BANK

A bank is a commercial or state institution that provides financial services , including issuing money in various forms, receiving deposits of money, lending money and processing transactions and the creating of credit.

TYPES OF BANKS

Central / Federal / National Bank

Every country of the world has a central bank. In India, Reserve Bank of India, in U.S.A, Federal Reserve and in U.K, Bank of England.
These central banks are the bankers of the other banks. They provide specialised functions i.e. issue of paper currency, working as bankers of government, supervising and controlling foreign exchange. The principal responsibility of Central Bank is thorough control on currency of a country.

Commercial Banks

These banks collect money from general public and give short-term loans to people by way of cash credits, overdrafts, etc.
Commercial banks provide various services like collecting cheques, bill of exchange, remittance money from one place to another place. In India, commercial banks are established under Companies Act, 1956. The policies regarding deposits, loans, rate of interest, etc. of these banks are controlled by the Central Bank.

Industrial Banks / Development Banks Industrial / Development banks collect cash by issuing shares & debentures and provide long-term loans to industries. The main objective of these banks is to provide long-term loans for expansion and modernisation of industries. Some of them are Industrial Finance Corporation of India (IFCI), Industrial Credit and Investment Corporation of India (ICICI) and Industrial Development Bank of India (IDBI).

Co-operative Bank
In India, Co-operative banks are registered under the Co-operative Societies Act, 1912. They generally give credit facilities to small farmers, salaried employees, small-scale industries, etc.

Co-operative Banks are available in rural as well as in urban areas. The functions of these banks are just similar to commercial banks.

Exchange Banks

Hong Kong Bank, Bank of Tokyo, Bank of America are the examples of Foreign Banks working in India.
These banks are mainly concerned with financing foreign trade.Following are the various functions of Exchange Banks :-

Remitting money from one country to another country, Discounting of foreign bills, Buying and Selling Gold and Silver, and Helping Import and Export Trade.

Land Mortgage / Land Development Banks

Land Mortgage or Land Development banks are also known as Agricultural Banks because these are formed to finance agricultural sector. They also help in land development.

In India, Government has come forward to assist these banks. There is a great risk involved in the financing of agriculture and generally commercial banks do not take much interest in financing agricultural sector.

Classification on the Basis of Domicile: On the basis of domicile, the banks are divided into two categories: (a) Domestic Banks: These are registered and incorporated within the country, (b) Foreign Banks: These are foreign in origin and have their head offices in the country of origin.

Classification on the Basis of Ownership: On the basis of ownership, banks can be classified into three categories: (a) Public Sector Banks: These are owned and controlled by the government. In India, the nationalized banks and the regional rural banks come under these categories, (b) Private Sector Banks: These banks are owned by the private individuals or corporations and not by the government or co-operative societies, (c) Cooperative Banks: Cooperative banks are operated on the cooperative lines. In India, cooperative credit institutions are organised under the cooperative societies law and play an important role in meeting financial needs in the rural areas.

Scheduled and Non-Scheduled Banks:

In India, banks have been broadly classified into scheduled and nonscheduled banks: A Scheduled Bank is that which has been included in the Second Schedule of the Reserve Bank of India Act, 1934 and fulfills the three conditions : (a) It has paid-up capital and reserves of at least Rs. 5 lakhs. (b) It ensures the Reserve Bank that its operations are not detrimental to the interest of the depositors; (c) It is a corporation or a cooperative society and not a partnership or a single owner firm. The banks which are not included in the Second Schedule of the Reserve Bank of India Act are non-scheduled banks.

BASEL NORMS
Basel is a city in Switzerland. It is the headquarters of Bureau of International Settlement (BIS), which fosters cooperation among central banks with a common goal of financial stability and common standards of banking regulations.

Every two months BIS hosts a meeting of the governor [current Governor of RBI is Duvvuri Subbarao] and senior officials of central banks of member countries. Currently there are 27 member nations in the committee. Basel guidelines refer to broad supervisory standards formulated by this group of central banks - called the Basel Committee on Banking Supervision (BCBS).

The set of agreement by the BCBS, which mainly focuses on risks to banks and the financial system are called Basel accord.
The purpose of the accord is to ensure that financial institutions have enough capital on account to meet obligations and absorb unexpected losses. India has accepted Basel accords for the banking system. In fact, on a few parameters the RBI has prescribed stringent norms as compared to the norms prescribed by BCBS.

Basel I

In 1988, BCBS introduced capital measurement system called Basel capital accord, also called as Basel 1. It focused almost entirely on credit risk. It defined capital and structure of risk weights for banks. The minimum capital requirement was fixed at 8% of risk weighted assets (RWA).

The values of bank's assets are not taken according to the book value but according to the risk factor involved. The value of each asset is assigned with a risk factor in percentage terms.

Basel II
In June 04, Basel II guidelines were published by BCBS, which were considered to be the refined and reformed versions of Basel I accord.

The guidelines were based on three parameters, which the committee calls it as pillars. Capital Adequacy Requirements: Banks should maintain a minimum capital adequacy requirement of 8% of risk assets.

CAPITAL ADEQUACY RATIO A measure of a bank's capital. It is the ratio of capital fund to risk weighted assets expressed in percentage terms.

Also known as "Capital to Risk Weighted Assets Ratio (CRAR).

Two types of capital are measured: tier one capital, which can absorb losses without a bank being required to cease trading, and tier two capital, which can absorb losses in the event of a winding-up and so provides a lesser degree of protection to depositors.

Basel II Supervisory Review: According to this, banks were needed to develop and use better risk management techniques in monitoring and managing all the three types of risks that a bank faces, viz. credit, market and operational risks . Market Discipline: This need increased disclosure requirements. Banks need to mandatorily disclose their CAR, risk exposure, etc to the central bank. Basel II norms in India and overseas are yet to be fully implemented.

Basel III
In 2010, Basel III guidelines were released. These guidelines were introduced in response to the financial crisis of 2008. A need was felt to further strengthen the system as banks in the developed economies which were under-capitalized, over-leveraged and had a greater reliance on short-term funding.

Basel III

Also the quantity and quality of capital under Basel II were deemed insufficient to contain any further risk. Basel III norms aim at making most banking activities such as their trading book activities more capitalintensive. The guidelines aim to promote a more resilient banking system by focusing on four vital banking parameters viz. capital, leverage, funding and liquidity.

ANOTHER TERM RELATED TO BANKS

FACTORING : Factoring is a financial transaction whereby a business sells its accounts receivable (i.e., invoices) to a third party (called a factor) at a discount. Lets say that XYZ Enterprises makes table clothes. They receive an order from ABC worth Rs.10,000 XYZ makes the table clothes and delivers them on credit basis. ABC has up to 30 days to pay (assuming they pay on time). Meanwhile another company, LMN wants to order table clothes worth Rs. 80,000. The problem is that XYZ does not have sufficient money to buy raw goods to fulfil LMNs order. They need ABC to pay their bill (which is not yet due or may even be paid late). So, in this case, XYZ could factor (sell) the invoice to any third party (Factor) at a slight discount thereby getting them money they need today to take the LMN order.

ANOTHER TERM RELATED TO BANKS

Interbank Call Money Market :

A short-term money market, which allows for large financial institutions, such as banks, mutual funds and corporations to borrow and lend money at interbank rates. The loans in the call money market are very short, usually lasting no longer than a week and are often used to help banks meet reserve requirements.

INSTRUMENTS USED IN BANKS

Treasury Bills:
The Treasury bills are short-term money market instrument that mature in a year or less than that. The purchase price is less than the face value. At maturity the government pays the Treasury Bill holder the full face value.The Treasury Bills are marketable, affordable and risk free. The security attached to the treasury bills comes at the cost of very low returns.

Certificate of Deposit:
The certificates of deposit are basically time deposits that are issued by the commercial banks with maturity periods ranging from 3 months to five years. The return on the certificate of deposit is higher than the Treasury Bills because it assumes a higher level of risk.

Commercial Paper:
Commercial Paper is short-term loan that is issued by a corporation use for financing accounts receivable and inventories. Commercial Papers have higher denominations as compared to the Treasury Bills and the Certificate of Deposit. The maturity period of Commercial Papers are a maximum of 9 months. They are very safe since the financial situation of the corporation can be anticipated over a few months.

Banker's Acceptance
A banker's acceptance is a short-term investment plan created by a company or firm with a guarantee from a bank. It is a guarantee from the bank that a buyer will pay the seller at a future date. A good credit rating is required by the company or firm drawing the bill. The terms for these instruments are usually 90 days, but this period can vary between 30 and 180 days. Companies use the acceptance as a time draft for financing imports, exports and other trade. Also known as letter of credit.

Repos: The Repos or the repurchase agreements are sold by sellers with a promise of purchasing them back at a given price and on a given date in the future. The buyer will also purchase the securities and other instruments in the repurchase agreement with a promise of selling them back to the seller. Hence the Repos have terms raging from 1 night to 30 days. They are very safe due to government backing.

Monetary Policy and its Instruments

Fiduciary or paper money is issued by the Central Bank on the basis of computation of estimated demand for cash. Monetary policy guides the Central Banks supply of money in order to achieve the objectives of price stability (or low inflation rate), full employment, and growth in aggregate income. This is necessary because money is a medium of exchange and changes in its demand relative to supply, necessitate spending adjustments.

To conduct monetary policy, some monetary variables which the Central Bank controls are adjusted-a monetary aggregate, an interest rate or the exchange rate-in order to affect the goals which it does not control.
The instruments of monetary policy used by the Central Bank depend on the level of development of the economy, especially its financial sector. The commonly used instruments are discussed further.

Bank Rate
This is the rate at which RBI lends money to other banks (or financial institutions . The bank rate signals the central banks long-term outlook on interest rates. If the bank rate moves up, long-term interest rates also tend to move up, and viceversa. Banks make a profit by borrowing at a lower rate and lending the same funds at a higher rate of interest. If the RBI hikes the bank rate the interest that a bank pays for borrowing money (banks borrow money either from each other or from the RBI) increases. It, in turn, hikes its own lending rates to ensure it continues to make a profit
CURRENT RATE : 9%

Repo (Repurchase) Rate

Repo rate is the rate at which banks borrow funds from the RBI to meet the gap between the demand they are facing for money (loans) and how much they have on hand to lend.
If the RBI wants to make it more expensive for the banks to borrow money, it increases the repo rate; similarly, if it wants to make it cheaper for banks to borrow money, it reduces the repo rate.
CURRENT RATE : 8%

Reverse Repo Rate

This is the exact opposite of repo rate. The rate at which RBI borrows money from the banks (or banks lend money to the RBI) is termed the reverse repo rate. The RBI uses this tool when it feels there is too much money floating in the banking system If the reverse repo rate is increased, it means the RBI will borrow money from the bank and offer them a lucrative rate of interest. As a result, banks would prefer to keep their money with the RBI (which is absolutely risk free) instead of lending it out (this option comes with a certain amount of risk)

 Consequently, banks would have lesser funds to lend to their customers. This helps stem the flow of excess money into the economy Reverse repo rate signifies the rate at which the central bank absorbs liquidity from the banks, while repo signifies the rate at which liquidity is injected.
CURRENT RATE : 7 %

Both bank rate and repo rate serve the same purpose for meeting the liquidity needs of the commercial banks. Both the rates are determined by RBI in accordance with the money supply in the market. The only difference between the two are,in REPO RATE, there is sale of security to RBI on an agreement to" repurchase" it at a future date at predetermined price. That is why the term REPO means "REPURCHASE AGREEMENT". Whereas in BANK RATE, there is no such sale or repurchase agreement. It takes place as mere lending of money to commercial banks at fixed rate ,i.e the bank rate.

Difference between bank rate and repo rate

Call Rate
Call rate is the interest rate paid by the banks for lending and borrowing for daily fund requirement. Since banks need funds on a daily basis, they lend to and borrow from other banks according to their daily or short-term requirements on a regular basis.
CURRENT RATE : FLUCTUATES REGULARLY

Open Market Operations:

The Central Bank buys or sells (on behalf of the Fiscal Authorities (the Treasury)) securities to the banking and non-banking public (that is in the open market).
One such security is Treasury Bills. When the Central Bank sells securities, it reduces the supply of reserves and when it buys (back) securities-by redeeming them-it increases the supply of reserves to the Deposit Money Banks, thus affecting the supply of money

CRR
Also called the cash reserve ratio, refers to a portion of deposits (as cash) which banks have to keep/maintain with the RBI.

This serves two purposes. It ensures that a portion of bank deposits is totally risk-free and secondly it enables that RBI control liquidity in the system, and thereby, inflation by tying their hands in lending money

CURRENT CRR :

4.75 %

SLR
Besides the CRR, banks are required to invest a portion of their deposits in government securities as a part of their statutory liquidity ratio (SLR) requirements. What SLR does is again restrict the banks leverage in pumping more money into the economy.

CURRENT RATE :

23 %

Benchmark Prime Lending Rate

In banking parlance, the BPLR means the Benchmark Prime Lending Rate. BPLR is the interest rate that commercial banks normally charge (or we can say they are expected to charge) their most credit-worthy customers. Although as per Reserve Bank of India rules, Banks are free to fix Benchmark Prime Lending Rate (BPLR) for credit limits over Rs.2 lakh with the approval of their respective Boards yet BPLR has to be declared and made uniformly applicable at all the branches.

 The banks have also to declare the maximum spread over BPLR with the approval of the ALCO/Board for all advances. However, with the introduction of Base Rate concept, BPLR is slowly losing its importance and is made applicable normally only on the loans which have been sanctioned before the Base Rate has been made compulsory

Base Rate
The Base Rate is the minimum interest rate of a Bank below which it cannot lend, except for DRI advances, loans to bank's own employees and loan to banks' depositors against their own deposits. (i.e. cases allowed by RBI) Base Rate is to be reviewed by the respective banks at least on quarterly basis and the same is to be disclosed publicly. On the other, the calculations of BPLR was mostly not transparent and banks were frequently lending below the BPLR to their prime borrowers and also under pressure due to various reasons.

CURRENT RATE :

10 10.5 %

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