-owned asset reconstruction company, PARA.
• PARA will resolve the twin balance sheet problems
• PARA will deal with TBS cases
• Idea taken from South East Currency Crises of mid-1990s.

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 What is TBS
• The Economic Survey of 2015-16 recognized a key issue
called ‘the twin balance sheet’ problem.
• Both Banks and Corporates balance are in bad condition i.e
overleveraged and distressed private companies and the
rising NPAs in Public Sector Bank balance sheets.
• India has been fighting with its twin balance sheet (TBS)
problem since global financial crisis.
• Correcting it is important because it is discouraging private
investment in the country and hence growth in all sectors.

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79
 Why PARA
• It’s not just about banks, it’s a lot about companies
• It is an economic problem, not a morality play.
• The stressed debt is heavily concentrated in large
companies
• Many of these companies are unviable at current levels of
debt requiring debt write downs in many case
• Banks are finding it difficult to resolve these cases, despite
a proliferation of schemes to help them
• Delay is costly
• Hence we may require a PARA
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 Benefits of PARA
• Centralized Agency

• Effective Coordination

• Speedy Resolution

• Recoveries within a defined time period

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 Benefits of PARA
• Recoveries within a defined time period
• It would purchase specified loans from banks and then work
them out, depending on professional assessments of the
value-maximising strategy.
• Once the loans are off the books of the public sector banks,
the government would recapitalise them, thereby restoring
them to financial health.
• Similarly, once the financial viability of the over-indebted
enterprises is restored, they will be able to focus on their
operations, rather than their finances.
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Is PARA the Bad Bank

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Q1. Consider the following statements with regard to the Statutory
Liquidity Ratio (SLR)
1. It is the reserve requirement that commercial banks are
required to keep in RBI in cash
2. It has to be maintained at the close of business on every day
3. Like CRR, banks earn some amount of interest on SLR
investment also
Select the INCORRECT statements using the codes given below
(a) 1 and 2
(b) 1 and 3
(c) 2 and 3
(d) None of the above

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B
Statements 1 and 3 are incorrect.
• SLR: It is the share of Net Demand and Time Liabilities that a bank is
required to maintain safe and liquid assets, such as government
securities, cash, and gold.
• SLR is the amount of money that is invested in certain specified
securities predominantly central government and state government
securities.
• Statement 1: This is not kept with RBI but with banks themselves.
• Statement 3: The banks earn some amount of interest on SLR
investment as against CRR where it earns zero.
• In March 2020, the SLR was at 18.25 per cent of the NDTL of the
banks.
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Q2. With regard to the Government Security (G-Sec), consider
the following statements
1. It is a tradable instrument and can be issued by both the
Central Government and the State Governments
2. These can be short term as well as long term
3. To increase money supply in the economy, RBI purchases
government securities
Select the CORRECT statements using the codes given
below
(a) 1 and 2
(b) 1 and 3
(c) 2 and 3
(d) 1, 2 and 3
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D

All the statements are correct.

• A Government Security (G-Sec) is a tradable instrument issued by the Central
Government or the State Governments.
• Such securities are short term (usually called treasury bills, with original
maturities of less than one year- presently issued in three tenors, namely, 91 day,
182 day and 364 day) or long term (usually called Government bonds or dated
securities with original maturity of one year or more).
• In India, the Central Government issues both, treasury bills and bonds or dated
securities while the State Governments issue only bonds or dated securities,
which are called the State Development Loans (SDLs).
• G-Secs carry practically no risk of default and, hence, are called risk-free gilt-
edged instruments.

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Q4 Which of the following is/are the similarities between the Payment
Banks and Small Finance Banks?
1. Minimum capital required for both is Rs. 100 crore
2. Both require to establish 25% of branches in unbanked areas
3. Foreign shareholding is allowed in both banks
Select the CORRECT answer using the codes given below
(a) 1 Only
(b) 1 and 2
(c) 2 and 3
(d) 1, 2 and 3

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D
• All the statements are correct.
• Differentiated banks are
banking institutions licensed
by the RBI to provide specific
banking services and
products.

• Differentiated banks licensing

was launched in 2015. The
differentiated banks are of
two types- payment banks and
small finance banks.

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Q4. Which of the following statements is incorrect about Chit
Funds in India?
(a) It is regulated under the Central Chit Funds Act, 1982
(b) These are included in the definition of NBFCs by the
RBI
(c) RBI has laid out a separate regulatory framework for
them
(d) None of the above

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C
• Chit fund business is regulated under the Central Chit Funds
Act, 1982 and the rules framed under this Act by the various
state governments for this purpose.
• Functionally, chit funds are included in the definition of
NBFCs by the RBI under the sub-head miscellaneous non-
banking company(MNBC).
• Statement c: Both RBI and Central Government have not laid
out any separate regulatory framework for them.

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Q5. Consider the following statements with regard to the Sovereign
gold bond
1. These are issued by the RBI on behalf of the government of
India
2. Bonds have a tenure of eight years without an exit option
3. Investors can buy these bonds through designated scheduled
commercial banks, Small Finance Banks and Payment Banks
Select the CORRECT statement(s) using the codes given below
(a) 1 Only
(b) 1 and 2
(c) 2 and 3
(d) 1, 2 and 3
92
A
Only statement 1 is correct.
• Sovereign gold bonds are issued by the RBI on behalf of the
government. They are government securities denominated in grams of
gold. They are substitutes for holding physical gold.
• Investors have to pay the issue price in cash and the bonds will be
redeemed (bought back by the issuer) in cash on maturity.
• Statement 2: Sovereign gold bonds have a tenure of eight years, with
exit options are available from the fifth year.
• Statement 3: Investors can buy these bonds through designated
scheduled commercial banks (except Small Finance Banks and
Payment Banks), Stock Holding Corporation of India Limited, and
designated post offices.

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94