Money, Banking & Finance Notes for UPSC Part 2

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Money, Banking & Finance Notes for UPSC Part 2

PNB Fraud
  1. Bank earns commission by issuing letter of undertaking to the foreign bank on behalf of customer (Guarantee)
  2. For last 7 years PNB’s branch from Mumbai kept issuing LoU to tge foreign banks on behalf of Nirav Modi
  3. Fraud was not detected as SWIFT is not connected with CBS
  4. Structured financial messaging system for domestic clients

 

ILFS crisis

Shadow banking

Shadow banking comprises a set of activities, markets, contracts and institutions that operate partially (or fully) outside the traditional commercial banking sector and are either lightly regulated or not regulated at all.

Was there any early sign of crisis?

Economic survey showed that health score of NBFC was giving early sign of the crisis. 

Reason behind crisis

  1. Financial institutions rely on short term financing to fund long-term investments. This reliance on short-term funding causes an asset liability management (ALM) problem
  2. Over dependence on short term funding requires frequent refinancing. Due to this NBFC is connected to Liquid debt mutual funds. This systemic risk in NBFC can transferred to the LDMF and vice versa
  3. Liquidity crunch in debt markets often leads to credit rationing. [ limiting by lenders of the supply of additional credit to borrowers who demand funds]
  4. In short problem is over dependence on short term wholesale funding
  5. For HFC ALM risk is higher for retail NBFC interconnected risk is higher. 
Refinancing risk

Possibility that a borrower cannot refinance by borrowing to repay existing debt. For NBFC the risk is driven by their dependence on the short term wholesale funding.

Redemption risk

Risk associated with redemption of bond before maturity. 

Remedies taken

  1. Replaced companies board
  2. Investigation of IL&FS auditor and accountants
  3. CRA has to disclose bond default probability
  4. Amendment in RBI act for more regulation of NBFC. 
Monetary transmission

It is a way by which general economic conditions and asset prices are affected by the monetory policies

Channels

  1. Interest rate channel,
  2. Credit channel
  3. Exchange rate channel,

Lower domestic interest rates could lead to a depreciation of the domestic currency, on the one hand making exports more competitive in the global market and adding to domestic demand and economic activity

  1. Asset price channel.

Lower interest rates also boost asset prices such as housing and equity prices as these can now be purchased at cheaper borrowing cost

Challenges

  1. Bank balance sheets are weak
  2. Lag of 3-4 quarters
  3. Unlike USA in Indian banks are not much depend on RBI for borrowing

What done ?

  1. MCLR (Marginal cost of lending rate) to the benchmark rate
  2. NPA reduction
Banking Reforms

PJ Nayak Committee

  1. Government should transfer its shares to Bank investment Company (BIC), with functional autonomy.
  2. All PSB should be incorporated under companies act
  3. liberate the banks from grasp of CVC-CAG-RTI (Own vigilance mechanism)
  4. Bank board bureau till BIC
  5. BIC delegate power to directors Either merged or privatize state own bank. 

NARSIMHAN Committee

  1. Four tier banking structure with three to four big banks including SBI should be developed as international banks. Eight to Ten Banks having nationwide presence should concentrate on the national and universal banking services. Local banks should concentrate on region specific banking. And Rural banks for agricultural lending activities

Bank Consolidation / Bank merging

  1. Merging banks and forming a new entity
  2. All duplicate operations and redundancies are rationalised thus reduces cost
  3. Vijaya Bank, Dena Bank with Bank of Baroda – Diversifiaction of customer base
  4. However in increases risk and harms interest of shareholders of good banks
  5. Merger will lead to a bigger capital base and higher liquidity which will help in meeting the norms under BASEL
  6. It should not be used as tool to bail out weaker banks but for commercial consideration
  7. New entity will have similar problems of old banks thus bring governance reforms
  8. At present, FDI of up to 49 percent is allowed in private banks without the permission of the government, and upto 74 percent can be invested with the government’s approval. (Increase to 100% in PSB it is 20%)
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RBI vs PSB

The RBI regulates both governance and prudential norms of private banks. For public banks, the government exercises the powers relating to governance while leaving prudential regulation to RBI.

 

Other Reforms

  1. HR training
  2. Coorigination of PSL loan (2018) – Pooling of PSL. 

Share Market

Unnecessary facts for prelims if you fail

T Bill – Sold at discount and buy at face value

Ways and means advances is not counted in calculation of fiscal deficit

Indian bond risk – BAA2/BAA by moody

ISIN number – 12 Digit number issued by NSDL to identify securities
Sensex = Present price * 100/ original price

FATF – G7

FSDC – Headed by FM (Chiefs of all regulators)

Financial stability board – G20 [Secretory DEA, Dy Governor RBI, SEBI chairperson]

Definition

Equity – Ownership (Last claim in liquidity)

Bonds – lending instruments.

Debenture – Unsecured bonds

Money market – <1 year

Capital market – >1 year

Primary market – New securities issued for the first time

Secondary Market – Old securities are resold

Spot market – Buy and sell for immediate delivery

Future market – where parties write contract today to buy and sell something in future

Universal exchange – Where all capital and money market products are available at one place

Gilt edge securities – Bond issued by government

Call money – Borrow for a day

Notice money – 2 to 14 day s

Bearer bonds – Not linked to id. Anyone who present it to issuer will get interest and principle

Coupon – Contain detachable coupon

Masala Bonds – Rupee dominated bonds issued outside India (Kerala first state)

Maharaja Bonds – IFC bonds in India

Sweet equity – Shares given at discount to the directors and employee for their contribution

Penny stock – Value less than face value

Blue chip stocks – Well established and financially sound company which provides good dividend

Venture capital – Professional firms helping start ups with seed capital

Angle investor – High net worth individuals helping start up companies

Share pledging – Use share as collateral

Underwriter – Who help companies to raise capital by IPO. If IPO is undersubscribed underwriter will by unsubscribed securities

Investment banking – a special segment of banking operation that helps individuals or organisations raise capital and provide financial consultancy services to them

Follow on public offer – Company who issued IPO previously issued additional shares (First right to existing share holders)

Global Depositary receipt/ American depositary receipt – Indian company mobilizing capital from foreign American stock exchange

Circuit breaker – If fluctuation in share price exceeds x percent then stop trading for y minute

Box trading – Trade occur on unofficial ledger of broker (he may not execute it on demat)

Algorithamic trading – Some companies uses algorithmic trading programme to buy and sell securities at speed and frequency. (Not banned but regulated by putting limitation on per second trade)

Commodity market – Where buyer and sellers trade goods in bulk (Grain, oilm gas, precious metal)

Future commodity trade – Earlier used to regulated by FMC now FMC merged with SEBi after NSEL scam

Mutual fund – a company that pools money from many investors and invests the money in securities

Equity linked saving scheme – Tax benefit, Three year lock in period, Equity linked MF

Side pocketing – Allow MF to separates bad asset from good asset

Hedge fund – Pools money from high net worth individuals and invest in risky but high return investment

Sovereign wealth fund – State owned investment fund (NIIF)

ETF – It is like mutual fund traded on stock exchanges, much like stocks.

Alternative investment fund – Venture capital, angle investor, private equity or debt fnd, hedge funds

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Forward – Settlement takes place in future date. Not tradable, (futures are tradable)

Options – Call (Buying right) and Put (Selling right)

Derivatives – It is a contract whose value is derived from the value of the another underlying assets

Participatory Note – Offshore derivatives which derives values from Indian bonds and shares (Not registered with SEBI thus risk of money laundering and tax invasion)

Dormant company – Not filed annual return in last two years

Competition Commission of India

  1. To promote fair competition among companies
  2. Prevent cartelization and monopoly
  3. In 2002 CCI act replaced MRTP act
MRTP vs CCI

To check the expansion of industrial houses with assets > Rs. 20 cr (1985 100cr) such provisions was abolished in CCI

Success

  1. 2012 fine on cement cartelisation
  2. Competition Commission of India (CCI) had penalized the three airlines for cartelisation in determining the fuel surcharge on air cargo

Strengthening it

  1. Understaffed In India 1 person in CCI handles 28 companies compared to US where 1 person handles 2 companies.
  2. Dominant position clause

Software used by stock exchange

  1. BOLT – BSE
  2. NEAT – NSE
  3. VSAT satellite

Why to issue shares to institutional buyers (They have expertise and financial muscle)

To increase confidence of other investors in the securities (Also known as anchor investor)

Role of SEBI

To protect investors interest and to prevent scams in capital market

Issues

Electoral Bonds

  1. Its a promisary note bought buy the Indian citizen of companies for the election funding
  2. SBI
  3. To parties with 1% vote share
  4. 10 days start of each quarter
  5. Only an Indian citizen or company registered in the India can buy

Benefit

  1. Reducing cash in the political funding
  2. Confidentiality of donor

Issues

  1. Earlier firm could donate only 7.5% of profit this limit is excluded
  2. Affects right to information of the share holders of the companies
  3. Possibilities that shell companies will be opened to use black money in election

Way forward

  1. Transparency with total digitisation
  2. Reintroduce profit rules
  3. To avoid pro quid quo National way of donations to a national election fund

 

Corporate Governance

  1. It ensures the protection of all the stakeholders
  2. Legal, Technical, Moral and Ethical
  3. Absence of corporate affair leads to fraud, employee harassment

 

CSR

  1. Spend 2% of Last three year avg profit
  2. Education, environment, health, sanitation, disaster management, etc
  3. Applicable on both Public and private sector companies

 

Insurance

Prelims facts

  1. 1870 – First Indian insurance company (Bombay mutual life insurance)
  2. FDI limit – 100% in insurance intermediaries and 49% in investment companies (Link it with liberalisation and LIC disinvestment)

 

Challenges

  1. Risky business
  2. Skilled insurance agents are required
  3. Insurance gap is high in India (Total asset/ Insured asset)
  4. Capital intensive industry
  5. Hard to recover investment if company in which invested fails
     

Insurance schemes

  1. Sampoorn Bima gram Yojana – Cover under RPLI
  2. Aam Adami Bima Yojana – BPL and marginally above
  3. Pradhan Mantri Jiva jyoti Bima yojana – Any type of death (No hospitalisation cost)
  4. PM Suraksha Bima Yojana – Accidental death + Accidental loss (No hospitalisation cost)
  5. Rashtriy Swastya Bima Yojana – No premium by beneficiary only one time fee. Now RSBY and SCHIS is sub assumed in PMJAY

Ayushman Bharat

  1. 80% of hospital expenditure is out off pocket expenditure
  2. 1.5 lakh PHC to be transformed to health and wellness center
  3. PMJAY – 5 lakh per family
  4. NHA is implementing authority

Challenges

  1. Health is state subject. States have their own insurance scheme . Name should be changed to PM-CM JAY
  2. Budgetary allocation is insufficient

 

Should insurance sector be liberalized?

  1. More capital in the insurance sector
  2. Companies act has norms like independent directors, auditing, whistle blower, CCI is also there so probability of mischief by foreign companies is less
  3. Care – Regulation not to invest in junk bonds to increase profits and premiums

 

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Pension

Monthly instalment received after retirement

 

PM Rojgar Protsahan Yojana

  1. EPFO applies for establishment having employee greater than 20
  2. Employer contribution 12%
  3. Under this scheme employer contribution is paid for three years on formally hired employees

 

NPS

  1. NPS opened for all citizens and NRI on voluntary basis
  2. Employees contribution 10% and 14% government

 

PM Vay Vandana Yojana

  1. 8% interest on deposits – 1.5 lakh to 15 lakh deposit

 

Financial Inclusion

  1. Fin inclusion is providing access to banking to all citizens irrespective of their socio economic status
  2. Helps to improve less cash economy
  3. Helps in DBT
  4. Access to credit
  5. Safety of hard earned money
  6. Banking Ombudsman in 1995 (RBI Act) -> Higher appeal to Dy governor
  7. Digital Transaction Ombudsman – 2019 (Payment settlement act)
  8. India 4th rank in Financial inclusion among 55 countries

 

New Banking Policy 1969

  1. Nationalisation of 14 banks
  2. Lead bank scheme
  3. Priority sector lending (40% at low rate)

Impact

  1. 4 branch in unbanked rural area for 1 urban branch
  2. Rural bank branches increased from 1,833 (in 1969) to 35,206 (in 1991)
  3.  The share of institutional sources in the outstanding debt of rural households increased from just 16.9% in 1962 to 64% in 1992.
  4. The gross savings rate rose from 12.8% in 1969 to 21.7% in 1990.
  5.  The gross investment rate rose from 13.9% in 1969 to 24.1% in 1990.

After Liberlisation

  1.  The rate of growth of agricultural credit fell sharply from around 7% per annum in the 1980s to about 2% per annum in the 1990s.

Conclusion

India’s nationalisation shows that monetary policy, banks and interest rates can be effectively used to take banks to rural areas, backward regions and under-served sectors, furthering redistributionist goals in an economy.

 

Yes Bank crisis

  1. Risky loan disbursement ( DHFL, Jet Airways and Cafe Coffee day, Reliance communication)
  2. Loan disbursement to the promoter owned companies
  3. Independent director failed to check
  4. Companies becoming fued of founder
  5. Institutional shareholders failing to act against promoter
  6. Media failed to expose balance sheet
  7. ICAI failed to act against auditor
  8. At the end RBI has failed to check to loan divergence and RBI acted late (NPA not shown)

Action taken

  1. Moratorium placed
  2. Restructuring plan is discussed by RBI

What else needed

  1. Corporate governance
  2. Monitoring
  3. Whistle blower act
  4. Rotate auditor

Corporate governance in India

  1. It is important for healthy functioning of the company and protection of interest of all the stakeholders
  2. It is rules which ensures fair, efficient and transparent functioning of the company

Need

  1. Interest of stakeholders
  2. Minority shareholders
  3. Prevent scams

Provisions

  1. Independent directors
  2. Independent Auditing (Rotation system needed)
  3. Bonds rating (Rotation ssytem)
  4. Insider trading

Kotak committee

  1. Director to attend at least half of meeting else can not continue
  2. Limit on being independent director one at a time
  3. Independent director incerase from 33 to 50
  4. SEBI should have power to act against auditor

Other

  1. Strengthen regulators
  2. Provide staff, funds, technology to monitor

 

The Bimal Jalan panel

  1. RBI may pay interim dividends only under exceptional circumstances
  2. unrealised gains in the valuation of RBI’s assets ought to be used as risk buffers against market risks and may not be paid as dividends.