Banking White Label ATM: Meaning, Features, Advantages, Limitations, Financial Inclusion, Nested Design, Contagion Risk

What is White label-ATM?

. Traditionally, Automated Teller Machines (ATMs) have respective bank‘s logo. So just by looking, this is SBI‘s ATM, this is ICICI‘s ATM and so on.

. But White label ATM doesn‘t have such Bank logo, hence called White label ATMs.

. RBI has given license / permission to non-bank entities to open such ATMs.

. Any non-bank entity with a minimum net worth of Rs.100 crore, can apply for white label ATMs. (not just NBFC, any non-bank entity can apply.)

. Late 80s: first ATM in India; 2012: RBI issues guideline for White label; 2013: RBI gives license/permission.

. Tata Communications Payment Solutions Limited =the first company to get RBI‘s permission to open White label ATMs.

. They started their chain under brandname ―Indicash‖.

. Other White label= Muthoot Finance, Srei Infra., Vakrangee Software, Prizm Payments, AGS. More than 15 companies given such permission.

What’s the difference between Brown label vs White label ATM?

Brown Label ATM White label ATM

When ATMs are owned and operated by non- When banks outsourced the ATM operations to a third bank entities but they are not doing ‗outsourcing- party. contract‘ from a particular bank.

The private company owns & operates the ATM machine, pays office rent. They negotiate with the landlord, Same electricity company, telecom company and so on.

The bank (which has outsourced this work) provides cash Sponsor bank provides the cash. for that ATM.

ATM has logo of that bank (which has outsourced this No. White label ATM doesn‘t have such logo. work). Not even of the sponsor bank.

They‘ve to compulsory open a few ATMs in (tier

No such compulsion. 3 to tier 6) areas. (explained after a few

paragraphs)

RBI directly involved because these white label RBI not involved directly. These outsourcing companies Companies have to separately get have contractual obligation with their respective banks. license/permission from RBI to run business.

Initially, RBI did not permit White label ATMs, and Banks wanted to reduce the operational cost, so they came up Brown Label ATM (outsourcing) system.

So in a way, the evolution is: (Bank‟s own ATM) =>(Brown Label) => (white label)

Stakeholder/Players in White label ATM game?

Gives license/permission to open White label ATMs. Under Payment and Settlement

RBI Systems Act, 2007. (And NOT under Banking regulation act or SARFAESI Act,

Ombudsman or any other act.)

Rents the place, looks after maintenance and servicing of the machine. (non-bank) White

Label ATM company

Loads the cash in those White label ATMs. This also ensures counterfeit/fake Sponsor bank currency notes are not circulated through white label ATM.

. Visa, Mastercard, the National Financial Switch (NFS under National Payment Payment network Corporation of India.) operator . They provide technical connectivity in the system. Why do we need White Label ATM? 1. ATMs offer convenience to customer (Because he doesn‘t need to visit Bank branch every time). ATMs are open 24/7, and even on holidays. 2. Convenience to bank, because they don‘t have to keep large staff/office (compared to a system without ATMs). It reduces their cost of branch-operation. 3. But in India, ATM penetration has been very low. Observe:

Country Approx. No. of ATMs per 10 lakh population

USA 1400

UK 500

China 200

India less than 100

Most of the ATMs concentrated in urban areas- that too only at prime locations e.g. near shopping malls and airports= financial inclusion not achieved.

How does White Label ATM help in financial inclusion? RBI requires White label-ATM companies to install machines in the ratio of

Two ATMs in (tier 3 to 6 place) : One ATM in (tier 1-2 place).

Confused? Observe:

Center city census definition:population is ____ White Label ATM

Metropolitan 10 lakh and above Tier 1 if company wants to Setup ONE ATM Urban 1 lakh and above here,

Tier 2 50,000 to 99,999

Semi-Urban Tier 3 20,000 to 49,999

Tier 4 10,000 to 19,999 Then, company must install TWO

ATMs here. Tier 5 5,000 to 9,999

Rural Tier 6 Less than 5,000.

For example, RBI has permitted Tata to deploy 15000 White label ATMs. Meaning [2/(2+1)] x 15000 = 10,000 ATMs will be setup in the rural and semi- urban areas. = more access to ATM= financial inclusion.

Facilities @White label ATM? 1. Any customer from belonging to any bank, can use it. 2. Every month, Five transactions are free. 3. White label ATM users can also withdraw a maximum of 10,000 per transaction. 4. Open 24/7 and on holidays 5. Value added services like mobile recharge, utility bill payments etc. Where does the Commission come? White ATM Company doesn‟t run for charity or goodwill. Company has to make profit. So where does the asli-maal/commission come?

Before White label ATM With White Label

1. If you used card in your own bank‘s ATM= everything free. 1. First five transactions free every

2. If you used card on other bank‘s ATM= first five transactions month.

free (every month). After that commission charges of Rs.~17-20 2. Then, transaction fee ~Rs.15 and

for taking out money and Rs. 5-9 for making balance inquiry or balance inquiry fee ~Rs.5 BUT

mini statement. (This commission directly charged on your this commission is paid by your

account.) bank to the White label

Company.

3. White label company cannot

directly charge money on you.

(RBI rules).

4. Although it doesn‘t mean White

label ATM=totally ―Free‖

because your bank will cut those

charges from your account.

Additionally, White Label ATM company can make commission from 1. value added services @their ATM e.g electricity /telephone bill payments, mobile recharge, DishTV-Tatasky recharge etc. 2. Selling advertisement space in the room and above the door. White label ATM: Challenges/Limitations/Problems 1. For a white label ATM company, biggest challenges = office rent + Security guard. 2. If they want to make profit, every White ATM needs to get at least 75-125 transactions per day= very unlikely, especially when RBI requires them to setup 2/3rd of the ATMs in semi-urban and rural areas. 3. Even in Bangalore, some of the white-label ATMs are getting barely 2-3 customers every week=loss making business at the moment. 4. Despite the entry of White Label ATM companies, the regular banks have not slowed down their ATM expansion drive, because branded ATM=passive advertisement and customer loyalty. Result? ATMs everywhere =too much competition= small players will bleed out just like in aviation business. 5. Last year, a lady was brutally attacked in ATM booth in Bangalore. Police have warned all banks to put security guards=input cost increased. Banks themselves admitting ―five transactions free every month=loss making‖ in this scenario. 6. SBI has the largest ATM network in India (30,000+)= economies of scale= they‘re supposed to be making profit. But this week, even SBI chairman herself has admitted

their ATM business is making losses. So, it is unlikely that White label ATM companies will run profitably for a long period of time. 7. Customer complaint: failed ATM transactions = matter falls into Issuing Bank (=bank where you have account). Some critiques fear it will lead to taarikh pe taarikh because data records are with sponsor bank and machine maintenance is under ATM company‘s responsibility. Nested Design

RBI appointed Nachiket Mor Committee on financial services, talks about this limitation.

. The White label-ATM does not have direct access to the settlements system. (like SBI or ICICI has access to RBI monitored NEFT online money transfers.)

. Instead White label ATM is tied with a ‗sponsor-bank‘. And the sponsor bank looks after the settlement. Sponsor bank loads and withdraws the cash from those ―machines‖. Example Federal Bank is the sponsor bank for Tata‘s White label ATMs.

Mohan Ok so what‘s the problem?

Nachi Nested Design= contagion risk.

. Contagion = Bad condition in one institution leads to negative effects in the other institutes in the market.

. Suppose few of Tata‘s White label ATMs break down for xyz reason (hacking, staff negligence or whatever) and some clown starts baseless rumoring on facebook/twitter/whatsapp that Tata‘s ATMs not working because federal bank has stopped supplying cash.

. Another clown then starts rumor mongering that Federal Bank is about to collapse because of NPAs and hence not honoring its obligation to Tata. Result: Fed.Bank account holders panic and line up at other ATMs (sponsored or owned by other banks) to pull out their money = these type of “runs” destabilize the banking system. Extreme cases lead to situation like Cyprus- Banking crisis.

Mohan But don‘t the banks have CRR and SLR to arrange cash in such emergency situations?

Yes they have. But with nested design, they‘re exposing themselves to additional ―contagion-risk‖

Nachi from other banks/White-label ATM companies. Especially when White label ATM company grows

too large in very short time and sponsor bank cannot foresee the cash requirements.

Mohan Then what‘s your recommendation?

. White label ATM companies should be directly linked to settlement system, without sponsor

banks.

. RBI should allow White Label Banking Business Correspondent agents. [Same like earlier Nachi BC, but they can work with multiple banks at the back-end.]

. Potential candidates= NBFCs, mobile phone companies, consumer goods companies, the post

office system, existing corporate BCs, and milk/agri./sugar etc. real sector cooperatives. Mock Questions 1. Who among the following can operate White label ATMs? 1. Nationalized Banks 2. Scheduled Commercial Banks 3. Retail Banks

4. None of above. 2. What is ―Indicash‖ ATM? 0. Brown label ATM chain under Indus Bank 1. Brown label ATM chain under Bank of India. 2. White label ATM chain owned and operated by Tata 3. White label ATM chain owned and operated by Prizm payments 3. Correct statements about White label ATMs 0. RBI permits non-bank entities to setup White Label ATMs under Banking regulation Act. 1. Only Non-Banking financial companies with 15 years of experience can open White label ATMs. 2. In case of failed transaction, the complaint is automatically sent to Banking Ombudsman. 3. None of above. 4. Correct statements about White label ATMs 0. Company has to open 2/3rd of its ATM in areas having tier 3 to tier 6 level population. 1. Before opening such booths in rural areas, the company has to get permission from NABARD. 2. Both 1 and 2 3. Neither 1 nor 2 5. Incorrect statements about White label ATMs 0. The operator company is required to maintain SLR and CRR reserves similar to a scheduled commercial bank. 1. To prevent conflict of interest, RBI has forbidden White label companies from providing Value added services in such booths. 2. Both 1 and 2 3. Neither 1 nor 2 6. What is the role of a Sponsor bank in White label ATM system? 0. provide maintanance and service to the equipment 1. provide cash to the equipment 2. both 1 and 2

3. Neither 1 nor 2 7. Suppose RBI rules require the company to open ATMs in Urban: Rural areas in the ratio of 5:9. If Muthoot Finance owns total 3500 ATMs, how many of them are located in the rural areas? 0. 225 1. 1250 2. 2250 3. None of above 8. Suppose RBI rules require the company to open ATMs in Urban: Rural areas in the ratio of 1:1,at the end of the given year. In January 2014 Muthoot Finance owns total 3000 ATMs but its rural:urban ratio is 8:7. So, by 31st December 2014, How many new rural ATMs should they open to comply with RBI‘s rules? 0. 400 1. 300 2. 200 3. none of above 9. The ratio of Indicash White label ATMs in urban: rural areas is 4:5. If Indiacash opened 360 new ATMs each in both urban and rural areas, then ratio will be 7:8. So, originally, how many ATMs did Indicash have in rural areas? 0. 640 1. 560 2. 600 3. None of Above 10. The ratio of Indicash‘s urban:rural ATMs is 3:2 and total number of ATMs is 600. If Indicash wants to change this ratio to 7:3, what should it do? 0. Add 200 ATMs in rural area 1. Add 200 ATMs in urban area 2. Add 200 ATMs each in both rural and urban areas 3. None of above Descriptive: 1. Despites certain risks and limitations, the White label ATM has a potential role in financial inclusion. Elaborate. (10m | 200 words)

2. Define White label ATM. What are its features, advantages and limitations? (10m | 200 words) 3. What are the differences between White label and Brown Label ATM? (5m | 100 words)

Cheque Truncation System (CTS-2010): Meaning, Advantages explained

What is cheque clearing house?

. Suppose a party from Delhi pays you via cheque of Citibank and you have account in SBI, Ahmedabad. You deposit this cheque in your area‘s SBI branch.

. Now the SBI branch manager would send his [overworked, underpaid] Bank PO to Citibank‘s office in A‘bad. He‘d show the cheque, collect the cash and return to deposit the money in your account.

. But SBI would be getting thosands of cheques everyday- some from ICICI, some from Citibank, some from axis and so on. SBI cannot send its staff to every other bank to get the cash, that‘d be extremely time consuming.

. Therefore To simplify this cheque transection process, each bank will send a representative to a central place and exchange cheques drawn on each other.

. This centralized place is called clearing house/processing house.

. Reserve bank of India is act as clearing house.

. In cities where RBI‘s office doesnot exist, usually SBI or other public sector bank acts as the clearing house. What is MICR code?

. By seeing the PIN code, a postman can know the destination of an envelope. Same way by using the MICR code, RBI (clearing house) can know the name of a bank, location of its branch from where the cheque was issued= faster clearing of cheques.

. MICR = Magnetic ink character recognition.

. At the bottom of every cheque, you‘d see some black colored numbers with weird looking fonts. That is the MICR code.

. These numbers are printed with a special ink containing iron oxide, so that it can be automatically read by a special machine.

. Ofcourse this sounds similar to bar codes, but there is a difference: unlike barcode, you can read the MICR code and decode it, without the use of special machines.

What is Cheque Truncation System (CTS)?

. Under the old paper cheque based clearing, the SBI bank will send the paper cheque to the clearing house and get the money and then transfer it to your account.

. This is still time consuming. because SBI (or any bank) would need to physically move the cheques to a clearing house.

. So RBI came up with a new idea known as „Cheque Truncation System (CTS)‟.

. In this Cheque Truncation System (CTS), SBI branch will not send the paper cheque to the clearing house, but instead, it‘d merely scan the cheque, and electronically send the image + MICR data, to the clearing house.

. From the clearing house, the data would goto the paying bank (Citibank in our example), they will inspect the MICR data, signature on the scanned image and release the money to SBI.

. This process is faster and more safer than the conventional paper-cheque clearing method. What are the benefits of Cheque Truncation?

. It Eliminates the time, money and manpower wasted during physical movement of cheques (from banks to clearing house).

. Thus, Cheque Truncation =faster clearing = better service to customers,

. Cheque Truncation system reduces the scope for clearing-related frauds

. There is no fear of losing cheque in transit. CTS-2010

. In the year 2010, RBI came up with the guidelines for Cheque Truncation system. (CTS 2010)

. The banks would need to upgrade a few things to comply with CTS 2010 standards of RBI.

. For example, in their branch offices, they would need to buy scanners and install special software provided by RBI, to securely transfer and receive the scanned image and data.

. They may need to change the color-scheme of chequebooks so that signature and handwriting is visible in the scanned image. And so on…

. Problem: some jholachhaap banks, are yet to comply with RBI‘s CTS 2010 guidelines.

. Hence recently RBI issued a warning to all banks: upgrade your banking infrastructure according to CTS 2010 guidelines, before the end of Sept. 2012

Bretton Woods and Fixed Exchange Rate system : Meaning Explained

While reading newspaper columns about global economy or Eurozone crisis etc. you may have come across a sentence, multiple times : “we need another Bretton woods.” so, What is Bretton Woods? It‟s a place in New Hampshire State of USA, just like BASEL is a city in Switzerland. Why is important?

. In 1944, President Roosevelt hosted a conference here, to rebuild the world economy, after Second World War. Delegates of 44 allied nations ( ) had came to participate in this conference.

. Officially it is known as United Nations Monetary and Financial Conference, commonly known as Bretton Woods because of the place where it was held.

. This conference resulted into creation of four extremely important things

Result of Bretton Woods

. 1. IMF

. They give short-term loans to help nations settle the balance of payment crisis.

. They‘ve a system called ―SDR‖ :Special Drawing rights. (requires another article)

. 2. World Bank

. Officially known as IBRD :International bank for reconstruction and Development, that time

. They give long term soft loans to rebuild the third world.

. Soft loans= interest rate is very low. Sometimes you don‘t have to pay back the principle.

. 3. GATT (General Agreement on Trade and Tarrif) – later becomes WTO

. To facilitate the international trade.

. This will later become WTO. Already written an article on this.

. 4. Fixed Exchange Rate system. (although Discarded in 1970s)

. Explained in this same article. Main Players in this meeting

. Total 44 nations participated, but Main players were:

. US President Franklin D Roosevelt

. UK Prime Minister Winston Churchill

. Lord John Maynard Keynes, Famous economist, UK treasury advisor. India @Bretton Woods

. Absent from the meeting: Mohan, Montek, Pranab, and Chindu (good otherwise they‟d have messed up International Economy, just like they did to Indian Economy.)

. India was represented by Sir C.D. Deshmukh, he was the first Indian Governor of RBI, This gentleman had cracked IAS exam in British-raj ,known as ICS exam in those days. And No, he is not the grandfather of Ritesh Deshmukh. Back to the topic,

Impact of World War II on Economy

. Second world war started in 1939, ended in 1945

. There is large scale bombing and destruction in the world. Production has declined.

. Agriculture, Dairy, Manufacturing, Export- everything is brought to standstill=huge inflation Agenda of conference

. Help rebuilt the World Economy. Provide money, loan, finance to needy nations. (World Bank)

. After WW2, lot of colonies will get independence (India, Sri Lanka…), they‘ll introduce their own national currencies without control of big superpowers (Britain, France etc) and they‘ll enter in international trade in their own capacity.(Exchange rates, IMF)

. Hence, Some rules/order had to be created to facilitate smooth international trade. (GATT) Fixed Exchange Rate system. What is Fixed Exchange Rate System?

. Under this system, if RBI says $1=30 rupees, and you‘ve 30 rupees and want to convert it in dollars but the Foreigners are willing to give 1 dollar to you…don‘t worry.

. RBI will accept your 30 rupees and give your one dollar out of its own reserve and vice versa.

. Cons are obvious : When India is not exporting enough and not attractive enough foreign investment (in dollars) and still RBI keeps paying people in dollars, one day the bank lockers will be empty, there will be no dollars to pay. System will collapse.

. But it has Pros (advantages) in the times of uncertainty- When you‘re writing on a clean slate, after WW2, if every nation decides to have a fixed exchange rate system- it leads to stability and predictability in Exchange rates = good for foreign trade. Roosevelt Vs Mohan: Pegging the Currencies (Fictional, technically incorrect, imaginary)

President Roosevelt: ok I say we put fixed exchange rate system. Let‟s fix the rates that 40 Rupees will equal to 1 dollar. 15 Yens will equal to 1 dollar. 12 Pounds will equal to 1 dollar and so on. In short, I‟m pegging your currencies to US Dollar. Thus Dollar will be the international reserve currency. AND Your country‟s RBI (central bank) will make sure these exchange rates don‟t fluctuate more than 1% from these values.

Mohan: ya man, but what if the exchange rate fluctuates? for example, What If I start running my country in a totally pathetic and irresponsible manner and hence nobody wants to invest in India so supply of dollar is low but demand of dollar is high- because Indians love gold and we‟ve to import crude oil and pay in dollars. In short, this will fluctuate the exchange rates between Dollar vs Rupee. President Roosevelt: Let me ask you a question. Suppose Onions are selling 100 rupees a kilo because of low supply but suddenly farmers produce fresh new 50 million tonnes of onions and supply it to market, what will happen? Mohan: Easy! Onion Price will drop down to 40 rupees a kilo because the supply has increased. President Roosevelt: yes dude, the same way, whenever exchange rate fluctuates from our standard rate, you‟ll tell your RBI to supply dollars from its own forex reserves in to the market to calm down the demand and bring the rate back to normal level. If the reverse happens: (Onions are selling @ 2 rupees a kilo) then you tell your RBI to buy all Onions dollars using its own rupees, until the supply is reduced and price is back to normal. Mohan: What nonsense is this? If 40 rupees equals 1 dollar but then what does 1 dollar equal to? What is the value of your own dollar? Why should we accept your dollar as international reserve currency? President Roosevelt: I‟ve fixed the value of your currency to my dollars. And I‟m fixing the value of my own dollars to Gold. 1 ounce of Gold shall equal to 35 dollars. Meaning you walk in with 35 dollars in my RBI (Federal Reserve Bank of USA), and you‟ll get one ounce of gold in return. Gold will remain precious forever. So, it‟s not like we‟re running the show in thin air. Dollars are backed by GOLD. Mohan: ya man but what if my RBI doesn‟t have enough dollars in its lockers? What will we do then? President Roosevelt: don‟t worry, come to IMF. They‟ll arrange short term loans for you, in dollars.

Mohan: but still, why should we fix price of our currency to dollars? Why should we accept dollar as the reserve currency and not Yuan, Yen or Pound? Why should we accept you as our big boss? President Roosevelt: Because I‟ve the aukaat to pay enough gold, so I say dollars will be the international reserve currency. IF you‟ve enough gold reserve in your RBI, come sit in the chair and we‟ll see whether rupee is strong enough to become the international reserve currency or not. Even Britain is so financially bankrupt after Second World War, they don‟t have the guts to tell me set this exchange rate according to their Pounds. Btw, I also got some nuke missiles in my limousine.

Mohan: no no…I was just kidding man. I‟m well aware that you‟re the superpower both financially and militarywise. President Roosevelt: Besides When we‟ve a stable and fixed exchange system like this, it‟ll ensure smooth and long term trade deals between merchants of various countries. When you don‟t have fixed exchange rate system, it is bad for economy. For example, today your call-center boss may give you free lunch and coffee because $1=60 rupees but next day when value of rupee declines and it is $1=50 rupees, same boss will even stop running the water-cooler in your office. Third day when $1=40 rupees, He will just kick you out because outsourcing generate that much profit for him. Such uncertainty, is not good for economy. And since Gold is in limited supply, Dollar will be spent carefully, and so your currency will be in spent carefully. i.e. Since currencies are „pegged‟, you will not indulge in extravagant spending in subsidies, welfare schemes, tax-reliefs or debt-waivers to farmers. This ensures fiscal discipline => That ensures less Fiscal deficit = less inflation. Mohan: Mr. President Sir, I think I got the point now. I‟ll tell my RBI Governor here to sign the Bretton Woods agreement papers, because fixed exchange rate system sounds safe and good. Fast forward to 1970s

. As you can see, the fixed exchange rate system, is good for stable international trade environment, atleast on paper.

. But this system can run smoothly only as long as USA has the aukaat to pay gold to every swinging dude that walks with dollars into their RBI (US Treasury).

. Problem started with Cold War. Both USA and USSR (not Russia), are busy in an arms race, building new tanks, missiles and submarines every week.

. They‘re also giving huge donations and help to poor nations, in order to win their support and dominate the region. This is a non-productive activity, they‘re basically wasting money.

. Now, USA gets involved in a very lengthy and expensive Vietnam War from 1959 to 1975. Inflation and Gold Prices

. Fact: War leads to inflation

. Fact: Inflation decreases the value of your money.

. Fact: Gold becomes more expensive because of Inflation.

. US still kept fixed value of 35 dollars = 1 ounce of gold. But thanks to this inflation, Gold is trading at higher price in open market – 40 dollars per ounce.

. So there is an opportunity to make quick money, just tell the RBI manager to take suitcase full of dollars from RBI‘s locker to US Federal Reserve, take their gold in return, and sell it to the local jeweler at higher market price and use this profit to fix india‘s problems- poverty, education etc. (may be by starting another welfare scheme named after Nehru-Gandhi family.)

. For a while, US Presidents had enough clout over international politics so that they could force other nations‘ RBI managers not to indulge in such cheap profiteering. But Vietnam war is fast deteriorating America‘s clout and now RBIs of various countries have started lining up with their suitcases full of dollars and they want gold in return.

. 1971, President Nixon decides that if we continue giving gold for dollars, we will go bankrupt. There will be no gold left in our lockers. So I give up. I‘m not going to let anyone exchange their dollars for my gold.

. And thus Bretton Wood system breaks down.

. 1973, World moves to floating exchange rate system.

. What is Floating Exchange rate? Governments / Central Banks don‘t fix exchange rates here. It is left to the Forex markets, private players and laws of supply and

demand.Government /RBI will only intervene if there is huge fluctuation in the exchange rates. Do we need Bretton Woods?

. With respect to the Eurozone crisis (click ME), many columnists write ―We need another Bretton Woods‖.

. They don‘t actually mean that we need to move back to the same old Fixed Rate exchange system, in which every currency was pegged to Dollar and Dollar was pegged to Gold. Because that fixed rate thing is impractical in real life scenario, as we saw in above paragraphs.

. Just imagine, if tomorrow World starts running according to Bretton Woods system, what will happen?

. We know that China already has more than 1000 billion dollars in its Forex Reserves. So People‘s Bank of China will send its Probationary officer with suitcases full of dollars and take away all the gold from Fort Knox*. They don‘t even need to fight a war, USA will come down to its knees financially.

. [*Fort Knox is a place in Kentucky State, US Government keeps the gold reserves in this place.]

. In real life, not that China will actually do so, but the mere threat and possibility will keep USA on its toes. Hence US will not agree to Fixed Exchange rate in the first place.

. There is no chance any other country will agree to become the ‗big brother‘ and let their currency become the reserved currency and peg it to gold.

. Especially India, because if we peg our 10,000 Rupees to one ounce of Gold and declare that we are the new international reserve currency, just like dollar before 1970s, What will be the Result? Pegged currency means Government can‘t do extravagant spending in MNREGA. They‘ll have to stop subsidy on diesel, kerosene, LPG and fertilizers, because they can dole out only as much rupees as the amount of gold held in RBI’s locker.

. As You can understand, no political party has the guts to do that, hence no nation will want to become the big brother or Sacrificial goat (Bali kaa Bakraa) for ―another Bretton Woods‖.

. So, The sentence ―We need another Bretton Woods‖ is just a metaphor, to say that all the Presidents, Prime ministers and Economists of the world should meet up once again and hold conference in some gambling den, drink someDesi liquor ( ), watch some Item-song, brainstorm for new ideas and start something from scratch, totally new, Just like the Gentlemen at Bretton Woods did, in 1944. Then what to do?

. It could be anything, untried and untested before like-

. China could agree that we‘ll not dump our products in foreign market, we will not keep our yuan under-valued,

. US could agree that we‘ll bring back our troop from Afghanistan and cut down on our Defense Expenditure and its inflationary effect on world economy. We will also stop supporting Pakistan. Thus reducing defense Expenditure of India in the arms race= that will also reduce fiscal deficit of India= India could decrease taxes=boost for economy and world trade.

. Iran could agree that we‘ll stop our irrelevant obsession with nuke weapons and give up, So that UN removes the sanctions and our traders can make more money, thus improving the standard of living for Iranian aam-aadmis.

. EU could agree that we‘ll kick out Greece, because it‘s just way too messed up beyond fixing.

. And India could agree that we‘ll bring all the black money from Switzerland and use it to finance our bogus Government schemes and subsidies instead of looting the aam-aadmi via direct and indirect taxes, to finance those things.

. And finally you and I could agree that facebook is a waste of time, so a serious Aspirant should concentrate on his studies instead of uploading funny/motivational photos there.

Banking Amendment Bill: Issues, Features, Problems, Reforms meaning explained

Boring technical details intentionally skipped. I don‟t do Ph.D on current affairs, neither should you. What is Banking Regulation Act?

This act empowers reserve bank of India (RBI ) to regulate all public sector banks (SBI, PNB etc.) and private sector banks.(ICICI, HDFC etc.) in India. Set : Finance Minister’s Office Finance minister and RBI governor are holding a meeting.

Yaar many new players want to open banks in India. But they can‘t, because you‘re not Chindu giving new licenses, So what is your problem?

Well, I‘m given powers to regulate public and private sector banks, under Banking

Regulation Act 1949.But those powers are not enough. RBI governor So, I‘m not going to give new bank-licenses to anybody, unless and until you get me

more powers, by updating that Banking Regulation Act.

Ok, I‘ll move a Banking laws (Amendment) bill, to amend the necessary things.But first Chindu tell me what new powers do you need?

RBI Power #1: Can remove entire Board of a Bank

At present, if a Bank doesn‘t play by my rules, I can remove its CEO or one or two directors. But that

is not enough. What if the whole board of directors is involved in some mischief.

RBI So, I want powers to remove the entire board of directors.

I also want you to increase the rates of existing monetary penalties that I can impose on a bank if it

disobeys my rules, directives or gives me false information.

Ok agreed.I‘ll get you the powers to supersede boards of the banks if any irregularities.And I‘ll Chindu increase the penalty rates as well.Anything else?

RBI Second problem. Connected lending.

Chindu What is that?

RBI Power #2: Connected Lending Prevention

. Suppose Mr.Paraajay gets license to open a new bank.

. He opens Pawn-Fisher bank, people deposit their hard earned cash in it.

. Ideally, bank should lend this money to the home, car, education and business-loan seekers, who then pay interest and thus bank makes profit.

. Bank must make good profit, so It can pay 1) good interest rate to its bank account holders. 2) good dividends to its share holders.

. But Mr.Paraajay also owns another company, Pawn-Fisher airlines.

. And this airlines company is making losses. Mr.Paraajay gives loans from Pawn- Fisher bank to Pawn-Fisher airlines @very low interest rate, to fix the mess.

. And or, this Pawn-Fisher airlines gets the bank loan @market rates from the Pawn- Fisher Bank but it doesn‘t pay EMIs regularly, yet the bank doesn‘t take any action.

. Similarly, Mr.Paraajay also opens Pawn-Fisher Mutual funds, but it also makes losses, and money is transferred from bank deposits to mutual funds, to cover up those losses.

. These type of activities = Not good, because in long term, bank will collapse and depositors‘ money will be stuck.

So, I must be given powers to check the records and account-books of those mutual funds, insurance RBI and other companies associated with a bank.

Agreed.

Chindu you‘ll get the power to inspect those other business arms of a bank.

Anything else?

RBI Yes, money from unclaimed bank accounts.

RBI Power #3: Unclaimed Accounts

. If Mr.X has not used his bank account for more than 10 years, it is called ―unclaimed bank account.‖

. There are crores of rupees in such unclaimed bank accounts, it increases the Administrative burden on bank employees (=need to maintain files etc)

. Plus there is also an opportunity to commit a fraud. for example some bank employee knows that Mr.X‘s bank account is never checked, then he‘ll forge checkbooks signature or some other trick to withdraw money from Mr.X‘s account.

so we must take some measure to tackle this issue.

. If a bank account is not operated for more than 10 years, bank will have to transfer its money in

RBI the ―Depositor Education and Awareness Fund‖

. And I‘ll appoint a Committee to use money from this fund to create awareness.

. Although if Mr.X returns, he can claim his money and that bank will have to pay him interest

also.

Chindu Agreed. Anything else

Yes one tea, two samosas and four more powers

1. If any person wants to buy more than 5% shares of any bank, he‘ll have to take permission from

me. And before giving him approval, I can put conditions on him, For example give me deposit

worth Rs.xyz, so if you play some mischief, I‟ll take away your deposit.

RBI 2. If primary cooperative societies want to continue their banking business, they‘ll have to get a

license from me.

3. I can conduct special audits of cooperative banks because they‘re more liable to collapse and

frauds.

4. If a bank fails to maintain the prescribed minimum amount of Cash Reserve Ratio (CRR) on any

day, I can demand penalty interest from that bank.

Chindu All agreed. Anything else.

RBI That‘s enough for now.

Chindu Ok then please leave my cabin and send the SBI chairman in. He too had an appointment with me.

Public Banks Issue#1: Need consolidation

Good morning Mr. Finance Minister. As you‘re aware, SBI is the largest public sector bank in

SBI chief India, we‘ve more than 11,000 branches. Yet if you make a list of top 5 biggest banks of the

world, our name doesn‘t figure.

Chindu Why is it so?

This is because too many small public banks exist in India. So, the ‗incoming-money‘ (from

SBI people to bank accounts) gets fragmented in so many bank branches. Finally, we don‘t have

enough cash, to expand in a big way.

Chindu Ok so what do you want from me?

. There is need for consolidation in the banking sector so India can have two to three large

public banks that can compete globally.

. For this, I need you to simplify Banking Companies Acquisition and Transfer of

SBI Undertakings Act.

. And to exclude bank mergers from the scrutiny of Competition Commission of India

(CCI).

. Bank mergers should need only approval of RBI.

Chindu Agreed.

PSU Banks Issue#2: Need more investment

Right now the Public Sector banks cannot issue shares worth more than Rs.3000 crores. I want you to SBI relax this, because We need lot of investment.

Ok agreed. You can issue more shares, including bonus shares and rights issue etc. (already

Chindu explained click me)But you‘ll have to take permission from Central Government + RBI if you want to

do it.

SBI Agreed.

Banks issue #3: More voting rights for investors

Before moving on, I must thank you for allowing us to issue bonus shares etc. But that alone will not SBI bring investment in public or private sector banks.

Chindu Why?

SBI . Because in shareholders‘ meetings, voting is done on many issues (for example election of board

of directors, changing name of company etc.).

. A shareholder should have voting rights proportional to the number of shares held by him.

. But in case of public banks, the shareholders have only 1% voting right irrespective of number

of shares held. So they cannot heavily influence any Decision.

. I need you relax these voting rights. Only then foreign investors will be attracted to invest in

Indian banks.

Chindu Agreed. We‘ll revise the voting rights.

Revised voting rights

Voting rights (%)

Bank Example Before After

Private sector HDFC, ICICI 10 26

Public sector SBI , PNB 1 10

Chindu Anything else.

SBI No this is all for now.

Then you may leave. But please send the chairman of Citibank in, he too had taken appointment and is Chindu waiting outside.

Foreign Banks Issue #1: Stampduty

Chindu Ok what can I do for you?

When I transfer my branches from the main company to the subsidiary company, I don‘t want to pay Citibank stamp duty. This should help me expand my business in India.

Chindu Agreed. Anything else.

Citibank Yes there is one more matter

Foreign Banks Issue #2: Want to invest in Commodity

. Right now, the Banks can trade in shares, bonds and currencies speculation but the Banking

Regulation Act forbids them from trading in commodities. Citibank . But we (foreign banks) see huge profit making opportunity in that sector.

. So we need you to amend Banking regulation Act, to allow the banks to invest in Commodities

market.

Chindu Agreed.

Standing Committee problem

. After a bill is introduced in parliament, it goes to the Standing Committee of Parliament for particular subject.

. for example Banking Regulation bill to Standing Committee on finance.

. They inspect the bill clause by clause, put forward their recommendations. And then voting is done.

. In case of Banking regulation bill, after the parliamentary Standing Committee on Finance put its report, Chindu added some new provisions in it.

. so opposition parties got angry “this wasn‟t part of the original bill, if you want to add new provisions, then this bill must be sent back to the Standing Committee for re-consideration”. Set: parliament In the parliament, Opposition members are shouting slogans. (as usual)

Meera Kumar says “beth jayiye, beth jayiye, kripyaa shaant ho jayiye.”(please sit down, please sit down, as usual)

Chindu What is the problem?

The share-market and mutual funds = regulated by SEBI.Similarly Commodity market= regulated by Oppn. Forward Market Commission (FMC)

Chindu So?

. So, if banks invest in commodity futures, it would lead to high-risk speculative trading,

especially with those Foreign banks.

. What if some investors loose money because of this?

. The Forward Markets Commission (FMC) doesn‘t have enough powers to safeguard

them. because

. 1) FMC doesn‘t have legal powers for compulsory registration of traders. Oppn. . 2) FMC doesn‘t have power to impose huge financial penalty.

. Parliament is yet to pass Forward Contract Regulation Act (FCRA) Amendment Bill, which aims

to empower FMC.

. And more importantly, you added the this Commodity provision in banking bill, after it was

reviewed by Standing Committee. So this bill must be sent back to standing Committee for

review.

No, no, no. if bill goes back to standing Committee, it‘ll take lot of time.Ok I back off, I remove this Chindu provision, so there is no need to send this bill back to standing Committee.

#1: Commodity speculation

#2: Competition Monitoring: RBI vs CCI

Friends, I also propose that only RBI‘s permission should be necessary for Bank mergers and Chindu acquisitions. Competition Commission of India should not play any role in it.

Not acceptable. Again this is new provision added after Standing Committee gave its report. So, Opposition send the bill back to Standing Committee.

No, no, no. if bill goes back to standing Committee, then it‘ll delay the implementation.Ok I back

Chindu off, I remove this provision.CCI will have the power to investigate and clear mergers and

acquisitions in the banking sector.

Lok sabha passed the bill. Rajya Sabha also passed the bill. Now this bill file will goto President. Once he signs it, this bill will become a “Law”.

Anti-Bill arguments In December, employees of public banks went on strike. (although SBI employees did not join the strike.)

The Bank unions give following Anti-Bill arguments:

. Government claims ―more banks = more branches = more poor people get banking facilities = financial inclusion‖. But it is mere lip service. Because new corporate banks/foreign banks won‘t have any interest in serving poor people.

. If mergers are allowed then rural branches will close down and/or rural banking operations will be outsourced via contractual business route.

. This type of ‗privatization‘ will negatively affect our job security and interests of those poor people.

. Statistics indicate that only 50 percent of people in India have bank accounts.

. The Centre should focus on educating rural people and cultivating banking habit among them instead of taking steps to merge banks or diluting voting rights.

. Merger of banks will de-stablise public sector banks, then corporate firms will start their own banks and gobble up public savings. And that money will be misused for the benefit of few corporate honchos and not for the general public. Although Chindu counters them saying “these banking reforms= new banks will be opened= more employment. (he expects 6,000 new bank branches and recruitment of 84,000 people next year.)

Critiques also argue that

. It seems the whole exercise is not a comprehensive banking reform but just firefighting because 1) Foreign banks and domestic players put pressure on FM to help them get bank licenses. 2) RBI blackmails FM to get more powers. 3) FM comes with banking regulation bill. Prime objective of this bill seems to help private players get new banking licenses.

. Government should further relax the voting rights otherwise, Government will keep abusing its majority shareholding to further its own political goals and election agendas.

. e.g. in 2008, public sector banks were asked to forgo farmers‘ loans (Debt Waiver scheme). Although Government promised to refund the loan-money to banks on behalf of farmers but it is not a good business practice. Summary

The Banking regulation bill, 2011 was passed in the Winter session of parliament in Dec.2012.

The salient features of the Banking regulation bill are (list not exhaustive)

1. RBI can inspect books of associate business arms of a bank. 2. RBI can supercede entire board of directors of a bank. 3. RBI can conduct special audits of cooperative banks. 4. Cooperative societies cannot carryout banking activities without license from RBI. 5. A ―Depositor Education and Awareness Fund to receive money from deposit accounts not operated for more than 10 years. 6. Increased the penalties and fines for violating Banking Regulation Act.

7. Public Banks can obtain more capital via bonus shares and rights issue. 8. Increases the voting rights of shareholders in Public and Private sector banks. 9. Prior approval of RBI necessary if a person wants to purchase more than 5% shares of a bank. 10. Banking Mergers and acquisition will fall under purview of CCI. 11. Bank will have to pay penalty interest rate, if it doesn‘t maintain CRR on daily basis. 12. Foreign banks exempted from stampduty payment for certain cases.

SARFAESI Act, Asset Reconstruction Company (ARC), Security Receipts (SR), QIB, DRT, Central Registry

What is NPA?

. Bank gives loan to a person.

. Person fails to make regular payments.

. Bank gives him notice to correct his behavior. But he doesn‘t.

. Bank declares that loan as Non-Performing Asset (NPA) (=Bad Loan)

. Currently Indian banks have NPAs worth more than Rs. 1 lakh crores. Debt Recovery tribunals?

. Prior to 90s, banks had very hard time recovering bad loans.

. Because often, borrowers (loan takers) would file frivolous cases in civil courts, then …taarikh pe taarikh, taarikh pe taarikh….. proceeding would go on for years.

. So 1993, Government established Debt Recovery Tribunals to deal with NPA matters.

. Now borrower cannot approach civil court, they‘ve to goto special Debt Recovery Tribunal (DRT).

. This led to some relief, but then DRTs clogged down by truckload of cases. (Even now, more than 60,000 cases pending with DRTs)

. In 2002, Government came up with new Act, named ―SARFAESI Act‖. What is the Sarfaesi Act?

. Securitisation

. and Reconstruction

. of Financial Assets

. and Enforcement of Security Interest Act, 2002,

Suppose, Mr.Paraajay has opened factory with Rs.100 crores. He financed this, via mixture of Debt + equity in following way. (make sure you understand debt vs Equity, if not click me)

Holder Rupees in Cr.

Paraajay and his family 20 Equity (IPO->Shares) Juntaa (public) 30

Debt (loans, Bonds) Business loan from SBI 40

Bonds 10

Total 100

. Initially the company runs well and good.

. But then Mr.Paraajay doesn‘t revise his MBA books often, so he forgets the business concepts. His company starts making losses.

. He fails to pay loan EMIs for many months.

. SBI gives him notice to correct his behavior.

. Still, he doesn‘t start paying money.

. SBI declares this Rs.40 crores loan NPA (Non-Performing Asset).

. Once a loan is declared as non-performing asset, SBI can take actions under SARFAESI act, to recover the loan money. Bank have following powers under SARFAESI Act

1. Take possession of Mr.Paraajay‘s assets without requiring court order. (Commericial or residential, fixed or moving assets.) 2. Auction / Sale them. 3. Change the administration/ Management of those assets. 4. If Mr.Paraajay had sold away the mortgaged asset to third party Mr.X, bank can order Mr.X to surrender that Asset. 5. If Mr.X owes money to Mr.Paraajay, he can be ordered to pay money.

. *ARCs explained after a few paragraphs.

. SARFAESI applies only to loans above Rs.10 lakhs.

. By the way SARFAESI applies only to those assets ―mortgaged/secured‖ to get the loan.

. E.g. if Mr.Paraajay had taken business-loan, SBI would have asked him to sign away his factory/machinary/vehicles/land etc. specific items as mortgage.

. Hence SBI can attach only ^those assets.

. But SBI cannot take away Paraajay‘s personal home-furniture, expensive wrist-watch or his son‘s bicycle in the name of SARFAESI.

. Similarly, Agricultural land is exempted from SARFAESI attachment. Appeal structure in SARFAESI ACt? The borrower (loan taker) has following options:

. Get a stay order from Debt Recoverty tribunal (DRT) against the auction/sale of his properties. (He cannot file case in Civil courts.)

. Fight the case in DRT.

. If unhappy with DRT verdict, he can appeal to Debt Recovery Appellate Tribunal (DRAT).

. But before filing appeal with DRAT, he‘ll have to deposit 50% of his pending loan money. Bank: Power to Auction

. First SBI contacts the experts, gets valuation of Mr.Paraajay‘s assets.

. Expert says “those assets are worth Rs.50 crores according to present market value of land/ building/ machinary whatever.”

. Then SBI will give advertisement in newspapers ―we are auctioning xyz land/machinary/building. Minimum bidding amount is Rs.50 crores. Whoever wishes to bid, send us application along with Rs.50,000 as deposit, and their class 10, 12 mark-sheets and school leaving certificates, duly attested by a Gazetted officer.‖

. Problem: sometimes, bidders donot take interest in buying such properties, factories etc.

. To fix this problem, Amendment bill of 2011, makes a new provision: if noone else comes to bid in the auction, Bank itself can buy that property.

Here comes the new problem:

. Suppose SBI attached a warehouse of Mr.Paraajay.

. If the land was in good urban area, SBI could open a new branch office there (or housing for its employees).

. But if plot/factory/house is in some remote area= useless for SBI‘s personal business.

. Under the Banking regulation Act, a bank cannot keep such immovable property beyond 7 years, (max 12 years with RBI‘s permission).

. So ultimately SBI will have to auction it to someone. What if they don‘t get better price? Critiques of the bill say, this is not clarified in the bill.

What is ARC?

. Asset reconstruction company (ARC).

. They buy NPA (Bad loans) from Banks and try to extract maximum money out of it=profit.

. They‘ve to register with Reserve Bank of India. Examples:

1. ARCIL (India‘s first and largest asset reconstruction company (ARC)) 2. Reliance Asset Reconstruction Company Limited by Anil Ambani

. In our example, SBI has NPA worth Rs.40 crores.

. ARC will buy the NPA file from SBI at a lower rate say 35 crores. (well, SBI is making loss, yes, but something is better than nothing.)

. Besides, banks have hundreads of bad loan cases, they donot have time or manpower to pursue individual case, sometimes no bidders are interested in auction. All the filework and donkey labour, In such cases, it‘s better for bank to transfer NPA to ARC.

. But that doesn‘t mean ARC will give 35 crores to the SBI from its own pocket!

. Then how will the Asset reconstruction company (ARC) arrange for the money?= via Security Reciepts. What are Security Reciepts (SR)?

. In above example, ARC needs Rs.35 crores to buy a Non performing asset from SBI.

. So ARC will issue ―security reciepts (SR)‖ worth Rs.35 crores.

. Only Qualified Institutional buyers (QIB) can buy these security reciepts (SR).

. SR are not ―bonds‖, they donot carry fixed interest rate.

. ARC will promise to pay money on SR, when it gets money the bad loan.

. Although, ARC usually promise 9% profit on ―security reciepts (SR)‖.

. So, three possible situations: 1. Qualified institutional buyers (QIB) buy those security reciepts (SR). So Rs.35 cr cash goes from QIB -> ARC -> SBI. 2. SBI itself recieves SR worth Rs.35 crores for free. (that means ARC will gradually pay the money to SBI). 3. combination of both: QIBs buy SR worth 30 crores + SBI recieves free SR worth 5 crores. What is Qualified Institutional Buyer (QIB)? These people have the expertise and the financial muscle to evaluate and invest in the capital markets.

Examples: (click on each to read previous articles on them)

1. Scheduled Commericial Banks 2. Foreign Institutional Investor 3. Mutual Funds 4. Venture Capital Investors

5. Insurance Companies 6. Pension/ Providend Funds Foreign investment in ARC

. ARC =buy bad loans from banks.

. ARC =arrange money from QIBs to buy bad loans from banks.

. Problem= Indian QIBs do not invest much in ARCs.

. Therefore ARC‘s capacity to buy NPA= very low.

. And bank themselves don‘t have enough expertize or manpower to dispose those NPAs quickly.

. Previously Foreign investors could invest only upto 49% in ARC=minority shareholder=cannot influence company decisions.

. Now, Government also increased foreign investment limit in ARCs. This would attract more investment in ARCs and help in quicker purchase and disposal of NPAs.

Foreign investment in ARC %

Earlier 49%

Now (December-24-2012) 74%

Anyways, back to the topic, let‟s recap:

1. SBI had NPA. First solution: auction the property. Did not work out. 2. Second solution: sell it to ARC. So, ARC purchased the NPA worth Rs.40 crores (at Rs.35 crores).

ARC‟s aim= extract maximum money out of this investment. But how?

1. Auction the assets fully or partially. (sell the machinary now, rent the building and wait for land prices to go up for two years and then sell it.) 2. Sell the property in combination with other NPA properties of other defaulters. (similar to ―buy one large pizza and get 20% discount on any medium sized pizzas‖). 3. Restructure the EMIs of Mr.Paraajay. E.g. instead of 1 lakh per month, give us 75,000 per month. 4. Change the Management of that asset, appoint its own directors/officers.

5. Order Mr.Paraajay to outsource or lease his business to a another company. ^SARFAESI act empowers ARC to do such things. The amendment Bill adds a new power to the ARC.

ARC New Power: convert Debt into equity Before reading further, Make sure you know the pros and cons of Debt Vs. Equity (else refer to Mrunal.org/ECONOMY)

The new Amendment in SARFAESI, empowers ARC to convert debt into equity.(fully or partially).

Shares Rupees Cr. %

Paraajay and his family 20 40%

Juntaa 30 60%

Total shares worth 50 100%

Share holding Before:

Share holding After

Shares Rupees Cr. Approx. %

Paraajay and his family 20 22%

Juntaa 30 33%

ARC 40* 44%

Total shares worth 90 100%

*that is the paper value of original debt (NPA loan of SBI to Mr.Parajaay), Otherwise ARC purchased it @Rs.35 crores.

Anyways, This leads to two situations:

1. If company starts making more profit in future, ARC will receive more share from that profit. (because more profit=more dividend to shareholders.) 2. If price of company‘s shares go up in the sharemarket, ARC can sell those shares to third party and make decent profit. Anti-arguments: Debt to Equity conversion Critiques says this “debt to equity”provision will be abused. This provision is made to help bad corporates. How so? Well consider following:

Bank’s loss

. SBI gave Rs.40 crores loan to Mr.Parajaay

. He refuses to pay loan=bad loan/NPA.

. Then SBI sells this bad loan file to an ARC company @Rs.35 crores.

. Hence, SBI‘s loss is 40-35=5 crores. (actually more than 5 crores, if we count the possible interest rate that he would have paid, if he had not defaulted. And loss figure will be different if he had paid a few installments earlier. Anyways, let‘s keep the loss at 5 crore for the moment.) ARC’s profit

. Now ARC owns the NPA assets. (their investment Rs 35 crores)

. Paraajay offers Rs.37 crores and ask ARC to sell the assets to his relative, friend or proxy.

. Hence, ARC‘s profit is 37-35=Rs.2 crores.

. And yet Mr.Parajaay successfully saved Rs.3 crores (because originally he had to pay Rs.40 crores to SBI, but he walked away by paying just Rs.37 crores!)

. Few years back, CVC had held a meeting with Bank chairmans and CBI officers. They alleged ^this type of mischief going on, in many loan default cases. Now under the new provision: if ARC converts its debt into equity (shares), then what will happen?

1. It is very unlikely that Parajaay‘s company will start making huge profits (otherwise it wouldn‘t be in bad loan problem in the first place!)

2. It is very unlikely that share-price of Parajaay‘s company will go up in sharemarket. (because it has negative publicity due to NPA). Hence it is very unlikely that ARC will make huge profit out of this “Equity”.

Then Mr.Parajaay can simply offer them a way out : “sell those shares to me, in my friend,relative,driver or peon‟s name @Rs.37 crores.” And ARC would agree, because 37-35=Rs.2 crores profit!

Side question

How would Mr.Parajaay arrange those Rs.37 crores?

Ans. If Mr.Parajaay is “totally awesome” then he wouldn‟t give 37 crores from his own pocket. He‟d just open another company, get new loan from second bank, issue IPOs to get money from juntaa. Then Iski topi uske sar pe. ^This is (one of the many) reasons why Mr.Ratan Tata said following thing:

. Overseas people go bankrupt or companies go bankrupt. Here they never do–they continue to be sick and still operate. Then they are operating to kill you with destructive competition (using predatory pricing etc.)

. (Airline business) is proliferated by many operators, some of them in financial trouble.

. I would hesitate to go into the (airline) sector today in the sense that the chances are that you would have a great deal of competition which would be unhealthy competition. Bank Employee unions are also against the “Debt to Equity” clause of SARFAESI amendment. (When they had gone on strike to oppose Banking Amendment bill, they also cited this Debt-equity reason as well.) Central Registry

. Previously, borrowers used to forged property documents and get loans from multiple banks by giving them duplicate property documents as security.

. So when borrower refuses to pay up loan, many banks would make claim for the same property!

. To fix this problem, Reserve Bank of India (RBI) setup Central Registry in 2011, under SARFAESI.

. This central registry has details of all properties against which loans have been taken.

. Any person or bank can inspect records of this registry to make sure the mortgaged property is genuine.

. Official name: Central Registry of Securitisation Asset Reconstruction and Security Interest of India (CERSAI) Misc.Amendments 1. In public interest, Union Government can issue notification that xyz provision of SARFAESI act may not apply or may apply with modifications to a class or classes of banks or financial institutions. Suppose many textile exporters have taken loans from banks but due to global recession they are not receiving payments and hence unable to repay loans. In that case, Government can order notification that “SARFAESI will apply to all loans except those given for textile-export business.” 2. Earlier a borrower could approach Debt Recovery tribunal (DRT) to get stay order against bank/ARC. New amendment says DRT cannot grant any stay order unless both parties (Borrower vs. lender bank) are heard. This will ensure the process of law is not misused by unscrupulous borrowers to get stay orders just to delay money- recovery. 3. Bill proposes to enable banks and financial institutions to enter into settlement or compromise with the borrower. It also seeks to empower the Debts Recovery Tribunal to pass an order acknowledging any such settlement or compromise. Summary

. SARFAESI empowers banks and other financial institutions to attach secured assets of a loan defaulter and sale, auction or manage them without requiring court intervention.

. Parliament passed the amendment to SARFAESI Act and the debt recovery tribunal, in Winter session 2012. Salient features of new amendment

. can buy for the NPA property if there are no other bidders.

1. Bank . multi-state co-operative banks can also take actions under

SARFAESI.

. can‘t get stay orders from DRT easily. 2. Borrower . Can make settlement / compromise with Bank/ARC.

3. Asset reconstruction companies (ARC) can convert their debt into equity (fully or partially)

can prohibit or modify SARFAESI‘s applicability in public 4. Government interest.

Apart from this amendment, Government has also increased foreign investment limit in ARCs from 49 to 74%.

Mock Questions Q1. Which of the following are Qualified Institutional buyers (QIB)?

1. ICICI 2. LIC 3. EPFO 4. FII registered with SEBI 1. Only 2 and 3 2. Only 1 and 4 3. Only 2 and 4 4. All of them. Q2. Which of the following is not correct about SARFAESI act?

1. It mandates the Rural regional banks to lend atleast 15% of their total loans to rural cottage industries. 2. It empowers banks to reduce their NPAs. 3. It empowers RBI to impose penalties on Bank responsible for NPAs. 1. Only 1 and 2 2. Only 2 and 3 3. Only 2 4. Only 1 and 3 Q3 Find Correct Statement

1. Foreign investment is prohibited in asset restructing companies.

2. To enjoy the priviledges under SARFAESI act, the Asset Reconstruction Companies have to get themselves registered with SEBI.

1. Only 1 2. Only 2 3. Both 4. None Boring details

1. Recovery of Debts Due to Banks and Financial Institutions Established Debt Recoverty tribunal (DRT)

Act of 1993 (RDBF) and

2. Securitisation and Reconstruction of Financial Assets and Helps banks recover money from bad loans. Enforcement of Security Interest Act of 2002 (SARFAESI)

Passed in Lok Sabha in Dec 2012, to amend 3. Enforcement of Security Interest and Recovery of Debts above two laws (RDBF + SARFAESI) Laws (Amendment) Bill, 2011

Committees SARFAESI was based on recommendation of these two Committees

1. Committee on Banking Sector Reforms (Narasimham Committee II), 1998 2. Restructuring of weak Public Sector Banks -Verma Committee.

Banking Business Correspondents Agents (BCA): Meaning, functions, Financial Inclusion, Swabhimaan, Common Service Centres (CSC)

What is financial inclusion?

. Give every poor man a bank account. And help him get a loan from banks. Financial inclusion involves

1. Give formal banking services to poor people in urban & rural areas. 2. Promote habit of money-savings, insurance, pension-investment among poor-people. 3. Help them get loans at reasonable rates from normal banks. So they don‘t become victims in the hands of local moneylender cum thugs.

. Lead banking scheme (LBS).

. RBI assigns a district to a particular bank. 1969 . That Bank will be responsible for promoting banking services and financial literacy, in that

district.(=financial inclusion).

. No frills account. 2005 . Poor people can open bank accounts with very low balance e.g. Rs.5 only.

2006 . Business Correspondents (BC) system. Discussed in this article.

Three important initiatives taken by RBI for financial inclusion:

Why Business Correspondents system?

. If Financial inclusion means ―open bank accounts for poor people.‖ Then what‘s the big deal, just open a damn account!

. Not so easy. India has around 6 lakh villages. Most of them don‘t have bank branches.

. Ok so Why can‘t banks open branches in every village? No profit

. Because Administrative costs will be high= Building rent, telephone, electricity, staff salary, security guards.

. On the other hand volume of business is very ―low‖ in village areas=amount of money deposited, loans taken.

. Means there is No profit. Actually it‘ll lead to heavy losses. Reluctant staff

. In many villages, there is no electricity, no good schools/drinking water, naxalite problem= Bank staff doesn‘t want to serve there.

. Therefore banks don‘t like to open branches below district HQ or Tehsil level. Now comes the problem Hardships faced by poors

. A poor man lives in remote village.

. This man has deposited some Rs.2000 in a bank @his tehsil.

. Now, He wants to take out some money from his bank account.

. So He‘ll have to make a trip for 10-20 kms =travel =time and cost.

. He is illiterate so he doesn‘t know how to fillup bank slips, other paperwork. He needs to ask for help here and there in the bank office.

. And most banks/post-offices don‘t treat poor people with respect or priority like they do with regular customers.

. So, he may have to wait for many hours, move from this table to that table, before he gets his money.

. = he cannot return to his village and do his daily job/work.

. = his one day‘s income is lost.

. Same process repeats, when this man wants loan to buy a new cow, pumpset, seeds or fertilizers.

. One the other hand, local money lenders in his village, give money quickly, without asking many questions or requiring him to fillup two dozen application forms. (but then they extract 36% compound interest from this poor man, thus making his life a living hell.)

1. Banks We can‘t open branches @every village, because it‘s not profitable.

We can‘t make trip to nearest town to access banking facilities, because it is 2. poor people inconvenient.

finally the problem emerges

So, what‟s the solution? How about a “middleman / agent” between banks and the poor people?

Who/What is Business correspondent?

. Business correspondents are bank representatives.

. They help villagers to open bank accounts.

. They help villagers in banking transactions. (deposit money, take money out of savings account, loans etc.)

. The Business Correspondent carries a mobile device.

. The villager gives his thumb impression or electronic signature, and get the money.

. Business Correspondents get commission from bank for every new account opened, every transection made via them, every loan-application processed etc.

8. farmers‘ clubs

1. Non-Governmental Organisations(NGOs) 9. Community based organisations

2. Self Help Groups (SHGs), 10. Cooperatives societies

3. Micro Finance Institutions (MFIs) 11. Village Knowledge Centres,

4. Post Offices 12. Agri Clinics/ Agri Business Centers,

5. Insurance agents 13. Krishi Vigyan Kendras

6. Panchayats 14. Khadi and Village Industries units

7. Civil Society Organisations (CSOs) 15. corporate entities with IT outlets in rural

parts.

Who can become Business correspondent for Banks?

Functions of Banking Business Correspondents? 1. Create awareness about savings. 2. Give advice to villagers, about how to save/invest money and how to arrange/manage loans. 3. Help the villagers to open bank accounts. 4. Collect loan applications, forward them to bank. 5. Preliminary processing of loan applications for example: verification of person‘s identity, home-address etc. 6. Help the Self Help Groups (SHG), to get loans. 7. Help the bank to collect EMIs and recover loan money. Swabhimaan

. Initiative by the Finance Ministry + Indian Banks‘ Association

. launched in 2011

. To bridge economic gap between rural and urban India. Objectives of Swabhimaan

. Make banking facilities available to every habitat with a population >2000 (by March 2012.)

. Banks will provide basic services like deposits, withdrawal, Kisan Credit Card (KCCs) etc via Business Correspondents (BCs) also known as Bank Saathi.

. Banks will also working together with the Unique Identification Authority of India (UIDAI) for opening new bank accounts.

. Government will send subsidies and social security benefits (pension etc.) directly to beneficiary‘s account.

. Beneficiary can withdraw the money from the Business Correspondents (BCs) in their village itself.

. Government has provided 500 million rupees to banks for taking these ^initiatives.(e.g. paying Commissions to Bank Saathi, their training cost, doing paperwork with UID.) Reforms in BC model Common BC

. Last year Finance ministry came up with this proposal:

. India be divided into 20 clusters.

. A common BC be appointed for all public sector banks operating in that geography.

. Such a move would improve the economics of the BC model. (otherwise so many BCs, fragmentation=nobody earning decent Commission=nobody improving the service delivery.)

. Reserve Bank of India (RBI) has permitted all business correspondents (BCs) working for one particular bank, to conduct business for other banks as well.

. FINO, India‘s largest Business Correspondents company

. FINO=Financial Inclusion Network and Operations (FINO).

. It is promoted by various Public and Private sector banks and insurance companies like LIC.

. Last year, FINO become the common Business Correspondents company for all public sector banks operating in Jharkhand.

Old system New system

1. A villager earns some cash under 1. All accounts will be maintained by core banking system.

MNREGA. 2. So, cash directly goes from Government > Bank >MNREGA

2. Government gives cash to bank. worker‘s bank account.

3. Bank gives it to B.C. 3. Villagers will have the freedom to make their withdrawals

4. B.C. deposits it into MNREGA from any BC they choose.

worker‘s account.

NREGA payment

Kiosk Banking

. The D.I.Y. (Do it yourself) banking services e.g. ATM, internet kiosks = still expensive.

. There is also lack of education + awareness in rural areas about such things.

. So even if Government /bank installs such automatic ATM, internet kiosks=> most of the time they just gather dust.

. Therefore, technology-based ‗self-service‘ model (e.g ATM, internet kiosks) is not useful at this stage.

. And hence we need Personnel (these Business Correspondents=middlemen). Because often villagers are illiterate, so they can‘t even fill up the forms for opening bank accounts or loan-application or filling the deposit slips etc. Business Correspondents are essential at this stage.

. But again problem: The cost per transaction remains high. (Because Bank has to pay commission to B.C.agent.)

. Therefore, Chindu has suggested following solution for long term:

. Migrate from banking correspondent model to Kiosk banking = mobile vans fitted with ATM machines+ biometric devices.

. They‘ll provide banking services in remote areas. BCA for Direct Cash Transfer?

. In November 2012, Mohan announced Direct Cash transfer scheme. (will be covered in detail, later)

. Anyways, under Direct Cash transfer scheme, Government will directly deposit payments, subsidies, scholarships, pensions etc into the beneficiary‘s bank account.

. Sounds well and good? Well, here is the big problem

. There are about six lakh villages in India.

. And despite all these financial inclusion initiatives (of FINMIN+RBI), still only ~75,000 villages have a bank branch or business correspondent agents (BCA). So for

the poor people in remaining ~525000 villages still face the problems we saw` in MNREGA payment withdrawl.

. So Direct Cash Transfer will be #EPICFAIL unless each and every village is covered under banking services.

. Therefore, recently Chindu asked the banks to have at least one bank branch or business correspondent agents (BCA) for every village or group of villages with 1,000 to 1,500 households.

. In the villages without BCA, Department of Electronics and Information Technology will install Common Service Centre (CSC).

. This CSCs will serve as the BCA.

. Right now, CSC will used only for opening new accounts of beneficiaries under the scheme for direct cash transfer.

. Only after banks install the software and complete other technical requirements for cash transactions, the CSC will allow villagers to withdraw cash from their accounts. Side note on CSC

. Common Services Centers scheme= started in 2006.

. Aim= set up of 100,000+ (one lakh) internet enabled centers in rural areas under the National e-Governance plan (NeGP) Mock questions Q1. Financial inclusion involves

1. Covering rural poors in banking net. 2. Covering urban poors in banking net. 3. Providing jobs to poor people. 4. Providing vocational training to poor people. 5. Spreading banking awareness among poor people. Ans.choices

1. Only 1, 3 and 5 2. Only 1,2 and 5 3. Only 3 and 4. 4. All of them Q2. Find incorrect statements about “Swabhimaan” scheme

1. It was launched by the Ministry of Social justice in 2009. 2. It aims to provide insurance coverage to laborers in unorganized sector. 3. It aims to provide financial inclusion to people residing in remote areas of India. Ans

1. Only 3 2. Only 1 and 2 3. Only 2 and 3 4. Only 1 and 3 Q3. Who among the following, is/are eligible to become Business correspondents for banks?

1. Post office 2. Panchayats 3. NGO and Insurance Agents 4. Self Help Groups (SHG) Ans

1. Only 1 and 2 2. Only 2 and 4 3. Only 2 and 3 4. All of them. Descriptive Questions 1. Swabhimaan (5m) 2. Swavalamban (5m) 3. Common Services Centers scheme (5m) 4. Write a note on National E-governance Plan (NeGP) (10m) 5. Define Financial inclusion. Discuss the initiatives taken to achieve financial inclusion. (15m) Interview 1. Apart from what is already being done, what new initiatives should be taken to achieve 100% financial inclusion?

Banking Ombudsman: Meaning, functions, appointment, reforms explained

From UPSC point of view, you don‟t need to memorize all minute details given in this article (they‟re provided for IBPS/SBI PO exam). What is Banking Ombudsman (BO)?

. He hears customers‘ complaints against banks.

. BO was first setup in UK.

. In India, RBI started this scheme in 1995. Appointment & Tenure

. Earlier RBI used to appoint reputed persons from banking, finance, management, legal etc. sectors as Banking Ombudsmen (BO).

. But now RBI has reserved this BO post for its own Chief General Managers and General Managers.

. Tenure: 3 years at a time.

. Reappointment: yes possible. Jurisdiction of Banking Ombudsman?

. Banking Ombudsman (BO) Scheme applies to whole of India (including Jammu and Kashmir). Banking Ombdusmen have jurisdiction over

1. All commercial banks (scheduled and non scheduled, public and private) 2. Regional rural banks 3. scheduled primary co-operative banks 4. NBFCs (BO‘s Jurisdiction limited to ―loan‖ part.)

. Banking Ombudsman is not a replacement of Consumer forum/courts. He merely supplements them.

. Banking Ombudsman deals with matters less than or equal to Rs.10 lakhs.

. Here are some examples situation where BO can help you: Regular banking

1. Demand draft, cheques, pay orders etc. not issued on time. (or not paid on time) 2. Credit card related complaints (e.g. bank putting hidden charges. Your credit card was stolen but bank did not disable it even after you called them.)

3. You asked the bank to close your account / credit card but they are not doing it. 4. Bank refuses to open your account without giving valid reasons. 5. Bank closes down your account without valid reasons. 6. Government / your company deposited salary / pension in your account but the bank is not releasing it on time. 7. Bank is taking out money from your account in pretext of some flimsy charges. 8. Branch office notice board says ―10.30 to 5‖ but staff refuses to provide you service after 3.30PM. 9. NRIs having bank account in India and facing problems about remittances etc. (e.g. he deposited money from America, but his parents are not given money on time.) Loans

1. Your loan application is not processed in time. 2. Your loan application is rejected without valid reasons. 3. You loan application is accepted but money is not released in time. (and still bank is charging interest on it!) 4. Bank doesn‘t follow RBI guidelines regarding loan-recovery agents (e.g. bank hires some criminals to bully and harass you.) 5. Bank doesn‘t follow RBI guidelines regarding loan interest rates. Procedure for getting justice?

. You‘re unhappy with the bank for xyz reason. But you cannot directly approach BO.

. First you‘ve to give written complaint to the concerned bank that ―I‘ve so and so problem.‖

. and IF the bank doesn‘t deal with your complaint within one month, then you can approach BO.

. On the other hand, you cannot approach BO if the matter is older than 1 year.

. You don‘t need lawyer to approach BO.

. You don‘t need to pay any fees/ stamp papers for approaching BO. You can’t approach BO in following situations

1. Matter is higher than Rs.10 lakh. 2. If the matter is pending before any other court, tribunal, forum then you cannot approach BO. 3. If any other court, tribunal, forum has already passed an order on the same matter.

4. You cannot approach BO for frivolous or vexatious complaints (e.g. AC or water cooler was off when I went to the branch. Someone jumped the queue but security guard did nothing….) How does BO settle complaint?

. Upon receiving your complaint, first Banking Ombudsman will try to solve the matter via settlement /arbitration (=try to achieve a compromise, conciliation or amicable solution between bank and its customer.)

. This has to be done within one month after receiving complaint.

. But if either party (customer/bank) is not accept this (compromise/negotiation/settlement) then after 1 month, Banking Ombudsman will have to pass ―order‖.

. Now, he‘ll ask both parties to present their case/documents etc. And he‘ll pass the order accordingly.

. Two things can happen 1. He rejects your complaint (=bank is not guilty). OR 2. He finds the bank guilty and orders punishment. Punishment

. Banking Ombudsman (BO) can order the Bank to compensate the actual money loss OR Rs.10 lakh (whichever is lower).

. In case of Credit card related cases, BO can order the bank to pay additional fines (upto Rs.1 lakh) for the mental harassment caused to the customer. Appellate authority for Banking Ombudsman

. If either party (Bank / Customer) is unhappy with Ombudsman‘s order, then they can approach the Appellate authority (=Deputy Governor of RBI.) 1. If you‘re the customer, you can directly approach him. 2. But if you‘re the ―Bank‖, then you can approach him only after getting permission from your Chairman/CMD/MD or CEO. (This ensures Bank‘s lower staff doesn‘t automatically go for frivolous appeals against every order). Reforms and Issues

. Banking Ombudsman scheme was originally started in 1995.

. But in subsequent years, RBI made many reforms in it, some of them are:

originally After reforms

Reputed persons from law, finance, Only RBI‘s own officers can become BO. (=outsiders not banking, Management, administration etc. can allowed for this post.) become BO.

Banks provided Money+Staff for RBI itself gives the money and staff to Ombudsman. Ombudsman‘s office in their area.

He only accepted paper complaints. Accepts Paper + online complaints.

– Regional Rural Banks put under jurisdiction of Ombudsman.

Ombudsman can look into internet-banking related – complaints.

Banks are required to display salient features of the scheme

– for common knowledge of public. (e.g. posters in the branch

office.)

Banking Ombudsman: Before and after reforms:

#1: Netbanking frauds

. According to RBI‘s scheme, Ombudsman can also look into internet banking related matters.

. But Ombudsmen across the country often wash away their hands and ask the victim to wait for police investigation to finish.

. And on the other hand, Banks donot take responsibility saying ―net banking frauds as most of them happen due to customers‘ negligence and cyber-crime.‖

. So ultimately customer has to depend on the police to get justice. #2: Need more BOs

. A Committee formed by RBI has recommended that instead of having only 15 Banking ombudsman across country, have one BO appointed for every bank.

. The upper limit (of Rs.10 lakh) should be increased.

Location of Offices

. Banking Ombudsman has total 15 offices throughout India

. Those who‘re preparing for IBPS/SBI PO should prepare this table for MCQs, others need not worry much.

1. A‘bad Gujarat + UT of Diu, Daman, Haveli

Karnataka. 2. Banglore

MP+Chattisgarh 3. Bhopal

4. Bhuvneshwar Odisha

HP+Punjab+part of Haryana 5. Chandigarh

TN+Andaman, Nico 6. Chennai

7. Guwahati All north Eastern states minus Sikkim

AP 8. Hyd.

Raj 9. Jaipur

10. Kanpur UP (some areas excluded though)

WB+Sikkim 11. Kolkata

Mah+Goa 12. Mumbai

13. Delhi Delhi+J&K+part of UP+Part of Haryana

Bihar+Jharkhand 14. Patna

Kerala+Lakshdweep+Puducherry 15. Thiruvanthapuram

Regional Offices of Banking Ombudsman

Mock questions Q1. Which of the following falls under the jurisdiction of Banking Ombudsman

1. Regional Rural Banks 2. Scheduled commercial banks 3. Non Scheduled primary co-operative banks Answer choice 1. Only 1 and 3 2. Only 2 and 3 3. Only 1 and 2 4. All of them. Q2. Find correct statements

1. BO is selected and appointed by Finance ministry. 2. BO‘s staff and office expenditure are charged on the consolidated fund of India. 1. Only 1 2. Only 2 3. Both 4. None Q3. Find incorrect statement

1. If the promises made by a sales agent, are not kept by the bank, you cannot approach BO. 2. If the matter involves loss of more than Rs.10 lakhs, you cannot approach BO. 3. The appellate authority for BO is High court of the concerned State. 4. There is one separate BO for Union Territories of India. Answer choices

1. Only 2 2. 2 and 4 3. 1,3 and 4 4. All of them.

Q4. Which of the following are included in the purview of BO?

1. Net banking 2. Credit cards 3. ATM cards 4. Harassment by Loan recovery agents Answer choices

1. Only 2 and 3 2. Only 1, 2 and 3 3. Only 2,3 and 4 4. All of them.

Monetary Policy Prologue

. Next article is about RBI appointed Urjit Patel Committee on Monetary policy framework.

. But before dwelling into that, we must recap the basic concepts of what is monetary policy: its tools and limitations. Otherwise Urjit won‘t make much sense.

. Hence in a way, this whole article is a prologue to next article. Why RBI and Why Monetary policy?

Initially people used barter system for trading. But the barter system had many problems (click me). Therefore, people switched to money system.

. Financial intermediates = middlemen who help in the circular flow of money between households and business firms.

. There are two types of financial intermediaries: banking institution and non-banking financial institutions.

. RBI controls (all) banks and (some) non-banking financial institutions.

. RBI‘s main job is to control Money supply in this game, and thereby fight inflation and deflation.

. Inflation = price rise = bad for economy, you know that by common sense.

But Deflation = price decrease = we can buy things at a lower price. Isn‟t that good? Why is deflation bad for economy?

. Ans. Every business has ‗fixed cost of production‘ say minimum light bill, phone bill, office rent, staff salary etc. So, if prices keep falling and falling (say of Nano car), then car marker will suffer losses. He has no motivation to expand business. He wants to cut down his production costs, by firing some of the employees= less new jobs created= unemployment = social unrest.

. If prices of everything fall- then custom duty, VAT, excise duty, service tax- their collection will also decrease. Then government has less money to spend on education, healthcare, social sector, defense, law and order = poverty, disease, crime. by the way

TERM meaning Does RBI want it?

DEFLATION fall in the prices (and fall IN employment.) No.

yes (while fighting DISINFLATION Fall in the prices but without causing unemployment. inflation)

stagnation + inflation

STAGFLATION No . prices and wages rise

. but people can‘t find jobs, companies can‘t find customers.

policy to stop the fall in price levels, but without causing rise in REFLATION yes the price levels (inflation).

What is monetary policy?

. Policy made by the central bank.

. To control money supply in the economy. (and thereby fight both inflation and deflation). RBI implements monetary policy using certain tools. Two types quantitative tool qualitative tools

Let‘s start from here.

Quantitative Tools #1: Reserve Ratios (SLR and CRR)

SLR A Bank has to set aside this much money into gold or RBI approved securities. 23%

A Bank has to set aside this much as reserve. Bank cannot lend it to anyone. Bank earns no CRR 4% interest rate or profit on this.

Reserve ratio: SLR, CRR

. Suppose economy is showing inflationary trend. Prices of all goods and services are increasing day by day.

. How can RBI stop it using Reserve ratio as a tool?

. In this case, RBI should RAISE the reserve ratios. Observe:

Right now

People deposited total this much money in SBI (net demand & TIME liabilities NDTL) 100 cr.

CRR (4%) [SBI has to keep this much cash aside for reserve] -4 cr

SLR (23%) [SBI has to invest this much money in RBI approved securities] -23 cr.

Money left with SBI 100-4-23=73 Cores.

Say RBI raises SRL to 40% and CRR to 15% then?

Originally 100 cr

SLR 40 -40

CRR 15 -15

Money left with SBI 45 cr.

You can see, when Rajan has raised reserve ratio, money with SBI is reduced (from 73 crores to just 45 crores.)

What will be its implication?

. Imagine you‘re a money lender. You‘ve 100 crore rupees and you must make Rs.1 crore profit in a year.

. Obviously, you should lend it @1% interest rate. (because 1% of 100 crore = 1 crore.)

. But what if you‘ve only 2 crore rupees, and you still want to make Rs.1 croer profit in a year?

. Now you must lend it @50% interest rate. (because 50% of 2 cores = 1 crore.)

. Observe that as money decreased (from 100 to 2), loan interest rate increased (from 1% to 50%). Same happens when SBI is left with less money (after RBI increases reserve ratio).

Let‟s prepare a flow chart.

Situation: Economy has inflationary trend. Prices of goods and services increasing every day. Solution: RBI raised reserve ratio (CRR, SLR) Result: SBI is left with less money to lend. Consequences: 1. SBI raises its loan interest rate 2. Businessmen borrow less money from SBI 3. Businessmen donot start new business. Donot expand existing business 4. Result=Less jobs. Even existing employees discharged. If anyone remains in the job, he doesn‘t get pay raise. He starts cutting down unnecessary expenditure (e.g. buying two newspapers, getting his shirts ironed, drinking tea @4PM in office and so on. Thus even paper-wall, dhobi, chai-walla- everyone‘s income reduced.) 5. Result= Less income (Because of above reasons)

6. Result= Less demand of goods and services (because less income). 7. Ultimately shopkeeper will bring down the prices to attract people into buying more things. Thus inflation is reduced.

You may doubt- what about supply side bottlenecks, what about cost push and demand pull inflation : I‟m not going into all that details at the moment, else this article will become longer than five kilometers.

Let‟s just prepare a summary table:

Policy dear money cheap money

Tool To fight inflation To fight deflation

Reserve Ratio (CRR, SLR) Increase them. Decrease them.

Moving to the next (Quantitative) tool. Under monetary policy

#2: Open Market Operation (OMO)

. Open Market Operation= when RBI starts buying/selling government securities to control money supply.

. Government securities= piece of paper. It says something like this ―give me Rs.100, I‘ll give you 8% interest rate for next ten years and after that I‘ll repay the principle of Rs.100.‖ This is how government borrows from others.

. Situation: Economy has inflationary trend. Prices of goods and services increasing every day.

. Solution: RBI starts selling government securities in open market.

. Result: SBI buys them and thus SBI‘s lending money is reduced. Wait. How? Imagine Rajan is selling “sabzi” (vegetables). If SBI‟s chairman Arundhati Madam goes to buy vegetables. Obviously madam‟s money will decrease when she buys vegetables.

Then same as usual:

1. SBI left with less money to lend. 2. SBI raises its loan interest rate (to keep profit margin same) 3. Businessmen borrow less money from SBI. 4. Businessmen donot start new business. Donot expand existing business 5. Less jobs 6. Less income 7. Less demand 8. Ultimately shopkeeper will bring down the prices to attract people into buying more things. Thus inflation is reduced.

During deflation, RBI will do the reverse. (i.e. RBI buys “Sabzi” from SBI). How will it stop deflation? Think in your head.

Let‟s update our table

Policy dear money cheap money

Tool To fight inflation To fight deflation

Reserve Ratio (CRR, SLR) Increase them. Decrease them.

Open Market Operation (OMO) RBI sell securities RBI buy securities

Mock Question

In 2013, UPSC walla asked a very chillar question from this topic.

In context of Indian Economy, „Open Market Operation‟ refers to

1. Borrowing by scheduled banks from RBI 2. Lending by commercial banks to industries and trade 3. Purchase and sale of government securities by the RBI 4. None of Above Whenever you face a GS/GK type MCQ, You‟ve three choices

Skip If you don‘t know the answer, Just leave it instead of risking negative mark.

Attempt Correct answer is Opt C.

It means you‘ve unsure of the answer. 50:50. So you mark the question number (say 45), at

Mark n Review. the back of your question paper. At the end of exam, if you‘re left with 10-15 free minutes.

You look at the question again, and try to solve it.

So, should you put above question in “mark n review”?

. No.

. Because it‘s a definition based question. If you don‘t know the definition of ―OMO‖ you might tick a wrong answer and fail. Most of the sincere players fail in prelims because of this reason. They push their luck in negative marking to overcome an ‗imaginary‘ cutoff and thus dig up their own grave. (especially during last 10-15 minutes of the exam.)

. Moral of the story: never put ―fact/definition‖ type MCQs in Mark-n-Review. Let‟s solve a bit more complicated MCQ from 2012′s CSAT paper.

Q.Which of the following measures would result in an increase in the money supply in economy?

1. Purchase of government securities from public by central bank 2. Deposit of currency in commercial banks by the public 3. Borrowing by government from the central bank. 4. Sale of government securities to the public by central bank. Answer choice 1. Only 1 2. 2 and 4 3. 1 and 3 4. 2, 3 and 4

Whenever you face such multiple statement type MCQs, always use “elimination method”. First find a statement that is definitely right or definitely wrong and eliminate choices accordingly.

. Focus on first statement ―Purchase of government securities from public by central bank‖: will it increase money supply in the system?

. Imagine Rajan puts an ad in newspaper: bring your Sabzi (vegetables), I‘ll buy it. Junta gives him their own veggies, Rajan gives them money. (a classic buy and sell).

. Ultimate result: money supply increased in the system- because junta got the money. Meaning #1 definitely correct.

. If you think it on technical terms. Central bank purchases government securities=OMO (Open market operation), where money shifts hands from RBI to people.

. Hence money supply increased. (In reality, money doesn‘t go to ‗aam admi‘ directly, but those bankers and non-banking institutions who participate in OMO). Anyways, #1 is right, Eliminate choices that do not have #1 1. Only 1 2. 2 and 4 3. 1 and 3 4. 2, 3 and 4 Now the final answer depends on whether statement #3 is right or wrong?

. Statement #3 says ―Borrowing by government from the central bank.‖ (So, will it increase money supply?)

. How does Government borrow from Central bank? Does Mohan just callup Rajan and demand 1 lakh crores? No. Mohan will have to give Rajan that much government securities (vegetables) and Rajan will give him cash.

. Is money supply increased? Yes Mohan sold veggies to Rajan and got Money. Whenever Rajan buys veggies and pays – the money supply is increased. (this is similar to Open Market operation)

. Besides, Mohan can then use money to pay salaries of government staff, pay for rail- road-bridges and other infrastructure projects, pay for MNREGA and so on. Therefore Answer C: 1 and 3 correct.

Counter- argument?

. What if Rajan subsequently sells those (Mohan‘s) securities to bankers. Then banker‘s money reduced. Hence #3 is wrong. Therefore final answer A only 1. So, what‟s the final answer: is it A or is it C?

Ultimate judge= UPSC‟s official answer key uploaded on their site.

In 2012′s Question paper Test series “A”, this is Q77: and its official answer is “C”. Therefore, both 1 and 3 are correct.

Anyways, what to do in the exam?

Skip If you don‘t know the concept better skip.

Attempt This question is attemptable if you don‘t drag the logic too much in statement #3.

Yes, it can be put under ―mark and review‖ because this is not an absolute fact/ absolute definition

Mark n type MCQ. If you apply some concepts, you can eliminate wrong choices. But still if doubt persists in

Review. the mind (e.g whether Statement 3 is right or not) then it‘s always safe to skip and avoid negative

marking.

By the way, What about Statement #2: Deposit of currency in commercial banks by the public. (Will it increase money supply or not?)

. Viewpoint 1: yes. Because bank can used it to expand loanable credit. (as explained in Money creation topic in Class 12 NCERT Macroeconomics page 39 onwards).

. Viewpoint 2: no. (Because Bank will have to put some money aside as CRR- so that much money is less in the system.) Either way it doesn‟t change the answer. Because We know that statement 1 is definitely correct. And there is no option where (1,2) are given simultaneously.

Anyways, Moving on…So far, RBI has two tools under monetary policy:

1. reserve ratios (SLR, CRR) 2. Open market operation.

Third and the most important “quantitative” tool is

#3: Policy Rate “Policy rate”= in case of India its Repo rate. Before moving further, let‟s refresh our concepts of Bank rate, LAF, MSF, Repo and Reverse repo.

Bank Rate

. When banks borrow long term funds from RBI. They‘ve to pay this much interest rate to RBI. [Note: different books give different explanation of Bank Rate. I've used NDTV's definition]

. At present, Bank rate= 9%

. Collateral: nothing. (Bank can borrow money without pledging government securities to RBI)

. Bank rate is not the main tool to control money supply these days.

. Nowadays, RBI uses LAF Repo rate as the main tool, to control money supply. Ok then What‟s the use of Bank rate?

. Penal rates are linked with Bank rate. For example, If a bank doesn‘t maintain CRR, SLR as per the prescribed limit.

. Then RBI can impose penalty interest on such notorious bank.

. At present, Penalty rate = Bank rate + 3% (or 5% in some cases)

. Meaning if Bank rate = 9% then penalty rate=9+3=12% Anyways, what if RBI wants to fight inflation using bank rate as a “tool”?

Obviously they should increase bank rate. That way it becomes harder (more expensive) for banks to borrow from RBI.=> SBI increases its loan rates (to keep the profit margin same). Result?

. Less people get home loan, bike loan, business loans.

. Less business expansion

. Less jobs

. Less incomes

. Less demand

. Ultimately shopkeeper will bring down the prices to attract people into buying more things.

Thus inflation is reduced.

Let‟s update our (stupid) table

Policy dear money cheap money

Tool To fight inflation To fight deflation

Reserve Ratio (CRR, SLR) Increase them. Decrease them.

Open Market Operation (OMO) RBI sell securities RBI buy securities

Bank rate Increase decrease

Liquidity Adjustment facility (LAF)

. Liquidity Adjustment facility

. RBI started this in 2000. You can imagine it as a ―Adda/gambling den/gang-hideout‖ where RBI‘s clients gather, consumer desi liquor, play cards, watch item songs and borrow money from RBI (or lend Money to RBI).

. By the way, who are the clients of RBI?= Central and state governments, Banks and non-banking financial institutions (NBFI). NBFI further includes:

. AIFI (all India finance institutions) NABARD, SIDBI, EXIM Bank and National Housing Bank.

. Primary dealers (Morgan Stanley , Goldman Sachs, JP Morgan Chase, Standard Chartered Bank, HSBC etc.)

. Non-Banking financial companies.

. Anyways, Under this LAF ―adda‖, RBI has two tools:

If client borrows money from RBI (for short term) then client has to pay this much interest rate to Repo RBI. At present Repo is 8%. (article written on 29th Jan 2014)

If client lends money to RBI (for short term) then RBI has to pay this much interest rate to client. RBI Reverse doesn‘t like headache. So they made a simple formula: Reverse repo rate= Repo MINUS 1%=8- Repo 1=7%.

Collateral:

. Problem with running a ―adda/gambling-den‖ = sometimes client drinks too much desi liquor and passes out on floor. Sometimes he even dies because of ‗hooch‘. Sometimes police raids the den, and clients run away with cash and register.

. If such things happen, Rajan will be at loss. So, he demands ―government securities‖ as collataral. So even if client doesn‘t repay money on time, Rajan can sell those securities (in open market operations) and recover money. LAF Repo Rate Let‟s get a bit technically correct now. Observe following image

Scenario

. SBI chairman Arundhati ma‘m wants to borrow Rs.100 crore (for short term).

. She gives her stash of government securities to Rajan.

. Rajan gives her Rs.100 crore.

. Madam Also signs an agreement

. ―I, Arundhati Bhattacharya, agree to buy same securities from Rajan, at 108 crores after 14 days.‖

. Notice that she has agreed to ―re-purchase‖ same securities from Rajan. Therefore its called ―Repo.‖

. And how much interest rate did she pay on this ―loan‖? [108-100]/100=8%. That‘s our repo rate.

. Important:

. Recall that SBI also has to keep part of her money in RBI approved securities (under SLR).

. So Madam cannot USE those government securities to borrow under Repo Rate from Rajan. That leads to a new topic

Marginal Standing facility (MSF) MSF mechanism is same as repo. But some differences

LAF (Repo) MSF

Rajan says ―don‘t come here unless you Minimum Rs. 1 crore. want to borrow minimum Rs.5 crores.‖

All clients are welcome i.e. . Sorry. Not all clients welcome here. . Central and state governments . Only scheduled commercial banks can borrow under this . Banks – be it commercial bank or window. SBI, PNB, BoB, ICICI etc. RRB or cooperative bank . This MSF facility is specially created to help them solve short- . Non-banking financial term cash mis-match. institutions.

You (bankers) cannot pledge securities from SLR quota to borrow from this Can use securities from SLR quota. window.

Maximum 2% of NTDL. To put this in crude words, if SBI received No limit. You may borrow as much as 100 crores from aam-admi under savings account, current account, you want. (as long as you have fixed deposit etc. then SBI can borrow only upto Rs.2 crores from government securities to pledge to me.) RBI.

MSF = Repo Rate +1% = 8+1=9%. (earlier this margin of 1% used to Rajan decides Repo rate (8% right now) be higher. But nowadays just 1%!)

66 for those who still have doubt about Repo vs MSF: for repo borrowing, bank will need to pledge securities to Rajan. But bank cannot use SLR-reserved securities for this. so, imagine if a bank is in dire need of cash, but doesn‟t have spare government securities- then they can borrow using MSF by pledging those SLR securities. (and under MSF window, Rajan will demand 1% higher than Repo as one type of „punishment‟ for pledging SLR securities.) Reverse repo Rate

. Although self-explanatory. But let‘s check

. Repo = clients borrow from Rajan and pay this much interest rate. (short term loan)

. Reverse repo= when Rajan himself borrows from clients, then he has to pay this much interest rate to clients.

. Collateral = yes. What if police raids this gambling-den, and Rajan runs away to Nepal? Clients can sell Rajan‘s Government securities and recover their money.

. Reverse repo = Repo MINUS 1% = 8-1% =7%.

. Note: in official parlance, they call percentages in ―basis points‖ so 1%=100 basis points. So in that ‗official language‘, Reverse repo = Repo MINUS 100 basis points. Enough cheap jokes. What have we learned so far?

. That Rajan controls money supply using monetary policy.

. Under Monetary policy, Rajan has various ―weapons‖ (or tools) 1. Reserve ratios (SLR, CRR) 2. OMO: Open market operation 3. Rates: Bank rate, LAF (Repo, Reverse repo), MSF. We already know how to apply SLR, CRR and OMO to fight inflation (and deflation.) let me paste the table again.

Policy dear money cheap money

Tool To fight inflation To fight deflation

Reserve Ratio (CRR, SLR) Increase them. Decrease them.

Open Market Operation RBI sell securities RBI buy securities (OMO)

Bank Rate increase it decrease it

Repo rate increase it decrease it

it‘s value is linked with Repo, hence cannot be increased/decreased Reverse Repo independently.

it‘s value is linked with Repo, hence cannot be increased/decreased Marginal Standing Facility independently. Besides MSF= temporary firefighting, cash mismanagement.

. We learned that Rajan doesn‘t use Bank rate much, to control money supply.

. We learned that Rajan doesn‘t decide Reverse repo and MSF. (they‘re automatically -1% and +1% of Repo rate).

. Thus the only thing Rajan has to decide under monetary policy= Repo rate. Therefore, Repo rate is called the ―policy rate‖ Let‟s revisit out flow chart:

. Situation: Economy has inflationary trend. Prices of goods and services increasing every day.

. Solution: Rajan increases ―Repo rate‖. (say from 7.75% to 8%).

. Result: it becomes expensive for SBI to borrow from Rajan. They‘ll increase their own rates as well.

. Wait. How? Just like how things roll in Onion biz.

If prices of Onion rise in Maharashtra‟s wholesale yard (in Lasangaon), then immediately, retail veggie @Ahmedabad will also raise their onion prices to keep the profit margin same.

What‟ll be the consequences (if repo rate is hiked / increased)?

Consequences: 1. SBI raises its loan interest rate (to keep profit margin same) 2. Businessmen borrow less money from SBI. 3. Businessmen donot start new business. Donot expand existing business. 4. Less jobs 5. Less income 6. Less demand 7. Ultimately shopkeeper will bring down the prices to attract people into buying more things. Thus inflation is reduced.

Policy dear money cheap money

Tool To fight inflation To fight deflation

Reserve Ratio (CRR, SLR) Increase them. Decrease them.

Open Market Operation (OMO) RBI sell securities RBI buy securities

Policy Rate (Repo Rate) Increase it Decrease it

Repo Rate in recent years: Let‟s observe with a graph: how RBI fought inflation/deflation in recent times using Repo rate as the “main-weapon” of monetary policy.

From above above graph, you can see RBI has frequently changed its repo rate to combat both inflationary and deflationary trend. But You‟d agree that inflation has not been contained. No matter what number juggling or statistical interpretations are given- the hardship of common man has not stopped- be it milk, petrol, onion, LPG anything.

. Agreed that prices of onion, sugar, pulses and food are subject to vagaries of monsoon and black marketeering. Rajan cannot do anything about it.

. Agreed that crude oil prices are subject to rupee-Dollar exchange rate, external factors and government‘s de-regulation of their prices. Rajan doesn‘t have much control over this. But still even in the non-food, non-fuel type commodities- RBI‟s monetary policies have failed to curb inflation. WHY? Observe the following image.

Suppose Vijay Mallay got 100 crore loan from State Bank of India. If you trace the „source‟ of that money, it‟ll turnout 60-70 crores came from bank‟s savings account, fixed deposit etc. Rajan lends money in repo rate –yes, but that doesn‟t mean banks depend only on Rajan to arrange the cash for its clients.

Suppose Rajan reduces repo rate from 8% to 5%. Banks are not legally required to reduce their loan interest rates.

. The current system is following:

. Banks are free to decide their base rate. E.g. SBI‘s base rate is 10%.

. It means SBI won‘t loan money to anyone at an interest rate lower than 10% (except those farmers under Interest subvention scheme.)

. SBI will link all of its loan products with Base rate. For example

SBI Base rate =10% Calculation Result

Car loan 0.75% above Base rate 10.75%

Two wheeler loan 8.25% above base rate 18.25%

Education loan (upto 4 lakh) 3.5% above base rate 13.5%

Home loan for women (upto 75 lakh) 0.10% above base rate 10.10%

Meaning if SBI changes her Base rate then all of above loan interest rates will change automatically.

If Rajan changes his repo rate, will SBI change her base rate? Not always.

. Because those common men are the main suppliers of money to SBI.

. RBI is not the main supplier of money to SBI.

. SBI will only change its base rate, when she feels necessary for its own profit / loss compared to its competitors. Does it mean Repo rate system is bogus and ineffective?

Not always.

. In developing countries like India, most people park their money in only four things: savings account, fixed deposit (FD), provident fund and LIC. We‘ve mutual funds, we‘ve NPS, we‘ve ULIPs, we‘ve Rajiv Gandhi equity savings scheme –

. but most people (particularly the older generation) feels insecure in into such new things. Therefore lot of money flows into Savings accounts and fixed deposits= SBI‘s main source of money.

. But, In advanced economies, like USA, people don‘t invest large portion their income in savings account or FD. They‘ve variety of investment options. So, for those American banks, their own Central bank (US Feds) is a significant money supplier.

. Hence US Feds‘ monetary policy shows faster impact on their American Banks, THAN Rajan‘s monetary policy on Desi banks. Monetary Policy: limitations In developing countries, Monetary fails to bring quick results because

1. People don‘t have many investment alternatives. Commercial banks have large deposits. Rajan is not the main or even prominent money supplier for these banks. Whatever Rajan does, its effect will be felt only after 6-8 months but by that time,

new factors would cause another rise in inflation and Rajan will have to start from scratch again. 2. Non-Monetized economy: in rural areas, many transactions are still of barter nature. (E.g. kiranawalla cum middleman supplies seeds, pesticides, fertilizers- in exchange of share in farmer‘s produce.) 3. Lack of financial inclusion. Since most people are not in the banking net. They rely on Shroffs and moneylenders. Many of them circulate the black money of cops and politicians, and charge 36% interest rate on loans. Rajan has no control over them. 4. Monsoon uncertainty, cyclone, flood, draughts and their effect on food production. Food inflation =>newspaper walla, washerman, barber, car mechanic everyone will raise their service fees to accommodate their raised cost of living. Rajan has no control over them. 5. Crude oil and gold import + negative effect when rupee weakens. Rajan can try to bring 1$=Rs.65 to $1=63 Rs. But he has not enough forex reserves to bring $1=Rs.50. 6. Fiscal deficit, illogical schemes. e.g MNREGA worker digs a temporary road. After first rain, t he road is wiped out= physical infrastructure added to economy… no. Wages raised…..yes. = this mismatch leads to more inflation. 7. Subsidy leakage, Black money, underground economy. 8. And most importantly, because Rajan uses Multi-indicator approach, he focuses on WPI (minus food and fuel). That‘s why Urjit Patel recommends him to target CPI. More on that in next article. So far, we learned that RBI has two sets of tools/instruments under monetary policy:

Quantitative tool Qualitative tools

1. Reserve ratios We‘ll see them in a moment 2. OMO

3. Policy rate (Repo Rate) Qualitative Tools

#1: Margin Requirements/ LTV

. Mallya wants to borrow from SBI. He pledges his company‘s shares worth Rs.100 crores as collateral.

. For such loans, Rajan can prescribe margin, say 65%.

. In that case even if Mallya pledges 100 crores worth shares, SBI can give him 100- 65=only 35 Crore rupees as loan.

. Using this tool, Rajan can control money supply. e.g. during inflation, he should increase margin requirement, so Mallya can borrow less=> less job=>less income=>less demand=>prices reduced.

. If Rajan changes repo rate, it is not compulsory for SBI to change her loan interest rates. (we saw how Alok Nath keeps giving money to SBI, so they are not entirely dependent on Rajan.)

. But if Rajan changes margin requirements, then SBI and all other banks must obey it. In other words, this tool has direct impact on money supply. #2: Consumer credit regulation

. Suppose Nano car sells @1 lakh and Rajan has made rule that downpayment cannot be less than 30%.

. It means customer must bring Rs.30,000 from his pocket and bank can only give him maximum 70000 as loan. How can Rajan fight inflation with this tool?

. Increase downpayment from 30%=>50% (meaning bank can give less loan. Customer himself has to arrange lot of money from his own pocket)

. Rajan can make rule ―banks cannot accept EMI less than 5000 on car loan.‖ Observe: Case #1: 100 EMIs worth 1000 each = 1,00,000. (ignore interest rates)

Case #2: 20 EMIs worth 5000 each=1,00,000. (ignore interest rates)

In case #2: some of the lower-middleclass families may postpone their decision to purchase nano car (Because they can‟t afford higher EMIs.)

. Result= less demand=>prices reduced. (indirectly- because car mechanics get less work, number-plate painters get less orders etc. so they reduce fees to attract new clients and retain existing clients.)

. Thus, Rajan can control money supply by changing downpayment and installment (EMI) rules. #3: Selective credit control

. Under this, Rajan can specifically instruct bankers not to give loans to traders of certain commodities e.g. sugar, gur, edible oil etc.

. even if the said trader is ready to mortgage his shares/bonds/factory/machine/vehicle anything.

. this prevents speculations/ hoarding of commodities using money borrowed from banks. #4: Moral Suasion Here Rajan tries to persuade the bankers to do xyz thing. Example

1. Please reduce giving automobile loans- instead park your money in government securities. (above the SLR requirements.) 2. I‘ve reduced my repo rate, now you also reduce your base rate. Rajan will try to influence those bankers via- direct meetings, conference, giving media statements, giving speeches @public seminars, university convocations etc. (even where bankers are not present.) He‟ll do so, to build a public opinion, media opinion and influence those bankers by making them feel „guilty‟.

. Found in Planned economies/communist nations.

. Here central bank will decide ―upper limit‖ to loans in each sector (heavy industries, service, Rationing agriculture, small-scale etc.) of credit . So once that ‗quota‘ is over. Additional loans cannot be given to that borrowers from that

sector. This also controls money supply.

Direct Means RBI gives punishment to erring banks. Punishment can involve: penal interest, refuses to action lend them money from LAF etc. and in worst case even cancels their banking license.

Let‟s recap

Monetary policy tools: Quantiative vs Qualitative

Quantitative Qualitative

1. Margin requirements / LTV

2. Consumer credit regulation 1. Reserve ratios (SLR, CRR) 3. Selective credit control 2. Open Market Operation 4. Moral Suasion 3. Policy rate (Repo Rate) 5. Rationing of Credit

6. Direct Action

Indirect in nature. (Even if Rajan changes repo rate, its not Direct in nature. (e.g. those margin necessary SBI will immediately change its base rate / loan interest requirements) rates.)

Selective- can affect money supply in a General- they affect money supply in entire economy- be it specific sector of economy e.g. housing, automobile, manufacturing- everything. automobile.

Let‟s solve an Official MCQ from UPSC 2012 Question paper

Q. RBI Acts as banker’s bank. This would imply which of the following? 1. Other banks retain their deposits with RBI 2. RBI lends funds to commercial banks in the times of need. 3. RBI advises commercial banks on monetary matters. Correct Statement

1. Only 2 and 3 2. Only 1 and 2 3. Only 1 and 3 4. 1, 2 and 3 Approach: Whenever you face such 3 statement MCQ or 4 statement MCQ, Always use “elimination” method. First you find out a statement that is definitely right or definitely wrong. In above case, we can see #2 is definitely right. RBI lends funds to banks in the times of need (Repo, MSF)

So let‟s eliminate choices that don‟t involve statement #2

1. Only 2 and 3 2. Only 1 and 2 3. Only 1 and 3 4. 1, 2 and 3

. This did not help much. We still have three choices left. Observe statement #1: Other banks retain their deposits with RBI. That is correct with respect to cash reserve ratio. CRR is one type of deposit that banks make to RBI. (RBI doesn‘t pay interest on it- that‘s a different story).

. Meaning #1 is also correct eliminate choices that donot have #1 1. Only 2 and 3 2. Only 1 and 2 3. Only 1 and 3 4. 1, 2 and 3 Only two choices left and the ultimate solution = is statement #3 is correct or not?

Viewpoint #1 Viewpoint #2

The statement says ―RBI advises commercial banks on monetary matters.‖The word ―advises‖ makes this statement incorrect. Because RBI does advice those banks. We

RBI doesn‘t ―Advice‖ they just order the banks- be it SLR, CRR, PSL. saw it under ―Moral Suasion.‖

RBI doesn‘t advice, RBI gives orders and direction. Therefore statement Therefore, Statement #3 is right.

#3 is wrong.

Money Banking and finance, E Even if we accept that RBI ―advices‖, still the questions asks what is Narayan Nadar (PHI publication). implied by ―RBI as Banker‘s bank.‖ So, RBI advices ―moral suasion‖ He has specifically listed this that is a monetary policy tool. RBI‘s not doing it as a ―Banker‖ to those ―Advice‖ function under Banker‘s banks. Therefore, Statement #3 is definitely wrong. bank topic.

Answer (B) Answer (D)

. So, is it B or is it D? Final judge is UPSC.

. They had uploaded CSAt-2012 official answer key on their site.

. This question is Test Series A, Question #75 and its official answer is ―D‖ = meaning all three statements are correct. If you face such MCQ in exam, what should be your approach?

Upto you. But if you start skipping all such question (OMO, Money supply, Banker‘s

bank), because you‘re completely unaware of those topics=that is not pardonable.it shows Skip you‘re underprepared for this exam. You should either change your study method or

change the game- try for some easier exam.

This question is attemptable, if you don‘t ‗nitpick‘ over the word ―advises‖ in third Attempt statement.

If you‘ve thoroughly prepared the RBI‘s monetary tools (both qualitative and

quantitative), you can solve it by applying concepts/principles- particularly the moral

Mark n Review suasion thing. But if you‘re still doubtful over whether #3 is right or wrong, then better

skip. If you skip because you‘re ‗doubtful‘ = that is pardonable. But if you skip because

you‘re completely unaware of this topic= non-bailable offense.

Appendix These are the topics I wanted to discuss in the article, but they would break the flow of other topics. Hence writing them @bottom:

#1: Why High SLR and High CRR are bad? From the discussion so far, you might think why Rajan only focuses on Repo rate to control money supply. Why not simply raise SLR and CRR requirements.

Let’s check the de-merits of high SLR and CRR: Prior to LPG reforms in 90s, RBI used to keep SLR and CRR very high. Let‟s take an example

A Bank can two types of deposits

Deposit type examples

Time Deposit Fixed deposit (FD) recurring deposit.

Demand Deposit Savings account, current account

. Using this money, bank has to count its Net Demand and Time liabilities (NDTL), every fortnight. Suppose its 100 crores.

. Both CRR and SLR are counted on this figure. In the old times, these reserve ratios used to be as high as 15% and 40% respectively. Observe the effect:

Net Demand and Time Liabilities (NDTL) +100 cr.

Reserve ratios

CRR (15%) (-) 15 [no profit]

SLR (40%) (-) 40 [some profit]

Money left with bank =45 cr.

From 100 crores, barely 45 crores left with the bank. But adding insult to the injury- even here RBI mandates Priority sector lending (PSL). Meaning, at least 40% of the loans has to be given to farmers, small businessmen, students etc. groups.

Let‟s update the table:

Net Demand and Time Liabilities (NDTL) +100 cr.

Reserve ratios

CRR (15%) (-) 15 [no profit]

SLR (40%) (-) 40 [some profit]

Money left with bank =45

PSL (40%) =45 x 0.4 =18 crore.

Money left for big borrowers (i.e. big businessmen, upper middleclass) =45-18=27 crores.

. By the way, PSL is counted on annual basis while SLR, CRR counted on fortnight basis so above table is technically incorrect but I‘ve plugged in those numbers only for the sake of explanation.

. before the 90s- Government would even interfere and order public sector banks to give PSL-loans @cheap interest rates. The local politicians would coerce the branch manager to give PSL-loans to ineligible people. They default on loans, Branch manager cannot recover money (because defaulter will goto civil court then taarikh pe taarikh.) So, bank would have to forget about most of those 18 crores given in PSL loans.

. Anyways you can see people deposited 100 crores in the bank yet bank is left with barely 27 crores (over which, bank has ―Freedom‖ to decide whom they should give the loan.) What are the consequences for businessmen?

1. High cost of credit (because bank will try to make maximum profit from those 27 crores- so bank will charge very high interest rate on the business loans- to pay off for the staff salaries, branch office rents and everything.) 2. Businessman cannot expand his business. 3. Less exports. 4. Less tax income for the government. So in a way- that was also one of the factors leading to Balance of Payment crisis (and subsequently LPG reforms.) You can read more about that in NCERT Class 11- chapter 2 and 3.

#2: Narsimhan (I) Committee 1991 Plagued by problems and losses in nationalized banks, Government of India formed this Committee.Recommendations were: 1. Deregulate interest rates. Let the banks decide their loan interest rates. Accepted. Gradually, we moved to the Base Rate system. 2. PSL loans should be given at normal interest rates. Accepted (but with exception=> interest subvention- that we saw under Nachiket articles.) 3. NPA/Loan default matter should be handled by separate body and not civil courts. Result: Debt recovery tribunal created in 1993. Ultimately SARFAESI Act in 2002. 4. Reduce CRR, SLR. Accepted. Today we‘ve them @4% and 23% respectively. 5. Allow Private banks and foreign banks. RBI invited applications in 1993. ICICI, Axis, HDFC and many others got license. 6. Liberate Branch expansion policy. Done (Except that 25% rural branching mandate we saw under Nachiket articles). 7. Prepare NBFC regulatory framework. Accepted. 8. Government should reduce shareholding (and thereby its official influence) in the public sector banks. Government agreed. Today government‘s shareholding in SBI =~60%. #3: Narsimhan (II) Committee 1998 Suggested more reforms.

1. allow VRS in the banks so they can get rid of excessive staff. 2. Suggested additional Legal reforms for loan recovery. =>SARFAESI 2002. 3. Computerization, electronic fund transfer, legal framework => Payment and Settlement Act=>Retail (ECS, NEFT, credit Card) + Wholesale (RTGS) 4. Permit new private /foreign banks. RBI invited license in 2001= Yes Bank and Kotak Mahindra got licenses. 2013: RBI again invited applications for bank licenses. [Note: list of recommendations not exhaustive, I‟ve only highlighted important topics that show „evolution‟ of banking sector in recent times.]

Mock Questions 1. With open market operations, RBI can 1. increase liquidity in the economy, but cannot decrease it 2. decrease liquidity in the economy, but cannot increase it

3. Can increase or decrease liquidity in the economy to control money supply. 4. None of above. 2. By which of the following methods, government can reduce money supply in the economy? 0. taxation 1. sale of securities to public 2. both A and B 3. neither A nor B 3. During the period of deflation 0. RBI should use dear money policy to combat it 1. Government should reduce its tax rates. 2. both A and B 3. Neither A nor B. 4. IF prices are lowered without causing unemployment, we call it: 0. stagflation 1. reflation 2. disflaction 3. Disinflation. 5. Which of the following contains correct set of quantitative instruments of monetary policy? 0. reserve ratio, bank rate, margin requirements 1. open market operations, margin requirements, regulation of consumer credit 2. cash reserve ratio, bank rate, open market operation 3. None of above 6. Which of the following contains correct set of qualitative instruments of monetary policy? 0. reserve ratio, bank rate, margin requirements 1. credit rationing, margin requirements, regulation of consumer credit 2. cash reserve ratio, bank rate, open market operation 3. None of above Q7. To counter the effect of deflation, which of the following steps should RBI initiate?

1. decrease reserve ratios 2. buy government securities through open market operation 3. increase policy rate Answer choices

1. only 1 and 2 2. only 2 and 3 3. only 1 and 3 4. 1, 2 and 3 Q8. To counter inflation, which of the following steps should RBI initiate? 1. Increase reserve ratios 2. sell government securities through open market operation 3. Increase policy rate Answer choices

1. only 1 and 2 2. only 2 and 3 3. only 1 and 3 4. 1, 2 and 3 Q9. Which of the following may cause deflation in the economy? 1. RBI raises policy rate 2. RBI raises cash reserve ratio 3. RBI sells securities Choices:

1. only 1 and 2 2. only 2 and 3 3. only 1 and 3 4. all 1,2 and 3 Q10. Money supply in the economy, is affected by 1. Cheap money policy and dear money policy. 2. Open market operation and Moral Suasion. 3. Consumer credit regulation and loan to value ratio.

Choices:

1. only 1 and 2 2. only 2 and 3 3. only 1 and 3 4. all 1, 2 and 3 Q11. An increase in SLR 1. will restrict the expansion of bank‘s credit 2. will increase bank‘s investment in safe securities 3. will ensure solvency of the banks choices:

1. only 1 and 2 2. only 2 and 3 3. only 1 and 3 4. all 1,2 and 3 Mains/interview type questions- after we check Urjit Patel‟s recommendations on strengthening monetary policy. Hints 1. can increase by buying, can decrease by selling 2. both [or only B, depending on how UPSC examiner interprets the effect of taxation on money supply. In one of the reputed book on Banking and finance, author Narayan Nadar claimed taxation can affect money supply.] 3. dear money policy during deflation =adds insult to the injury of businessman. If government reduces tax- then its revenue collection will drastically reduce. So both incorrect. [OR debatable- depending on how UPSC examiner interprets the effect of taxation during deflation.] 4. directly given in the article. 5. see the last table in the article 6. see the last table in the article 7. observe the table before the topic ―repo rate in recent years‖ 8. same as above 9. same as above

10. All correct. (Unless you nitpick and drag the logic too much.) 11. same as above.

Fiscal Policy, Spectrum, Subsidies, LPG and Banking Sector (Part 1 of 3)

Prologue

Overview of Economy related Affairs during 1-7 Feb 2014. Total three parts:

1. (you‘re here) Part 1 of 3: fiscal policy, macroeconomics issue, subsidies, banking sector. 2. Part 2 of 3: FDI, regulatory bodies and infrastructure. 3. Part 3 of 3: bilateral, poverty-hunger-HRD, Agriculture-food processing and Persons in News (PIN). [Act I] Government side: Fiscal Policy, Macroeconomics Topics: GDP, Fiscal deficit, Interim Budget, Subsidy raj, Spectrum auction and NELP X.

India’s bogus GDP growth rate

GDP growth rate : CSO calculation/estimates year

4.5% (earlier thought it‘d be 5%) 2012-13

4.9% 2013-14

CSO: other observations/analysis for FY13.

. GDP will be 1.7 trillion US dollars. important: DONOT confuse GDP (absolute number in rupees or dollars) vs GDP growth Rate (percentage)

. Per capita income will be ~75,500 rupees.

. >4% growth in Agro and allied sector

. Negative growth in Manufacturing, mining sector.

. Household savings have decreased. (Because of inflation, people are able to save less money.)

. Corporate savings have also decreased (meaning their profitability has decreased)

. gross fixed capital formation (GFCF) has also decreased. (Meaning less money going towards investment in business.)

. Cost of energy has increased. Because desi coal mining projects stalled by environment ministry and SC orders. As a result, we had to import ~25% of our coal requirements from abroad. + adding insult to injury, heavy floods in Australia last year= their own coal output delinked= coal prices increased. Solution

. @Government: Fast track clearance to infra-projects; decrease the excist duty; relax the strict environment rules over coal mining

. @RBI: Reduce the cost of borrowing (=decrease Repo rate); relax the rules for ECB (External commercial borrowing from foreign countries) Fiscal deficit 4.8% target = Mission impossible #6? What is fiscal deficit, why is it bad? We just saw in last article of Urjit Patel Committee. Click me

Year Fiscal deficit as % of GDP

FY2012 4.9%

FY2013 Target 4.8% (this mean nearly 5.4 lakh crore rupees)

. Why in news? Because we‘ve already reached 95% of the limit in till December 2013.

. Who calculated? Controller General of Account. (and not CAG). Is it good or is it bad?

. Imagine you‘ve fixed a target ―I‘ll try to contain my household Expenditure to Rs.1 lakh for the FY13.‖ but you already spent Rs.95000 so far.

. Then, for Jan, Feb, March= you can spend only Rs.5000 [if you want to stay within the target.] This is difficult especially during election year- subsidy bonanzas. Why fiscal deficit is problem?

. Even now, India‘s fiscal deficit = highest among BRICS [Brazil, Rus, India, China and S.Africa]

. If we cannot keep the 4.8% target, then S&P, Moody etc. will definitely cut down our rating to junk level=less FDI, FII= high CAD =weak rupee= inflation, and more economic problems. Can we keep with 4.8% target? Is it possible?

Possible (because of this incoming Not possible (because of these outgoing money) money)

. LPG subsidized cylinders increased

. LPG distribution policy changed

. Fertilize subsidy to be increased . Income from Spectrum auction . Interest subvention for Women SHG. (>55k crores) . NELP X(10) postponed (=money not coming) . Dividend from Coal India (~15k . In fact food-fuel-fertilizer subsidy alone costs near 3 trillion crores) rupees for FY13 [our target was to keep it less than 2.3 trillion] . Government decided to postpone . Government wanted to sell shares of a PSU called ―Engineers the purchase of Rafael jets (~60k India ltd.‖ but investors did not pay sufficient price for chillar crore saved, for now.) company. (=less income than expected)

. Gold import duty =10%; =>smuggling, government lost

Revenue worth Rs.1 billion. (=less income than expected) G-Sec auction cancelled

. When government wants to borrow money, they release government securities (g- sec), with help of RBI.

. Government was planning to borrow 15k crore rupees, through this. But Spectrum- 2014 auction and selling the shares of Engineers India ltd. = Government has got sufficient money, for now. Hence decided to postpone the G-sec auction. CAD & gold

>88 Billion USD = rupee starts weakening against dollar.

FY12 . To reduce this deficit, Chindu increased gold import duty to 10%.

. RBI also imposed various restrictions on gold imports.

FY13 (expected) <50 Billion USD. Chindu says I‘ll think about reducing gold duty after March 2014.

. FY13: 200 tonnes of gold came in through the black market. Government has lost ~$1 billion (6,200 crore) worth taxes because of this smuggling.

. Government raised import duty on gold from 8% to 10%. (mind it: import duty, NOT excise duty).

. Reserve Bank of India made it mandatory for jewelers to export 20 per cent of their gold jewelry before placing orders for fresh gold imports. (also known as 80:20 rule) Related topic FATF: Desi Diamonds = Money laundering

. FATF= Financial Action Task Force (HQ : Paris)

. inter-governmental body to fight money laundering.

. Their latest report says Indian diamond trade is used for money laundering. How? The agents will overvalue the prices of low quality diamonds

Incoming diamonds Outgoing diamonds

. Low quality diamond from Africa=>UAE=>Indian Indian trader will export low quality diamond businessman deliberately pays higher price.=>his (or @high prices=>foreigner sends more someone else‘s) black money goes from India to UAE money=>black money comes back. => sent to then its invested in UAE/Swiz. Etc. ―original‖ owner, via hawala operators. . Money sent to Hong Kong and China also in the same

way.

. Even terrorist financing is done via such overvaluation of bogus diamonds. After all UAE=>Paki=>Dawood & Co.

. By the way, if diamonds are super-high quality then trades don‘t import it officially (else they‘ve to pay high taxes). In case of high quality diamonds, they‘re smuggled through Belgium. Anyways, this is just an overview, you should prepare it in detail for GS Mains Paper 3 topic ” money-laundering and its prevention.” Back to our original topic of fiscal policy cum firefighting cum subsidy-raj (=Chindunomics)

Interim budget/Vote on Account? I‟ve published separate article on interim budget – click me Interim budget in past

Year FM What did he do? Budget speech

Gave quite a few schemes and tax-benefits. (Despite the fact 2004 Yashwant 12 page that it was a ‗vote‘ on account.)

Did not announce any new taxes or schemes. (perhaps because 2009 Pranab 18 page he was confident that UPA will be re-elected).

Most likely he‘ll announce some schemes/tax-benefits (with last ?? Bookies are taking 2014 Chindu hopes of winning some vote bank.). bets on how long it‘ll be!

Experts believe, Interim budget 2014, will contain following

1. Government will allot more money to certain schemes (NREGA, pension etc.) 2. reduce excise duties on certain consumer goods, automobiles etc. 3. May announce some disinvestment of shares from PSU (to get more money for allotting to schemes) 4. Announce some tax benefits. Previously excise duty exemption given to the industry in states such as Himachal Pradesh and J&K. They‘ll expire in May 2014. FM will renew them in Interim budget. = more job creation (or at least congress can make claim in election speeches). Important:

. Changes in indirect tax rates don‘t require Parliament‘s assent (Government only needs to notify and place before Parliament).

. Changes in Direct tax = need parliament‘s assent. [Subsidy] LPG: nau se baara (9 to 12)

LPG Price Who decides? 2012 2013 2014 Cylinder

Every connection holder

Subsidized 400+ Oil Ministry. gets 6 subsidized LPG 9 12

cylinders per year

. PSU oil companies. You‘ll have to . 1st of every month. buy additional Non- . They use formula of 1200+ cylinders subsidized Average imported cost @this market and rupee dollar rate priceprice. during last month.

Subsidy payment initially 2013 After Rahulbaba (2014)

Government would pay the Government would pay subsidy to Cancelled DBT plan. Meaning, subsidy directly to Public sector beneficiary‘s bank account via DBT subsidy will be paid to those PSU

Oil marketing companies. (Direct benefit transfer) oil companies.**

Direct Benefit transfer (LPG)

. Started in 2013, in selected districts

. Government would transfer 435 rupees in beneficiary‘s account, then he‘ll have to purchase cylinder @market rate.

. >2k crore transferred to 60+ million consumers this way. Problems / Challenges in DBT for LPG

. To enlist in this scheme, you‘ve to link three things (your Aadhar number-LPG connection number-Bank account number)

. Problem= not everyone has aadhar number, not everyone has bank account number (Census 2011: only 54% rural and 67% urban families have bank accounts]

. Supreme court said Aadhar card is not mandatory to claim benefits under government schemes. **given above reasons, government has postponed the DBT plan in LPG.

But Oil minister Moily is not accepting the #EPICFAIL of DBT, he says “We are quiet proud and happy that this programme has gone on very well. Even if there is a marginal error, we need to correct it.” Critiques: why 12 subsidized LPG cylinders= bad idea sir-ji?

. 89% families can survive with 9 cylinders per year. Only very big families need 12 cylinders. So if you give 12 cylinders= you‘re covering almost 97% of the families.

. Subsidy money doesn‘t fall from sky, you arrange money through direct/indirect taxes on the same families.

. So in a way, you first collect taxes from those 97% families and then give them subsidized LPG= idiotic. Let the juntaa themselves purchase it @market rate (after all they‘re indirectly paying for the subsidy through taxes)

. This will increase black marketing activity [diverting household cylinders to restaurants, because most families can survive on 9 cylinders, they'll sell away those three additional cylinders to restaurants, chai-walla.]

. You‘ve cancelled DBT plan= more black marketing and leakage.

. Imprudent consumption [because government giving subsidy, so people don't try to save / use LPG consciously.]

FY13 Rs. (Crores)

Oil subsidy >1.5 lakh crores

Out of ^that, LPG subsidy 40k [+5k because of 3 extra-cylinders]

DBT could have saved subsidy leakage worth Rs.60k crore [but now Government cancelled DBT for LPG]

Government also started DBT scheme f or Kerosene subsidy, But it‟s in pilot stage in a few district.

[Allocation] CNG reduced by Rs.15 per kg: how and Why?

DONOT confuse this topic with 9 to 12 LPG cylinders.

Background:

. Government had ordered gas companies to allot only 80% of domestic gas for ―retail‖ purpose (City gas entities- CNG stations, cooking gas pipeline companies).

. Remaining 20% exclusive for industrial purpose.

. As a result, many cities had to rely on imported CNG, LNG = prices expensive.

Mumbai Got all its gas supply from domestic field.

Not all of their requirements met to desi gas.They had to rely on imported gas ―regasified-liquid Delhi, natural gas (RLNG)‖This RLNG cost 4x times more then desi LNG. That‘s why CNG, pipeline Ahmedabad cooking gas was expensive all these years.

For example, Delhi‟s Indraprastha Gas supplies arranges 80% LNP+PNG from desi source and 20% from abroad.

After Kejirwal went to SC

. Delhi Government (Kejriwal) goes to SC against this above policy.

. UPA doesn‘t want negative publicity in election year therefore, Oil ministry has made new rule: from domestic gas fields, 100% allocation to city gas entities. Result?

Cheaper by Rs./kg

CNG 15

Piped cooking gas 5

So, is it good/bad?

. Observe that desi-gas allocation to ‗retail‘ sector has increased from 80%=>100%,

. where does the 20% gas come? Government arranged this by cutting the gas supply to petrochemicals, steel and refineries. (meaning those companies will have to buy

gas @market prices=> their input cost increases=> in long term this will lead to inflation in many products, declined in IIP and GDP.) By the way

Gas source Pricing mechanism

Domestic gas administered pricing mechanism (APM).

Imported gas Rangarajan formula

Related topic

Rafael jets=purchase delayed (kyoki apni hesiyat nahi)

. We decide to buy 126 Rafael fighter jets from a French company Dassault. 2012 . Cost: ~60k crore rupees.

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. They‘re MMRCA= medium multi-role combat aircraft

. Negotiations start.

. Defense Minister says we don’t have enough ca$H at the moment for FY13 (ends @31st March

2014). 2014 . If we borrow money to buy these planes then fiscal deficit target will not be achieved (4.8% of

GDP)

. So, we Will have to postpone this purchase- perhaps to FY15. [FDI] Environment clearances

. Old story, Needs a separate elaborate article. Just an overview.

. December 2013: Moily becomes Environment minister. But he simultaneously holding charge a petroleum minister.= one is pollution controlling ministry, one is pollution creating ministry. = incompatible jobs. Should be done by two separate ministers.

. Moily giving fast clearances = to attract investors, improve IIP and show that he is also ―pro-business‖ like Modi.

POSCO S.Korean company. Steel plant. $12bn USD. Odisha. cleared

bauxite mining project in in the Niyamgiri hills of Odisha Vedanta Not cleared Moily Says local gram sabhas are opposed to it, so I can‘t approve.

Tawang Arunanchal Pradesh Cleared

Ennore Coal based powerplant, TN cleared

Chennai Petroleum pipeline cleared

Teesta Sikkim hydroelectricity project. (NHPC) cleared

Coal Mines Allowed some of them to increase output without requiring new permissions. Cleared.

Hinduja Coal power station @Vishakhapatnam, Andhra Cleared

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[FDI] flows in last eight months (from highest to lowest) sector From country

. Service sector . Mauritius**

. Automobile . Singapore

. Construction . UK

. Chemical . Netherlands

** it doesn‟t mean Mauritian people are very rich. These investors are mostly American/European tycoons who setup post-office companies in Mauritius to get tax benefits. [Recall Vodafone/Hutch controversy.]

[FDI] declined in India: says UNCTAD

UN Conference on Trade and Development (UNCTAD) report.

FDI destinations:

Year India‘s position

2012 15

2013 16 (meaning incoming FDI has declined.)

[Act IV] Regulatory bodies (Truckload of) #1: DGH: need statutory status Directorate General of Hydrocarbons (DGH).

Present status What Finance ministry wants

Should be given Statutory status. Because DGH implements New Exploraton DGH falls under Oil Licensing Policy (NELP), matters related to Production Sharing Contracts for oil Ministry. exploration fields etc. = it must have autonomous status.

funded by the Oil Should get ca$h from consolidated fund of India (from Budget). Industry Development

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Board (OIDB)

Top officer from

ONGC and Oil India, No, should have independent staff. get posted here.

Not under direct CAG No. Once DGH starts getting funds from budget, then CAG will audit it. audit.

By the way, what‟s the situation in other bodies? Where do they arrange cash?

SEBI,

IRDA, Charge fees on the licensees.

FMC

Gets funding from government.

TRAI TRAI wants commission from the spectrum licensing, but government doesn‘t agree to share the maal.

It‘s the central bank. Central Banks earn money from ―seigniorage‖. We learned about it in RBI Nachiket Committee article.Click me+ income through OMO, repo, MSF, license fees.

#2: PNGRB- koi hum ko bhi puchho yaar It is a statutory body setup under Petroleum and Natural Gas Regulatory Board (PNGRB) Act 2006.

You need to get its permission before setting up city gas distribution network (cooking gas lines, CNG station).

. GAIL wants to setup its own CNG gas stations 2013 . Oil Ministry says, ok go ahead, you don‘t need permission from PNGRB to setup CNG stations in

cities.

2014 Oil Ministry makes a U-turn. Tells GAIL to get permission from PNGRB.

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#3: Civil Aviation Authority= no country for non-IAS

. Statutory body.

. Problem: this boss (DG) is mostly a serving/retired IAS => CAA has become an inefficient bureaucratic organization. = lazy approach => USA downgraded India‘s aviation safety rating.

. Now Ministry of Civil aviation proposing a bill, to ensure only professional person is appointed as DG. (and not some serving/retired IAS). And he must be given security of 3 years‘ tenure.

. Problem: cabinet not clearing this bill. #4: Rail fare regulator: I’m Useless without statutory status

. Cross subsidization = railway sells passenger tickets cheap (=~25k crore loss per year), but recovers that loss by keeping freight charges high. (=‖ticket‖ prices for transporting non-human things cements,coal etc.)

. Result= not making optimum profits. Bogus food, bogus toilets, bogus security.

. Government finally notified to setup a new Rail Tarrif authority. (Feb 2014)

. It‘ll suggest pricing in such way that railway generates healthy profit.

. Problem=Executive body. Recommendations not binding to rail ministry.

. If you want to make it statutory body, then need to amend Railway act ‘89 = but that‘s unlikely in the current budget session. #5: Desi Drug regulator: I want Firangi powers despite staff shortage

. USA has FDA (Food and drug administration)

. Similarly India has CDSCO- Central Drugs Standard Control Organization

. CDSCO‘s boss is called ―Drugs Controller General of India‖. (DGCI)

. CDSCO Falls under Ministry of Health (mind it: Drugs/Pharmaceutical falls under Chemical ministry) Anyways, why in News?

. USFDA even monitors the desi-plants of desi pharma companies (e.g they banned Ranbaxy‘s Toansa (Punjab) plant from manufacturing medical products for the US market.

. So CDSCO feeling envy, ―we also want similar powers‖ – to inspect the foreign plants of foreign companies- who supply drugs to India.

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. Problem: CDSCO doesn‘t even have enough staff to supervise desi drug companies. They asked Union government to increase budget – so we can hire 5000 more people. But no positive response. After all funding to drug supervision =not as important as MNREGA. #6: 14th Finance Commission: homework abhi baaki hai

. Constitutional body, setup in Jan 2013.

. Boss = Ex RBI governor Governor YV Reddy

. His recommendations will be effective from 1/5/2015, for a period of five years

. Apart from the usual terms of reference, 14th FC also has to make recommendations about: 1. Pricing of public utilities such as electricity and water in an independent manner 2. issues like disinvestment, GST and subsidies. Why in News

. It was to submit report by 31/10/2014.

. But things are moving slow, Finance commission will take long time to meet all state government and process the data and demands. + issue related to compensation to Seemandhra from mega Polavaram project from Telangana and so on.

. Finance commission is seeking an extension of 3 months (i..e up to Jan 2015)

. This is not the first time in history though. 13th FC (under Kelkar) they also submitted their report in December 2009 (instead of original deadline in Oct 2009) #7: 7th Central Pay commission

. Chief= Justice Ashok Kumar Mathur

. Member= Vivek Rae full time (IAS) + Rathin Roy part time (economist) + Meena Agarwal (Secretary, IRAS)

. Target audience= 50 lakh Central government employees, including the Railways and Defense. +30 lakh pensioners.

. Deadline= submit report in two years.

. Implemented from January 1, 2016. [6th PC's recommendations from January 1, 2006.]

. Criticism:

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. 6th PC cost us more than 20k crore rupees= fiscal deficit + and blamed to be one of the factors for inflation (Because money increased in babu-log‘s hands without subsequent increase in their productivity.)

. Timing before the general election. #8: EPFO- I want to stay in news everyday

. From aspirant‘s point of view, EPFO= most bogus of all public entities. Because they create new current affairs on almost daily basis – or just keep coming in news for no reason.

. Anyways what did they do in Feb. 2014, first week?

. For anyone earning upto Rs.15000 = EPF contribution is must. = this will enroll 50 lakh more employees in the EPFO game.

. Minimum Rs.1000 pension to retired people.

. (did not implement) minimum age to get pension: raise from 58 to 60 years. #9: IRDA- I also want to stay in news every day

. Just like EPFO, ye IRDA walla also keep doing something new every day to stay in the news. Anyways why in news? 1. Broker model for Bancassurance (already covered in past article. click me) 2. Allowed common service centres (CSCs) to sell life insurance products. CSC are setup under National e-governance plan. 3. Norms/guidelines for Micro-insurance products (for rural/poor people). Allowed RRB, Coop. Banks, SHG, Banking BCA etc to sell such micro-insurance products. 4. Asked companies to general insurance companies should increase their focus on agricultural insurance, disaster Management products. [Act V] Infrastructure related Important fact: that the 12th plan envisages $1 trillion for infra development GS3 (Mains): Infrastructure: Energy, Ports, Roads, Airports, Railways etc. Let‟s check communication spectrum auction

Energy NELP, LPG, Electricity = given in part1 airport aviation safety sucks =given in part 3

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Railways FDI given above, Monorail given below

#1: Monorail @Mumbai Monorail runs on a single rail. This rail may be located either above or beneath the railway cars. Observe the photo

. Mumbai Monorail was setup by Mumbai Metropolitan Region Development Authority (MMRDA) + L&T Engineering.

. None of our neighboring countries have Monorail (except China).

. First phase: ~9km from shootout @Wadala to Chembur.

. Minimum fare: Rs.5 When entire project is completed:

. it‘ll have ~19km length.

. 7000 passengers per hour

. Cost: Rs. 3000 crores

Ranking Monorail in

1 Osaka, Japan

2 Mumbai, India (when entire project completed)

3 Tama, (Tokyo), Japan

4 Kuala Lumpur

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#2: Metro @Mumbai BOT Problem

. Being developed by Anil Ambani‘s Reliance infra

. PPP Project under BOT model (build–operate–transfer).

. But dispute with Maharashtra government about pricing of metro rail tickets.

. CM asks union government to setup a dispute redressal mechanism at the national level to resolve disputes in such BOT projects. Railway Misc.

New rail coach factory here. (will build passenger coaches) Kolar Rail minister + Karnataka State government will share cost.

Delhi-Amritsar Bullet train Bids invited

Chennai Metro Under testing. manufactured in Brazil.

#3: North East: hydro, manpower potential Truckload of schemes and issues, only listing new points happened in Feb2014 week#1, related to economy:

Planning commission says

. North Eastern states can earn ~650 crores per year by hydroelectricity.

. 12th FYP wants to add 88000 MW electricity generation. And out of them North East can generate ~3000MW

. 5000 crore spent on developing airports @North East. Asks state governments to hasten the land acquisition Modi says: 1. Youngsters in the North Eastern states are generally tech-savvy with good command over English 2. = Suitable for digital outsourcing/IT jobs. But at present they‘ve to migrate to Bangalore and Hyderabad. 3. Government should create such job opportunities within their own villages in North Eastern States.

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Related issue: Arunanchal boy Nido Taniam murdered in Delhi in a racial hate- crime.

#4: [Summit] 101st Indian Science Congress \Not an economy topic as such but Mohan said “we must spend atleast 2% GDP on science tech,” hence making a passing reference here (else separate discussion in S&T compilation later on)

. Where? Jammu

. Theme? ‗Innovations in Science and Technology for Inclusive Development‘. Major Points/Achievements listed by Mohan

. Neutrino-based Observatory @TN

. India joins CERN as associate member

. ISRO‘s missions to Mars and moon

. Can issue Tsunami alert within 13 minutes

. Setup new dept for Health Education and Research

. A Rota Virus vaccine, a new drug for malaria, CSIR discovering new drug for TB

. We should not succumb to unscientific prejudices against genetically modified (GM) crops. #5: Exhibition upgrades

. India Trade Promotion Organisation (ITPO)- government owned company. It has planned to spend crores of rupees to upgrade following venues 1. Pragati Maidan, New Delhi. 2. Vigyan Bhavan 3. Kochi (for coffee, tea, spcies exhibition). 4. Karnataka: wan to setup a venue for IT-related fares and exibitions. Some notable expos in 2014:

Expo-2014 Venue

Auto Pragati Maidan, New Delhi

Defense Noida (UP); organized by Defense ministry.

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Petro-Tech Noida (UP)

#6: Infrastructure Misc./chillar topics Pharma

. You‘re aware of the mega food parks click me. – In mega food parks, the companies have ‗common facilities‘ for packaging, weighing etc. = operation cost reduced.

. Chemical ministry launching similar scheme for Pharma companies.

. In SEZ/industrial locations, Government will give them financial assistance to setup common infrastructure for setting up effluent plants, R&D labs, training centers etc.

Toll Tax

. Fall under State list (entry 59)

. As per National Highway Authority of India (NHAI) — minimum distance between toll booths should be 80 km.

. But in Maharashtra toll booths are setup even at distance of every 20-30 kms

. The toll collection money is supposed to be used for road-repair, but it‘s not done.

. Traders allege bribery and irregularity by toll booth operators. Road contractors have ‗recovered‘ their original investment, yet toll tax still collected.

. Shiv Sena and MNS have ordered their troops to attack and vandalize toll-booths. Steel industry: we ar unhappy

. Goa used to be India‘s top Iron-Ore exporter. But declined after SC ban on illegal mining. = less supply= input cost increased.

. government imposed a 5% tax on the export of iron ore pellets

. Jindal Steel says Karnataka-walla miners have formed a cartel = steel industries suffer.

. Inflation = automobile sales declined, therefore demand of steel decline.

Bilateral, Poverty Hunger, Food Processing, PIN (Part 3 of 3)

Prologue

Overview of Economy related Affairs during 1-7 Feb 2014. Total three parts

1. Part 1 of 3: fiscal and monetary policy

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2. Part 2 of 3: FDI, regulatory bodies and infrastructure. 3. Part 3 of 3: bilateral, poverty-hunger-HRD, Agriculture-food processing and Persons in News (PIN). [Act 6] Bilateral/Policy affecting Indian Interests IR topics can run miles long, but only cursory points here- of those related to Economy/trade.

#1: Visa on Arrival for 180 countries Mechanism for (Tourist) Visa on Arrival (applicable from Sep’14)

. Foreigner has to apply online (3 days before arriving to India)

. When he reaches India, pays 60$ fees, goes through biometric identification and gets the (Tourist) Visa.

. Validity: 30 days, Cannot be renewed. He must leave after that. But Why should India give Visa on Arrival? 1. Will boost tourism and business 2. Can help us earn >40 billion USD by 2017 3. Challenges: women security, bad infrastructure, unhygienic places.

Before 2014 from Sep.2014

Visa on arrival facility available to tourists

from 180 countries. Including

1. US (Despite Devyani!) ~40 countries eligible for visa on arrival. 2. China (Despite Dushmani!)

3. UK

4. UAE

5. Bangladesh

Not eligible for Visa on Arrival [security reason]

1. Pakistan Same continued. 2. Sudan

3. Afghanistan

4. Iran

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5. Iraq

6. Nigeria

7. Somalia

8. Sri Lanka Tourists from these countries need to apply for visa through Indian embassies in their country.

By the way, India is not the first country in the world to have “Visa on arrival” facility. Following countries already offer this facility: Japan, Finland, Singapore, Indonesia, Luxembourg, New Zealand, Cambodia, Vietnam, the Philippines, Laos and Myanmar.

#2: [USA] Dushmani with Indian pharma cos.

. US Food and Drug Administration (FDA) commissioner is coming India

. To inspect quality of Ranbaxy, Wockhardt and other companies. (+Spices processing companies in Kochi).

. They‘ve already banned production in Ranbaxy‘s factory in Toansa, Punjab. Why? (Conspiracy theories) 1. American wants to teach us a ―lesson‖ for the Devyani issue. 2. Other foreign pharma companies have lobbied /bribed USFDA to teach us a ―lesson‖. American/European MNC hate Desi companies because

1. We‘re largest producer generic drugs. (=cheaper copy of the foreign drugs, whose patent has expired.) 2. We‘re second largest drug supplier to US and Canada 3. We‘re major supplier of low cost medicines for Cancer, AIDS and Malaria to Africa and Latin America= Those foreign MNCs are loosing business. #3: [USA] India’s Aviation safety sucks

. US Federal Aviation Administration (FAA)

. They reduced India‘s safety rating from Status #1 to Status #2; meaning we‘re as bogus as Ghana and Bangladesh. Infact even Pakistani Airlines are more safer than India!

. Main reasons

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1. India doesn‘t have sufficient number of Flight operation inspectors. 2. India‘s aviation regulator Directorate General of Civil Aviation (DGCA) does not meet the safety standards set by ICAO. [as we saw earlier this post has become retirement house for IAS.] 3. (conspiracy theory) America intentionally downgraded the safety rating to ―teach‖ us a lesson for the Devyani Khobragade controversy. Consequences:

. When Indian flights go to USA, their officers will do more safety checking = more time will be wasted, inconvenience to Desi passengers.

. Jet airways‘ share prices fell down.

. Domino effect: Singapore‘s aviation authority also started inspecting Indian aircrafts.

. The aviation regulators of EU, Japan, UAE will also reduce our rating. Related topic: “Policy of USA affecting Indian interests” = Obama has urged the house to pass immigration reform bill, that‟ll give legal citizenship for illegal immigrants (=indians will be benefited) so, it‟s not like Obama wants to “teach” us a lesson everywhere. Anyways, moving on:

#4: Pakistan- MFN status for India (hum nahi Denge)

. Pakistan has still banned import of 1000 Indian items, including automobiles, pharmaceuticals, agriculture and chemicals.

. Only when Pakistan permits their import, we can say ―India got Most-favored nation (MFN) status in India.‖

. Then our bilateral trade will increase to $10 billion USD.

. Commerce Minister wrote a letter to pakis about this, but they didn‘t reply, so it seems he will cancel his plans to visit Pakistan.

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#6: India and Morocco (Ibn Batuta)

. Our Foreign minister had gone to visit 3 North African countries (Morocco, Tunisia, Sudan)- ―Look Middle East‖ policy.

. Morocco significant supplier of Phosphate to India= fertilizer, food security.

. 14th Century: famous traveller Ibn Batuta came from Morocco to India

. Morocco supports India‘s demand to get Permanent seat in UNSC.

. During this visit, many agreements on Environment coop, HRD, IT training. #7: India-Fiji DTAA

India and Fiji- Signed DTAA: double taxation avoidance agreement (DTAA).

From Indian businessman‟s point of view:

. If he has permanent business in Fiji, then his business profit will be t axed in Fiji only. And not in India.

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. If he makes capital gains in Fiji, he‘ll have to pay taxes to Fiji only (and not in India). Recall Vodafone/Hutch controversy.

. If his airline‘s HQ in India, then India will tax (and not Fiji).

. Dividends, interest, royalty and fees for services will be taxed both in the countries (India and Fiji).

. + both countries agreed to exchange of banking information. #8: India-Mauritius

Mauritian authorizes have urged Indian investors to come in their country because:

. Low tax regime

. In doing business index (of World bank) = Mauritius rank 19th all over world, and 1st in Africa

. Possible to start business in three working days

. Indian entrepreneurs can setup base in Mauritius and focus on EU, Africa and West Asia.

. IOCL already started Aviation fuel business here.

. Potential areas: Seafood, IT, movie production. #9: Misc./Chillar developments

German President Joachim Gauck visit to India. Germany 1 Billion Euro worth agreement for green energy project.

NZ UGC and its NZ counterpart signed agreement for research collaboration and education exchange

Japan JICA gives loan to Bihar road upgrade in NH82

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. Our small cars (nano, Alto etc.) have failed safety tests conducted by a UK-based body that

tests car safety worldwide.

UK . Car companies make excuses but fact is, none of these cars have airbags (because desi std.

don‘t require airbags).

. Consequences= negative publicity= decline in sales in rich foreign countries.

. Rosneft = World‘s largest oil company (by output). HQ: Russia

. They‘ve offered stakes to ONGC for exploration blocks- in Barents Sea and Black sea. ONGC . ONGC Videsh Ltd (OVL) and GAIL India also looking f or gas exploration opportunities in

Tanzania. [Act 7] Issues related to Poverty, Hunger, HRD #1: DTH = DBT v2.0

. DBT= Direct benefit transfer (to beneficiary‘s bank account)

. Now, Rural development minister (Jairam) came up with a new idea

. DTH= Direct to Home (benefit transfer)

. Women, disabled, widows, elderly and students will not have to go to banks or post offices to get their entitlement.

. DTH system will transfer money to beneficiary via Micro-ATM and Mobile banking.

. Pilot project in Andhra Pradesh #2: UIDAI is against Indian Constitution

. Petition in SC, by a group of retired judges and army officers.

. They say UIDAI violates Indian Constitution because

. UIDAI has no statutory powers. Its functioning under an executive order.

. Even UIDAI was a statutory body (like SEBI) still, this project violates fundamental rights under Art. 14 and 21. Because project is putting a surveillance mechanism over humans = right to privacy, right to dignity violated.

. Public funds given to private companies without parliamentary oversight.

. Biometric= unreliable technology, privacy can be compromised. #3: Both UIDAI+RGI to focus on 4 states

UIDAI setup. They were mandated to give Unique ID number to residents in 18 states + Union 2009 territories.

In the other states this work is done by Registrar General of India, under National Population

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2013 >55 crore Aadhar numbers generated. end

Government orders both UIDAI + Registrar General of India (RGI). 2014 To enroll people in Uttar Pradesh, Bihar, Chhattisgarh and Uttarakhand

Why? This will help fully implement Direct Benefits Transfer schemes in these States as well= some vote bank benefit.

At present, the DBT scheme covers 28 Centrally-sponsored schemes in 121 districts.

#4: NSSO survey: Poverty Declined because its election year

. Planning Commission is the nodal agency for estimation of poverty at the national and state levels (with help of NSSO)

. NSSO carries survey on quinquennial basis. (Every five years)

. Poverty line is measured on Monthly Per Capita Consumption Expenditure

. Rs. 447 (rural)

. Rs. 579 (urban)

. This method designed by Suresh Tendulkar Committee (2005)

. 2012: Planning commission sets up a new Committee under C.Rangarajan to review this poverty estimation n method.

. 2014: latest NSSO survey found that Poverty declined under Congress government (!)

FY11 ~40 crores poor people

FY14 ~27 crore poor people

For more, refer to Frontline Data card: click me

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#5: Gujarat: Earning >11 Rs. = not poor kyoki Lakdawalla says so

1993 Lakdawalla Committee to determine poverty status. He suggested calorie intake method.

Union government asks state governments to implement Lakdawalla‘s Calorie intake method. 2004 Accordingly, Gujarat = people earning more than Rs.10.80 per day=are not poor.

2005 Suresh Tendulkar Committee setup to review the poverty determination method.

2009 Tendulkar gave report

Planning commission and Union government accepted Tendulkar method. Poverty line= 32 rupees 2011 (Urban); 26 Rupees (Rural).

2012 Rangarajan Committee (by Planning commission)

Gujarat State government website mentions the old figure based on Lakdawalla (10.80 Rupees=poor). 2014 Hence the controversy.

BJP defends saying: 1. this is based on Union government‘s 2004 notification (Lakdawalla), and since Union did not update it, hence outdated number in our website‖. 2. Btw, we did accept Tendulkar, and for Gujarat, the official poverty line is Rs.38.40 (Urban) and Rs.31.06 (rural). #6: Women SHG- interest subvention

. Scheme: National Rural Livelihoods Mission (NRLM)

. Women Self-help groups (SHG) under this scheme, will get interest subvention Mechanism:

. All banks have to give them loan @7% (upto 3 lakhs)

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. Government (Rural development Ministry) will give interest subvention of 3% (meaning government will pay that much interest to bank, on SHG‘s behalf)

. Women SHG will have to pay only 7 minus 3 = 4% interest only. #7: Contract workers

. Among the employed people in India, ~40% are contract workers. (as per Assocham survey)

. Is it good / bad? It is Bad because: 1. They don‘t get Job security 2. They don‘t get medical aid, gratuity, provident fund, educational funds, pension and health insurance and leaves benefits,‖ 3. Regular worker gets >3 times salary for doing the same job. 4. Given the oversaturated labor market, mushrooming self-financed colleges with overqualified people= even scientists, doctors, MBA and Engineers are also serving as contractor workers in private companies/hospitals. #8: NSDC National Skill development Corporation.

Ownership %

Private sector 51%

Finance Ministry 49%

Target: give skill training to 150 million Indians by 2022.

Why in news: signed MoU with some state government. Anyways that happen every now and them, Important thing for MCQ= above table and target.

#9: DSDS 2014: Desi liquor=sustainable livelihood

. DSelhi Sustainable Development Summit 2014

. Theme/ Focus: “Attaining Energy, Water, and Food Security for All”.

. Location: Delhi

. By Who? The Energy and Resource Institute (TERI). DG=RK Pachauri.

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. In the summit, Guests made lengthy speeches to give fodder points for essay/interview. Not covering here because article will run mile long. #10: IMF: Inequality is growing (ya like we don’t it!) Nothing that you don‟t know already. Just some fodder points:

. Chief=Christine Lagarde

. Their report says: in last 15 years, the income of Indian billionaires increased by 12 times.

. These Indian billionaires have enough money to eliminate India‘s poverty TWICE!

. In the coming decades, India‘s population will surpass China; Nigeria‘s population will surpass the United States.

. Income inequality rising in the entire world.

. Richest 85 people in the world own the same amount of wealth as the bottom half of the world‘s population.

. In the Asia-Pacific region, 1.7 billion people lack access to sanitation and 680 million are without electricity. [Act 8] Agriculture/food processing/Export industries Some fodder points from Feb Week#1, 2014:

Indian Potential Challenges Industry

. Large harvest in South America (Brazil, Argentina). . non-genetically modified Hence foreigners not making inquiry to Indian exporters. (GM) nature. Hence diet . In India, majority production comes from Central India- conscious rich foreigners but excess rain destroyed the crops prefer it. Soybean . MP, Rajasthan farmers are also holding back the . When USA had imposed soybeans, in hope of fetching higher prices (which is not various sanctions on Iran, going to happen because of South America) they used to buy Soybeans . Result: Desi food processing industries that Soybean= from India @high prices. suffering losses.

. USFDA chief is making visit to Kochi, to inspect the Spices Many charges that Indian spices are ―Contaminated‖.

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. Export oriented Textile factories concentrated in South

India, particularly TN. But cotton production

concentrated in Gujarat, MH = transport cost.

. Transport cost increased (Because of hike in diesel

. Textile ministry believes prices) Textiles we have export potential . Cotton cultivation price increased (labor shortage

of >40 Billion USD. MNREGA)

. Gujarat cotton farmers are holding back the cotton bales.

(Because cotton non-perishable, and want higher prices to

coverup those labor costs.)

. Factory cost increased due to electricity shortage.

. Union government allows import of rubber= foreign

competition destroying desi farmers. (Solution: Kerala 90% of production comes from Rubber government started directly buying Rubber from farmers, Kerala. @prices higher than Rubber board of India)

. VAT needs to be reduced.

. Dry weather condition hurting harvest Cardamom . Bumper production in Guatemala, they‘re selling

@cheaper price.

. High demands from

Singapore, NZ, Australia

and Europe during

valentine day.

. Our competitors are China . Some of these countries rejected our rose exports for Rose and Africa- but their rose- phytosanitary issues. (mites in the roses) production declined due to

adverse climate.

. Good production around

Bangalore (Karn.) and

Hosur (TN)

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. Russia also permitted rose

import.

. Factories in Kerala, but shortage of raw material.

. Majority of the coir supplied from Tamilnadu. (Because Coir Keralite grow coconuts as household activity, while

Tamils do as a plantation= economies of scale, bigger

production.)

. Main ports from where Only marginal increase in export, compared to last year (except seafood is exported: seafood Kochi) Vizag, Chennai, Tuticorin

and Mangalore El Nino

Needs separate article. Just a cursory mention here:

. Central & East Pacific gets warm

. Western Pacific gets cold.

. Result: less rainfall in India.

. Experts believe 2014=El Nino year= less rainfall, desi farmers will suffer. [Act 9] Persons in News (PIN): Feb Week#1 (2014) List can go long, only the major names related to business/economy and been in news during 1st Week of Feb 2014.

#1: India

DG of Hydrocarbons BN Talukdar (newly appointed, FM wants to give him statutory status)

Arvind Mayaram (makes statements on daily basis. He has to give new Secy, Economic Affairs definitions FDI, FII)

Drug Controller General of GN Singh (wants firgani powers like USFDA, but doesn‘t have staff) India

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IRDA TS Vijayan (wants Broker model for bancassurance)

TRAI Rahul Khullar (doesn‘t fully agree with Sibal on Spectrum auction)

UTI Leo Puri (golden jubilee of UTI)

LIC SK Roy (passing comments about IRDA guidelines)

Labour minister (Oscar Fernandes) =Chairman of the Central board of Trustee EPFO of EPFO. 16k max for compulsory EPF, 1k min for pension.

7th Pay commission Justice Ashok Kumar Mathur

Walmart lobbying Justice Mukul Mudgal gave report

14th Finance commission YV Reddy, cannot finish report on time.

#2: Abroad

S.Jaishankar Indian Ambassador to USA.

aerospace and cyber security expert. He became appointed special advisor to United Vivek Lall Nations

Hyderabad born CEO of Microsoft. Replaced Steve Ballmer. Microsoft has seen only three Satya Nadella CEOs so far Gates, Ballmer, Nadella.

Prez. Joachim Gauck. Recently visited India. 1 billion Euro worth green energy deal. Germany Note: Angela Markel is ―Chancellor‖ and not the ―President‖ of Germany.

US Feds Ms. Janet Yellen replaced Ben Bernanke as the chief of US Feds. (American RBI)

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Margaret A Hamburg, commissioner, she is coming to India to inspect our pharma cos and USFDA spices factories.

IMF Christine Lagarde. Says income inequality rising in the world.

#3: Women entrepreneurs: Fortune Top 50

Notable Companies chief

General motors Mary Barra

IBM Ginni Rometty

Lockheed Martin (fightjets) Marillyn Hewson

Facebook Sheryl Sandberg (COO)

Yahoo Marissa Mayer

Pepsico Indra Nooyi (too clichéd)

ICICI Chanda Kochhar (too clichéd)

Epilogue Q. Where are the mock questions? Separately, when sufficient content is generated (perhaps at the end of entire Feb).

Q. Will you release the same Week#2 (i.e. 8 to 14 February 2014?) Yes.

Q. does it mean I should stop maintaining notes from newspaper? of course not. This is merely a reference point to crosscheck you did not miss any important development. Mrunal.org is no substitute for newspapers and standard reference books.

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Q. what about current affairs on polity? Refer to prsindia.org + [Hindu/IE]

Q. What about IR/diplomacy Refer to idsa.in + official site of MEA. + [Hindu/IE]

Q. When are you going to release Hindu Sci-Tech compilation? Somewhere in March or may be April. The way things rolled in Prelim and Mains 2013, Hindu Sci-tech compilations were mostly useless hence not in my priority list right now.

Q. When are you going to finish the pending articles in the land reform, world geography, and world history? Ya I‟ll finish those loops but next Mains is in December 2014, hence those pending articles are not in my priority list right now.

Q. When are you going to release PIN-2014 compilation? Had plans to release it before CDS2014 and IBPS Specialist office exams (Feb2014) but after Nov‟13, there weren‟t many high profile PIN developments (Padma, Bharat Ratna is too clichéd). other than that, very few new noteworthy appointments/sports winners between Nov‟13 to Jan‟14. Hence dropped the idea. Now PIN-2014 =In April 2014, before SSC starts.

Q. will you release answer key for CDS(I) 2014? Yes. Ofcourse.

Q. When are you going to release the remaining answerkeys for Mains 2013? World history answerkey most likely in Feb-end, and remaining in March.

New Bank Licences: Bandhan, IDFC, Bharatiya Mahila Bank; Differential Bank licences, Bimal Jalan Committee, Narsimhan Committee; arguments favor against, Bank nationalization, Historic evolution of Banking sector in India

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Bandhan and IDFC got new licences, you already know that. it‟s just two line current affairs. but for SBI /UPSC interviews, we need to some background information for questions like:

1. After Sahara Scam and NSEL crisis, why should we risk giving bank licences to private companies? In fact why not simply nationalize the existing private sector banks so they cannot do any scams!? 2. We already have large banks such as SBI, ICICI, BoB- all of them having pan-India presence, capable of fulfilling the goal of financial inclusion, then why is there a need to get new private sector banks? To answer such “Devil‟s advocate” type interview questions, we need to go back in history:

Banking sector in British India There were two types of banks

British Banks ―Swadeshi‖ Banks

. First, East India company establishes

three Presidencies in India- Bombay, . Parallel to British banks, Indian banks also setup- Bengal and Madras Allahabad Bank, Punjab national bank (PNB), Bank of . Three Presidency banks setup in those Baroda (BoB), Canara bank etc. cities. Later merged into one Imperial

bank (‘21)=> SBI (‘55)

Their target audience = British army, civil Target audience= big merchants, particularly raw-material servants and judges exporters in Bombay and Madras Presidency.

Overall, neither British Banks nor Swadeshi banks helped in the financial inclusion of poor people, they still had to rely on local money lenders and Zamindars. Birth of RBI

. By early 30s, there were >1200 banks in India!

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. But all of them under Companies law- there was no banking regulation, no RBI, no SLR, CRR, repo rate, reverse repo rate etc. So the Civil service & BankPO aspirants of that era, were relatively ―Stress free‖ compared to present generation.

. Problem starts with Great American depression (‘29) => sharemarket and companies of US and Europe collapse= raw material import declines = desi merchants cannot repay loan EMIs = Indians banks starts collapsing one by one.

. therefore, British Indian government setups Reserve bank of India to supervise over these banks (‘34) Banking sector Post Independence

. from mid-50 onwards, there is gradual expansion of banking sector in India

. SBI, ICICI, PNB, BoB all start opening more and more branches.

. but still target audience= merchants, urban (upper) middle class and industrial houses

. Branches increased? YES

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. Rural penetration? NO

. Did they help aid in Five year plans like giving cheap loans to farmers and micro- enterprises? NO

. All these banks were in the hands of industralists. (who owned majority shareholding => can vote majority of board of directors=> bank‘s policy decision will only be made to suit those industrialists e.g. opening branches near factory-townships, giving loans @cheap rate for setting up new factories and so on….) Nationalization

. Government gets impatient with ^all this.

. starts nationalizing banks (By taking over the ownership from those industrialists)

Year How many? who?

‘55 1 Imperial bank (SBI)

‘69 14 banks with >50 cr. deposits.

‘80 6 banks with >200 cr. deposits (Andra, Vijaya, Oriental bank of commerce etc.)

Nationalization: more problems

1. In theory, nationalization =government becomes majority shareholding in those banks => government can pick board of director of her choice = bank takes decisions to suit government‘s Five year plan requirements= everyone‘s happy, right? nope 2. In reality, nationalization =created more problem than it solved. for example 3. Now all the board members = politicians, their relatives, retired IAS/IPS etc. Result? Professionalism =nope, sycophancy=yes. 4. Banks were forced to give loans @throwaway prices to farmers/ small enterprises, sometimes even cost of giving loan (staff salary, light bill, office rent etc.) would be higher than the profit involved. 5. Local politician interfered in operations. Run ―loan mela‖ in our Constituency, open all branches in RaiBareily and Amethi only, pass applications of our chamcha-log. They would get lakhs of rupees @4% interest rate (to buy cattle) and then circulate the same money to farmers @36% interest rate and so on…

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6. When banks tried to recover loan money from such political elements, t hey‘d get stay order from courts, then“taarikh pe taarikh”. 7. This politicization even came into Bank employee unions- they‘d always demand higher wages and lower working hours, irrespective of how much profit bank made. 8. adding insult to injury, RBI kept the CRR and SLR very high (15 & 40% respectively) 9. =very less money left for banks to lend. 10. Business man cannot get easy loans = no business expansion =export declines =in a way all this contributed to the Balance of Payment crisis (BoP) in 1991. moral of the story = nationalization is not a solution – even if Sahara, NSEL, Ramalinga Raju, Ketan Parekh, Harshad Mehta or Mr.XYZ is doing scam- that doesn‟t mean you should nationalize everything. Narsimhan Committee I (1991) By government of India in 1991. It recommended following: recommendation result?

Government / RBI mustnot regulate the banks‘ loan RBI adopts BENCHMARK PRIME LENDING RATE interest rates. Banks should be allowed to decide (BPLR) => nowadays Base rate system. their home loan, bike loan etc rates by themselves.

setup Debt recovery tribunals. so loan defaulters DRT setup in 1993 => later SARFAESI Act in 2002 to cannot get stay orders from courts, no more give them more powers. ―Taarikh pe taarikh‖

done. banks can open branches anywhere. only condition Liberate Branch expansion policy. Let the banks 25% of the new branches each year must be setup in open branches outside Raibarely and Amethi also. rural areas. For more readNachiket Committee article.

Reduce CRR and SLR so banks are left with more Done, gradually reduced. from (15,40)=>(4,23) money to lend.

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. NBFC regulatory framework done

done, SBI shares sold, nowadays government owns government should reduce its shareholding from ~60%. (this facilitates entry of professionals in the board public sector banks. of directors)

Allow entry of private sector banks and foreign done, leads to first round of bank licences, explained banks. below:

Bank licences: 1 st Round (1993)

. RBI invites application 1993

. New private banks start Operation: 1994-95 onwards

. Total ten private banks given licences: 6 still running + 4 closed down. 6 running

1. ICICI 2. HDFC 3. UTI=>became Axis bank (2007) 4. IDBI 5. Indus 6. DCB All of above running successfully, so that gives us “positive arguments”- that not all private entities are seamstress. in fact, ICICI, HDFC, Axis = top banks of India, even have presences abroad, employ lakhs of people. Hence no harm in giving bank licences to private players.

4 closed down

merged Bank why? with

Global Oriental recall Ketan Parekh- he took money from Madhupura cooperative Bank, A‘bad and

Trust bank of used it to run scam in Sharemarket. Same Ketan had also taken some money from

Bank Commerce Global Trust bank also=> news stories =>junta panics and runs to take out all

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money=> business collapsed.

Bank of Centurion loss making. hardly any depositors and loan takers, couldn‘t stand in competition

Punjab bank against SBI, ICICI, BoB etc.

Centurion HDFC same as above bank

Times HDFC same as above Bank

These four #EPICFAIL banks give us the “negative arguments” that private companies must not be given bank licences. Because they can also close down like ^these, creating panic among the clients, blood pressure, heart attacks and suicides.

Anyways, moving on

Narsimhan Committee II (1998) 1. Introduce Voluntary retirement scheme (VRS) in public sector banks. 2. Legal reforms for loan recovery. =>SARFAESI 2002 3. Computerization, electronic fund transfer, legal framework 4. Payment and Settlement Act=>Retail (ECS, NEFT, Card) + Wholesale (RTGS) 5. Continue allowing entry of private banks and foreign banks. New Bank licences 2nd round (2001)

. 2001: applications invited

. 2003-04: winners launch banks. From the earlier #EPICFAIL of those four banks, RBI also learned lesson.

This time RBI gave licence only two strongest contenders:

1. Kotak Mahindra 2. Yes Bank New Bank licences 3rd Round (2013-14)

. 2010: Finance minister says we need to give more licences.

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. 2013, February: RBI invites applications with following conditions: Conditions/guidelines for new bank licence application:

1. must include class 10-12-college marksheet, school leaving certificate and three passport sized photos 2. 10 years‘ successful work-ex (=‖Fit and proper‖ criteria) 3. minimum capital Rs.5 billion 4. Will have to get shares listed on stock exchange within three years, bring down voting rights to 15% within 12 years.why?

. say Anil Ambani gets licence, in the beginning he‘d have ~100% ownership and decision making. But in the long run such ―one man game show‖ = not good in banking sector. So he‘ll have to get the shares listed within three years.

. once shares are listed, junta starts buying those shares= they elect the board of directors (BoD) and then BoD makes policy decisions of the bank, appoints CEO and top executives and so on.

. By 15 years, Anil should sell majority of his shares to junta- so that he holds barely ~40% or less of the bank shares = he cannot have lot of ―say‖ in bank‘s decision making = bank doesn‘t run according to his whims and fancies =rational decision making. Anyways moving on to the rules 5. foreign shareholding must not be more than 49% (for the first five years) 6. 50% of the directors should be independent (=not chosen by majority shareholder e.g. Anil) 7. Such bank must not invest in shares/bonds of its parent group (e.g. Anil‘s telecom/electricity business) 8. must have viable business plan 9. must open atleast 25% branches in the unbanked rural areas. (as per latest census there are ~10000 such places) 10. Have to comply with PSL (priority sector lending) norms. Many other technical rules but for descriptive/interview answer- above 9-points sufficient.

. Total 26 applied, including Anil Ambani, Birla, Bajaj, Tata, Muthoot, Indian post.

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. later two left (TATA, Videocon)

. + one came (KC Land and finance ltd.)

. Thus 25 left. Bimal Jalan Committee

. Now Rajan had to decide winners among those 25 applicants.

. Sep 2013: Rajan sets up RBI High level advisory Committee to process those applications.

Bimal Jalan (Chairman) Former RBI governor

Usha Thorat Ex-RBI Deputy Governor

C B Bhave Ex-Sebi chairman

Nachiket Mor RBI board member

Important: Bharatiya Mahila Bank also launched in Sep‟13 (but its public sector bank, has nothing to do with this “third” round of Bank licences or Bimal Jalan Committee) Anyways, moving on

November 2013 Bimal first meeting

February 2014 Bimal submits report

March 2014 Rajan fears Election commission‘s model code of conduct, seeks their approval.

31st March EC gives approval

2st April Two winners announced. (Bandhan Microfinance and IDFC)

Bandhan Microfinance and IDFC

Bandhan Microfinance IDFC (Infrastructure Development and Financial

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Corporation)

West Bengal Mumbai

Micro-finance company infrastructure finance company

Chandra Shekhar Ghosh Rajiv Lall

net worth 1100 Cr., 45% branches in rural net worth 21000 cr., but rural presence low. areas

These two are given only “in-principle” approval. Meaning

In principle approval

. Within 18 months

. must get net worth Rs.1000 crore

. Must open 25% branches in unbanked rural areas.

. once they fulfill above conditions, RBI will give them licence under Banking Regulation Act, 1949 [Sec.22(1)]

. Once they get licence under BRA, then we can open current account, savings account etc. RBI has also prohibited the promoters (Ghosh and Lall) to hold CEO position in their respective banks. This is meant to prevent conflict of interest. Because in past, Global Trust bank‟s CEO Ramesh Gelli was accused of involved in Ketan Parekh scam.

Curiously though Yes Bank‟s promoter Rana Kapoor enjoys both MD and CEO position in his bank!

India post

. For Indian postal department, Bimal Jalan said ―RBI should consult separately with government and give licence if necessary.‖

. Kumar Mangalam Birla‘s name involved in Coal block scam, Anil Ambani in 2G case, hence licence not given.

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What is Differential licences?

. Total 25 applied, but only two won so what about the remaining 23 contenders? Will they get any consolation prize? Yes.

. Rajan said they can later apply for Differential bank licences.

. Differential bank licences = for opening payment banks, wholesale banks etc (who‘re not ―full‖ banks like SBI, PNB etc.)

. for more on these differential banks read following articles on Nachiket Committee: 1. Wholesale Banks 2. Payment Banks New Private banks: Pro and Against arguments

Anti arguments Pro arguments

. Existing banks not sufficient for 100% financial

inclusion.

. only one in two Indians have bank account

. Only one in seven Indians gets loan from banks (others There is no need for additional private banks, have to rely on the evil money lenders who charge 36% existing banks sufficient. compound interest rate!) As per Census 2011

. Only 67% of Urban households getting banking services.

. Only 54% Rural households getting banking services. well in that case, government should launch . Throwing sakaari money, subsidies and schemes to solve some Rajiv Gandhi scheme to open bank every problem = bad idea. Business has to become accounts for everyone, there is no need to get vibrant by itself. new private banks! Besides, these two . It is true both Bandhan and IDFC are ―mosquitos‖ (Bandhan and IDFC) are too small to be any compared to elephants like SBI and ICICI but every relevant in ―financial inclusion‖. maestro was an amateur someday.

As per your own table, Bandhan already has . as a Microfinance company, Bandhan cannot open

45% of her branches in rural area as savings account / current account etc (Because they don‘t microfinance company, then why do they have bank licence)

147 need bank licence? They‘re already doing . as a result, such microfinance companies have to borrow financial inclusion! money from other banks, NABARD etc @12-15%

interest + have to maintain profit margin=> they give

loans to poor people yes, but at 23-25% interest rate.

. but if same Microfinance company was given bank

licencee, they can accept public‘s deposit money under

savings account ~4% interest, fixed deposit ~9% interest

=> cheaper way to arrange loan money. can give loans to

poors at reasonable rate like 10-15%

In the first round, ten banks were given licence, four of them closed down…..private The same licensing round gave us giants like ICICI, Axis bank sector cannot compete with existing giants. and HDFC. It is wrong to think every private player is out there

They try to take ‗shortcuts‘, hence all the only to bully, loot and steal. scams.

The same ICICI Bank, HDFC Bank and Axis RBI has taken quick and firm action against those three banks.

Bank were caught violating KYC norms and And the inquiry revealed it wasn‘t the mass scale organized doing money laundering case in the Cobra money laundering operation but irregularity on part of certain post sting operation. branch managers to overcome the ―targets‖.

These two small players cannot even afford to They don‘t need to open ATMs anyways, because of the launch all India ATM network, forget about ―White label‖ ATM scheme. opening ―branch‖ offices.

In the early 90s, all nationalized banks were heading towards

#EPICFAIL, so to correct the course, RBI had to get in more

RBI should gave given licences to more players to breed competition. Same is not the case today- two applicants, like they did in the 90s (ten new banks are good enough. If Rajan gave licence to 15-20 licences). applicants at once => too much competition => predatory

pricing like in aviation industry => smaller players will be

wiped out.

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Public sector banks are already bleeding In the end, Business is all about the survival of the fittest. because of the heavy marketing and teaser Public sector banks and their ―trade unions‖ should learn to rates offered by Private banks. Two more perform or perish. Customer deserves better services. Just to such banks will increase the misery of the make life easier for sarkaari banks, we must not prevent the public sector banks. entry of private sector.

Rajan‘s ―American‖ ideas of free market, Just two new banks cannot create Subprime crisis. RBI is much wholesale banks, differential licenses etc. will more vigilant and strict than their American counter part US ruin Indian banking sector and Economy. feds. It is wrong to assume that Rajan comes from America so What works in USA need not automatically he is automatically an evil capitalist, and all the ―hushiyaari‖ work in India as well. This will lead to (smartness) is with Newspaper columnists in The***** only. subprime crisis like disaster.

More pro-con arguments can be added, post them in comments below!

Bharatiya Mahila Bank (2013) This has nothing to do with Bimal Jalan Committee or third round of private bank licences. But to confuse you in MCQs, the examiner will deliberately include some facts related to Mahila bank. Therefore, you must know the basics:

. Budget 2013: Chindu announced to open this bank with 1000 crore Rs. (=100% State Owned / public sector bank.)

. Keep in mind, Chindu also setup ―Nirbhaya fund‖ for women security initiatives. But that‘s separate 1000 crore fund and this is separate 1000 crore bank. (tricky MCQ)

. Concept is not new: Pakistan and Tanzania already setup such banks in past.

. MBN Rao Panel prepared blue print (he was chief of Canara bank)

. Sept. 2013: licence given

. November 2013: bank launched on Indira Gandhi‘s b‘day.

. HQ= Delhi but since assembly election was going on, hence to follow the model code of conduct, they launched the bank from Mumbai How is it a Mahila Bank?

. Boss Usha Anantha-Subramanian =woman

. Board of Directors=all women.

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. but staff = male + female

. mid-level staff from BoB, PNB on deputation= male + female.

. Customers (Depositors) = male + female. (no distinction among them, both get same interest rate on their savings account / FD etc.)

. BUT Loan giving => predominantly to women.

. Women entrepreneurs can get loans up to Rs 1 crore without collateral (meaning they don‘t have to mortgage their house/factory/jewellary)

. kitchen loans, education loans, small home-based catering businesses

. Projects for Skill development, financial literacy among women.

. hence the name ―Mahila Bank‖- because it‘ll predominantly cater the credit needs of women entrepreneurs and Self help groups. Business plan of Mahila Bank? 1. By March 2014: 25 branches in capitals/major cities of India 2. 25% branches in unbanked rural areas. 3. By 2020: 700+ branches; 60k cr business Software

. as such most desi banks use ―finacle‖ core-banking software designed by Infosys

. But this Mahila bank got Core Banking Software by FIS (American Co.) (^ya this type of GK essential for IT-graduates for the bank interview stage.)

Why Mahila Bank is mere publicity stunt? (Interview Q.) Bharatiya Mahila Bank is a mere symbolic exercise for feel good publicity. Do you agree? Yes/No and Why? I already mentioned the Positive points 1 cr. loan without collateral, skill development for women etc.

But in Group discussion/ interview, you need to be aware of the negative points as well, in case the other party decides to play “Devil‟s advocate”.

Mahila Bank is mere tokenism, without substance because: 1. SBI, PNB, BoB better suited, they have pan-India presence including in rural areas. Govt. already majority shareholder. Could have launched the 1 crore without collateral scheme without Mahila Bank. 2. 25% rural branching: duplication of effort.

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3. In the first phase focus on state capitals and UT = real need of women financial inclusion is in rural areas and not those big cities. 4. Mid-level executives all ―imported‖ from BoB, PNB etc. such deputed staff usually don‘t have or motivation to put their blood and sweat in making this new bank successful. Their loyalty remains with their own parent bank only. 5. They‘re offering 4.5%/5% interest rate on savings account but pan India presence necessary, otherwise customers won‘t feel attracted. Besides private banks like Kotak already offering 6%

Nachiket Committee: Universal Electronic Banking Account (UEBA), Payment Access Points, Financial Inclusion, Seigniorage and More

Prologue

Time: September in 2013

Location: Ministry of Finance

The term of our government is soon to expire, so we can‘t form any new Committees. I‘m getting Chindu bored.

Then just watch my jalwaa- This month, I‘ll form not one, but TWO Committees!

Rajan 1. Bimal Jalan for Bank licenses

2. Nachiket Mor for financial services

YES, YES, YES, Now even if I can‘t become PM, I‘ll have no regrets, because UPSC aspirants

Chindu are thoroughly harassed! By the way, I know Bimal Jalan was ex-governor of RBI, but who is this

Nachiket fellow?

. Nachiket Mor is my batchmate from IIM Ahmedabad, served in ICICI and right now RBI

Rajan board-member.

. As per office-gossip, he‘ll become a Deputy Governor of RBI in future.

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(enters) Mr.Rajan could you please tell Mr.Nachiket to allow me silently watch his Committee Mohan proceedings?

Rajan But why would you want to do that?

Because I haven‘t read economy books since a long time, I‘m not maintaining notes from

Mohan newspapers, so my command over economy is very weak. If I watch Mr.Nachiket talk, it‘ll help me

refresh the concepts of economy.

Cut to Next Scene Location: Nachiket Mor‟s Cabin.

(To self) I need more gangmembers, otherwise, I‘ll have to do all reading-research-typing labor

Nachiket myself. (Sends Committee invites to facebook friends-only 12 people accepted, remaining 99 were

just too busy ‗liking‘ funny photos of their 12999 friends.)

Mohan Could you please tell me the names of those 12 people in your Committee?

Nachi: Ofcourse! Please Note down: 1. Prakash Bakshi: He was NABARD chairman. (He recently retired. The new NABARD chairman is Harsh Kumar Bhanwala.) 2. Shikha Sharma: Axis Bank. This is same Shika Sharma whose annual salary package is almost 2 crore rupees and LTC alone is ~12 lakh rupees. In short she is totally awesome. 3. S.S. Mundra: Bank of Baroda 4. Vikram Pandit: Retired from Citigroup. 5. Sunil Kaushal: Standard Chartered Bank India 6. Roopa Kudva: CRISIL Limited

Mohan But these are only six names? What about the other six?

They‘re not important for Person in news (PIN) type MCQs/two markers. Rule #73 of competitive Nachi exam preparation: NEVER pay attention to chillar parties.

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Toh thik hai (then it is ok). Anyways, what is the purpose of your Committee? What exactly do you Mohan want to accomplish?

. The official name/purpose is ―Committee on Comprehensive Financial Services for Small

Businesses and Low Income Households―. Nachi . And we want to accomplish 100% financial inclusion (by giving financial services those small

businessmen and poor people in a comprehensive manner) What is Financial Inclusion? Financial inclusion means everyone is given access to:

BANKING Savings & payment (through ATM, cheques, e-transfer etc.)

CREDIT loans @affordable interest rates.

INVESTMENT mutual funds, pension plans, child investment plans etc.

INSURANCE life insurance and non-life (general) insurance.

We need financial Inclusion because 1. It Turns savings into investment. Circular flow of income=helps the economy. (Compared to if everyone just hid their money under pillow.) 2. Insurance/investment/savings =Protects family against unfortunate circumstances. Child future secured. 3. Income inequality falls more rapidly in areas that have more developed financial intermediaries (banks, insurance companies). 4. In the 80s, countries that focused on providing easy financial services to small businessmen =became large economies today be it Japan, South Korea or USA. 5. Financial inclusion = cheaper loans=faster growth of agri and small business. (Because Banks charge less interest rate than private moneylenders and financers.) 6. IF all of the government subsidy/benefit payments are done via netbanking/e-transfer then Rs.1 lakh crore rupee will be saved per year in terms of manpower-time- paperwork-leakages. [As per Mckinsey research.]

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7. If there are no formal channels to save money (like Bank), then low income households are more likely to fall victim to Ponzi schemes like Saradha chit fund in Bengal. 8. IF everyone has bank account=> lowers the transaction costs, paperwork and time. (Compared to counting currency notes, maintaining records, manually recovering money vs cheque drop box and so on.) 9. Economic well-being of the poor people also ensures social harmony, they‘ll not fall into brainwashing by Maoists/Secessionist/Extremist elements. 10. + Women empowerment. [If you can add more points, post them in the comments below] Financial Inclusion: Steps taken so far

. In a free market economy, banks, NBFC, mutual funds and insurance companies would only focus on urban areas and High networth individuals (HNI). Because if they try to serve poor people, the cost of operation =higher than the profit.

. Therefore, RBI and Government had to intervene and force these financial intermediaries to serve the poor people all over India. Here is a list of steps taken so far Giving More Access to banking /Payment

1. Post office: savings account, e-money order, even international money transfer (remittances)via Western Union. 2. Government has nationalized Banks and insurance companies, made them serve low income groups and rural areas. 3. Government helped setting up Regional rural banks, Cooperative banks, Primary Agriculture societies. 4. Lead bank schemes: RBI assigns a district to a particular bank. That Bank will be responsible for promoting banking services and financial literacy, in that district. 5. Government launched Swabhiman project to extend banking services to rural areas. 6. RBI permitted Business Correspondents (BC) system. Banks extend their services to villagers with help of these agents. click me for more. 7. Bhartiya mahila bank setup and owned by GOI,exclusively for women is a initiative towards financial inclusion

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8. RBI permitted White label ATMs, and ordered the companies to open 2/3rd of these ATMs in semi urban and rural areas. click me for more. 9. RBI has ordered the banks to open at least 25 per cent of their new branches in unbanked rural centres. 10. RBI‘s No Frills accounts for poor people. Later renamed to Basic Savings Bank Deposit Account (BSBDA). 11. Government‘s Direct Benefit Transfer (DBT) initiative. Money directly sent to beneficiary‘s bank account. If he doesn‘t have bank account already then it‘ll be opened. 12. RBI relaxed Know Your Customer (KYC) norms for small value accounts. RBI allows customer accounts to be opened without any documentary proof of identity or current address if the amounts involved are less than Rs.50,000. (but once that limit is crossed, he‘ll have to give proofs). 13. RBI permitted Aadhar card can be used as proof, for opening bank account. Giving Access to Credit (Loans)

1. Priority sector lending targets. Banks have to compulsory give some of the loans to farmers, students, small businessmen etc. 2. NABARD=>Microfinance, Various schemes for Self-help groups. 3. Interest Subvention scheme for farmers. 4. Debt relief to farmers in 2008. 5. General Purpose Credit Card (GCC)and Kisan Credit Card (KCC) to help people get loans easily. Giving More Access to Investment

1. National Savings certificates 2. Public Provident Funds 3. New Pension Scheme + Swavalamban 4. Rajiv Gandhi equity savings scheme + tax benefits offered. 5. inflation indexed bonds Giving Access to Insurance

1. Post office: has tied up with LIC, offering variety of insurance schemes, particularly targeting rural junta e.g. Gram Surakha, Suvidha, Sumangal etc.

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2. Weather based crop insurance loans for farmers 3. Aam Admi Bima Yojana 4. Rashtriya Swasthya Bima Yojana (RSBY) 5. Rajiv Gandhi Shilpi Swasthya yojana (one type of Health insurance) Plus, RBI and SEBI running financial literacy campaigns.

[Sidenote: If you’ve more points to add, do mention them in comments]

Impressive!! But If government and RBI have taken so many steps for financial inclusion, then why

Mohan do we need a new Committee under your chairmanship? apart from the obvious motive of harassing

aspirants of various competitive exams!

Because despite all the previous efforts, result has been unsatisfactory. As per Census 2011

. Only 67% of Urban households getting banking services.

. Only 54% Rural households getting banking services. Another study indicates that: Nachi . In Banglore alone: while 70% micro-enterprises have bank accounts, barely 1% of them given

loans.

. There is also regional variation: some districts in Nagaland – 0% people have bank account

while in some urban districts of Southern and Western states, more than 70% adults have bank

accounts.

hmm… so far I‘ve learned following:

. Financial inclusion – its meaning and benefits.

. In past, RBI and government took many steps to achieve financial inclusion. But by and large

Mohan they were #EPICFAIL.

. So now RBI has formed a new Committee under your chairmanship for old wine in new bottle. So, tell me Mr.Nachiket Mor, if all the previous attempts have failed to achieve 100% financial inclusion, then what makes you think you can succeed?

Nachi My six pack abs six point vision.

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Six Visions Statements

Topic What will we do? Vision Statement

1. A Universal Electronic First, we open bank account for every adult resident, via 1. Bank Bank Account by their Aadhar card. (mind it: “Resident” not citizen.) account 1/1/2016

. But if people don‘t have a branch office/ATM nearby

then bank account is useless. 2. Ubiquitous Access to

. Therefore, we‘ll setup ―access points‖ to help Payments and Deposit 2. Access to everyone takeout/deposit money within 15 minutes Products at bank of walking distance. Reasonable Charges

. We also setup special ―Payment banks‖ to facilitate by 1/1/2016

banking services.

. Banks don‘t easily give loans to poor people and

small businessman=100% financial inclusion not 3. Sufficient Access to

3. Easy loans achieved. Affordable, Formal

. So, for that, I‘ll suggest reforms in Priority sector Credit by 1/1/2016

lending (PSL), NBFC, RRB etc. But they too have

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their problems of NPA, liquidity and loan defaults.

We‘ll setup special ―Wholesale banks‖ to help them

out.

. IF you deposit money in bank, at max you can get

~9% return (on fixed deposit/FD). But today,

consumer price index is 11%. The inflation is rising 4. Universal Access to higher than the money you can earn from your bank Investment Products at 4. investment savings. Reasonable Charges . To fix this anomaly, we‘ll help people access variety by 1/1/16 of investment products- mutual funds, inflation

indexed bonds, NPS etc. that protect your savings

against inflation.

5. Universal Access to We must give Insurance to everyone at reasonable cost, be Insurance and Risk it life insurance, health insurance, crop insurance, livestock 5. insurance Management Products insurance, property/fire insurance and so on. @reasonable at Reasonable Charges price ofcourse! by 1/1/16

. Above initiatives will be meaningless, if consumers

are not protected against unscrupulous agents and

financial advisors.

. Crook agents only sell plans/policies where they get 6. Consumer protection, 6. consumer high commission – irrespective of what is suitable for right to suitability, rights customer‘s needs. So, we must give the customer grievance redressal

―right to suitability‖.

. We‘ll setup a Financial Redress Agency (FRA) to

protect people in banking-financial-insurance sector.

Let‟s check these visions one by one. In the present article, we‟ll see vision 1 and 2. other visions later on.

Vision #1: UEBA Bank account for Adult

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. Bank account is an essential gateway to all financial services, even those outside RBI regulation. For example IRDA has ordered the life insurance companies to give money only through cheque/electronic transfer to bank account of beneficiary.

. So if you don‘t have a bank account, you‘ll be shut out of the entire financial system.

. Government also wants everyone to have bank accounts so money/subsidies can be directly transferred into beneficiary‘s account under DBT.

. Nachiket recommend that By 1/1/2016, every Indian resident (above 18) will be given a Universal Electronic Bank Account (UEBA). HOW? 1. When Aadhar Card is issued to any adult (above 18), he‘ll be given a choice to open a bank account automatically. 2. It‘ll be called Universal Electronic Bank Account (UEBA). 3. In the bank of his choices. (So far, State Bank of India, Bank of Baroda and Axis Bank have indicated their willingness to participate. ) 4. Account opening=Totally free of cost. (But subsequently bank is permitted to charge fees- for ATM, credit card etc.) 5. This UEBA account would remain active as a perpetual account as long as the Aadhaar number remains active.

What is so special about this 1st January 2016? Why not some other date like 26th January or 15th Mohan August or 2nd October?

I‘m hoping that by 1/1/2016 National Population Register (NPR) will almost finish issuing Aadhar

Nachi cards to all adults in India. We‘ll give unique bank account number with Aadhar card= target will

automatically complete!

Mohan Well, Your target is ambitious but unrealistic. Consider these facts:

1. Earlier RBI tried the no-frills account for poor people, but the response has been lukewarm. 2. In 2009, your IIM-buddy Raghuram Rajan chaired a panel on financial sector reforms (to harass UPSC aspirants of that era.) At that time, Raghu hoped 90 per cent of Indian households will get bank accounts by the end of 2011. But that target still not achieved. Proof? Census 2011.

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3. Now you‘ve put all your eggs in UID-Aadhar. But: 1. ~50% of juntaa yet to get Aadhaar cards (Nov.2013 data). 2. Chhattisgarh and Madhya Pradesh have performed even less on Aadhar enrollments. 3. If BJP/AAP/third front forms next government, Will they continue UID project with same enthusiasm and budget support? Doubtful!

(This panel member has officially criticized Nachiket‘s 1/1/2016 plan)

. You‘re talking about ―Electronic‖ Bank account but In many rural and naxal areas, we don‘t

Shikha have the physical structure (office/staff) OR even virtual structure (by mobile/broadband) to

Sharma run banking services.

. Besides, if deadline is 1st Jan 2016, means everything has to be finished by the end

31/12/2015= Mission impossible.

. A more plausible target is 100% bank accounts by 1st January 2018.

Both of your concerns are valid. But I believe 1/1/2016 is possible. Besides

Nachiket . France: People are given ―right to bank account‖

. Sweden: Banks cannot refuse to open an account

. I recommend RBI to issue similar guideline/order to banks in India.

Additional criticism to Nachiket’s Universal Bank account plan: 1. Nachi‘s plan is noble but no different than the Paternalistic formulation which say the State knows everything- about what should be consumed by each customer= licence- quota-inspector raj. 2. Nachi says bank account for every ―resident‖ (not citizen). So even outsiders like Bangladeshi and Nepali immigrants get the benefit, and money comes out of tax payer‘s pocket. (How? because even if SBI agrees to open UEBA accounts for free, it‘ll need to spend money on paper-work and staff. and over the years, SBI is not making optimum profits and suffering from large NPAs. So, Government will have provide some special scheme, Rajiv Gandhi Sabko bank account dedo Yojana, under which, Government pays 10-20 rupees to such public sector banks for every new UEBA account opened.) Vision#2: Access Points for Banking/Payment Services

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. ok, for the sake of argument, let‘s assume everyone gets a universal bank account by 1/1/2016. BUT if a person has no branch office / ATM nearby, then it is useless.

. So, by 1/1/2016, we‘ll also create so many ―access points‖ that everyone can reach them within 15 minutes of walking distance.

. Example of access points: bank branch office, Bank‘s business correspondence agent, mobile recharge/repair shop, small retailer, Panchayat office, post office. (+Payment bank, separately discussed click me)

Facilities given @access points:

. Deposit and withdraw money

. Transfer money from one bank account to another This service will not be 100% free. You‟ll have to pay “reasonable” charges.

Again, your plan is Ambitious but unrealistic. Suppose a person is climbing Mt. Everest or

Mohan some Baba is doing samaadhi in a Himalayan cave, how will you create an access point within 15

minutes of his walking distance?

Technically speaking, we‘ll try to create one access point per square kilometer in areas where atleast Nachi 400 people live.

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Then why don‘t you just say ―1 Access point for each sq.km with population of 400 people, across the Mohan country by 1/1/2016.‖

Because ―within 15 minutes of walking distance‖ = ―shock value‖ = Newspaper will talk about it and Nachi junta will take me seriously. This is marketing funda #101.

Mohan Still, it is an unrealistic goal.

Nachi well, consider these facts:

1. Government is planning to cover all the 2.5 lakh gram panchayats through the National optical fiber network(NOFN) by 2014. This network + Panchayat office can be used for e-banking. 2. Mobile Penetration is higher than you believe: There are more than 85 Crore mobile phone subscribers in India. Out of them 35 crores in Villages. And that number is increasing at 10% every year=> Mobile banking opportunity. 3. Additionally, I also recommend RBI to give license for ―Payment Banks‖. (Topic separately discussed click me) Rural Branching Mandate

Center city census definition:population is ____ SCB (Scheduled commercial bank):

Metropolitan – 10 lakh and above Need RBI permission needed to open

Urban Tier 1 1 lakh and above new branch [Except Northeast and

Sikkim] Tier 2 50,000 to 99,999

Semi-Urban Tier 3 20,000 to 49,999

doesn‘t need RBI permission to open Tier 4 10,000 to 19,999 new branch.

Rural* Tier 5 5,000 to 9,999

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Tier 6 less than 5,000.

*Additionally, Bank will have to open atleast 25% of its branches in unbanked rural areas.

Nachi I recommend this 25% rural branching mandate rule should be continued.

Mohan Ok but 25% of what?

. 25% of ABEP (annual branch expansion plan)

Nachi . Meaning, if SBI wants to open 1000 new branches in 2014-15 then alteast 250 need to be opened

in unbanked rural areas. White label Business Correspondence Agents

. Banking Business correspondent Agents already discussed click me

. White Label ATM discussed already click me

. Nachiket recommends White label Business correspondence agents. Meaning same agent be allowed to tie up with multiple banks.

. Why? Same logic like White label ATM: if all banks open ATMs in every village=operation cost increased. But is a white lable company gives service common to all of them, then operational cost reduced. In short, NOFN + Mobile Banking + Payment Banks + Rural Branching Mandate=the Vision#2 achieved.

Apart from these, Nachiket also suggested reforms in NBFC, RRB etc. to achieve vision #2 but they also overlap with vision 3,4,5 and 6. So, we‟ll discuss them later on in separate articles.

The end of the article, unless you want to read some additional topics associated with vision 1 and 2

Appendix: side topics Basic Savings Bank Deposit Account (BSBDA)

. 2005: RBI cameup with ―No frills account‖ for poor people.

. Allows you to open bank account with no minimum balance requirement.

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. 2012: RBI renamed it to Basic savings Bank deposit account (BSBDA). Facilities/ features:

. Anyone can apply for BSBDA (rich, poor, middle class doesn‘t matter)

. Available at All scheduled commercial banks in India (including foreign banks with branches in India)

. Can deposit and withdraw cash

. Cheque and electronic payment facilities.

. Free ATMs-cum-Debit Card

. If you account remains inactive, still bank cannot charge any penalty on you.

. KYC norms apply

. Account opening is free

. Each year, First chequebook free.

. Netbanking facility is free

. Interest paid : 4% just like regular savings account. Limits

. Maximum of four withdrawals in a month, including through ATMs.

. He cannot open any other account in the same bank. Are Bank Branches useless for financial inclusion?

. A traditional bank branch (of SBI or ICICI) has high cost of operation – office rent, staff salary, securiy guard, lightbill, telephone bill etc. Even an ultra-small branch will cost ~20-22 lakh per year.

. In rural area, most people will get No frills account / Basic savings and deposits account= bank can hardly make any profit to make.

. Some Regional rural banks and cooperative banks are yet to be integrated with Core Banking platforms (CBS) = difficult for NEFT and RTGS money transfers.

. Traditional bank branches have fixed working hours and bank holidays. If a poor labourer wants to access his account, he‘ll have to waste 2-3 hours in walking and talking=>late at work =>contractor will cut his wages.

. Most villagers need loans less than Rs.5 lakh. In this type of small loans, bank‘s paperwork, headache, loan default risk is high compared to the profit/reward. But It doesn‟t mean Bank branches are useless. Nachiket recommends following

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1. Branch should focus on high value customers, transactions, cheque clearing and cash management only. 2. Outsource other things to Business correspondence agents. e.g. account opening, organising financial literacy camps, sourcing loans resulting in sanction and disbursal, maintaining records, and post-sanction monitoring and recovery of loan accounts. 3. Allow White lable Business correspondence agents. (i.e .same agent/PCO operator/kiranawalla can do work for multiple banks) in other words, permit Interoperability of BCs. 4. Allow Non-deposit taking NBFCs to run Business correspondence agents‘ network for Banks. 5. Real Sector Adjacencies to increase banking penetration: For example 1. Diconsa, an operator of 22,000 grocery stores in rural Mexico, began a program to deliver cash payments from government benefit programs to people in its stores. 2. Axis Bank partnered with Airtel and Idea to leverage their wide outreach in rural areas. 3. Banks should partner with Community Service Centres (CSC) and Panchayat Offices in the villages. 6. Right now Aadhar cards enrolling is done via ―camps.‖ Once this phase is over, bank branches could be used for handling new aadhar cards in applications in upcoming years. Banks should get commission for DBT

. If a person wants to transfer money via NEFT (netbanking) from one bank account to another- he‘ll have to pay fees between 2.5 to 25 rupees to the bank.

. Similarly if government wants to give direct (cash) benefit transfer to poor beneficiaries accounts, then government should also pay fees the banks.

. Nachiket recommends that for every DBT Transfer, the government should pay the bank 3.14% commission (upto to maximum Rs. 15.71 per transaction).

. Problem? Most government departments don‘t like it. Not one bit. RBI’s Seigniorage and E-Money Just food for thought, not very important for exams.

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. In the medieval times, there was no RBI (central Bank.) The king himself issued the coins. He‘d give gold/silver/copper/bronze metal to mint-officers. They‘ll melt it and make coins.

. In this case, Profit of the king (Seigniorage)= face value of a coin MINUS the Input cost. (salary to staff, blacksmith, charcoal burned to melt the metal etc.)

. Today we live in the era of Fiat-currencies- Rupee, Euro, Dollars, Yen and Yuan.

. So, how does the Seigniorage work now?

. Suppose cost of printing one ―fifty rupee‖ note= twenty rupees (in terms of the money spent on buying paper, ink, electricity and staff salary).

. Thus RBI‘s Seigniorage (or profit) = face value of currency notes MINUS the cost of printing currency notes. In our example, 50-20= 30 rupees.

. But that‘s not ―the end‖. There are two cases when RBI needs to print money 1. To replace the torn out currency notes. 2. To pump additional money into the system. In the second case, RBI cannot arbitrarily print money as per its time and mood (because it‟ll lead to inflation). First government will have to give equivalent amount of bonds/government securities (G-Sec) to RBI. Say worth 100 crores. Then RBI will print 100 crore worth notes and circulate it in the market. And on those G-sec, government will have to pay interest to RBI. so, What will be RBI‟s Profit in this case?

1. Direct profit: face value of notes minus production cost of those currency notes. 2. + Interest earned from G-sec. [RBI earns more than Rs.85,000 crores from this only!] Anyways, what’s the point?

. When junta switches to Electronic money transfer (NEFT, RTGS, mobile banking etc.) then less wear-n-tear of currency notes= demand of physical currency notes decreased=RBI‘s profit (Seigniorage) decreased.

. In a futuristic society, junta will stop using physical cash altogether, All transactions will be done through mobile and electronic devices. How will RBI make profit? obviously the ‗direct profit‘ is stopped (because RBI doesn‘t have to ‗print‘ currency notes anymore).

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. RBI will still earn interest from G-sec. (because even in an electronic money system, RBI Governor will have to type the ―100 crore― in his super-duper banking software to pump 100 crore rupees in the electronic system. and he cannot do so, unless government gives him some legal backing through those securities/bonds.) But overall, e-money= threat to RBI‟s Seigniorage(Profit). Nachiket gives two solutions (just like Yudhisthir when asked about Ashwashthama‟s death): 1. We should admit it will not a big problem, and RBI can survive on less Seigniorage, even if Junta switches to e-money. 2. We should admit that it will a big problem, and find an alternative solution. (e.g. Rajiv Gandhi RBI Bachaavo Yojana, under which government will agree to pay *** crores to RBI every year to compensate for the loss of Seigniorage because of electronic money.) Mock Questions 1. Correct Statement 1. Since Independence, if India had followed a free market capitalistic model of economy, Financial inclusion would have been extremely high. 2. Since Independence, If India had taken concrete steps for financial inclusion, the regional disparities would have been less. 3. Both A and B 4. Neither A nor B 2. Recently RBI formed a Committee under Nachiket Mor. Which of the following is one of the vision statements issued by the Committee? 0. Bank account for every citizen by 2016 1. Bank account for every resident by 2018 2. Bank account for every BPL by 2018 3. Bank account for every resident by 2016 3. Nachiket Committee has recommended Universal Electronic Bank Account (UEBA). How will it be achieved? 0. Nationalized Banks will be required to hold camps and Melas to enroll people in UEBA 1. RBI will issue a circular mandating all scheduled commerical banks to enroll all the unbanked BPL families in their branch-territories under UEBA

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2. Every resident will be issued a UEBA account automatically at the time of receiving their Aadhaar number 3. None of Above. 4. What do you understand by RBI‘s ―Rural Branching Mandate‖? 0. that all scheduled commercial banks have to open atleast 25% of their branches in tier-1 and tier-2 areas 1. that all scheduled commercial banks need RBI‘s permission before opening 25% of their branches in tier-1 areas 2. that all scheduled commercial banks to open atleast 25% of their branches in tier 3 to 6 areas. 3. None of above 5. Correct statements about Basic Savings Bank Deposit Account 0. This is special type of bank account only Micro finance institutes can open. 1. only BPLs and self-help groups can apply for it. 2. They get higher interest rate than (regular) savings account. 3. It was earlier called ―No frills account‖. 6. If we completely moved to an electronic money system in place of physical currency, then which of the following will be reduced? 0. Government‘s subsidy burden 1. RBI‘s Seigniorage 2. both A and B 3. Neither A nor B 7. A place is given Tier 6 rank in Census 2001. it means the given place is a ____ area. 0. Semi Urban 1. Rural 2. Urban 3. Semi-rural 8. (Aptitude) Suppose rural branches ratio of SBI : PNB=1:3, PNB: ICICI=2:5 and ICICI:BoB=2:3, then what is the ratio of SBI :PNB: ICICI:BoB? 0. 4: 12: 3: 5 1. 12: 4: 50: 10 2. 4: 12: 30: 50

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3. None of above 9. (Aptitude) SBI, PNB and BOB have rural branches in the ratio of 2:3:4. If each of them adds 40 new branches, then ratio becomes 4:5:6. Find the total number of rural branches in the beginning. 0. 220 1. 200 2. 180 3. None of above Q10. Match the following

1. Bimal Jalan 1. Financial Services

II. Nachiketa Mor 2. Banking licenses

III. Arvind Mayaram 3. Multi Dimensional Index to measure state backwardness

IV. Raghuram Rajan 4. New definitions for FDI and FII

Answer choices

choice I II III IV

A 1 2 3 4

B 4 1 3 2

C 3 2 4 2

D 2 1 4 3

Q11. Which of the following factor(s) aid in financial inclusion? 1. That under National optical fiber network, government plans to connect all Gram Panchayats with internet connection. 2. That Mobile penetration is increasing day by day in rural areas

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3. That as per Census 2011, India‘s working age population (15-64 years) is more than 60% Answer choices

1. only 1 and 2 2. only 1 and 3 3. only 2 and 3 4. All of above Q12. Financial inclusion doesn’t automatically help in: 1. turning savings into investment 2. reducing current account deficit 3. Decreasing inflation Answer choices

1. only 1 and 2 2. only 1 and 3 3. only 2 and 3 4. None of above. Descriptive/Mains

1. Examine the lack of financial inclusion as a factor responsible for inequality of income in India. (10m | 200 words) 2. Nachiket Committee‘s plan of providing Universal Electronic Bank Account to everyone by 2016, is ambitious but unrealistic. Do you agree? Justify your stand. (10m | 200 words) 3. Nachiket Committee‘s recommendations, if implemented in letter and spirit, can achieve 100% financial inclusion. Elaborate. (10m | 200 words) 4. Critically evaluate the utility of Aadhar card in facilitating financial inclusion. (10m | 200 words) 5. (Ethics Paper 4: Case study) DevAnand is member of a Committee on financial sector reforms appointed by the Finance Ministry. Chairman Alok Nath comes up with recommendations that are good in theory but highly impractical if implemented in real life. Dev had some reservations but this wasn‘t a matter of life and death, so

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Dev did not object while recommendations were being finalized. After the report was released in public domain, TIMESNOW editor Arnab Goswami invited DevAnand on his show, and started asking uncomfortable questions pertaining to the practicability of those recommendations. The following are some suggested options. Evaluate the merits and demerits of each of the options: 1. DevAnand should tell the truth that he did not agree with some of the recommendations but did not oppose officially during the meetings because it wasn‘t a matter of life and death. 2. DevAnand should tell Arnab that he was merely a member, and Alok Nath is the chairman of the Committee, he is more capable of answering such interview questions. 3. DevAnand should fervently defend those recommendations of the Committee. 4. DevAnand should informally request Arnab Goswami not to ask hard questions because such Committee reports are never implemented anyways. Also indicate (without necessarily restricting to the above options) what you would like to advise to DevAnand, giving proper reasons. (25 marks | 300 words) some chillar questions: 6. What is National optical fiber network? How does it facilitate financial inclusion? (5m | 100 words) 7. Write a note on the steps taken by RBI for prompting financial inclusion. (5m | 100 words) 8. Write a note on the steps taken by Government of India for prompting financial inclusion.(5m | 100 words) 9. Write a note on the steps taken by RBI and Government of India for prompting financial inclusion.(10m | 200 words) Interview

1. 100% financial inclusion vs 100% literacy. Which one will you pick first, as the prime minister of India? and why? 2. Do you think higher literacy levels and financial inclusion are directly related with each other? Yes/No and Why?

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3. If yes, then why North Eastern States have performed relatively low on the parameters of financial inclusion, despite having relatively higher education levels? 4. As a policy maker, what will you do, to fix this anomaly, apart from giving money in subsidies and schemes with special component for NE states? 5. Recently Nachiket Committee recommended bank accounts for everyone in India. Others recommend government to give food to everyone, give education to everyone, even mobiles for everyone! Critiques say this type of paternalist planning or Maai- baap-mindset is outdated. The state should not be doing everything. Do you agree? Yes/No and why?

Nachiket Committee: Payment Banks- Rationale, Features, Advantages, Limitations, Pre Paid Instrument Providers (PPI), USSD Banking

Pre-Paid Instrument Providers (PPI)

Airtel money is an example of PPI. So, What do they do?

. You give them money (from your regular bank account)

. They give you a ―digital wallet‖ tied with your mobile.

. You can use it to pay bills, shopping, movie tickets etc. What are the features/characteristics of such PPI?

. They‘re regulated by RBI under Payment and Settlements Act of 2007. (More than 20 such companies allowed to run their PPI scheme.)

. KYC norms apply.

. You don‘t earn interest rate on the money saved in it

. You can put maximum Rs.50000 in it.

. You cannot ‗pull out‘ money from it. (Meaning you‘ve to spend. You cannot ask for refund in cash. except under some special models/schemes.)

. Transaction fee applies. Every time you buy something using your Airtel Money account, they charge ~0.5% as commission. Other examples of PPI:

. Gift cards issued by banks e.g. prepaid.onlinesbi.com/giftcard.html

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. Airtel money, Oxigen Prepaid cards

. Paypoint, Zipcash, flipkart wallet, Paytm, Mobikwik

By the way, unlike currency notes, these prepaid instruments are not fungible. For example, if you have 500 Rs. in your Airtel money account, you cannot get it exchanged for 500 Rs. in Oxigen prepaid card. (even if you manage to do it by some jugaad- there will be ~0.5% commission charge, you never get full convertability from one instrument to another instrument.)

For more on fungibiity, click me Why Nachiket hates PPI model? Last year, RBI appointed a Committee for financial services under Nachiket Mor. Committee observed that:

. PPI doesn‘t offer interest rate. From financial inclusion point of view, this doesn‘t help the poor people and small businessmen save their money.

. PPI is a nested payment model: you give money to PPI, they deposit it in an escrow account in some bank. Everytime you do something using digital wallet, they take out money from that escrow account and pay on your behalf. What‘s the problem?

. Problem is nested models= they increase ―contagion risk‖.

. Contagion risk = bad thing happens @one place, then it also leads to more negative outcomes @other places in the market. Suppose TRAI/Supreme court cancels Airtel‟s license for xyz reason, result?

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. Direct problem for people who‘ve money in Airtel account.

. indirectly, gives an opportunity for some crook to start a baseless rumor via facebook that airtel has deposited all that PPI money into ICICI/xyz bank and now they‘ll also go out of business => then juntaa will rush to demand their money back, share prices fall down and so on…. creating instability in the banking-finance system.

. plus, Issues related to account security, KYC etc. Therefore, Nachiket recommends: 1. RBI should NOT give any more licenses to open PPI. 2. Still, If anyone is interested, RBI should ask him to become a Banking business correspondent OR apply forPayment Bank license. Now comes the main topic:

Why Payment Bank? Nachiket‟s thought process is like this:

1. Pre-Paid Instrument Providers (PPI) = suck because they don‘t pay interest on your money. 2. But their basic model /concept is good= You load cash into your mobile (airtel), use it for buy things, pay utility bills and so on. No need to carry cash, cheque book, credit card or visit ATM booth. Thus, from financial inclusion point of view, PPI model is good, if they gave interest on your money. So, based on that idea, Nachiket recommends RBI to give license to a new type of banks called “payment banks”. [Under the banking regulation Act.]

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What is payment bank? Payment banks will have following characteristics:

1. Target audience: small businessmen and poor people. (=low income households) 2. Potential candidates to run Payment banks: mobile phone companies, consumer goods companies, post office system, agri/dairy type cooperatives and Corporate Business correspondents. Even Scheduled commercial banks can open payment banks as their subsidiaries. 3. Payment bank will have to keep CRR (Cash reserve ratio) just like other Scheduled commercial banks (SBI, PNB, BoB, Dena, ICICI etc) 4. Payment bank cannot hold more than Rs.50,000 per customer. (This is similar to PPI.) 5. Payment bank cannot involve in any credit risk. (again similar to PPI)

Mohan Cannot assume ―credit risk‖? What does that mean?

Nachiket It means Payment bank cannot give loans to anyone, especially to liquor kings like Vijay Mallya.

. Hold on! That raises even more questions. Bank‘s main function is to take deposit from one

guy, give it as loan to other guy and make profit in between these interest rates. Mohan . But if bank cannot loan the money, then how will they make profit and how‘ll they give

interest to those depositors?

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Na Hold your horses, brother. Payment bank will be permitted to invest in SLR approved securities.

Mohan Meaning?

Meaning Payment bank can invest customer‘s money in Government securities (G-Sec) and Nachi corporate bonds of reputed companies like Infosys, reliance, TCS etc.

Mohan So?

Investment in SLR securities give you return of atleast ~8%. So, payment bank can keep some Nachi money as profit and give the remaining to customer as ―interest‖.

Mohan Toh thik hai. (then it is alright!) but what is SLR?

Nachi click me

more characteristics of Payment banks:

1. Payment bank will enjoy all the rights and responsibilities of a Scheduled commercial banks (SCB- like SBI, PNB, BoB, Dena and ICICI) 2. Entry capital requirement will be Rs.50 crore.

Hold on. I read in some newspaper that, to open a full scale SCB like SBI, you need minimum entry

Mohan capital of Rs.500 crore. Then why such relaxation given to Payment banks? Why do you allow them

to open bank with just Rs.50 crores?

. As I told you earlier, Payment bank cannot assume credit risk (meaning they cannot give out

loans)

. and since they cannot give out loans=> there is no danger of loan default/NPA. Nachi . Payment bank can invest money in SLR securities, but they are safe investments, you can easily

recover money.

. In short, Payment bank faces near-zero risk of default. so, they don‘t need a large capital for

emergency backup.

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Mohan Toh thik hai. (Then it is alright!) side note: Nachiket also recommended wholesale investment banks and wholesale consumer banks. But we‟ll see about them in a separate article later. For now, Let‟s make a table:

Can Give Loans Can Accept Retail System Can Make Payments? (Credit)? Deposits?

Payments Network Operator (like No No Yes Mastercard, Visa)

Payments Bank (Nachiket‘s Brainchild) No Yes Yes

Sch. Commercial Bank (SBI, ICICI) Yes Yes Yes

White Label ATM (TATA/Indica$h) No No Yes

Yes (only if both party

Bitcoin digital wallet No No agree)

M-Pesa: Why India should get Payment banks? Nachiket cites the “case study” of M-Pesa, to strengthen his argument in favour of Payment banks. So let‟s check what is this M-Pesa?

. M-Pesa is Kenya‘s Payment bank. (Fundamentally, it is a Mobile payment service, just like our Airtel Money.)

. M=mobile; Pesa=swahili word for money.

. M-Pesa is the brainchild of Vodafone (=enemy#1 of our Income tax department) + Kenya‘s local mobile company called Safaricom +IBM.

. 2006: M-Pesa launched. At this time, more than 70% of Kenya‘s Juntaa didnot have bank accounts. How does M-pesa system Work?

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. You go to an M-Pesa outlet (local kiranawalla, shopping center, petrol pump, paan- ki-dukaan etc.)

. Give him cash, he fills up your M-pesa electronic account with that money. (just like how you recharge your prepaid mobile)

. This M-pesa Account is tied up with your mobile phone. Wherever you go, money goes.

. M-pesa helps in money transfer between one person to another, international remittances (e.g. Kenyan worker from USA can send money home), utility bill payments and so on.

. You can even borrow money from Microfinance Institutions (MFI) via mobile phone (and later repay the loans, via same mobile phone). M-Pesa size and Success:

. Today, More than 75% of Kenya‘s juntaa uses M-Pesa system

. More than 25% of Kenya‘s GDP flows through M-Pesa system.

. M-Pesa also offers a separate model called ―M-Shwari‖ to give 2-5% interest rate on your money saved in that M-Pesa account. So, If Payment bank model can succeed in Kenya, it can also succeed in India. (Atleast that‟s what Mr.Nachiket believes)

Payment Banks: Anti-Arguments Bankers have criticized this idea of “Payment banks” because:

#1: Nothing new under the sun

. M-Pesa model you saw above- it is nothing ―radically new‖- SBI, ICICI and all other big banks already offering such services via mobile banking platform.

. So instead of opening new Payment banks, better just let those existing banks to give these banking-investment-insurance services through their branches, mobile banking, internet-kiosks, business correspondents and bancasurrance model.

. OR Mr.Nachiket could have simply recommended “all PPIs like Airtel money should pay interest on the money held in digital wallets.” instead of coming with a new type of ―payment banks‖ #2: Not 100% financial inclusion

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. Financial inclusion is a bigger thing than mere ―payment/money transfer‖- Financial inclusion means access to complete bouquet of financial services —banking, investment, insurance, pension – everything.

. But that‘s very difficult to achieve through Payment bank system. (Because Nachi himself said, bank cannot assume ―Credit risk‖.) #3: Price wars

. Schedule commercial banks also permitted to run Payment banks through their subsidiaries. That defeats the whole purpose because SBI is a giant elephant with large resources and manpower. If it starts a payment bank then other small player‘s payment banks cannot compete, and they‘ll bleed in price wars.

. in the previous article on White label ATM, we saw how ATM operation costs are hurting the entire banking sector.

. So instead of allowing NBFCs and private companies to open ―Payment banks‖ and compete with regular (commercial) banks, Nachiket should better suggest a model where they all can work in synergy to achieve 100% financial inclusion. USSD and Conflict of Interest

. For mobile banking, you need an active mobile number to send those SMS and passwords during Mohan online transaction.

. And You just said Mobile company can also get license to open Payment bank.

Nachi What is your point?

Mohan There is conflict of interest=> customer exploitation. Observe:

. Suppose both Airtel and Idea got Payment bank license. I open a payment bank account with Idea but keep airtel phone number.

. Then what if airtel charges more money per SMS when I want to do some net banking /balance inquiry about my Idea BANK account?

. And airtel walla also promises me that if I open Payment bank account in Airtel, they‘ll give free services and even discounts @Bharti-walmart malls!

Your concern is valid. There will be conflict of interest when such large companies also run payment Nachi banks. To solve this problem, All mobile companies must be ordered:

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1. to provide USSD connectivity as per recent TRAI regulations (Rs 1.5 per 5 interactive sessions.)

2. to categories all SMSs related to banking and financial transactions as Priority SMS services

(with reasonable rates)

. Man!! that means RBI and TRAI will have to take additional headache and supervision to

prevent customer exploitation.

Mohan . That is one more negative argument against Payment banks. Better just let the regular banks

handle stuff instead of opening new payment banks. Anyways, what is this USSD connectivity?

USSD connectivity for Banking USSD=unstructured supplementary service data

. Example of USSD= When you type #123* etc. numbers in your mobile to check balance, activate 2g/3g pack, ringtones etc.

. USSD can be used for prepaid call-back service, location-based content services and menu-based information services.

. Unlike SMSs, USSD messages create a real-time connection during a USSD session.

. The connection remains open, allowing a two-way exchange of a sequence of data making USSD more responsive than services that use SMS.

. Last year, TRAI cameout with guidelines on USSD that:

. For banking related USSD, the mobile company can charge only Rs.1.50 per session.

. This money will be charged on subscribers account (i.e. ―balance‖ in your mobile phone).

. ICICI and SBI have already launched their USSD Based mobile banking services. For example click me for SBI page Mock Questions 1. What do you understand by the term ―Pre-Paid Instrument Providers (PPI)‖? 1. White label ATMs 2. Brown Label ATMs 3. Both A and B 4. Neither A nor B

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2. Recently, Nachiket Committee on Financial services, has recommended a new type of Payment banks. Which of the following, is not true about them? 0. Scheduled commercial banks will be allowed to open Payment banks as subsidiaries. 1. Payment banks will be exempted from CRR and SLR requirement. 2. Mobile phone companies, consumer goods companies, post office and cooperative societies will be allowed to apply for Payment bank license. 3. None of Above 3. Correct statements about Pre-Paid Instrument: 0. With RBI‘s permission, prepaid instruments are issued in the form of smart cards, internet wallets, or mobile wallets. 1. They can be used for purchasing railway tickets, paying utility bills and purchase of goods and services. 2. Scheduled Commercial banks can issue such Pre-Paid instruments. 3. As per RBI rules, 4% interest rate has to be paid on each such Prepaid instruments 4. Find the correct statement(s) about Payment Banks as recommended by Nachiket Mor Committee 0. Payment banks will be kept outside the purview of Banking regulation Act. 1. Payment banks will be focusing mainly on Service class employees and HNI (High networth individuals). 2. Payment banks will have to follow the targets under PSL (Priority sector lending). 3. None of above 5. Correct Statements about USSD 0. USSD facilitates real-time two-way exchange of data between mobile phone and the service provider. 1. As per TRAI regulation, mobile companies are requireed to provide all USSD services free of cost. 2. Both A and B 3. Neither A nor B Descriptive/Mains

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1. Nachiket Committee‘s proposed payment banks are better suited to achieve the goal of financial inclusion compared to the existing setup in banking sector. Do you Agree? Justify your stand. (10m | 200 words) 2. Write a note on Nachiket Mor Committee‘s recommendations regarding Payment Banks. (5m | 100 words) 3. Compare and contrast between the proposed Payment banks and Scheduled Commercial banks. (5m | 100 words) 4. Define USSD. Explain its utility in Mobile Banking and Financial inclusion. (5m | 100 words)

Nachiket Committee: Remove SLR, Reduce CRR, Raise PSL to 50%, Increase Loan Access: Issues, implications explained

Prologue

So far, we‟ve seen RBI appointed Nachiket Mor Committee on financial products for small businessmen and poor people (low-income households). Nachiket cameup with six-point vision.

1. Universal bank accounts for everyone (already done click me) 2. Better access to payment services, payment banks (already done click me) 3. Better access to loans (Credit) discussed in this article 4. Better access to investment 5. Better access to insurance 6. Consumer protection.

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In this article, we‟ll see vision #3: better access to loans (Credit). Nachiket has three major recommendations in this regard:

1. Remove SLR, reduce CRR 2. Remove interest subvention, Remove debt relief 3. Priority sector lending: raise from 40% to 50% 4. Other Misc. recommendations to increase access to credit (loans). Accepting Deposits: “Bank” is an organization who got license from RBI (under Banking regulation act) A bank must have three features:

1. Accepts deposit from public 2. Gives these deposits for loan / investment 3. Deposited Money can be withdrawn by cheque (and other means like Debit card, ATM card, netbanking etc.) Bank accepts mainly two types of deposits:

They ‗mature‘ at a particular time e.g. Fixed deposit for 1 year @9% Time Fixed deposit, recurring interest rate. If you demand this money before expiry of one year= they Deposit deposits, cash certificates cut penalty.

. Savings account

(for general public)

Demand . current account (for You can demand / takeout money without as per your wish. Deposit businessmen)

. Demand Drafts

(DDs)

. For bank, both of them are ―liabilities‖. Because bank has to repay this money sooner or later.

. RBI counts SLR and CRR only on ^these net demand and time liabilities (NDTL.)

Incoming (Time and Demand Liabilities) suppose its 100 crores

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4 cr.gone here. (Bank

CRR: Cash reserve ratio. (4%) earns no profit/interest

here)

SLR (23%): Bank has to keep aside some money in liquid assets such as gold, 23 cr. gone here. (some government security other RBI approved securities of public/private companies. interest/profit earned)

Money left with bank 100-(23+4)=73 cr.

Now whatever car loan, home loan, and education loans the bank wants to give, they have only 73 rupees left. (even there, you‟ve Priority sector lending requirements.)

So, Nachiket recommends reforms:

SLR CRR

Remove SLR CRR should be counted only on the ―Demand deposit‖.Ignore What Nachi requirement. ―Time deposits‖ for this calculations= CRR will be reduced recommends? (gradually) automatically.

Money kept under CRR doesn‘t earn additional money. it is a

WHY? Explained below dead asset. So let money kept in CRR=better.For more

points, click me to know why SBI hates CRR?

Why Remove SLR?

. SLR=Statutory liquidity ratio =banks have to keep aside some assets into ―liquid‖ form= cash / gold / government securities / RBI approved securities of public and private sector companies.

. these assets are called ―liquid‖, because you can easily sell them and recover money in ‗cash‘ form. This cash comes handy during emergency for example: When many people simultaneously come to take out money from their savings/current account during festivals, after natural calamity, or when someone rumours that bank is going to collapse.

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. When customers make such ―bank runs‖, bank can sell away the SLR securities and quickly arrange cash for customers.

. So, in a way SLR=one type of emergency backup.

. But SLR securities=very safe, low risk securities. And in market, ―low-risk = low reward‖. Banks hardly earn ~8% interest/dividend on such investment. So most bankers consider the SLR investment = lazy investment or even dead investment. BASEL norm

BASEL norms=lengthy topic, needs separate discussion. For the moment, just know that

. BASEL is a town in Switzerland, where bankers across the world met, to decide how to make banking sector more safe and sound, and how to prevent repeat of sub-prime crisis.

. This leads to various terms: Capital adequacy requirements, tier I, tier II assets and so on.

. Third version of this system =BASEL III. Effective from 2013.

. Bankers agreed ―we must keep some money apart, as emergency backup‖ (just like our SLR).

. They came up with a new concept called ―Liquidity Coverage Ratio (LCR)‖. The basics are similar to our SLR, that bank should invest part of their money into liquid assets like Treasury bonds / government securities and highly rated shares & bonds.

. RBI has been talking with BASEL board to include SLR securities into this LCR system.

. Indian banks have to comply with BASEL-III norms by 2018. Nachiket’s argument is following

. SLR = lazy investment (Because it gets barely ~8% return)

. In future, we‘ve to comply with BASEL-III norm. and they‘ve LCR system that is very similar to our SLR

. If banks have to keep money aside for both LCR+SLR => less money available for lending=not good for economy. So, better abolish SLR and just follow the BASEL norms.

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Overall, SLR removed + CRR reduced = more money available for banks, for lending to needy people = access to loans increased =financial inclusion.

Why Priority sector lending? You‟re aware of the common sense principle “no risk no reward”=>”high risk high reward”. So, What will happen in a free market economy (where RBI and Government donot interfere with the system)?

How much interest should Loan customer Banker‘s thought process bank charge on the loan?

Maximum risk, because his income depends on the

Farmer vagaries of monsoon. He is mostly to default on the High (50%)

loan.

Less Risky than farmer but still he may make losses Small businessman High (45%) during high inflation/recession and default on loan.

He‘ll not repay until he finishes graduation and gets a Student High (40%) job.

Salaried middleclass Minimum risk. Low (10%) family

High net-worth Low (5%) because individual (HNI), Big Minimum risk. minimum risk=minimum businessman reward.

Obviously, farmers, small business and students:

1. Will be exploited with high interest rate OR 2. Will never get any loan. Therefore, RBI requires the banks to give part of their loans to the weaker sections of society. This is called Priority sector lending (PSL) requirement.

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Late RBI asks the banks to increase lending to agro + small Industries (but did not give any ‗targets‘ 60s

RBI required the banks to submit data on how much money do they lend to agro+small industries? (RBI 70s had not imposed any ―targets‖ on the banks yet)

80s Finance minister comes up with the idea of ―40%‖ lending to priority sectors.

Priority sector includes following categories:

1. Agriculture and allied activities: (dairy, fishery, animal husbandry, poultry, bee- keeping and sericulture.)

Direct lending Indirect lending

Individual farmer, self-help groups (SHG), Food processing industry, other Corporates and firms cooperative societies engaged in this sector.

2. Micro and Small industries (upto 2 crores) 3. Education loans (10 lakh in India, 20 lakh for going abroad) 4. Housing loans (upto max. 25 lakh in metropolitan cities) 5. Renewable Energy: Loans for solar and renewable energy solutions. Note: Export credit is not a separate category. Export credit to eligible activities under agriculture and MSE will be reckoned for priority sector lending under respective categories. Weaker section Within „priority‟ sectors, bank has to give some of the loans to weaker section of society. Weaker section means: 1. Small and marginal farmers;

Farmer Landholding upto

Small more than 1 ht. but less than 2 ht.

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Marginal upto 1 hectare

1. Artisans, village and cottage industries 2. Beneficiaries National Rural Livelihood Mission (NRLM); Swarna Jayanti Shahari Rozgar Yojana (SJSRY); and Manual scavangers rehab. scheme 3. Scheduled Castes and Scheduled Tribes; 4. Women, self-help groups 5. Distressed people in the clutches of non-institution lenders (private Moneylenders, loan-sharks, financers etc.) Overall, PSL targets are as following

Desi Banks. (+foreign banks with 20 branches Foreign banks with less than 20 Target of more) branches

Agro 18% No specific targets

Weaker sections 10% No specific targets

Remaining categories Whatever left to reach the 40% target No specific targets under PSL

Overall PSL target 40% of net loans given** 32%

**To be technically correct that is Adjusted Net Bank Credit (ANBC) or credit equivalent amount of Off Balance Sheet Exposure (CEOBE), whichever is higher? But such minute technical details not important for exams. What if PSL target not met? Most banks miss their PSL targets.

Year 2013 %

Official loan target of PSL 40%

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Public sector banks gave 36.3%

Private sector banks gave 37.5%

So what happens when bank fails to meet PSL target?

Foreign bank with Desi Banks. Foreign banks (with 20 or more branches) less than 20 branches.

They‘ve to send remaining target money to RIDF To SEDF

SEDF= small

RIDF=Rural infra. Development fund enterprises

development fund

NABARD manages RIDF SIDBI manages SEDF

NABARD pays interest rate to the bank for this money (RBI decides the rate) Same by SIDBI

State governments get money from this RIDF fund to launch various infra. Projects. Similar case. But this isn‘t ‗free‘ money. The state will have to repay money with interest rate.

Additional safeguards under PSL just for general awareness, not much important for exam: 1. Bank itself has to arrange for applicant‘s photograph. (in other words, Bank cannot reject application because poor man did not have photograph.) 2. Branch manager is given discretionary powers while handling loan applications of weaker section. He can approve suc loan application without consulting his boss. 3. If an SC/ST person has applied for loan under priority sectors, then Branch manager cannot reject. If he wants to reject, he must forward the file to boss. 4. If loan application is less than Rs.25000, Branch manager must clear it within 15 days. (and for bigger amount than Rs.25k, then within four weeks)

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5. During natural calamities, floods, cyclones etc. bank has to restructure the loan repayment terms so the victim doesn‘t suffer more. 6. Bank cannot charge penal interest, if borrower delays repayment. (for loans upto Rs.25000) 7. A farmer took loan but late in repayment, still bank cannot charge compound interest rate on his dues. 8. At regional level, banks have to setup special machinery to handle complaints of PSL-borrowers. 9. Bank has to maintain a separate register for all rejected PSL loan-applications, along with reasons. RBI has powers to inspect these records. PSL target raised to 50%

Ok so far, I understood:

Mohan . That you want to remove SLR, reduce CRR = increase availability of loans for people.

. What is Priority sector lending, its features. Now, tell me your next ambitious but unrealistic target!

Nachiket well, I suggest PSL target should be raised from 40% to 50%

. Whoa, whoa, whoa…….PSL borrowers often default on loan repayment. If bank has to give

half of its deposits to Priority sector=high NPA, system will collapse, like it happened during

Subprime crisis. (Because American banks gave too much home loans to people who did not

have the aukaat to repay. Technically called ―Sub-prime‖ borrowers.)

. Most banks even fail to reach 40% target. How‘ll they reach the 50% Obviously, they‘ll fail Mohan and all the money goes to RIDF =>State government=>chowed down by local politicians,

bureaucrats and contractors in bogus infrastructure projects.

. Besides, If banks have to give half of their loans to PSL/weaker section, then where will

middleclass get loan? Is this another election gimmick or what? MAN! I thought you‘re an

IIM graduate but your mindset is of a jholachhap NGO/NAC member.

Hold on man. Don‘t jump the gun so quickly. 50% doesn‘t mean 50% of 100 rupees. It is a Nachi ‗weighted scoring‘ system. Allow me explain:

Existing situation

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. There are no ‗regional‘ targets under PSL. Suppose SBI‘s plans to give total 100 crore as loans, then they‘ve to give 40 crore as loans to priority sector areas. BUT, SBI is free to give this loans- anywhere in India.

. As a result, most of the PSL-loans are given in rich-n-developed states e.g. Gujarat, Andhra, TN, Punjab, Haryana etc. where a farmer is more likely to repay the loan, compared to a farmer in Assam or Arunachal Pradesh. Observe

. Therefore, I recommend a new system: if bank gives loan to ―hardship‖ areas, then they‘ll get more ―marks‖, and they must get minimum 50% marks to reach PSL target. That‘s our new system. Observe:

Financial inclusion at the Direct Weaker Other District moment agro. section sectors highest Pattanamthitta, Kerala 1.25 1.1 1 high Namakkal, TN 1.38** 1.21** 1.10** medium Rajkot, Guj 1.43** 1.25** 1.14** medium Muzzaffarnagar, UP 1.46** 1.28** 1.16**

Kurung Kumey, lowest 1.56** 1.37** 1.24** Arunanchal

Suppose SBI‟s net credit (ANBC)=100 Crore. So their (new) Adjusted PSL target =50%=50 crore rupees.

If SBI gives agri.loan of Rs.1 lakh to a farmer in Kurung Kumey district of Arunanchal, then under the (new) PSL target, we‟ll say SBI has given 1 lakh x 1.5617=1,56,170 rupees loan under PSL target.

Now, Observe from SBI bank manager‟s point of view:

Earlier PSL-system (40%) New (adjusted) PSL system (50%)

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Whether SBI gives loan to farmer in Assam hardship area will get more weightage. or in TN, its counted one and same.

40%=40 crores target 50%=50 crores target

Not necessary to give exactly 50 crore rupees. Suppose SBI

To reach this target, SBI will have to give focuses only where they get multiplier of at least 1.3. then how away exactly 40 crore rupees. much money does SBI need to give out?50 crore / 1.3 = approx.

38 crores.

Meaning, only 100-40=60 crore left for Meaning, 100-38 crores=62 crores left. So additional two crores giving out as ‗normal‘ loans (car loan, for giving out as ―normal‖ loans=more profit than previous business loans etc. where SBI earns more (40%) system. profit margin)

In other words, this is win-win situation for both parties:

. Banks earn more profit (Because they‘ve to give out less money in PSL).

. Loan seekers in hardship areas, get more attention from banks.

. Hmm…Interesting. In your example SBI‘s new PSL target actually reduced to 38% (although on

paper it will be 50%). Mohan . Plus, you‘ve already recommended removal of SLR, and reduction in CRR.

. So, you‘re not a jholachhap NGO as I had thought.

Right, I‘m totally opposite of that. And to prove it, I give another recommendation: government Nachi stopping giving debt reliefs and interest subvention to farmers.

Mohan But why??

Nachi For that, you‘ve to understand the concept of Base rates.

Base Rate Banks accepts deposits from people and gives it as loan to others. But who or what decides how much interest rate should be charged on such loans?

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Benchmark prime lending rate (BPLR).

From . Banks would use this complex formula to calculate the rates for various loans.

2003 . Drawbacks: system was opaque, middleclass had to pay high interest rates, while rich corporates

got big loans at cheaper interest rates.

. Even if RBI changed its repo rate, the banks will not change their loan interest rates.

RBI abolished above BPLR system. Introduced Base Rate

From . Under base rate system, the individual bank is free to determine its own base rate. (7%, 8%, 9%

2010 whatever.) bank is free to adopt a formula, as long as RBI feels it is consistent.

. Banks have to publish the Base rate on their website.

. Banks cannot lend money below the ―base rate.‖

Benefit: System more transparent, all type of loans are linked with Base rate. For example: SBI „s Base rate is 10% (as of Nov 2013)

SBI’s Calculation result

Car loan 0.75% above Base rate 10.75%

Two wheeler loan 8.25% above base rate 18.25%

Education loan (upto 4 lakh) 3.5% above base rate 13.5%

Home loan for women (upto 75 lakh) 0.10% above base rate 10.10%

If tomorrow, SBI changes the base rate, then all these loan interest rates will change accordingly. SBI cannot give loan to anyone, at a rate below the base rate. But Problem comes with the…

Agri. interest subvention scheme

. By government of India

. Applies to scheduled commercial banks (both public + private)

. Target beneficiary: farmers

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. If farmer is given loan upto 3 lakhs @7% interest rate, THEN government will give 2% interest subvention.

. In other words, farmer has to pay only 7 MINUS 2 =5% interest rate to bank, and that remaining 2% will be given by government (From tax payer‘s money)

Mohan Ok man but what‘s the problem?

This interest subvention scheme is inconsistent with RBI‘s base rate system. Recall that a bank cannot

Nachi give loan to anyone below the base rate. Most banks have base rate higher than 8% but government

will give subvention only if farm loans given @7%.

Mohan So what do you recommend?

. government should stop giving interest subvention. If government wants to give any

benefit/subsidy/relief to farmer, then give it under direct (cash) benefit transfer. (DBT) to

farmer‘s bank account. Nachi . This would ensure that the banking system is able to price loans in a sustainable manner based

on the risks involved.

. It‘ll also protect credit discipline amongst its borrowers.

Whatever dude. In the election year, it is unlikely that government will scrap down interest subvention Mohan scheme just because ―Nachiket the great‖ recommends so!

Debt relief= bad habits 2008= Government waived all the debts taken by farmers. (so they get happy and vote for UPA in 2009 election.)

Lazy I don‘t need to repay loans on time because government will again waive all the farm loans farmer before next general election!

Honest if other lazy farmers are not repaying loan on time, why should I bother? farmer

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. Thus, government‘s debt waiver scheme has created negative implications for the banking system. Farmers now expect more such loan waivers schemes would follow before state/general election, so they don‘t repay loan installments on time.

. This also hurt taxpayers because

. Government waived farmers loans=>government pays to the banks on behalf of farmer.

. But money doesn‘t fall from sky. Such freebies =fiscal deficit increased and it leads to plethora of new problems. (To learn more on negative effects of high fiscal deficit click me) Nachiket recommends that:

. From now on, government should stop giving debt waiver or interest subvention.

. Bank should bundle farm loans with weather based insurance scheme, that way, during crop failure, the farmer doesn‘t default on loans. His insurance money will cover the loan payment.

. In case of large scale loan defaults after natural calamity, banks should work closely with insurance companies to recover money. (instead of relying on state or central government to pay bank losses from budget.)

. If at all, government wants to give relief to debt ridden farmers, then transfer money to their bank account via DBT (Direct benefit transfer- just like in LPG subsidies). Don‘t directly waive everyone‘s loan.

. Every loan defaulter should be reported to credit bureaus (e.g. CIBIL)- be it small farmer, self help group or big businessman. Then people will automatically become cautious to protect their credit history, and repay loans on time. Why? Because if a person has low score in CIBIL, next time bank will not give him loan easily. PSL: Misc. Issues/recommendations to increase access to credit/loans among small businessmen and low income households:

PSL Insufficient

. Banks alone cannot fulfill the credit/loan requirements. Entire MSME (micro-small- medium) enterprises need 4 lakh cores of credit.

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. Banks don‘t have that much money to lend to a specific sector. If banks divert all of the incoming money to business/agro loans then middle class will have hard time getting loans. Nachi recommends:

. Legal/regulatory framework should be relaxed to help NBFC to raise more money from capital market, FII, External commercial borrowing etc. So NBFC can also lend more money to needy people.

. Setup ―Wholesale‖ banks. (we‘ll see it in detail, in a separate article) Middle & Large farmer benefits most

. Small/marginal farmer= relies on self-labour. So, apart from seeds, fertilizer, pesticide and irrigation, he has to spend money on himself for health, food, life insurance and disability insurance premiums, clothing, shoes etc. => he‘ll have to borrow again to manage expenses during the off-season.

. But such items are not counted as ―Agricultural lending‖ under PSL. So banks have no interest in helping farmers for those side-expenses. And even if bank gives the loan, it‘ll charge higher interest rate under ―personal loan‖.

. On the other hand, Middle / Large Farmer= Already has some machines (tractors, harvesters, diesel pumpset etc).

. So ―labor‖= Not his main factor of production and he has sufficient money to survive even in the off-season.

. Thus, medium and large farmers have benefit the most from PSL target. But small- marginal farmers have not benefitted much from PSL. Nachiket recommends: Loan given to small/marginal farmer and landless labourer= should be counted under PSL target, irrespective of whatever it is meant for buying direct agricture Inputs or indirect wage components.

Middleman model failed

. Banks cannot open branches in each and every village (and still they have to fullfill the PSL targets), so they tried the ―real-sector intermediary‖ model.

. In this model: fertilizer dealers, Sugarmill owners, APMC agents etc. disburse loans to farmers on behalf of the bank.

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What is Problem in this model?

. Overconsumption of fertilizers and pesticides. How? Because fertilizer dealer will invariably advice the farmer to buy more inputs using the loan money. And farmer would fear that dealer will create some hurdle in loan-processing if he doesn‘t use complay.

. Dealer will increase the price of seeds, fertilizer and pesticides. And farmer has no alternative but to buy at higher price (Because dealer processes the loan papers.)

. Sugarmill owner will deliberately give less price to farmer‘s sugarcane. +None of these agents have any complaint/redressal facility where farmer can quickly seek justice. (unlike the regular bank and banking ombudsman model)

Nachi recommends: This Real-sector intermediary model should be used only as a „stop-gap‟ arrangement. Bank should focus on increasing penetration in rural area by direct branch or business correspondence model. March Rush

Season Kharif Rabi

Months when farmer needs the loan desperately June, July, September December and January

. But, statistics indicate that most of the loans are given in March month. Why? Because PSL-compliance is calculated at March end.

. This is similar to ―March rush‖ in government departments. Parliament sanctions budget =>government gives crores of rupees departments=> but if department doesn‘t spend it before 31st March, all the unspent money will go back.

. For the entire year, sarkari babus sleep, but during March, they rush to buy new office equipment, start clearing all tenders and project files. Same happens in Banks for PSL-target. Result? 1. In the haste, banks don‘t thoroughly verify the credit history of farmer=more chance of loan default. 2. Farmer gets the money when he doesn‘t need. (in the march month). He is more likely to spend it on unproductive things such as festivals, weddings, pilgrimage to

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Amarnath/Nashik etc.=> Only a small part of a loan money to agriculture inputs=>More chances of loan default. Nachiket recommends: PSL counting should be done on quarterly basis (every three months) rather than yearly basis (12 months). That‟ll prevent the „March rush‟ among banks. Customer Data Architecture

. When you apply for loan, Bank Officer will first check your credit worthiness.

. For city folks, this is no problem because they already have xerox passbook showing their balance history, income tax records, salary slips, land possession titles, vehicle registration and so on.

. But most villagers and city poors don‘t have such records.

. In banking parlance they‘re called ―Thin file‖ clients. (Because their credit record, bank balance history is very thin).

. Banks don‘t give loans easily to these ―Thin file‖ clients. =100% financial inclusion not achieved.

. Solution? Make their file thicker. But how? Ans. Via customer data Architecture.

But Again how?

. Even if the person doesn‘t have a thick file record to show his credit worthiness, he may still have some ‗evidence‘ that he regularly pays his dues e.g. lightbill, phone bill, gas-cable bills etc.

. In Italy, even water utility bill is counted in credit score. If you pay your water bill regularly, your loan application will be processed easily.

. In Brazil, phone companies share all data records that would predict creditworthiness of low-income borrowers. (e.g. how many times did the person recharge his phone, average monthly call/sms/internet usage and so on.)

. In India, even the poors without toilets, have mobile phones. Banks can crosscheck with mobile company about their credit worthiness. Nachiket Committee recommends

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1. New guidelines so mobile companies can share data with banking and finance companies.- even with prospective employer, landlord, or creditor, whether bank or non-bank. 2. But only with written authorization from user. (=the mobile phone customer) 3. Special IT system to prevent misuse of information (e.g. only an officer above ** grade can login the system and check data, data cannot be copied in Usb and so on) Weather stations

. Farmers need loan to buy seeds, pesticides, fertilizers and machinery

. But their loan repayment capacity depends on the vagaries of monsoon.

. Therefore, most banks sell agriculture loans along with weather based insurance cover. For example, the Weather Based Crop Insurance Scheme (WBCIS)

. Such insurance schemes give protection from crop loss during

. Adverse monsoon: Both excess rainfall and drought situation.

. Adverse weather: frost, heat, relative humidity, and un- seasonal rains during Rabi season.

. So what‘s the problem? Lack of weather monitoring stations. So even if there is crop loss, it is difficult for farmer to prove the loss was because of bad weather. For complete coverage we need ~40,000 weather monitoring stations across India. Nachiket Committee recommends: 1. If bank gives loan to setup weather station, it should be counted under PSL target (priority sector lending). This will encourage entrepreneurs to setup weather stations. 2. If farmer suffers crop loss due to bad weather, he should be given the compensation before next cropping season, without delay. 3. Setup Automatic Weather Stations (AWSs) and Automatic Rain Gauge (ARGs). Land Registries

. You can get loan more easily if you‘ve an immovable collateral (e.g. apartment, factory, farmhouse in your name.) because even if you default on loans, the bank can take over that property and sell it to recover money under SARFAESI act.

. But most poors don‘t have land records to prove their ownership over immovable collaterals.

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. Therefore, banks don‘t give them loans easily= 100% financial inclusion not achieved.

. In India, registration is compulsory for sale of land and property. But the authorities don‘t verify the history or ownership of the property from the seller= nuisance of real estate mafias and property disputes pending in courts = difficult for the victim to get loans. Solution? reforms in the Tenancy reform acts. Complimentary infrastructure

If bank gives equity investment in following, then it should also be counted under PSL target:

. warehouses,

. market yards,

. godowns,

. Silos

. NBFCs operating in district with low financial inclusion.

. Weather monitoring stations in rural areas. In other words, Nachiket recommends that complementary infrastructure for rural Development should be brought under PSL targets.

Bond purchase in MFI

. If bank gives loans to an NBFC Microfinance institutions (MFI)= counted under PSL target

. But if bank buys the bonds of such NBFC-MFI= not counted under PSL.

. Nachiket says ―count such bond purchases under PSL.‖ Warehouse receipts

Basics Already explained click me Nachiket recommends that Food Corporation of India (FCI) and State Governments should use warehouse receipts to raise money, rather than being reliant only on bank credit.

Mock Questions 1. Which of the following, is/are not a part of priority sector lending? 1. Food processing industry. renewable energy

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2. Small industries, housing loans 3. both A and B 4. Neither A nor B 2. Which of the following is/are correct about classification of Small vs Marginal farmers? 0. This classification is based on total hectares of land owned. 1. This classification is based on total income from the land owned 2. This classification is based on number of crops cultivated on the land owned 3. None of above. 3. Correct statement about Priority sector lending targets 0. These are administered by Finance ministry 1. If a bank fulfills its PSL targets, RBI gives it permission to open more branches in Metropolitan cities. 2. Within the PSL targets, a bank is required to give 18% of the loans to weaker sections of society. 3. None of above. 4. NABARD administers a fund called Rural infra. Development fund. What is the major source of its funding? 0. borrowing from RBI 1. borrowing from World bank 2. Penalties levied from foreign banks who fail to meet PSL targets. 3. None of above 5. Correct statements about small enterprises development fund? 0. It is administrated by Ministry of Commerce. 1. It gets funding from certain types of banks that fail to meet PSL targets 2. Both A and B 3. Neither A nor B 6. What do you understand by Base Rate? 0. As per RBI norms, Banks cannot pay interest rate higher than the base rate to time and demand deposits 1. As per RBI norms, Banks cannot pay interest rate lower than the base rate to time and demand deposits

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2. As per RBI norms, Banks cannot charge interest rate lower than the base rate to any borrower. 3. As per RBI norms, Banks cannot charge interest rate higher than the base rate to any borrower. 7. Who decides Base rate of a bank? 0. RBI through monetary policy 1. Finance Ministry through gazette notifications 2. Meeting among the representatives of RBI, Finance ministry and the respective banks. 3. None of above. 8. Which of the following will reduce the fiscal burden of the government? 0. Removal of interest subvention scheme 1. Removal of Priority sector lending targets 2. Both A and B 3. Neither A nor B 9. Which of the following will be detrimental to the objective of financial inclusion? 0. Removal of interest subvention scheme 1. Removal of Priority sector lending targets 2. Both A and B 3. Neither A nor B 10. (Paper II Decision Making) You‘re posted as a District Magistrate in an area affected by left wing extremism. With your efforts, a few of the naxalites had surrendered, spent jailtime and resumed family life after release. One day, a former Naxal turned farmer approaches you, complaining how the branch manager of a public sector bank has rejected his loan application for agricultural inputs. What you‘ll do? 0. Call up the Branch manager, order him to pass the loan. 1. Call up the SP, order him to write a police verification certificate for the said farmer, so he can avail the loan again. 2. Ask the farmer to approach higher authorities within the said bank 3. ask a journalist friend of yours to unearth the truth and get justice for this farmer. Q11. RBI appointed Nachiket Committee has recommended 1. RBI should Abolish Marginal Standing facility system.

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2. Government should stop giving debt waiver and interest subvention to farmers 3. SLR system should be gradually removed. Answer choices

1. only 1 and 2 2. only 1 and 3 3. only 2 and 3 4. None of above. Q12. According to the current PSL-system: 1. Banks are required to allot 23% of their deposits into SLR securities 2. Banks are required to allot comply with BASEL-III norms by 2018 3. Banks are required to allot 18% of their credit to North Eastern States Answer choices

1. only 1 and 2 2. only 1 and 3 3. only 2 and 3 4. None of above. Assertion Reasoning: Assertion reasoning instructions: Each of the following questions contain a set of Assertion (A) and Reasoning (R) statements. Answer codes are as following: 1. Both the statements are individually true and Statement R is the correct explanation of Statement A 2. Both the statements are individually true but Statement R is not the correct explanation of Statement A 3. Statement A is true but Statement R is false 4. Statement A is false but Statement R is true Question statements 13. (A) In the recent years, most of the public sector banks have full filled or even over crossed their PSL targets (R) Public sector banks are given interest subvention benefit by government of India.

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14. (A) In the recent years, the farmers in Southern states have received large amount of agricultural loans under PSL targets (R) Southern States have highest % share in gross cropped area in India. 15. (A) In recent years, Public sector banks have suffered large NPAs. (R) Delay in environmental clearance in power, iron and steel sector have reduced the industrial output. Descriptive/Mains

1. Despite the robust guidelines under PSL, the small and marginal farmers continue to suffer from lack of access to formal sources of credit. Examine the reasons and suggest remedies. (10m | 200 words) 2. Lack of timely access to credit, has been one of the main factor behind the dismal performance of micro and small industries in the Eastern and North Eastern Sector. Examine the reasons, and suggest remedies. (10m | 200 words) 3. Examine the ―access to credit‖ as a factor for geographical distribution of secondary and tertiary industries in India. (10m | 200 words) 4. Nachiket Committee‘s new model of Adjusted Priority sector lending targets, will be a win-win situation for both the banks and the borrowers, do you agree? Justify your stand. (10m | 200 words) Interview

1. Are you in favor of the removal of SLR? Don‘t you think it‘ll make our banks more vulnerable? 2. You‘re aware of the PSL targets and all the issues about farmer debts, financial inclusion and NPA. What are your thoughts on following alternative: 1. government orders the banks to submit 40% of their deposits to the consolidated fund of India 2. A separate department is created ―loans for weaker section‖. They receive money directly from consolidated fund of India, and dole it out to the farmer via district collector‘s office or post office. 3. Whatever interest is earned, that is directly given back to bank account holders.

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Don‟t you think this is a better alternative than existing PSL? Why should we even trust the banks to give economicjustice to farmers? Shouldn‟t the government and the executive take up this job? 3. (looking at your DAF form) In banking sector, if an officer serves in a hardship area, he is given additional points while the promotion list is prepared. Now, Nachiket Committee has a new system under which, if a bank lends money in the hardship districts, they get additional score under PSL target. Following the same logic, if Personnel ministry gives you an option to pick a ―difficult state‖ cadre in North East or Red-corridor, we‘ll give you faster promotion and pay grades. Will you change your cadre preference? Yes/ No and why?

Shadow Banks, Wholesale Banks, Securitization: Functions & Features Nachiket Committee‟s recommendations

Prologue

Under [Banking] Nachiket Committee article-series, so far we‟ve seen following

1. What is financial inclusion, steps taken by RBI and Government to achieve it. 2. Nachi gave six point vision to achieve financial inclusion. Under that, Universal Bank account for everyone. Access to banking within 15 minutes of walking distance. 3. Priority sector lending: meaning, benefits, constrains and Nachiket‘s recommendation for 50% PSL target and 0% SLR. If you‟ve not read those articles, go to Mrunal.org/economy.

Securitization As such very technical topic and not important for exam but basic understanding necessary before dwelling intoShadow Banking, Whole-sale banking. So, first let‟s

205 construct a technically-not-so-correct model:

. A retail Bank has given home loans worth total 100 lakhs to 50 families @10% interest rate. (if anyone defaults, bank snatch their house.)

. An investment banker, Hrithik Roshan, buys these loan-files from the normal bank.

. Hrithik makes a new company/entity, backed by those home loan files worth Rs.100 crores.

. Then he breaks down those 100 lakhs into (10 lakh bonds x worth Rs. 10 each) and promise to pay 8% interest rate.

. Aam Aadmi/retail investors/Mutual funds/insurance companies etc. buy these bonds. Securities =some piece of paper that promises to some money to someone.

. Shares, bonds, IPOs, Debentures these are all examples of ―securities.‖

. So, What did the investment banker do in above example? He turned those ―mortgages‖ (homes loan files) into ―securities―. [and made some profit in between].

. This is called securitization. Is it good or is it bad?

. Good for banks because they can gather some new cash, look for new clients. (rather than waiting for EMI payments for 20-30 years.)

. Good for investors, because they can earn interest by buying those bonds.

. Bad? Yes, when the game is played without good faith- as it happened in Sub-prime crisis.

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What happened in Sub-prime crisis?

. (normal) Banks gave loan to people who did not have the aukaat to repay the loans (hence they were called ―Sub-prime‖ Borrowers.)

. But banks were smart, they ―securitized‖ those loans, recovered money from investment bankers in wall street.

. Investment bankers in turn, sold securities (bonds) to aam aadmi/retail investors/pension funds/mutual funds/hedge funds etc.

. Then investment bankers used that money to buy even more loan-files from (normal) banks, and created even more mortgage backed securities.

. Everyone is happy. Bubble keeps blowing.

. But soon, one after another, those sub-prime borrowers default on EMIs.

. Wait, we shouldn‘t worry right? Because we‘ve their loan papers, we can attach their property and auction it to recover money.

. But unfortunately, as many people defaulted on loans, there is over-supply of houses on sale/auction => Real estate prices go down. if the house was originally worth 3 lakh dollars, now it‘d sell not even for 30,000 dollars.

. Thus whole system collapsed.=>2007′s subprime crisis.

. World: Since investors all over the world had joined this game, they also suffered losses=>2008 global financial crisis. Ripples were felt even in India.

. Europe: Since European investors also lost money in Subprime crisis + Decline trade, tourism, export+ Their own governments had MNREGAish Maai-baap mindset with huge fiscal deficits and loss making PSUs=> PIGS crisis, sovereign default crisis, Greece crisis. (more on that, explained in old articles under Mrunal.org/Economy) Shadow Banking 1. Shadow Banks = organizations that function like banks but outside the banking regulation. American examples- hedge funds, securitization companies, Special Investment Vehicles (SIV), Money Market Funds (MMFs) etc. 2. This term came after ―subprime crisis‖ in USA, 2007. 3. Shadow banks helped creating that asset bubble. But one day, home loan borrowers defaulted and the bubble collapsed =>crisis.

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4. Shadow banks have significant presence in Netherland, Hong Kong, USA, EU= they continue to remain vulnerable to such crisis even in future. Shadow Banks: Why good? They provide quick source of loan/credit/finance/liquidity.

Shadow Banks: Why bad? 1. Shadow Banks lack transparency about their business model, modus operandi and profit margins. 2. Some companies intentionally adopt shadow banking model to evade banking regulations for making higher profits. (e.g. CRR= bank earns no profit. SLR=bank earns barely ~8% interest. But if NBFC lends money they usually get 15-25% interest.) 3. Since shadow banks don‘t have ―Backup plans‖ like CRR, SLR, deposit insurance etc. =>they‘re more vulnerable to ―runs‖. (e.g. all depositors/FIIs pull out their money due to some rumor and company collapses.) 4. Shadow banks don‘t enjoy powers under SARFAESI Act.= difficult for them to recover money incase of loan defaults. 5. Shadow banks send/receive money from many sources (mutual funds, insurance cos. etc.) so if Shadow bank collapses, it‘ll have negative ripples in other areas of economy as well. (As it happened during Sub-prime crisis =>global financial crisis.) 6. Even in China, recently one of the shadow bank defaulted, and ~3 billion yuan are lost. (Jan 2014) Shadow Banking in India? Not all the NBFCs are directly regulated by RBI. Observe:

Regulated NBFC Function example under

Insurance Take ―premium‖ from you, invest It in LIC, Bajaj Allianz IRDA companies shares/bonds.

They arrange money from variety of DHFL, Muthoot Housing Housing Finance National sources, lend it to home-loan seekers finance etc. Companies housing

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Bank (NHB)

Canara Bank, Andhra Bank

Merchant Banking They lend money to company via (and many other banks- they SEBI Companies buying its ―shares‖ / underwriting. take separate license to operate

as a Merchant Bank)

They help buying-selling securities 1. Indiabulls Stock Broker (of their clients) and earn commission SEBI 2. Sherkhan companies in between. 3. Reliance Money

Venture Capital They finance start-up companies via IFCI, IDG SEBI Fund Companies equity. (=shares, partnership)

Nidhi South Madras Benefit Fund Department They borrow money from members, Companies(mutual Limited and many similar of Company lend it among the members. benefit funds) names affairs

. Members contribute money on

monthly basis, and give it to one

of their own member through 1. Sriram Chit fund (TN)

bidding. 2. Saradha Chit fund (=not State

Chit Funds . Winner doesn‘t need to repay really a ―chit fund‖ but government‘s

―loan‖ directly, but needs to multi-level marketing registrar.

contribute money on monthly scam MLM)

basis, so others can also win

next time.

Some of these NBFCs do form one type of “Shadow banking” in India, because they‟re outside the traditional regulatory rules for Banks, don‟t have SLR-CRR “emergency backup”, still dwelling into deposits-loan-credit-finance type work. Among all these, Chit fund is the biggest headache. Why?

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. Constitution of India=>7th Sch.=> union list=> banking, post office savings, corporation, insurance, stock exchange, future market fall here.

. Hence union government make can make laws to setup All India regulators – RBI for bank, SEBI for securities and IRDA for Insurance.

. But as per SC verdict, Chit fund=contract = falls under concurrent list. = both union and state can make law. Hence chit funds government by their respective state laws. RBI only provides overall guidelines. SEBI doesn‘t watch. that‘s how Saradha chit fund managed to evade regulatory oversight and duped crores of rupees. Should India be worried? Ans. Not much. Reasons are following:

1. India‘s financial system is still Bank dominated. ~60% of financial sector‘s assets are controlled by banks. So NBFC =not large enough to cause an shock/asset bubble. 2. Largest NPAs are held by Public sector banks and not NBFCs. So if (god forbid) there is any ―subprime‖ type crisis in future, it‘ll be because of those banks and not NBFCs. 3. American Shadow banks have MNC-like presence in various countries of Europe=> indirectly responsible for PIGS crisis, EU Sovereign default etc. but their presence is not much in India because of strict rules on FDI. 4. 2008: Global financial crisis=> Indian NBFC saw a few negative setbacks but they‘re sorted now. 5. Indian NBFCs are strictly supervised by RBI/SEBI/IRDA/Government. Barring a few ponzi scams and Saradha Chit fund scam, there is no major threat seen in recent times. Besides Indian NBFC= shadow bank = automatically “villains”. That assumption is not true. Some positive points about Desi-NBFCs:

1. ~80% of the NBFCs have CRISIL rating of ―AA‖ or above. (= NBFCs will not cause systemic instability in the economy.) 2. NBFCs provide door to door service, their loan recovery rates are also better than banks. 3. NBFCs have extended the reach of the financial services to the more difficult parts of the economy via micro-finance.

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4. Their agent-network / manpower is more efficient than public sector banks. (because they don‘t have unions to go on strike every week.) 5. Public sector banks like SBI, Dena etc. =giant elephants, cannot move quickly. Their own bureaucratic procedures slow them down. On the other hand, NBFCs are entrepreneur driven companies. Main boss keeps an eye on everything and doesn‘t let any part of the company get slow or sick. Gold Loan Companies as Shadow Banks? 1. The gold-loan NBFCs were mostly catering South Indian borrowers. (Mannapuram, Muthoot etc.) 2. But in recent times, they‘ve seen high-growth and geographic penetration across the country. (thanks to Akshay Kumar.) 3. These Gold loan NBFCs are regulated by RBI but they don‘t fall under traditional ―bank‖ rules about SLR, CRR norms. 4. So, Do they pose a systematic challenge like American Shadow Banks? let‟s take an example:

. Jan 2014: 10 gm gold =30,000 rupees. I deposit it a gold loan company, they give me Rs. 30000 (=loan to value ratio of 100%; if they gave me only Rs.15k, the loan to value ratio=50%).

. I‘ve to repay this loan, with 25% interest by Dec 2014.

. December 2014: price of gold still remains in the 29-30k region. Then i‘ll not bother repaying the loan (because I‘ve to give Rs.7500 interest). So, let them have the gold. I don‘t care much.

. if large number of borrowers start doing ^this, system will collapse. Why? Because Gold Loan company doesn‘t print currency notes at its office. They also have to arrange money from market (mostly from banks and debentures sold to aam- admi/retail investors).

. So, if gold loan company collapses, then negative ripples even in other sectors of economy. RBI’s safeguards on Gold loan NBFC RBI has taken following steps in recent times to ensure it doesn’t happen:

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1. Gold loan NBFC must maintain loan to value (LTV) ratio maximum 75%. (meaning, if i give them 1 lakh worth gold, they should loan me only Rs.75,000 rupees.) This ensures, I‘ll try to repay the loan and take back my deposited gold. 2. Gold loan NBFC with more than 1000 branches, must get RBI permission before opening any new branches. 3. Strict rules for security and storage of such gold deposits. 4. Must insist on PAN card copy (for gold loans above Rs.5 lakhs) 5. RBI has ordered all NBFCs, not to lend money to any person for purchasing gold in any form (be jewelry or coins or even gold Exchange Traded Funds (ETF) and gold Mutual Funds. 6. RBI has instructed Gold loan NBFC to maintain transparency in loan pricing and follow KYC norms. 7. They were asked to adhere to a revised fair practices code and customer grievances. Wholesale Bank?

. So far we know What is Shadow banking, how it can be a threat to economy.

. Right now Desi-NBFC sector is still small (compared to Banks), but with time, some of these NBFCs will grow extremely large.

. Then, it‘ll not be our best interest to let them continue as ―NBFC‖ (Because they‘re not covered under CRR-SLR ―emergency backup.‖)

. Therefore, Nachiket Committee recommends a new type of bank called ―Wholesale bank‖. So, large NBFC could be allowed to transform into Wholesale banks and fall under full supervision by RBI.

. Please note: Nachi also recommended ―Payment banks‖. Make sure you‘ve read that topic first. Click me

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Let‟s make a comparative table of their features.

Sch.Commercial Payment features Bank (SBI, PNB, Wholesale bank NBFC Bank ICICI)

Has to get license under Yes Yes yes Nope Banking regulation Act?

No. They can only accept Can accept Ofcourse yes. Only for deposit taking deposits larger than Rs.5 crore. deposits from Hence also called Yes NBFCs (NBFC-D) like (hence called ―Wholesale‖ aam aadmi? ―Retail‖ banks. Mahindra Finance. banks).

Access to payment system Yes Yes Yes No. (can give cheque book?)

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1. Not to retail/aam-aadmi

borrowers.

2. it only lends in niche Can give loans? Yes No Yes wholesale markets such

as infrastructure or

corporates.

CRR? Yes yes yes Nope

Nachi did

not give

specific

targets. But SLR? Yes Yes Only for NBFC-D they can

invest in

SLR-

securities.

5 cr for Microfinane Entry capital 500 Crores. 50 crores. 50 crores company. 2 cr for requirement? others.

No.

Yes but at a ‗wholesale‘ level. because

PSL Yes. And they help ―retail‖ banks they cannot No.

fulfill their PSL targets. lend

money.

No. SARFAESI No. except housing because Yes Yes powers.* finance companies they can‘t

lend

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money!

*SARFAESI powers= If you default on loan, they‟ll take away your mortgaged property. You cannot get stay order from civil court. You‟ve to approach DRT (debt recovery tribunals) to get stay order, but they usually rule in favor of banks.

Wholesale Investment Bank vs Wholesale Consumer Bank? Within “Wholesale bank”, Nachi recommends two sub-types

Wholesale Investment Bank Wholesale Consumer Bank

If given institution has 20 branches If given institution has more than 20 branches. or less.

25% rural branching mandate will Applies. not apply.

They can act as Business Correspondent agents of other scheduled No commercial banks.

but Why Wholesale Banks?

Alright man, so far I know

1. What is securitization, how it helps transforming mortgages into securities. And how it can be a

threat, if misused. Mohan 2. What is shadow bank? How does it pose danger to Economy?

3. That you‘ve recommended new type of banks called Wholesale Banks. but what is the purpose of creating this wholesale bank? What exactly will they do?

Nachi Their main focus = securitization of PSL loans.

Mohan How?

Nachi Let‘s re-apply our earlier technically-not-so-correct model.

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1. Suppose Banks/NBFCs give loan to PSL areas worth Rs.100 crores. And for xyz reason they want to get rid of that headache and arrange money quickly, rather than waiting for EMIs. 2. So, They sell loan-files to wholesale bank. 3. (recall wholesale bank can accept deposit of Rs.5 crore or more=they have really deep pockets to buy so many loan files). 4. Now, Wholesale banker has purchased loan files worth Rs. 100 lakhs. He will create a structured investment vehicle worth Rs.100 lakhs. Then he‘ll divide it into (10 lakh bonds worth Rs.10 each). Offering xyz% interest rate. 5. Who will buy these bonds? Ans. Retail banks like SBI, ICICI, PNB; mutual funds, insurance companies, retail investors (aam Aadmi) etc. 6. Thus PSL loans are ‗securitized‘ 7. Wholesale bank can even such securitized loans from other entities/investment bankers in capital market and resell it further.

Mohan But why should retail banks (like SBI , ICICI, PNB) bother with investing money in such thing?

Nachi Because it‘ll be counted under their PSL target. (I‘ve recommended so in my report.)

Mohan Ok but why should Mutual funds, insurance companies, retail investors give money in such thing?

Because their investment will enjoy ―Tax-free‖ status. So whatever profit they make, they won‘t have Nachi to pay a penny to Government. (I‘ve recommended so in my report.)

Man wait a minute. Something doesn‘t feel right.On one hand:

1. Banks have PSL target.

2. People want tax-free investment.

Mohan So they want to park their money.

On the other hand

1. RRBs, NBFCs operating in rural area – they know wholesale bank will take „care‟ of their loan-

files.

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2. So what if they also started lending to ―sub-prime‖ borrowers in rural area who don‘t have

the aukaat to repay EMIs. Then system will collapse like it did in America?

Nachi Your concerns are valid but:

1. We already have investment bankers in India- performing almost the similar functions like these wholesale banks. (Standard Chartered, Kotak Mahindra capital, Citigroup, Morgan Stanley etc.) 2. But they‘ve not caused any risks in India because our regulators (RBI, SEBI) are more vigilant and strict than American counterparts. Besides, if we assume only the worst case scenario, progress cannot be made. And The advantages of wholesale bank, outweigh its risks. Observe:

Benefits of Wholesale Banks? 1. Wholesale banks will provide more liquidity in the system. (than in a situation where every bank keeps its loan-files to itself.) 2. Wholesale banks also loan money to corporate clients, infra. Projects=> retail banks like SBI and ICICI‘s cash is spared, that can be used as loans for small borrwers. 3. Regional rural banks, Cooperative banks etc transfer their ―local-risk‖ to Wholesale banks via ―securitization.‖ 4. This will make local banks structurally more stronger (because they‘ll have less risk and less liabilities.) 5. Big (retail) banks like SBI, ICICI etc. can fullfill their PSL targets by investing in Wholesale Bank‘s (mortgage) backed securities. Rather than wasting their time and manpower on finding borrowers under PSL targets. 6. This type of flexibility will help banks become more ―Specialized‖ and focus on a ―niche‖ groups e.g. RRB on farmers, SBI on small businessmen and middleclass, ICICI on corporate clients= new level of ‗economies of scale‘= bank‘s operating cost decreases, profit increases, clients get better services at lower prices. 7. Thus wholesale banks indirectly help in financial deepening and inclusion. Nachi’s thought process for arriving @Wholesale Bank concept? 1. PSL related problems: farmers don‘t get loans on time, banks mostly focus on southern and western states.

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2. Large NBFC=shadow bank problem=>need to transform them into ―Banks‖. 3. But if these Large NBFCs become regular banks, then they‘ll also need to fulfill PSL targets= difficult for them. E.g. suppose a NBFCs deals with only infrastructure- financcing. Later it becomes bank. But its staff, organization structure doesn‘t have the skills/experience/presence in rural areas to deal with Agri. Loans to fullfill PSL targets. 4. So, better let them handle PSL via ―securitization‖ process rather than via physical banking in rural areas. 5. This securitization will also provide investment opportunity for retail investors. (Because Nachi offered tax-free status.) 6. Therefore, we should allow such large NBFCs to transform into wholesale banks, instead of asking them to transform into retail banks. Mock Questions 1. Correct statements 1. All NBFCs are regulated by SEBI 2. All NBFCs are regulated by RBI 3. Both A and B 4. Neither A nor B 2. Which among the following is/are covered under the Concurrent list in our Constitution? 0. Banking, Bankruptcy, Contracts 1. Contracts, Corporations, Trusts 2. Trusts, Contracts, Bankruptcy 3. None of above. 3. What do you understand by the term Shadow Banking? 0. A system wherein banks use technical loopholes to open more branches and expand operations beyond what is permitted by RBI. 1. A system wherein scheduled commercial banks use technical loopholes to partially evade their true liabilities under CRR, SLR and PSL. 2. A system wherein financial entities undertake activities akin to banks while remaining outside the traditional regulatory regime which are otherwise applicable to banks.

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3. None of above. 4. Recently, Nachiket Committee has recommended ―Securitization‖ of PSL loans. What do you understand by the term ―Securitization‖? 0. It is a process under which banks get insurance cover for their loans under PSL targets, from General insurance companies. 1. It is a process under which the mortgages issued by banks and other lenders are converting them into securities that can be sold to investors. 2. It is a process by which a mortgaged loan asset can be converted to cash without losing value. 3. None of above. 5. Which of the following factor(s) make India less vulnerable to the risks from shadow banking? 0. RBI has specifically prohibited shadow bank entities from opening branches in India. 1. Under SARFAESI act, Government has specifically prohibited shadow bank entities from giving loans to people. 2. Both A and B 3. Neither A nor B 6. Recently, Nachiket Committee has proposed a new model of banks, called ―Wholesale banks‖. Find correct statement about them 0. Only Scheduled Commercial banks can setup such banks through subsidiary model. 1. They‘ll enjoy the rights and privileges under SARFAESI Act. 2. They‘ll have higher entry-capital requirements than commercial banks. 3. None of Above 7. (A) Chit fund companies are regulated by State laws. (R) The subject of Chit fund falls under State list in 7th Schedule of Constitution of India. 0. Both the statements are individually true and Statement R is the correct explanation of Statement A 1. Both the statements are individually true but Statement R is not the correct explanation of Statement A 2. Statement A is true but Statement R is false

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3. Statement A is false but Statement R is true Q8. All NBFCs are exempted from 1. Maintenance of CRR 2. Maintenance of SLR 3. Priority sector lending targets. Answer choices

1. only 1 and 2 2. only 2 and 3 3. only 1 and 3 4. all 1, 2 and 3. Q9. Who among the following is/are not required to maintain a Cash Reserve Ratio (CRR)? 1. Shadow Banking entity 2. Merchant Banking entity 3. Housing Finance Company Answer Choice

1. only 3 2. only 1 and 3 3. only 1 and 2 4. All 1, 2 and 3 Q10. Who among the following is/are fall under SEBI’s direct regulatory watch? 1. Nidhi Company 2. Chit funds 3. Housing Finance Company 4. Merchant Banking company Answer Choice 1. only 1 and 2 2. only 3 and 4 3. only 1, 3 and 4 4. all of them Descriptive

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1. Define Shadow Banks. Assess the vulnerability of Indian financial sector from the threat of Shadow Banking. (10m| 200 words) 2. Examine the need for a super-regulator over the other regulators in banking-finance- insurance sector with special reference to shadow banks. (10m| 200 words) 3. List the salient features and functions of these wholesale banks envisioned by Nachiket Committee. (10m| 200 words) 4. Discuss recent initiatives by RBI to preserve stability in Gold Loan sector. (5m | 100 words) Interview 1. Do you know the difference between: 1. Merchant banking vs corporate banking? 2. Wholesale banking vs retail banking? 3. Investment bank vs commercial bank? 2. Whenever someone raises even a hint of sub-prime like crisis in India or shadow banking in India, the RBI-apologists defend saying our fundamentals are strong, our regulatory regime is strong. If that is the case, why do Public sector banks have large NPAs? 3. And don‘t you think they pose danger of sub-prime crisis in India? 4. Some economists suggest government of India should completely disinvest from public sector banks. Given the threat of Shadow banking and sub-prime crisis on side versus the inefficiency-unionism-strikes, BASEL norms and NPAs on the other side, where do you stand on this issue? 5. Do you think ―Contract‖ as a subject should be shifted to Union list, to prevent any more chit fund scams?Yes/No and Why? Hints for MCQs 1. see the very first table given in the article. 2. M.Laxmikanth‘s Appendix 3. akin to banks but outside regulation 4. mortgage=>securities 5. neither 6. only SARFAESI 7. Chit fund in concurrent list.

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8. NBFC-D have to maintain SLR 9. None of them are banks. 10. All except Chit funds.

Bancassurance: Compulsory Broker Model, IRDA vs Banks, issue, benefits, challanges, insurance penetration, Financial inclusion & Nachiket Committee

Prologue

As such Bancassurance=important for IBPS but not so much for UPSC, but topic has recently came in limelight because:

1. (Chindu+IRDA) vs Banks on broker model for selling insurance policies. 2. Nachiket Committee‘s recommendations: ―insurance/investment service to all poors by 1/1/2016‖ Bancassurance

. Bancassurance= Banks as Insurance Agents=Bank and an insurance company form a partnership so that the insurance company can sell its products to the bank‗s customers.

. Concept originated in France.

. Overall, Insurance companies‘ 30% of the business comes from Bancassurance. (i.e. bank customers).

. There are three business models in Bancassurance. Benefits

1. Insurance company can reach more customers using Bank‘s marketing channel, without having to invest in more offices and manpower. Bank Customer is more likely to buy insurance policy because of past faith. (than if insurance company asked a shopping mall/cinema owner to sell insurance policies to their customers.) 2. Even Regional rural banks and cooperative banks are allowed to sell insurance policies like this= most economic for insurance companies, because they don‘t have enough money/manpower to reach every rural area. 3. Bank earns additional income. 4. Bank staff already proficient in processing such forms/applications.

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5. Banks already have e-banking, mobile banking, ATM etc. facilities=> easy to collect money from customers. 6. Customer gets both banking and insurance services at one place= time and effort saved in visiting multiple offices. 7. + financial inclusion (when bank‘s business correspondence agent or bank staff itself is providing insurance services to rural/poor customers.) There are three business models of Bancassurance.

#1: Referral Model

. Here, Bank will give office space to the insurance company in its branches.

. The insurance staff will sit in the bank branch and sell its products to bank customers.

. Bank staff doesn‘t participate in selling.

. Bank faces no risk. Insurance company pays fixed-fees for using the office space.

. Pro: Customer directly talks with insurance staff=less chance of bank staff misguiding/mis-selling policies to them.

. Con: In other two models, bank can make more commission.

#2: Corporate Agent model Here, Bank ties up with one life, one non-life and one health insurance company.

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For example:

Insurance company Its corporate Agent (Bank) Bank type

SBI life insurance State Bank of India Public sector

Tata AIG General Insurance HSBC Private sector

Bajaj Allianz General Insurance Saraswat Cooperative Bank Regional rural bank

United India Insurance. Tirunelveli District Central cooperative bank Cooperative

. Majority of banks follow this model.

. Bank sells policies of only one insurance company= customer is deprived of ‗choice‘, even if other insurance companies are offering better alternatives. (imagine walking into an Apple showroom- the salesman can only sell you apple phones, even if other Samsung/LG/Micromax phone is more suitable to your requirement and budget.)

. Bank is not liable to customer. #3: Broker Model

. Bank sells policy of multiple insurance companies under one roof. (multiple life insurance companies, multiple general insurance companies, multiple health insurance companies.)

. Bank earns commission according to sales-agreement with individual company. Imagine running a shopping mall displays variety of biscuit brands.

Timeline What happened

Government and RBI permitted banks to sell insurance policies. (either through corporate model 2000 or through referral model.)

2013 Chindu allowed Banks to act as insurance brokers. (so that insurance penetration can increase in budget rural areas= financial inclusion)

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November RBI permits Banks to use Broker model and starts drafting guidelines. 2013

Chindu writes letter to public sector banks- ―in budget 2013, I had hinted that you should switch to December Broker model. But you havenot yet implemented it yet. Anyways, adopt the insurance broker 2013 model by 15 Jan 2014!‖

Bank chiefs don‘t take Chindu‘s advice seriously. None of them adopts the Broker model. They Jan 2014 continue selling insurance under ―Corporate Agent‖ Model.

Chindu feels disrespected and maybe he even informally complained to IRDA chief.IRDA Chief

Jan 2014 TS Vijayan makes press statement that ―IRDA will make it make it compulsory for banks to adopt

Broker Model. (once RBI drafts final guidelines.)‖

Benefits of Broker model? 1. Bank will offer more choices to Customer= less chance of mis-selling. 2. insurance penetration will increase in rural areas, thanks to bank branches and their business correspondence agents. 3. In past, some insurance companies couldn‘t tie up with big banks under corporate agent model. These insurance companies get less sales, even if their products are better (Because big banks are selling other xyz single product.) The broker model will benefit these insurance companies- to display their products on banks‘ ―showroom‖. Anti-Arguments: Broker Model Banks and Financial experts have criticized the move of government + IRDA because:

#Bad impression to Foreign investors

1. Bank have already have signed MoUs/Agreements with specific foreign insurance companies promising ―we‘ll sell only your products.‖ (e.g. Bank of India with Japan‘s Dai-ichi life insurance.) 2. Now, If IRDA/Chindu forces them to adopt Broker model, then foreign insurance companies will feel cheated. They may even drag the banks to courts.

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3. Chindu‘s ―devil-may-care‖ attitude= Potential foreign investors fear Indian economic policies are ‗unpredictable‘ = less investment in future = current account deficit increases = rupee weakens = petrol expensive = more inflation. #Staff skills

1. Bank Staff lacks the skills in broking multiple insurance products. (again- Apple showroom salesman only needs to mugup the feature list of Apple phones and tell customer that Apply is best! But a smalltown‘s mobileshop salesman has to mugup feature lists for 3-4 dozen phones, and guide the customer in choosing the right phone!) 2. Therefore, Banks will have to hire separate staff to deal with insurance-brokering only. = operating cost increases. And NPAs are already high because of pending infrastructure projects and environmental clearances. = systemic risk. #Diseconomies of scale

. Broker model= bank has to keep staff trained for selling multiple products. They‘ve to keep literature, application forms of multiple companies. Keep separate finance/accounting records/softwares. Keep in touch with multiple executives in different companies = diseconomies of scale (Compared to doing this with just one company.) #BC already doing it

Banks are permitted to appoint Business Correspondents (BCs). This BC may even sell mutual fund products, pension products, and micro-insurance products of third parties. Examples:

. Syndicate Bank‘s officially tied with Birla Sun life insurance. But its Business correspondents in rural areas sell TATA AIG insurance policies as well.

. So Chindu‘s aim/intention that people in rural areas should get multiple product choice = this is already being done by Business correspondent agents. There is no need to ‗force‘ Banks to adopt to broker model.

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# Consumers more aware:

. With internet penetration, even customer himself go online and buy insurance product. So, there is no need to force bank to sell insurance policies of multiple companies.

. Sites like ―policybazaar dot com‖ even give daily ads ―don‘t buy insurance without comparing‖= consumer awareness is increasing. They can decide for themselves, even if bank staff tries to sell them a ―not-so-good‖ insurance product. Nachiket on Insurance

Mr.Nachiket, your Committee was appointed by RBI. But this insurance topic is related to IRDA. Mohan So, What are you doing here?

. Official name of my Committee is ―Comprehensive Financial Services for Small Businesses

and Low Income Households‖. Nachiket . Therefore, I‘ve to make recommendations on all type of financial services: be it banking,

loaning, investment OR insurance.

Mohan Fair enough. Then tell me about your next ambitious but unrealistic goal.

Nachiket here it goes

All small businessmen and poor families will be given insurance/investment products for

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1. insurance for humans: life insurance, health insurance, disability insurance 2. insurance of livestock (Cows, buffaloes, poultries) 3. insurance of crops/farming/agriculture 4. Insurance against property damage. 5. Protection against commodity price movement. (e.g. Negotiable warehouse receipts click me) Deadline: by 1 January 2016

Mohan and how to do you plan to achieve it?

Nachi observe:

Cross KYC

. At present RBI, IDRA, SEBI, PFRDA(NPS) have permitted Aadhar card as a ―proof of identity and address‖.

. But still Banks, Insurance company, mutual funds, NBFC- all carry their own separate KYC checks. = duplicity of effort. Villages face inconvenience because they‘ve to get photos and xeroxes of documents every time for every new account.

. Nachiket suggests RBI to give explicit instructions about Cross-KYC to Banks, Insurance Companies, Asset-Management Companies, Mutual funds, NBFC , Banks, and Non-Banking Financial Companies.

. All of them must be permitted to rely on KYC done by each other, instead of duplicating the effort every time you open a new account. Reforms in NBFC bancassurance models Like the banks, NBFCs also sell life and general insurance to their customer base. but there are limitation:

NBFC‘s Bancassurance IRDA‘s current guidelines Nachi

Referral model not permitted allow =>financial inclusion.

Corporate agent model permitted already permitted so nothing new to do here!

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Broker model not permitted. permit, with some conditions.

Allow NBFCs to take deposits At present there are two type of NBFC

. Deposit taking.

. Non-deposit taking.

Mohan So what‘s problem?

. Even if NBFC sells insurance products still NBFC cannot accept premium money from

customer.

Nachi . The customer will have to directly deposit the premium to the insurance company (LIC etc.)

. It‘s not a big deal for city folks. But in remote villages, people don‘t have access to netbanking,

cheque dropbox etc.=problem.

Mohan Then what‘s your solution?

. Remove this classification of Deposit taking vs. non-deposit taking NBFC.

. Simply allow all NBFC to accept deposits/premiums on behalf of banks/insurance companies.

Nachi . It‘ll facilitate financial inclusion.

. Insurance companies will be able to reach even the farthest parts of India, with help of NBFC

agents. NBFCs as mutual funds agents

at present NBFCs can sell/distribute mutual fund policies after RBI‘s permission. But RBI will grant

permission ONLY if

Nachi 1. the given NFC has minimum 100 crores of funds

2. making profit for last three years

3. minimum NPA

Mohan so?

Nachi given these stringent conditions, most of the small-time NBFCs are disqualified from selling mutual

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fund policies to their customer-base.

Mohan then what‘s your solution?

RBI should relax the eligibility critiera, so more NBFCs can apply. That way, people from remote Nachi areas can also invest in Mutual funds, through their local NBFC agents.

Banks as Mutual fund agents With RBI‟s permission, the Banks can also sell mutual fund policy and give investment advice to its customers.

Bank Where does the commission come from? as___

Bank will convince its customer to invest in xyz mutual fund policy. Customer fills up the Mutual application form, bank forwards it to the mutual fund company, and mutual fund company gives fund agent commission to Bank. = this is typical salesman / agent type model.

. Bank officials will give financial planning and investment advice to its individual customers. Investment . Consultancy/advice fees paid from customer‘s account or sometimes it is given totally free of advisor cost informally. Mutual fund company doesn‘t pay anything to bank (atleast officially!).

But as you can see, there is conflict of interest. IF the bank is simultaneously acting a mutual fund agent + investment advisor=problem. Because bank staff will only advice you to invest money in the mutual funds where bank earns commission= misguidance, mis-selling, fake promises.

Nachiket has given many recommendations for consumer protection in such cases. But we‟ll see that in a separate article. But let‟s get a brief overview here:

Guidelines for “Agents” 1. RBI should publish a guideline for appointment of agents including National Banks, Regional Banks, and NBFCs. (no matter whether they sell insurance or mutual funds policies.)

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2. All Agents must be required submit some security deposit. Minimum Rs.5 lakh. Amount can be increased depending on the number of customers and volume of transactions 3. Biometric authentication of customers to prevent frauds. 4. Agent must have trained staff to explain the risks and benefits of various financial products to customers. 5. Agent must not design the salary/bonus package in such way that staff is motivated to do mis-selling/fake-promises to reach the sales target. 6. Agent must set up an internal grievance redressal mechanism, must publish give contact number/helpline for customers complaints. 7. All customer grievances should be solved within a defined time frame. 8. Other recommendations related to consumer protection – discussed in a separate article. Mock Questions Q1. Who among the following can to sell insurance policies in India? 1. Scheduled commercial banks 2. Regional Rural Banks 3. District cooperative banks 4. NBFC Choice

1. Only 1 and 4 2. Only 2 and 3 3. Only 1, 2 and 4 4. All of them. Q2. Recently, Finance Ministry issued a circular asking the public sector banks to adopt Broker model for selling insurance products. This move will: 1. increase insurance penetration in rural areas 2. Reduce mis-selling of insurance products. 3. Improve profit levels of Public sector banks. Answer choices

1. Only 1 and 2

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2. Only 2 and 3 3. Only 1 and 3 4. All of them. Q3. Recently, Finance Ministry and IRDA have asked the Banks to adopt Broker model of Bancassurance. But the banks have not yet adopted this model because 1. Broker model doesn‘t allow them to sell life insurance, non-life insurance and health insurance simultaneously. 2. RBI does not permit Broker model-that sector is completely reserved for NBFC entities. 3. Bank unions have demanded additional overtime-payments to work under this system. Answer choices

1. Only 1 and 2 2. Only 2 and 3 3. Only 1 and 3 4. None of them. Q4. Which of the following is / are correct about Bancassurance? 1. If a bank provides bancassurance services to a farmer, poor or marginalized group, it qualifes under Priority sector lending targets. 2. If a customer doesn‘t make timely payments for Bancassurance services, bank is entitled to impose penalties under SARFAESI Act. 3. Both A and B 4. Neither A nor B Descriptive 1. ―The compulsory broker model for bancassurance, will improve Insurance Penetration in Rural India.― Comment. (5m | 100 words) 2. Despite the nationalization of insurance companies decades ago, the insurance penetration in rural areas has been far from satisfactory. Examine causes and suggest remedies. (10m | 200 words) 3. Write a note on the initiatives taken by Government of India to improve insurance penetration in rural India. (10m | 200 words)

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Interview 1. On the issue of Broker model of Bancassurance, bank chiefs have said unofficially that IRDA and Finance ministry shouldn‘t try to force their economic views upon others, this is akin to the erstwhile license-quota-inspector raj. Do you agree? Yes/No and Why? 2. Nachiket Mor has suggested removal of various restrictions on NBFCs, to allow them to sell insurance-mutual funds in rural India more easily. Of course his thought process is focused on financial inclusion. But don‘t you think this sudden exposure of free market forces in Rural India may lead to financial exploitation of villagers rather than ―inclusion‖? yes/no and how? 3. Suppose, NBFCs are allowed to freely sell insurance/mutual fund policies of private companies in Rural India- but what if one day stock market crashes and the villagers‘ investment is lost! Don‘t you think Government should setup a separate organization or department to sell policies in rural area? yes/no and why? MCQ Hints 1. all 2. FinMin‘s official letter to PSB mentions statement 1 and 2. Third statement is wrong (or debatable on how you drag the logic of ―increase in profit vs increase in operational costs‖.) 3. None. 4. Bancassurance is outside the purview of PSL and SARFAESI.

RBI Urjit Patel Committee: 4% CPI, Nominal Anchor, Multiple Indicator, Monetary Policy Framework Reforms (Part 1 of 2)

Prologue

This article won‟t make much sense, unless you‟re thorough with the concepts of monetary policy: its functions, tools and limitation. So make sure you‟ve read the previous article. click me.

. Place: RBI‘s Main Adda @Mumbai

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. Time: September 2013

. Boss: Rajan has recently taken charge as the new governor of RBI. Immediately he setups three Committees:

Occupation Chairman Topic Result in RBI

Bimal Retire New Bank licenses Work in progress. Jalan Governor

Nachiket Board Financial products/ Financial Published report in January 2014.Discussed

Mor member inclusion in earlier articles.

Urjit Deputy Monetary policy framework: how Published report in Jan‘14. This is the topic

Patel Governor to strengthen it? of our article.

Urjit Patel Committee: Basics

1. Formed by: RBI (and not finance ministry) 2. Official name: Expert Committee to Revise and Strengthen the Monetary Policy Framework 3. Chairman: Dr. Urjit Patel, Dy. Governor of RBI 4. Eight Members: economics professors, finance experts etc. They‘re not important for exams, because No high profile members. [may be because Nachiket took away

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all the high profile members like Shikha Sharma of Axis bank, so Urjit bhai was left with only chillar parties.] Overall, Urjit Patel‟s main recommendations can be summarized in just three lines:

1. @Rajan, you fight inflation. [Nominal anchor, 4% CPI and everything] 2. @Rajan, you fix accountability in your own gang. [form MPC Committee, decisions by voting etc.] 3. @Chindu, you give cover-fire to Rajan, while he is fighting inflation. [fiscal consolidation.] Let‟s start with first recommendation.

My first recommendation is that RBI must target inflation only. Nothing else- don‘t focus on

Urjit increasing employment, don‘t focus on increasing growth, don‘t focus on stabilizing rupee-dollar

exchange rate. Just focus on one thing and one thing only- Inflation.

Mohan But why focus on inflation only?

Urjit Observe.

Monetary Policy: Where to focus?

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There are three main ways to frame monetary policy

1. Focus on Exchange Rate 2. Focus Multiple indicator (GDP, IIP, Exchange rate, inflation) 3. Focus on Inflation (started in 80s) Let‟s check the pros and cons of each strategy.

#1: Focus on Exchange rate

. If RBI adopts this strategy/method to frame monetary policy then- what will happen?

. Rajan will first decide an ideal ―target‖ exchange rate say 1$=Rs.50.

. Then he‘ll try to amend monetary policy to control rupee supply in the market. To put this in technically incorrect example: Imagine dollars are “apples”.

. Prices of apple vs Rupee are decided by laws of supply and demand.

. At present 1 apple sells for Rs.60. But Rajan wants to bring it 1 Apple=50 rupees. What should he do? 1. Rajan will tweak his monetary policy to reduce the supply of rupee in the market. Then, 1 apple will sell for Rs.50. (apple supply is same but rupee supply is decreased.)

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2. Alternatively, Rajan will open his own refrigerator (forex reserve), and put some apples (dollars) for sale. That‘ll also bring down prices of 1 apple =50 rupees. (because apple supply increased) Advantages/Benefits of targeting Exchange rate?

1. Prices of imported goods are kept in check. 2. Prices of imported crude oil is kept in check. (so indirectly inflation is kept in check). 3. Since exchange rates are kept stable- both importers and exporters can decide their business expansion plans accurately. (compared to a situation where exchange rate is volatile-say today $1=40 Rs. And tomorrow $1=60Rs. Then it is not good for business decisions.) 4. Clarity. Transparency in Decision Making. Aam Juntaa can understand what RBI is trying to accomplish and whether Rajan is succeeding or failing? (if they ever get free after watching cricket matches, Saas-Bahu serials and (un)reality shows.) Disadvantages/limitations of targeting Exchange rate?

1. This method works well to control (imported) fuel inflation. But cannot control (local) food inflation. 1. Works well for a small countries. Because their population is small, they can even import food from India, China and just focus on export competitiveness in electronics and consumer goods. e.g. Singapore, Taiwan etc. 2. But Doesn‘t work for large countries like India, Mexico or Brazil. Our population is so large, we cannot sustain on imported food. We must be self-reliant in food production. 3. Country becomes vulnerable to external shocks. Continuing the previous example of Apple vs Rupee 1. What if American RBI tightens their own monetary policy to control local American inflation (= US Feds follow a dear money policy =dollar (apple) supply is reduced.) 2. Then Rajan‘s statistical projections will go wrong. He‘ll have to make new adjustments in Rupee vs Dollar (Apple) quantity in Indian market. 4. Government is bogus, and causes high food inflation. Result= Real interest rates become negative, Juntaa will start investing more in gold=>Gold import

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increased=>payments have to be made in Dollar. This also creates imbalance in supply-demand of rupee vs Dollars (Apples). Rajan will have hard time controlling this mess. 5. Country becomes vulnerable to Speculative attacks. e.g. Forex traders in Europe or China decide to hoard Apples (dollars) in their refrigerator to create artificial shortage in market, so later then can sell their apples @higher rate. In such speculative attacks, Rajan will have hard time controlling supply-demand of Rupee vs dollars. He cannot prosecute them under FERA/FEMA laws, those traders live outside his jurisdiction. 6. Outdated: During WW1 era, most central banks used to follow this Exchange rate targeting strategy. But today, almost all banks in developed countries, have shifted to inflation targeting strategy. Only few exceptions- like Singapore‘s RBI – use this strategy. Moving to next method/strategy

#2: Focus on Multiple indicators At present, this is the strategy RBI uses for making monetary policy.

Under multiple indicator method, Rajan will first gather information about:

1. Index of industrial production (IIP), Consumer confidence 2. Professional forecasts (CRISIL, S&P, Moody, World Bank) about GDP, inflation, unemployment 3. Inflation data: WPI minus food, fuel. Then, he will design the monetary policy (mainly repo rate), with following objectives/focuses:

1. Increase employment 2. Increase GDP 3. Stabilize inflation 4. Stabilize exchange rate Sounds fair enough? Not really!

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Multiple indicator method: Negative points/ Limitations

1. Multiple indictor method has no ―nominal anchor‖- no actual target. What exactly are you trying to accomplish? Bring down WPI by 5%, raise GDP to 9%…..no such targets. Just bol-bachhan. Therefore ineffective. 2. Multiple indicator strategy worked well between 1998 and 2008. GDP was good and inflation was kept in check. But in recent times, this strategy is no longer working- inflation has skyrocketed and GDP is falling day by day. 3. Since 2008, Consumer price index rose to double digits (i.e. 10% or more) 4. But RBI doesn‘t focus on CPI. They only focus on WPI (minus food and fuel). Result? 1. WPI doesn‘t track changes in the service sector related inflation (e.g. doctor, physiotherapist, IT, call center etc.) 2. Service sector contributes more than 60% of GDP. So, when monetary policy is designed without considering service sector inflation=then it‘ll be ineffective. 5. WPI commodity list has been revised in recent times- they added ice cream, oven, cricket ball, guitar and so on.Result? 0. RBI has to make new statistical calculation about each of such busines arenas- number of people employed in it, total bank loans given, their contribution to GDP etc. 1. But when WPI commodity list is revised, RBI has to calculate new statistical projections= problem. Policy doesn‘t give effective result in the meantime. 6. Even if Rajan makes best policy, its Impact will be seen after a lag of 3-4 quarters (i.e. nine to twelve month). Why? We already learned the limitations of Monetary policy in a developing country, the past article. Click me 7. Since this strategy doesn‘t have a clear cut transparent targets, it becomes vulnerable to various pressure groups. For example

Pressure informally forces Rajan to: group

. Please increase SLR ratio. That way government is able to sell more of its securities to the Chindu banks and- arrange cash from more schemes to increase employment- after all that‘s what

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you want- increase employment!

. Secondly, please increase the quota for women under Priority sector lending because Rahul

baba has been advocating ―women empowerment‖ everywhere, including @Arnab

Goswami‘s interview.

Exporters/ . Rajan Bhai, please tweak your monetary policy in such way that $1=becomes 1000 rupees, IT then we earn more rupees while exporting goods n services abroad. companies

. Please design your monetary policy in such way that $1 = Rs.1. then we‘ve to spend less Importers rupees while importing stuff from abroad.

. Please decrease Priority sector lending, CRR and SLR that way more money is left for FICCI business loans for corporate giants.

. Maai baap, please reduce PSL targets, SLR, CRR and Repo, that way more money is left Bankers with us, and we can lend it to middle class and businessmen.

Therefore, Urjit recommends Rajan to dump this multiple indicator method.

Ok boss. So far I‘ve learned following:

1. Monetary policy should not focus on exchange rate because our country is very large, unlike

Singapore and Taiwan. Mohan 2. Monetary policy should not focus on ―multiple indicator‖ approach, because of the limitations

we just saw in above paragraph. Then what is your solution?

Urjit Simple. Focus on inflation

#3: focus on inflation In this strategy- Rajan will decide a “Nominal Anchor” say CPI -to monitor inflation. Then he‟ll fix an inflation-target say 2-6% and adjust his monetary policy so that inflation remains within that range.

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Nominal anchor (CPI) method: Benefits/Advantages of 1. Once Rajan sets a CPI target. Noone can ‗influence‘ him or put informal pressure- be it Chindu, Exporters, Importers, FICCI, Mallya, Ambani or Bankers cannot influence Rajan‘s policy. Because Rajan 2. Easy to track progress. Because CPI data released after every twelve days. 3. Central banks in all advanced economies and Emerging market economies have adopted this method. (Except India and China). 4. It brings transparency. Even aam-juntaa can understand what RBI‘s policy is and whether it‘s yielding result or not? Because there is only target to monitor=CPI. Previous Committees have also directly/indirectly recommended for this system. For example: year Committee Chairman

2007 Mumbai as International Finance Center Percy Mistry

2009 Financial sector reform Rajan the Boss himself

2013 Financial Sector Legislative Reforms Commission (FSLRC) BN SriKrishna

Nominal anchor (CPI) method: Drawbacks/Limitations/Anti-arguments

Hold on a second. You‘re trying to paint a very rosy picture. But if Rajan‘s monetary policy tries to Mohan control CPI, it‘ll have many problems!

Urjit Such as…??

In CPI index- more than 50% weightage is given to food and fuel components.

. Food prices= depend on monsoon and blackmarketers. Rajan has absolutely zero control over

Mohan this.

. Fuel/crude oil prices= depend on external factors and Rupee-Dollar exchange rate. Rajan doesn‘t

have sufficient forex reserves to control rupee-dollar exchange rate in the manner he wants (e.g.

1$=50 rupees and not 1$=60 Rs.)

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. You‘re right. But under multiple indicator method, Rajan focuses on WPI (minus food and fuel

inflation).

. That‘s why his policy has remained ineffective in controlling inflation.Because he always Urjit ignored food and fuel inflation.

. Infact, We must focus on CPI – for the very same reason-because it give >50% weightage to the

food and fuel inflation.

Point taken. But in India, we have three CPIs: Urban, Rural and Combined…if we try to control all Mohan three of them, then…..

No problem. We must focus only on CPI (Combined). Its data is released @every 12 days. Very easy Urjit to monitor, tracks price movement all over India.

Mohan Ya but still, Its data is not accurate and….

yaar if you start to find fault in everything (like a TheH**** columnist), ….then only God can help

Urjit you. Fidel Castro and Che Guevara cannot fix India‘s inflation problem. This only gets fixed from

inside the RBI!

But even if Rajan focuses on this Nominal Anchor (CPI), still there will be a lag of 6-8 months before Mohan its impacts are seen.

Brother, no matter which method we use – there will be lag of 6-8 months before its impact is seen on

inflation @ground level. Urjit

. Because we are not a developed country, we are a developing country.

. We‘ve already learned this limitation of monetary policy in developing countries. Click me.

Ok one last obstacle. Governments own policy to fight CPI. For example, whenever prices of sugar,

Mohan onion or pulses get very high, the government arbitrarily puts export ban on those commodities, start

importing them from xyz country, starts distributing them @subsidized rates in various cities.

Urjit So?

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So Rajan may be designed his policy to fight CPI using abc statistical projections but at random, the

Mohan government will do xyz policy on its own to fight inflation= Rajan‘s statistical projections will become

wrong and his monetary policy will become #EPIFAIL.

For this I recommend better coordination and data sharing between Government of India and RBI, Urjit regarding inflation control.

Why Target inflation?

I‘m still not clear. Why should Rajan only focus on inflation (CPI). Other things are also important –

Mohan like GDP, IIP, employment, investment, exchange rates. why focus on CPI only, and ignore everything

else?

Urjit let me explain:

petrol and onion prices, hardship to middleclass= those are clichéd points. Let‟s learn some new points.

. In recent years, India‘s inflation has been highest among all G20 countries.

. India‘s inflation has been higher than its trade competitors.

CPI 2008 2012

World 4 4

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Brazil 5 5

China 6 <3

India 9 >10

S.Africa 11 6

Russia 14 5

From above table, you can see that

. Between 2008 to 2012- China, South Africa and Russia have drastically reduced their inflation. Only India is the #EPICFAIL country where inflation has increased- instead of decreasing!

. Higher inflation = real interest rates decreased => makes people buy more gold=>CAD=>rupee weaken=>petrol expensive=>everything expensive=>every more inflation =vicious cycle.

Mohan Whoa, whoa, whoa man slow down. What is real interest rate? How does it affect economy?

Nominal vs Real interest rate

Urjit Suppose I‘ve 100 rupees. But instead of buying onions, I put this money in a savings account.

Observe what happens with my purchasing power:

Onion Rs./kg Money How much can you Buy?

1st Jan 20 100 5 kg

31st Dec 100 104 ~1 kg

Meaning, although bank increased your money from Rs.100 to 104, but you can buy very less onions. Therefore, we must not focus on nominal interest rate i.e. 4% but on real interest rate.

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Bank deposit Nominal Interest Rate CPI (Inflation) Real Rate of Interest=(Nominal-Inflation)

Savings account 4.00% 11% -7%

Fixed deposit 9.00% 11% -2%

From above table, you can see Banks in India offer “negative” real interest. Therefore, people prefer to invest in gold, instead of putting money in bank accounts.

Result:

. Excessive gold import=>Current account deficit increased=>Rupee Weaken =>Petrol/diesel expensive=>even more inflation. This becomes a vicious cycle where you cannot find whether hen came first or the egg came first?

. When people invest money in gold, instead of putting it in bank=> businessmen get less loans=>less expansion =>less jobs=> less growth in GDP.

. Now if you compare India vs [China, Russia, South Africa]. You can see- their inflation is low=> real interest rate would be higher => people invest less in gold=> more money flows towards banks=>business loans=>higher GDP, higher IIP (index of industrial production).

In other words, when Rajan frames monetary policy, he should only fight against inflation – then low Urjit GDP, low IIP will be fixed automatically.

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Mohan fair enough.

Nominal Anchor (CPI): the 4% Target Ok far we‟ve learned:

When Rajan frames monetary policy

1. He must focus on fighting inflation only. 2. To fight inflation, he must focus on ―CPI‖. Now the problem? What should be his exact CPI target? 4%, 5%. 0%, -50%??

This is easy. Rajan should design monetary policy in such way, that CPI is -50%. If bottle of desi

Mohan liquor was sold @100 Rs. in 2010, then in 2014 its price should reduce to Rs.50 only. Then Maujaa hi

Maujaa.

Urjit I hate to break your spirit, but such deflationary trend is not good for economy.

. Every business has ‗fixed cost of production‘ minimum light bill, phone bill, office rent, staff salary etc. So, if prices keep falling and falling, then businessman will suffer losses. He has no motivation to expand business. He wants to cut down his production costs, by firing some of the employees= less new jobs created= unemployment = social unrest.

Mohan Then what should be the ―minimum‖ target? What should be the lower limit of inflation?

Urjit Minimum 2% inflation is necessary in any economy.

Mohan Then what should be the ―maximum‖ limit for inflation/CPI?

I‘ve analyzed data from various countries. When CPI gets higher than 6.2%, it negatively affects GDP Urjit and employment. Therefore Rajan should ensure CPI inflation doesn‘t cross more than 6%.

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Mohan Ok, minimum 2% and maximum 6%.

Right RBI should try to get CPI inflation @4% with band of +/-2%.

Urjit . meaning 4-2=2% minimum

. and 4+2=6% maximum

Mohan But why give this 2% band? Why not just say 4% is our target?

. Because in real life, it is not possible to get inflation controlled @exactly 4% level. There will be

unanticipated price shocks in food and fuel items, wars, famines and natural disasters. Urjit . Therefore, Rajan should be given some ‗room‘ to accommodate such shocks – that‘s why 2-6%

target.

Besides, the RBIs of other countries also use similar „band‟ method: observe

Central Bank of CPI target under their monetary policy

Mexico 2-4%

South Africa 3-6%

Israel 1-3%

Chile 2-4%

So, it‟s a tried and tested method. we should follow the same.

Nominal Anchor CPI 4%: WHEN to reach?

Ok so far I‘ve learned:

Mohan . Urjit Patel Committee wants to strengthen monetary policy framework

. You insist RBI to fight inflation only.

. You even gave Rajan a target: 4% CPI (Combined), with +/-2% band

Urjit That is correct.

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well, Your recommendation is ambitious, but unrealistic. I repeat again- There are many factors

Mohan outside Rajan‘s control like monsoon and black marketers. I don‘t think Rajan can ever bring down

inflation to 4% level.

Urjit It is possible. Let me give you the case study of Chile.

. During 90s, Chile was facing CPI inflation as high as 25%.

. But in the early 2000s, the RBI of Chile made the target ―3% CPI (With +/-1% band)‖=2-4% CPI

. Now observe the following graph- particularly the green band between 2002 to 2006. You can see Chile‘s RBI has successfully managed to contain inflation within that 2- 4% level. Urjit recommended following timeframe:

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0 month (i.e. when Urjit was making CPI is ~10% report)

Within 12 months RBI should reduce CPI to 8%

Within 24 months RBI should reduce CPI to 6%

Just try to maintain inflation within the 2-6% range. (i.e. 4% with +/- Then 2% band)

In short: 0/12/24 (months)=>10/8/6 (CPI)

Nominal Anchor CPI 4%: How to reach?

Mohan Alright. If Chile can do it, we can also do it. But HOW?

. Using the same tools available in the present monetary policy framework. Urjit . Especially the ―policy rate‖.

Mohan What is policy rate?

Urjit Repo rate under Liquidity adjustment facility (LAF)= that‘s our policy rate.

. And reverse repo(RR) = Repo – minus 1%;

. MSF=Repo +plus 1%

. ^This system is fine. I recommend that Rajan should continue with it. Urjit . RBI should not change this +/- 1% spread between RR-Repo-MSF. (unless in extreme situation)

because unpredictable policy making= not good for banking sector‘s own business plans and

tactical projections .

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Hawkish trend: Why interest rates will rise?

Ok so far I‘ve learned:

. Urjit Patel Committee wants to strengthen monetary policy framework

Mohan . You insist RBI to fight inflation only.

. You even gave Rajan a target: 4% CPI (Combined), with +/-2% band

. You even gave Rajan a timeframe: 0/12/24 (months)=>10/8/6 (CPI)

. You even gave Rajan the firing ―strategy‖: fight inflation via Policy rate (Repo Rate)

Urjit That is correct.

But then what‘s the new story my friend? All these years, RBI has tried to fight inflation by using

Mohan Repo rate as its ―policy rate‖. But it has failed to yield any positive result. What makes you think repo

rate can fix our inflation problems?

Swami Vivekanand has said ―Aim higher.‖ On the same logic, I recommend Repo Rate should be Urjit kept higher than CPI. Then it‘ll fix the problem.

Observe.

At present

Repo 8%

CPI ~10%

Difference (Repo MINUS CPI) -2

You can see Repo rate is lower than CPI. That‟s why its ineffective. In the previous article on monetary policy, we learned that

Monetary policy Tool How to Fight inflation? How to fight deflation?

Repo rate Increase repo rate Decrease repo rate.

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Therefore, to fight inflation repo rate MUST be increased. Urjit Patel recommends that Repo rate should be increased so much that its higher than CPI.

At present Urjit Patel’s recommendation

Should be higher than CPI. Here CPI=10, so let‘s keep Repo Repo 8% @11%

CPI ~10% ~10

Difference(Repo -2 (11-10)=+1 MINUS CPI)

In other words, Urjit Patel recommends that difference between Policy rate (Repo rate) and CPI should be “positive”, Only then Policy rate can fight inflation.

What will be the consequences of high repo rate?

. Banks borrow less from RBI (Because they‘ve to pay more interest rate)

. Banks will increase their loan interest rates (because they‘ve less new money and still want to keep profit margin same)

. Less business expansion (because less people take loans, due to higher interest rate)

. Less new jobs created

. Less income

. Less demand

. Sellers will reduce Prices of goods and services, to attract and retain customers.= inflation reduced.

Wait wait wait. Urjit Patel, you‘re a ―hawkish‖ person, a person who believes inflation can be fought Mohan by increasing the interest rates.

Urjit So what?

. So man…Rajan raises Repo rate=>SBI increases loan interest rates=>harder to borrow for Mohan businessmen=>less business expansion =>less new jobs=>deflationary trend=>this will hurt our

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GDP.

. CRISIL, Moody and other experts have made statistical projections- that even in 2015, our CPI

will be ~8.5%. So by your logic, Rajan should keep Repo @9%. It will kill the growth!

. Theoretically you‘re right. High interest rates are not conductive for higher GDP growth.

. But Indian inflation has become so high, that extreme steps are necessary.

. Besides, the RBIs of Australia, Canada, S.Africa, Mexico, Brazil, Israel…… all have taken same Urjit measure in past.

. When inflation became very high, they raised repo rate to level higher than inflation. Only then

problem was fixed.

Whatever man. I‘m going to write a column in TheH**** to criticize you that ―If Urjit Patel

Mohan Committee‟s report is implemented, interest rates will rise and growth will be killed.‖ (Packs his

laptop and Prepares to leave.)

WAIT! Picture abhi baaki hai mere dost. Overall I made three important recommendations. In this Urjit article we only learned the first one:

1. @RBI fight inflation 1. Target=4% CPI, +/-2% Band [=control inflation in 2-6% range.] 2. Tool=Repo as policy rate, +/-1% spread in RR-Repo-MSF, 3. Time limit: 0/12/24 (months)=10/8/6% (CPI) 4. Strategy=keep repo higher than CPI. 2. @Chindu, give cover fire to Rajan, while he is fighting inflation (=in next article click me) 3. @Rajan fix accountability in your gang. (=in next article click me)

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Mock Questions 1. Incorrect statement 1. Nominal interest rate doesn‘t take inflation into account. 2. Real interest rate doesn‘t take Nominal interest rate into account. 3. Both A and B 4. Neither A nor B 2. What do you understand by Real interest rate? 0. Nominal interest rate plus inflation 1. Nominal interest rate minus inflation 2. Nominal interest rate multiplied with inflation 3. None of above. 3. In a futuristic society, if Real interest rate became a positive number, which of the following is mostlikely to be correct? 0. Fiscal deficit increased at the expense of current account deficit. 1. People have started putting their entire savings into gold. 2. RBI and Government failed in combating inflation. 3. RBI and government successfully managed to bring down inflation below the nominal interest offered in banks.

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4. Urjit Patel Committee has observed that 0. CPI lower than 2% is good for economy but CPI higher than 6% is bad for economy 1. CPI lower than 2% facilitates growth but CPI higher than 6% reduces employment. 2. CPI lower than 2% and higher than 6%, are bad for GDP and employment. 3. None of above. 5. Urjit Patel Committee has recommended that 0. RBI should continue with multiple indicator method to frame monetary policy, while targeting 4% inflation. 1. RBI should ignore fuel, food and service sector inflation and focus on core inflation only. 2. RBI should frame monetary policy while keeping CPI as the nominal anchor. 3. None of above. 6. Urjit Patel recommends RBI to: 0. Bring down consumer price index inflation to 6% within next twelve months. 1. Switch its focus from multiple indicators to exchange rate stabilization 2. both A and B 3. Neither A nor B. 7. To Combat inflation, Urjit Patel Committee has recommended RBI to: 0. Keep Repo rate lower than CPI. 1. Keep Reverse repo rate higher than MSF. 2. Keep the value of Reverse repo rate between Repo rate and MSF. 3. None of Above. Q8. If RBI frames monetary policy with primary objective of stabilizing the exchange rate, what will be the consequences? 1. Country becomes vulnerable to shocks emanating from the country to which its currency is pegged. 2. Country becomes immune to speculative attacks in forex trading market. 3. Imported inflation will be kept in check. Choices

1. Only 1 and 2

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2. Only 2 and 3 3. Only 1 and 3 4. All 1, 2 and 3. Q9. What are the recommendations of Urjit Patel Committee? 1. Inﬂation should be the nominal anchor for the monetary policy framework. 2. RBI should adopt the new CPI (rural) as the measure of the nominal anchor for policy communication. 3. WPI inﬂation should be set at 4 per cent with a band of +/- 2 Answer choices

1. Only 1 and 2 2. Only 2 and 3 3. Only 1 and 3 4. Only 1 Q10. Match the following:

1. Hawk 1. Purchases securities under the assumption that they can be sold later at a higher price.

II. Bull 2. Believes that a particular stock or the market as a whole, is headed for a fall in prices.

III. Bear 3. Favors relatively high interest rates in order to keep inflation in check.

– 4. Favors relatively low interest rates in order to keep deflation in check.

Answer choices

Options I II III

A 1 2 3

B 4 1 2

C 3 1 2

D 3 2 1

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Q11. Match following

1. Nachiket Mor 1. Nominal Anchor Method to frame Monetary Policy

II. Urjit Patel 2. Financial Sector Legislative Reforms

III. BN SriKrishna 3. Governance of Boards of Banks in India.

IV. P. J. Nayak 4. Financial products for small businessmen.

– 5. State backwardness index

Answer choices

Options I II III IV

A 5 1 2 3

B 3 1 3 5

C 4 1 2 5

D 4 1 2 3

Mains / interview type questions, once we finish remaining recommendations of the committee in next article.

MCQ hints: 1. incorrect statement is B 2. technical formula is bit different- but here opt B 3. last one 4. <2 and >6 both bad. 5. second last 6. neither 7. none 8. second statement is wrong. 9. only first statement is right

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10. hawk-interest, bull -will rise; bears-will fall 11. Nachi- products, Urjit- Nominal, BN-reforms, Nayak-Board.

Urjit Patel Committee: Fixing Accountability in RBI, Monetary Policy Committee, Decision by Majority, Fiscal Deficit (Part 2 of 2)

Prologue

RBI had formed a Committee under Dy. Governor Urjit Patel to strengthen monetary policy framework. Committee gave three major recommendations:

1. @RBI Target inflation (4% CPI; 2% band). Already covered in previous article click me. 2. @RBI fix accountability (discussed in this article) 3. @Government: help RBI fight inflation (in this article) #2: @RBI fix accountability in monetary policy making What is the existing mechanism in RBI? 1. Governor: Selection by finance minister, approval by Prime minister, appointment by Government of India. 2. Term: three years for Rajan. 3. Eligible for re-appointment? Yes RBI Act provides for appointment of a governor for a period of up to five years. 4. He is directly accountable to government of India. 5. Government can even issue him directives in public interest. 6. Rajan is also accountable to Parliament‘s standing Committee on Finance. They can summon him. On and average, RBI governor has to appear before this Committee 3- 4 times a year. How is monetary policy formed right now?

. At present, monetary policy is made by the governor alone.

. Rajan does consult with his Dy. Governors, board of directors etc. but only Rajan‘s signature necessary for approval file= meaning Rajan and Rajan only is the decision maker. Some initiatives in recent times:

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. 2005: RBI governor started consulation meeting with noted economists, industrial bodies (FICCI etc) and Credit Rating Agencies (CRISIL etc.)

. RBI‘s annual reports put on the official website

. Governor publishes quarterly reviews, and during the release, he answers media queries.

. But overall, Monetary policy is still ―one man‖ game, without any formal mechanism for ensuring participation and accountability. Recommendations in Past: Previous Committees Tarapore, Reddy, FSLRC etc. have directly/indirectly recommended that

1. Monetary policy should be decided by a Committee 2. Decision based on majority voting 3. Publish minutes of such meetings on the website/media.

Mohan alright man now come to the point.

Well, Considering all of above facts and factors, I recommend that RBI should form a monetary policy Urjit Committee.

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Monetary Policy Committee

Total five people in this Committee:

1. Chairman: Rajan himself (governor) 2. Vice Chairman: Any one Dy Governor (RBI has total four governors) 3. Members: 1. One Insider: RBI‘s own Executive Director (in charge of Monetary policy). 2. Two outsiders/External members:

. Noted Economists, finance experts etc, who‘re not office bearers in RBI.

. term: three years

. not eligible for re-appointment. Outsiders: Safeguards and provisions

The outsider members will have the right to assess all data/files/records in RBI office.But he cannot Urjit hold office of profit under the government.

Mohan Meaning?

Urjit To put this in crude words: he should not be on the payroll of the government. for example: IAS

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officers, bureaucrats, even certain bodies / corporations funded by the government.

Mohan But why?

Government may try to influence RBI‘s decision making via such member- because his bread n butter Urjit depends on that job.

. In all the advanced economies, monetary policy is made by a Committee of independent members- even in China, government directly doesn‘t interfere with its officers/representatives.

. Exceptions where government side is represented in Monetary policy Committee =Colombia, Philippines. Conflict of Interest

Urjit Secondly, such outside member must not involve in any activity that has conflict of interest with RBI.

Mohan Meaning?

. Consider HSBC, Morgant Stanley, JP Morgan Chase etc giants. They have license to operate as

―Primary dealers‖ in India. Meaning they can directly buy and sell government securities. So, if

monetary policy Committee member also provides consultancy services to such firms= there is

Urjit conflict of interest.

. What if he leaks information to that company, e.g. ―RBI will start Open market Operation in

week OR RBI is set to decide Repo rate @xx%.‖

. Those primary dealers could make windfall profits from such insider tips. MPC Decision by Majority

Urjit Monetary Policy Committee (MPC) will decide the monetary policy by voting among themselves.

Mohan But what if there is a tie?

. Noone will be allowed to abstain from the voting. (unlike the CBI fearing parties in Rajya Urjit Sabha).

. All five members must vote on each and every issue brought on table.

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. Since ―5″ is an odd number, there is no chance of tie.

Mohan Ya but what if one member is absent? Then four members left= 2 vs 2 tie possible!

Urjit In that case Rajan (Chairman) will give the casting vote to break the tie.

Mohan But what if Rajan himself is absent? And there is 2vs2 tie?

Urjit Then Vice Chairman of the Committee (Dy.Governor) will give the casting vote to break the tie.

Mohan But what if He is also absent?

Urjit if both chairman and VC are absent, then common sense suggests we should postpone the meeting!

Ok one last doubt: you told there are five people in MPC Committee: three insiders (Rajan, Dy

Governor and one member) vs two outsiders (external members).

. What if one of the outsider member always gives dissenting vote….Ultimately, Rajan bhai‘s Mohan goonda-log beats him to pulp to make sure he remains absent in the meeting.

. and then Rajan bhai uses his own casting vote to decide policy according to his own whims and

fancies!

. How will you maintain accountability in that case? Solve it for [Ethics] GS4.

Urjit I‘m not going to dignify that stupid question/case study with an answer. Let‘s move to next topic:

MPC: Accountability for #EPICFails

. In the previous article we saw the ―Target‖: RBI must control CPI within 2-6% range. (i.e. 4% CPI with +/-2% band)

. EPICFAIL = When MPC fails to keep CPI within this range for three successive quarters. (meaning 3 x 3 = 9 months continuously CPI remains outside the [2,6] range.) In case of such #EPICFAILs, Urjit Patel recommends

1. MPC Must issue a public statement 2. Every MPC member must sign it

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3. This statement will contain 1. Why did we fail? (Reasons) 2. How will we fix it (Future action proposed) 3. By when will we fix it? (Timeframe) MPC: Summary

Total five persons.

1. RBI governor as chairman

2. RBI dy.governor as Vice chairman Members:

STRUCTURE . One Executive director of RBI

. Two members from outside RBI.

. cannot hold office of profit,

. cannot involve in work that has conflict of interest with RBI

. term: three years

. not eligible for re-appointment.

. Must meet once every two months.

. Decision by majority voting DECISION . Each person has one vote. MAKING . Member cannot abstain from voting.

. If there is tie, Casting vote power to Governor and Dy.Governor.

. Must publish minutes of the meeting.

. Must publish Bi-annual report. TRANSPARENCY . In case of failure to contain inflation with 2-6% range for three successive quarters,

MPC will release a public statement signed by all members.

^~130 words.

Moving to the third main recommendation:

#3: @Government give Cover fire to RBI

. RBI Makes monetary policy to control money supply in the system [and thereby fight inflationary and deflationary trends in economy.]

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. But RBI‘s monetary policy fails to yield result because of government‘s policies and subsidies. Observe: #: MNREGA:

. Money increased in Juntaa‘s hand? Yes

. Productive infrastructure/assets increased =Hardly. (Most of those kuccha roads and ponds get washed away in first rain.)

. So in a way, more money in public‘s hand, without corresponding rise in some physical goods/infrastructure/services. => leads to inflation.

. Additionally, MNREGA=>less poors migrating to rich states to work as farm laborers=> the farmers in those states have to arrange local laborers @higher wages=> food inflation.

. + lot of this money chowed down by Sarpanch, Patwari and Tehsildaar=> they give it local money lender, who in

. turn loans it to farmers @36% interest rate. Rajan has no control over this. His monetary policy fails to control this. #: MSP

. In recent years, government kept increasing minimum support prices (MSP) of foodgrains (To benefit farmers/vote bank politics.)

. But APMC merchants are not ready to buy grains @such high price.

. So, Farmers bring the grain to FCI (to sell it @Minimum support price declared by the government.)

. FCI buys it, but FCI doesn‘t have sufficient godowns= grains rotten @railway stations and eaten away by birds, rats, dogs and cows.

. Money increased in farmers‘s hand? Yes

. Products/Goods/services increased in the economy? Nope. in fact foodgrain destroyed=> less commodities/products/breads/biscuits.

. Result= inflation.

. + even if this reaches to PDS shop, those shopkeeper themselves involved in hoarding and black marketeering. So, inflation continues.

. Ill-gotten money gets reinvested in gold, real estate etc (because black-marketer cannot deposit in banks- else Income tax walla will track him down through KYC form.)

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. Again, Rajan doesn‘t have control over this, so his monetary policy will remain ineffective. #: Fiscal Deficit

Without getting into all details:

. Any type of deficit = as such bad. Because it shows government is spending beyond its income.

. Revenue expenditure = not good. [e.g. salary to staff]

. Capital expenditure = good. [e.g. building new road/bridge]

. Receipts= incoming money Let‟s check the formulas to calculate various deficits:

Deficit formula

Budget deficit Total expenditure – Total receipts

. Budget deficit + Borrowing. Fiscal deficit . (Total Expenditure – Total Receipts) + Borrowing

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. (Total expenditure + borrowing) – [Revenue Receipts + Capital Receipt]

. Total expenditure – [Revenue receipts + (Capital Receipts non debt type)]

. Total Expenditure – [Revenue receipts + (Recovery of loans +Other receipts)]

Primary deficit Fiscal deficit – interest payment (on previous loans)

Revenue Deficit Revenue Expenditure – Revenue receipt

Effective Revenue Revenue deficit – grant for creation of capital assets deficit

So what do we get from above formulas?

. As such, any type of deficit is bad, because it shows you‘re spending beyond your income.

. Sometimes it is good to overspend- e.g. A middleclass family takes loan to send their kid for higher education. [because money will recover when kid starts job/business.]

. Similarly, if government also overspends for productive purpose like building new bridges, dams, canals and powerplants (i.e. capital Expenditure), then it is good, even if they run into ‗deficit‘.

. ^Atleast Keynesian economists believe so. But in Modern Times, such “goodwill” expenditure also create more problems than they solve

1. because you‘re still ‗overspending‘ beyond your income, 2. even if bridges, dams, canals and powerplants are created – it‘ll take 20-30-50-100 years before the money is recovered through tolltax/selling electricity and water. 3. Besides governments tend to subsidize here also. So the ―capital Expenditure‖ will not be recovered quickly. 4. E.g. Kejriwal offering free water and cheap electricity. (After all it does come from some dam, some canal, some powerplant.) Therefore, Free Market economists argue that Government should not borrow money even for capital Expenditure (building roads, canals, bridges and

265 dams). Government should only spend according to its income. And thus fiscal deficit should be kept minimum.

There are two ways to cut down fiscal deficit: 1. Government should increase its income (e.g. increase taxes, order PSU to give more dividend) 2. Government should decrease its expenditure (e.g. stop bogus schemes, reduce subsidies, sell away loss making PSU, recruit less people and so on.) But in real life scenarios, both solutions are difficult to implement, therefore instead of decreasing fiscal deficit, government will keep issuing more bonds/Government securities to arrange additional cash.=> fiscal deficit keeps increases. And High level of fiscal deficit leads to following problems:

1. Banks and investors buy these government securities. 2. As a result, less money left for businessman to get loans/investment => less business expansion, less jobs=>GDP reduced. 3. In other words, fiscal deficit crowds out investment in private sector. Business loan interest rates continue to remain high.=> Rajan‘s statistical projections about money supply, will become wrong. Thus monetary policy won‘t be effective. High Fiscal deficit: the vicious cycle:

. High Fiscal deficit=> S&P, Moody etc. reduce our ―Rating‖ to junk level=> FDI, FII slows down. But crude-oil, gold imports remain high => less incoming ―Dollars‖=> rupee weakens => crude oil more expensive=> fuel inflation => inflation in everything transported by petrol/diesel.

. And IF government starts giving subsidies on petrol/diesel, then more fiscal deficit=>vicious cycle of weak rupee and high inflation continues.

. Rajan‘s monetary policy give much positive result in this case. #: Loan Waiver

. 2008: Government announced debt waiver scheme for farmer. Accordingly, government paid >60k crore rupees to the banks, on farmers‘ behalf to settle their loans. This hurts in three ways 1. Fiscal deficit increased=> more problem as we saw above. 2. Rajan‘s statistical projections for monetary policy go wrong.

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3. Farmers get bad habit of not repaying loans on time, hoping that government will again waive off their loans before general election.=> again NPA increases, banks are left with less money to lend => banks will charge high interest rate on business loans (to keep profit margin same)=> less business expansion = GDP, IIP declines. Urjit Patel’s recommendations to Government

Given all these negative factors, Urjit Patel recommends government to do following:

1. Eliminate administered prices (MSP on foodgrains, LPG cylinders), 2. Eliminate administered wages (MNREGA) 3. Eliminate administered interest rates (interest subvention given to farmers.) 4. Implement Vijay Kelkar Committee‘s recommendations on fiscal consolidation. 5. Religiously follow the guidelines of Fiscal responsibility and budget Management Act (FRBM). 6. At present fiscal deficit is ~5% of GDP. Reduce this to just 3% of GDP, by 2016-17.

Waah Urjit bhai waah. You‘ve given some radical recommendations.Lejin Hum nahi

Chindu sudharenge (we‘ll not reform and continue to give truckload of subsidies and freebies before election.)

Just observe:

1. We‘ve increased number of subsidized LPG cylinders from 9 to 12 => subsidy burden increased by 5000 crore. 2. Previously 6th Pay commission‘s recommendation cost us Rs.20000 crores. Now We‘ve formed 7th Pay commission under Justice Mathuor. You can be damn sure it‘ll cost more than Rs.20000 crores. 3. And before the Model code of conduct is announced, we may launch a few more schemes, freebies and highest MSP for farmer.

Then I better just run away to Nepal, Dubai or Bangkok than try to fix the inflation mess through Rajan monetary policy.

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Urjit Patel: Misc recommendations 1. Create standing deposit facility (similar to MSF.) 2. Reduce SLR rate as per basel III framework. (Nachiket Committee said remove SLR completely). 3. Government‘s cash and Debt management function should be under a separate Government body. (and not with RBI) 4. Government should not give directives to public sector banks on interest rates. 5. Exchange rates related. (QE, Tapering.) 6. Fixed income financial products (e.g. various maturity plans, Non-convertible debentures, small savings scheme etc.): = for TDS and tax benefits, treat them similar to bank deposits. That‘d motivate people to save into them rather than in gold. Mock Questions 1. Find correct statements 1. Primary deficit cannot be higher than fiscal deficit 2. Primary deficit is obtained by deducting interest rates from Revenue deficit 3. Both A and B 4. Neither A nor B 2. Find Incorrect statements 0. Fiscal deficit cannot be lower than budget deficit

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1. Fiscal deficit cannot be lower than Revenue deficit 2. Both A and B 3. Neither A nor B 3. Effective revenue deficit means 0. Revenue deficit + Interest payment 1. Revenue deficit – Borrowing 2. Revenue deficit + grant for creation of capital assets 3. Revenue deficit – grant for creation of capital assets 4. RBI governor is__ 0. Selected by a panel consisting of Finance minister, commerce minister and the leader of opposition in Lok Sabha 1. Answerable to the parliament‘s standing Committee on finance. 2. Both A and B 3. Neither A nor B 5. (A) In the recent years, RBI‘s monetary policy has failed to contain inflation. (R) High level of subsidies and fiscal deficit reduce the impact of monetary policy on ground level. 0. Both the statements are individually true and Statement R is the correct explanation of Statement A 1. Both the statements are individually true but Statement R is not the correct explanation of Statement A 2. Statement A is true but Statement R is false. 3. Statement A is false but Statement R is true. Q6. Urjit Patel Committee has recommended setting up a monetary policy Committee. Which of the following statements are correct in that regard: 1. Members will be chosen by a panel of RBI governor, Finance minister, commerce minister and the minister for corporate affairs. 2. Their salaries will be charged upon the consolidated fund of India. 3. They cannot be removed from office without a proved misbehavior and voting in both houses on such motion. Answer choices 1. Only 1 and 2

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2. Only 2 and 3 3. Only 1 and 3 4. None. Descriptive

. (GS2-regulatory bodies)

. What are the recommendations made by Urjit Patel Committee, to bring more accountability in the monetary policy formation in India? (5m | 100 words)

. Write a note on the salient recommendations by Urjit Patel Committee to strengthen the monetary policy framework in India (10m | 200 words)

. (GS3) Examine the role of Minimum support prices and farm subsidies as the Factors responsible for inflation in India. Do you agree with Urjit Patel Committee‘s recommendations for removal of such administered prices and subsidies? Justify your stand. (10m | 200 words) Interview 1. Urjit Patel Committee has recommended RBI to keep repo rate higher than CPI. This type of hawkish policy to combat inflation, will hurt the growth momentum. Do you Agree? Yes/No/Why? 2. Urjit Patel Committee says bring down fiscal deficit to 3% of GDP by 2016. Do you think this is even plausible? Yes/no/why? If you‘re made by the finance minister of India, how will you address the problem of fiscal deficit? 3. In the recent years, RBI‘s monetary policy has failed to put much impact on inflation. If you‘re made the governor of RBI, how will you address this problem? 4. Suppose you‘re the Finance minister of India, and have to pickup the next governor of RBI. There are two candidates- both man of high integrity and impeccable career record- one is an IAS, who has long served in finance, commerce and corporate affairs ministries. And the second candidate is an IIM graduate with long experience of teaching economics at prestigious institutions abroad, and working with IMF but he holds a US Green card. Which one will you select and why?

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