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DAILY
CLASS NOTES
Economy

Lecture – 09
Commercial bank
and Related
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Commercial bank and Related

Base Rate:
 Base rate is the minimum rate of interest of banks below which banks are not allowed to lend to its
customers except in the cases allowed by the RBI such as differential rate of interest, loans to bank
employees, and loans against fixed deposit.
 Base rate is decided in order to enhance transparency in the credit market and ensure that banks pass on
the lower cost of funds to their customers.
 Loan pricing will be done by adding a base rate and a suitable spread depending on the credit risk premium.
 Banks are allowed to determine their actual lending rates on loans and advances with reference to the
Base Rate.
 Base rate is always greater than Repo Rate.
 From 1st April 2016, lenders need to calculate their lending rates based on the marginal cost of funds.
 According to the rules, every bank will be required to calculate its marginal cost of funds across different
tenures. To this, the bank will add other components including operating costs and tenure premiums.
 A tenure premium is compensation for the risk associated with lending for a longer time.
SARFAESI Act, 2002:
 Securitisation and Reconstruction of financial assets and enforcement of securities interest act, 2002.
 SARFAESI is an act which for the first time empowers the banks to recover their bad debts or bad
loans by selling the asset of defaulters like building a free etc whatever you pledge without prior
permission of the court.
 It is a landmark legislation for the banking sector because it enables banks to reduce their non-performing
assets by adopting measures of reconstruction. This power is given under section 13 of the act and 60 days
notice to be served to the borrowers.
 However this law does not apply to unsecured loans, loans below 1 lakh rupees or the remaining debt is
below 20% of the original principle.
 The law allowed the creation of asset reconstruction companies and allowed loans to sell the non-performing
asset to the ARCs.
Credit Information Bureau:
 A credit information company collects and maintains records of an individual’s payments pertaining to
loans and credit cards.
 These records are submitted to these companies by member banks and credit instructions on a monthly basis.
 This information is then used to create credit information reports and credit scores which are found to credit
institutions in order to help evaluate and approve loan applications.
 These companies play a very important role in the financial system of a country.
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Monetary Aggregate and Money Supply:

 RBI takes stock of the money supply in India from time to time on the basis of the monetary aggregate
adopted by it i.e., M1, M2, and M3.
 M1 (the currency which is used) is known as the narrow money supply and M3 is known as the broad
money supply.
 The aggregate now being used are the revised aggregate based on the recommendation of the Y.V. Reddy
committee in 1998.
 The equation expressing each of these is as follows.
 M1 = Currency and coins with public + Demand deposit held by banks (in saving and current account) +
'Other' Deposits with the RBI.
 Other deposits with RBI are the deposits of the banks with RBI in the form of CRR.
 M2 = M1 + Time Liabilities Portion of demand Deposits with the Banking System + Certificates of
Deposit (CD) issued by Banks + Term Deposits of residents with a contractual maturity of up to and
including one year with the Banking System (excluding CDs).

Time Liabilities Portion of demand Deposits & Certificates of Deposit (CD):

 The time liability portion of the demand deposit is the minimum balance one needs to maintain with
the banks in case of demand deposits (Savings account and current account).
 CD works in the same way like T-bill, bill of exchange, and commercial paper with a maturity of up to
one year.
 CD is sold by banks at discounted value and purchased with face value on maturity.

 M3 = M2 + Term Deposits of residents with a contractual maturity of over one year with the Banking
System + Term loans between the banking system.
 Among M1, M2 and M3, M3 is the largest in monetary aggregate and M3 is called broad money.
 M0 = Currency in Circulation + Bankers' Deposits with the RBI + 'Other' Deposits with the RBI.
 M0 is called high powered money or reserve money.
 M4 = M3 + Total deposits with Post Office savings organizations (excluding National Savings Certificates)
Old aggregates:
 M1 = Currency and coins with public + Demand deposit held by banks (in saving and current account) +
'Other' Deposits with the RBI.
 M2 = M1 + post office saving deposits.
 M3 = M1 + time deposits with banks.
 M4 = M3 + total post office deposits.

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