commercial banks and their functions

8/3/2019 Commercial Banks and Their Functions

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COMMERCIAL BANKS AND THEIR

FUNCTIONS

COMMERCIAL BANKS ARE ORGANISATIONSWHICH NORMALLY PERFORM FINANCIALTRANSACTIONS.

PRIMARY FUNCTIONS

ACCEPTING DEPOSITS MAKING ADVANCES

CREDIT CREATION


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COMMERCIAL BANKS AND THEIR

FUNCTIONS

SECONDARY FUNCTIONS

CLEARANCE OF CHEQUES

TRANSFER OF MONEY

TO WORK AS A REPRESENTATIVE

TO GIVE/ ACCEPT MONEY

TO PROVIDE LETTER OF CREDIT

SALE / PURCHASE OF SHARES/BONDS


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RETAIL BANKING

DIRECT WITH CUSTOMERS

HOME LOANS

CREDIT CARD

DEBIT CARDS

MUTUAL FUND

PERSONAL LOAN

SAVING ACCOUNT/ CA

MUTUAL FUND THIRD PARTY PRODUCTS

BUSINESS LOANS


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CREDIT CREATION

BANK LIABILITYDEPOSITS

ASSETSCREDITS

RESERVE TOTALASSETS

BANK 1 100 95 5 100

2 95 90.5 4.75 95

3 90.5 85.98 4.52 90.5

-

n 00 00 00 00

TOTAL 2000` 1900 100 2000


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Determinants of Interest Rates

LOANABLE

FUNDSTHEORY

Shifts

Supply

Demand

TERM

STRUCTUREOF RATES

RATES FOR

INDIVIDUALSECURITIES

RATESOVER TIME

Demand = borrowers, issuers of securities,

deficit spending unit

Supply = lenders, financial investors, buyers

of securities, surplus spending unit

Slope of demand/supply curves related

to elasticity or sensitivity of interest rates


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Supply of Loanable Funds Quantity supplied directly related to interest

rates Households are major suppliers of loanable funds

Businesses and governments may invest (loan)

funds temporarily RBIs monetary policy impacts supply of loanable

funds

Sector cash receipts in period greaterthan

outlayslender


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Demand for Loanable Funds

Quantity demanded inversely related to interestrates

Household demand (mortgages, cars,

appliances,..) Business demand (working capital, profitable

investments: Net present value NPV>0,..)

Governments (temporary imbalances, budgetdeficits, general economic conditions,)

Foreign demand (differential interest rates,)


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THE IS-LM MODEL


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Shifts in the Supply and Demand

Supply Wealth

Risk

Near-term spending needs

Monetary expansion Economic conditions

Demand Utility derived from asset purchases with borrowed

funds

Restrictiveness on nonprice conditions on borrowedfunds

Economic conditions


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Rates for Individual Securities= i

i = IP + RIR +DRP+LRP +MP +SCP

Inflation premium (IP)

Real interest rates (RIR) Default risk premium (DRP)

Liquidity risk premium (LRP)

Maturity premium (MP) Special covenant premium (SCP)


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Rates for Individual Securities= i Fisher effect: Inflation and Real Interest rates

Real interest rate= Nominal Interest Rate - Expected Inflation Rate

Default risk:The additional amount a borrower must pay to compensate the lender for

assuming default risk.

Liquidity risk: ability to sell at predictable price with low transaction

cots

Maturity risk In general, rates rise with maturity. (Upward sloping yield curve)

Special provisions Call premium Conversion premium Tax exemption of municipal bonds


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Term Structure of Interest Rates

The relationship between maturity and yield.

The Yield Curve is the plot of current interest

yields versus time to maturity.

Unbiased expectation theory

Forward rate calculations

Forward rate = Expected short rates

Different maturities are perfect substitutes

Liquidity premium theory

Market segmentation theory


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Upward and Downward Sloping Yield

Curve

Upward

Expected higher interest rate levels

Expansive monetary policy

Expanding economy

Downward

Expected lower interest rate levels

Tight monetary policy

Recession soon?


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Uses of The Term Structure

Forecast interest rates The market provides a consensus forecast of expected future

interest rates

Expectations theory dominates the shape of the yield curve

Forecast recessions Flat or inverted yield curves have been a good predictor of

recessions.

Investment and financing decisions Lenders/borrowers attempt to time investment/financing

based on expectations shown by the yield curve Riding the yield curve

Timing of bond issuance


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Effect of Increase in Interest Rates

1. a fall in stock exchange and in the value of other assets (as houses);

2. a fall in profitability of firms;

3. a fall in private investment;

4. a fall in consumption credit;

5. an inflow of foreign capital for buying bonds;

6. an upward pressure on exchange rate;

7. a larger public expenditure to pay for a previously cumulated public

debt, whose burden might lead to reduction in other chapters in public

expenditure;

8. a narrower disposable income for households having a large debt taken

at variable rates;9. a larger disposable income for households that have lent to others at

variable rates (e.g. they own government bonds with variable rates);

10. a redistribution of income from debtors to lenders (in the part of debt

that has variable rates).
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CRR

Cash Reserve Ratio

In terms of Section 42 (1) of the Reserve Bank

of India Act, 1934 the Reserve Bank having

regard to the needs of securing the monetary

stability in the country, prescribes the CRR for

Scheduled Commercial Banks (SCBs) without

any floor or ceiling rate.


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CRR

Procedure for Computation of CRR

In order to improve the cash management by banks, as a measure ofsimplification, a lag of one fortnight in the maintenance of stipulated CRR bybanks has been introduced with effect from the fortnight beginning November06, 1999.

Maintenance of CRR on Daily Basis With a view to providing flexibility to banks in choosing an optimum strategy

of holding reserves depending upon their intra fortnight cash flows, allScheduled Commercial Banks are required to maintain minimum CRR balancesup to 70 per cent of the average daily required reserves for a reportingfortnight on all days of the fortnight with effect from the fortnight beginningDecember 28, 2002.


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CRR

Reserve Bank of India does not pay any

interest on the CRR balances maintained by

Scheduled Commercial Banks with effect from

the fortnight beginning March 31, 2007


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CRR

In cases of default in maintenance of CRR requirement on adaily basis which is presently 70 per cent of the total CRRrequirement, penal interest will be recovered for that day atthe rate of three per cent per annum above the Bank Rate on

the amount by which the amount actually maintained fallsshort of the prescribed minimum on that day and if theshortfall continues on the next succeeding day/s, penalinterest will be recovered at a rate of five per cent per annumabove the Bank Rate.


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SLR

Maintenance of Statutory Liquidity Ratio (SLR)

Consequent upon amendment to the Section 24 of the Banking RegulationAct, 1949 through the Banking Regulation (Amendment) Act, 2007 replacingthe Regulation (Amendment) Ordinance, 2007, effective January 23, 2007, the

Reserve Bank can prescribe the Statutory Liquidity Ratio (SLR) for SCB inspecified assets.

The value of such assets of a SCB shall not be less than such percentage notexceeding 40 per cent of its total demand and time liabilities in India as on thelast Friday of the second preceding fortnight as the Reserve Bank may, by

notification in the Official Gazette, specify from time to time.


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SLR

Reserve Bank has decided that all SCBs shall continue to maintain auniform SLR of 24 per cent on their total net demand and time liabilities(NDTL) with effect from the fortnight beginning November 8, 2008, valuedin accordance with the method of valuation specified by the Reserve Bankof India from time to time: a) in cash, or

b) in gold valued at a price not exceeding the current market price, or

c) in unencumbered investment in the following instruments which

will be referred to as statutory liquidity ratio (SLR) securities":

(i) Dated securities issued up to September 8, 2009 as listed in the Annex toNotification DBOD.No.Ret.BC.40/12.02.001/2009-10 dated September 8, 2009

`(ii) Treasury Bills of the Government of India; (iii) Dated securities of the Government of India issued from time to time under the

market borrowing programme and the Market Stabilisation Scheme;

(iv) State Development Loans (SDLs) of the State Governments issued from time totime under their market borrowing programme; and

(v) Any other instrument as may be notified by the Reserve Bank of India.


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SLR

Cash includes

Any balances maintained by a scheduled bank

with the Reserve Bank in excess of the balance

required to be maintained by it under Section 42of the Reserve Bank of India Act, 1934 (2 of 1934);

and

Net balances in current accounts with other

scheduled commercial banks in India.


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SLR

Scheduled Commercial Banks are required to

include inter-bank term deposits / term

borrowing liabilities of all maturities in

'Liabilities to the Banking System'. Similarlybanks should include their inter-bank assets of

term deposits and term lending of all

maturities in 'Assets with the Banking System'for computation of NDTL for SLR purpose.


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SLR

If a banking company fails to maintain the required amount of

SLR, it shall be liable to pay to RBI in respect of that default,

the penal interest for that day at the rate of 3 per cent per

annum above the Bank Rate on the shortfall and if the default

continues on the next succeeding working day, the penalinterest may be increased to a rate of

5 per cent per annum above the Bank Rate for the concerned days of

default on the shortfall.


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SLR

Name of the Bank:

I. Liabilities to the Banking System in India

a) Demand and time deposits from Banks

b) Borrowings from Banks

c) Other Demand and Time Liabilities

Total of I

II .Liabilities to Others in India

a) Aggregate Deposits (Other than from Banks)

(i) Demand

(ii)Time

b) Borrowings

c) Other demand and time liabilities Total of II

Total of I + II


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SLR

III. Assets with the Banking System in India

a) Balances with Banks

(i) In current account

(ii) In other accounts b) Money at call and short notice

c) Advances to banks i.e., dues from banks

d) Other Assets

Total of III


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SLR

Net liabilities for the purpose of Section 42 of

the Reserve Bank of India Act, 1934 = Net

Liability to the Banking System + Liabilities to

Others in India i.e.,(I-III} +II, if (I-III) is a plusfigure or II only, If (I-III) is a minus figure.


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NRI deposits

NRI deposits exempt from CRR but overseas

borrowing not exempt

Both eligible for SLR


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Market Repos

Repo (repurchase agreement) instruments enablecollateralised short-term borrowing through the sellingof debt instruments

A security is sold with an agreement to repurchase it at a

pre-determined date and rate Reverse repo is a mirror image of repo and reflects the

acquisition of a security with a simultaneouscommitment to resell

Average daily turnover of repo transactions (other than

the Reserve Bank) increased from Rs.11,311 crore duringApril 2001 to Rs. 42,252 crore in June 2006


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LIBOR

LIBOR is the most widely used benchmark orreference rate for short term interest rates. It iscompiled by the British Bankers Association andreleased to the market at about 11:00 each day.LIBOR stands for the London Interbank OfferedRate and is the interest rate at which the banksborrow funds (US Dollars) from other banks in

the London interbank market. LIBOR is typically pretty close to the Fed Funds

Rate but is well below the Prime Rate.


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commercial banks and their functions

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