Money, Banking & Finance Notes for UPSC Part 1

What is difference between economics and finance?

Finance is study of money, banking and financial instruments. While economics is larger set associated with production, consumption, and distribution of goods and services.

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A brief history of modern India (Spectrum)	Get Book
Indian Art and Culture by Nitin Singhania	Get Book
Certificate Physical & Human Geography by GC Leong	Get Book
Atlas	Get Book
Indian Polity by Laxmikanth	Get Book
Indian Economy	Get Book
Shankar IAS Environment	Get Book
Internal Security and Disaster Management by Ashok	Get Book

Favourite Governor (Rajan)

1. Inflation control

Unnecessary facts if you fail in interview

Fiat currency – Issued by order of government or RBI

Legal tender – Valid for all transactions

Cash transaction limit – 2 lakh by Finance act 2017

Stale cheque – Not withdrawn in 3 months

Core Banking System – Centralized digital data management, Finacle (Infosys) & E Kuber (RBI)

RTGS – 2 lakh to 2000 crore (Only by banks)

NEFT – 10 lakh (Only by banks)

IMPS – By banks, prepaid payment instruments , mobile wallet, etc (That is no IFSC code required thus no direct involvement of RBI)

Radio-frequency identification (RFID) uses electromagnetic fields to automatically identify and track tags attached to objects. An RFID tag consists of a tiny radio transponder; a radio receiver and transmitter.

Card tokenization – Masks card number, expiry date , CVV , etc from third party

ATM types

1. Bank label
2. Brown label
3. White label

M3 is most commonly as used money supply (Currency with public + DD+TD with commercial banks)

Money in the hand of poor & developed countries has higher velocity

CRR – 4%

SLR – 19%

Bank rate

Banks borrows in long term from RBI without pledging collateral

MSF – Penal rate as SLR limit is breached, (Bank rate is also penal rate hence MSF and Bank rate are same), Only used by all schedule commercial banks, Use of collateral of Gsec including SLR [Overnight facility]

LAF – All client of RBI [Excluding RRB], Money lent at REPO, collateral is government securities (including state)  [7-14 days]

Reverse Repo – Clients lend money to the RBI

Standing Deposit facilities – Bank parks funds in RBI for short term to earn interest

Hawkish policy – Fight inflation

Dovish Policy – Expansionary policy

Mudra – 100% SIDBI subsidiary

Mudra loans are collateral free. If borrowers default losses will be covered by credit guarantee fund for micro units operated by NCGTL (Loan interest is high)

Banks lending rate is linked to the

1. Repo rate
2. 91 days T bill
3. 182 days T bill
4. Any other bench mark rare decided by Financial benchmark India ltd

CHIT fund – Concurrent list

Sharda chit fund– Ponzi scheme (After 100cr SEBI permission is required)

Definitions

Teaser loan – Earlier year low interest rate (Higher restrictions)

Subprime – Borrower does not have ability to pay (Teaser loan to home buyer was reason to subprime crisis)

Over leveraged borrower – Company borrows too much than its ability to pay back

Zombie lending – When a weak bank keeps giving new loans to a subprime overlaveraged borrower

Inverted yield curve

1. Reflects a scenario in which short-term debt instruments have higher yields than long-term instruments.

Operation twist

1. sells the short term securities and buys long term securities simultaneously through Open Market Operations (OMO).
2. Deals with steep bond yield curve
3. Reduced long term interest rate

Long term repo operations

1. Long term repo operations conducted with current repo rate
2. Reduced interest rate on the long term borrowing

Incremental CRR exemption

1. On few sectors like Auto, Housing, MSME

Accommodative stance

To increase the money supply in the economy.

Neutral stance

 Neutral stance of RBI provides it the flexibility to move in either of the directions. (Depend on the inflation)

Contractionary stance

Followed by RBI to decrease the overall supply of money in the economy

Issues

Cashless Economy (Already lots of digitisation happening)

1. Raise awareness about adoption of BHIM
2. RBI should prepare index of digital financial inclusion
3. 10% digital literacy increase it

Benefit

1. Reduction in black money
2. Better tax surveillance
3. Difficult to steal if proper care is taken

Challenges

1. Interoperability
2. KYC Adhar – Privacy debate
3. Issues for rural area Digital literacy
4. Internet issues

Blockchain

1. Its a decentralize, open ledger technology which maintain a growing list of transaction.
2. Each block contains a cryptographic hash of the previous block a timestamp, and transaction data
3. In cryptography and computer science, a hash tree or Merkle tree is a tree in which every leaf node is labelled with the cryptographic hash of a data block, and every non-leaf node is labelled with the hash of the labels of its child nodes.
4. Once recorded, the data in any given block cannot be altered retroactively without alteration of all subsequent blocks, which requires consensus of the network majority.
5. Last year Coffee Board had launched the Coffee Blockchain initiative. Under it, country’s first blockchain-based marketplace app for trading in Indian coffee was launched which aimed at getting growers better returns by removing middlemen
6. Yes bank vendor payment

Cryptocurrency

Its digital virtual currency created and stored using blockchain technology. (Bitcoin, Libra by facebook using move programming language, )

Why crypto?

1. Anarchist lost faith in fiat money because of subprime crisis due to eroded purchasing power of US dollar (Satoshi Nakamato – 10^8 Satoshi = 1 bitcoin)
2. Miner verifies transaction to get bitcoins
3. only 21 million bitcoins can be mined 

Challenges

1. Mining – Thermal electricity wastage
2. Difficult to trace by law enforcement agencies
3. Terror finance
4. Ineffectiveness of monetary policy
5. Volatility
6. Theft
7. Quantum computing can solve blocks very easily thus will crash the value of bitcoins
8. 2018 budget it is not a legal tender
9. If private key lost then bitcoin loss (SHA256 has function)
10. Cryptojacking

Challenges using blockchain

1. ‘immutable’ nature necessitates very valid data
2. Reduced need of intermediaries thus there is need of change in legal framework

Other use of blockchain (NITI Ayog)

1. Land Records: Creating a new system to manage land record transfer and ownership
2. Payment between banks can be settled using block chains
3. Pharmaceutical drugs supply chain
4. Bond market (Commercial paper by yes bank)

Co operative bank

Problems with co operatives

1. Politicization
2. Casteism
3. Scams
4. Demonetisation
5. Money laundering
6. Poor recovery of loan

PMC bank crisis

1. Bank is facing regulatory actions and investigation over alleged irregularities in certain loan accounts. Loans given to financially stressed real estate player Housing Development & Infrastructure (HDIL) are at the centre of the investigation.
2. HDIL promoters allegedly colluded with the bank management to draw loans from the bank’s Bhandup branch. The bank officials did not classify these loans as non-performing advances, despite non-payment.
3. The bank also allegedly created fictitious accounts of companies which borrowed small sums of money, and created fake reports to hide from regulatory supervision.

Steps taken

1. regulatory actions and investigation by RBI
2. Union proposed amendment in BRA to bring multi-state cooperative banks under the watch of the central bank
3. Proposed law seeks to enforce banking regulation guidelines of the RBI in cooperative banks, while administrative issues will still be guided by Registrar of Cooperatives
4. Cooperative banks would be audited according to RBI rules and appointment of CEOs would require prior approval from the central bank. The RBI will also have the right to supersede the management of a cooperative bank in case of governance failure

Subprime Crisis

1. Teaser loan – Earlier year low interest rate (Higher restrictions)
2. Subprime – Borrower does not have ability to pay (Teaser loan to home buyer was reason to subprime crisis)
3. Boom in the mortgage backed securities
4. Housing bubble burst around 2006
5. The subprime mortgage crisis was the collective creation of the world’s central banks, homeowners, lenders, credit rating agencies, underwriters, and investors. 

Response

1. Open market operations by FED to ensure the liquidities of banks
2. Economic stimulus – Income tax rebate

NPA Crisis

Some Facts

1. NPA – If loan principle or interest is not paid for more than 90 days from due date
2. Net NPA is simply the total bad assets (actual) minus the provision left aside.
3. NPA ratio declining to 9.1 percent in FY19 from 11.2 percent in FY18
4. Gross NPAs of public sector banks improved to 11.6 per cent in FY19 from 14.6 per cent in FY18
5. During the same period, private sector banks’ gross NPA deteriorated to 5.3 per cent from 4.7 per cent (Because of LIC)
6. Loan write off – Written off asset from bank balance sheet. It is just done for the tax benefit purpose and bank has not waived off write to recover loan.
7. Restructuring loans – principle, interest rate, tenure of loan is modified
8. Stressed asset = NPA + Loans written off + Restructured loans
9. Evergreening of loans – Borrower take loan to pay off his old loan
    

Why NPA are higher in PSB

1. vulnerability to political pressures to lend to certain segments of the economy
2. Recovery – Again political pressure
3. Fear of loosing job by employee the private banks thus most loans are provided with care
4. No CVC/CBI/CAG control thus loan restructuring is easy process

Origin

1. Before 2005 boom in global economy. Indian corporates took large amount of loan and overleveraged
2. 2007 – Subprime crisis . Indian export declined
3. 2008-2013 – Policy paralysis and environmental activism stalled projects
4. Balance sheet of borrowers became weak – Led to the Twin balance sheet problem

Strategy to fight NPA

1. RBI 4R framwork
   1. Rectification – No change in tenure, interest just ask client to rectify his irregularities
   2. Restructuring – Ease tenure, interest rate (Corporate debt restructuring is under IBC). In strategic debt restructuring bank’s debt is converted to the equity

1. Recovery – Auction, liquidation
2. recapitalisation
3. SARFAESI Act 2002
   1. Enacted in 2002
   2. Bank and HFC can attach the mortgaged asset when loan is not repaid
   3. Can change board of director, can auction such assets, can also sell sucha sset to ARC
   4. Not applicable on farm loan
   5. Debt Recovery tribunal
4. IBC 2016
   1. NCLT – For companies
   2. Rs 1 lakh threshold
   3. DRT – Individual and partnerships
   4. IBC is not applicable to – Wilful defaulter, Incapable defaulter (These two under SARFAESI)
   5. Separation of commercial and judicial aspect 
   6. Insolvency professional will be registered with insolvency professional agency (like CA insti)
   7. Insolvency and bankruptcy board – Will regulate IP and IPA 
   8. Initiation (Financial creditor, operational creditor, employees or company itself) -> Appointment of IP (180 – 270 days) -> Committee of financial creditors take decision -> Liquidation
   9. Preferences : Insolvency cost > workers salary (upto 24 months) > secured creditor > unsecure creditor > dues to government > priority shareholder > equity shareholders
   10. Banks are not included
   11. IBC has section related to cross border insolvency but it is not notified yet
   12. Due to fear of losing control of Company corporate governance and financial discipline increased
   13. 50k crore NPA updated to standard asset
   14. 1.70 lakh crore settled through I&B
   15. Promoters of small companies are exempted from disqualification criteria under Section 29A
   16. Improve infra and man power to fasten resolution process
   17. 1322 cases have been admitted by National Company Law Tribunal (NCLT). 4452 cases have been disposed at pre-admission stage.
        
5.  Strategic Debt Restructuring (SDR) is an attempt to revive stalled projects by giving equity participation to banks in such projects. (Similar is S4A both are withdrew)
    
6. Project Sashakt (Sunil Mehta Committee)
   1. Small size – Bank itself
   2. Mid size – Inter creditor agreement
   3. Large size – AMC
7. Deosthalee committee recommendation – Public credit registry to give 360 degree of borrower to lender
8. Legal entity identifier number – RBI order big companies to obtain it
9. Fugitive economic offender act
   1. 100 cr and above for schedule crime and fled India
   2. Special court under PMLA
   3. Appeal only in HC or SC
10. FRDI bill (Not yet passed)
    1. DICGCI as Resolution corporation
    2. RC drafts resolution plan for banks
    3. In case no resolution plan like merger, etc happened then Bail in provision using depositors money
11. Bad Bank (PARA) – PARA Buys bad loan from banks
12. Prompt Corrective Action
    1. Putting restriction on lending and beanch expansion
    2. Restricting bank’s directors salaries and dividend distribution
13. BASEL III
    1. Pillar 1 – Minimum capital and liquidity requirement 
    2. credit risk – Some of the borrower may not repay loan or interest 
    3. Market risk – fluctuation in value of investment 
    4. Operational risk – Fraud
    5. Capital adequacy ratio or Capital to risk assets ratio –  (T1 + T2) / Risk weighted asset;  RBI mandated 9% [Government debt is allowed 9% risk weighting hence subtracted from total asset ]
    6. limit on leverage ratio ( is the proportion of debts that a bank has compared to its equity/capital ) [3%]
    7. Liquidity ratio –  ability to pay off current debt obligations without raising external capital.
    8. Pillar 2 – Supervisory review process
    9. Pillar 3 – Risk disclosure and market discipline 
    10. Common equity is the amount that all common shareholders have invested in a company.
    11. Capital conservation buffer to hold above CAR in the form of common equity  (2.5%)
14. Recapitalization (2.1 lakh crore)
    1. If bank don’t have enough capital to comply with BASEL III norms then it can issue debt bond and equities to gather capital
    2. Investor may not buy such bonds from weak banks thus there is bond recapitalisation
    3. Bank lend money to the government and then with that money government buys equity
15. Bank board bureau – For appointment of the top officials of public sector financial company
16. Enhanced access and service excellence agenda 2018
    1. Customer responsiveness
    2. Reduce NPA & prevent frauds
    3. Improve quality of human resource through performance linked promotion, training