Imp Points for Prelims

RBI setup by Hilton Young Commission
CRR is in both RBI act 1934 that regulates scheduled banks and also in RBI Regulation Act 1949 that regulates scheduled, nonscheduled and cooperative banks
SLR is in Banking Regulation Act 1949. Hence applicable to those which are regulated by RBI whether scheduled or nonscheduled(foreign branches with no Indian branch is not regulated by RBI)
LAF(repo) is in Banking Regulation Act 1949. Hence can be used by Scheduled and Nonscheduled banks
MSF Marginal Standing Facility is in RBI Act 1934 and hence applicable to Scheduled Banks

RBI Act 1934 (scheduled banks)	CRR, MSF
RBI Regulation Act 1949 (Scheduled/non-scheduled/cooperatives)	CRR, SLR, LAF

SLR, CRR over fortnight while repo and reverse repo at overnight. Term repos for 7,14,21 days. Long term repos - 1 year & 3 years
SLR as collateral cannot be used for LAF while it can be used for MSF

Govt oil bonds and Sovereign Gold bonds are eligible as securities for RBI's LAF and MSF [Since Nov 2016]

[NOTE: RBI had introduced repos in corporate bonds in 2010, but the response had been lukewarm]

Implies that Govt securities, Sovereign gold bonds, Govt oil bonds, Corporate sector securities (certain conditions) are allowed as collateral for repo

RBI assets - Gold, foreign exchange reserves, Govt securities, Loans to Banks
RBI liability - Bankers deposit to RBI, Govt deposit to RBI, Money in circulation(M0 Money)

After all, money is also a type of debt bond issued by sovereign state central banker

Legal tender is only coins and currency as defined by the RBI. So, gold, stocks, bonds are not legal tender. But the fact that they are not legal tender makes no comment on whether they themselves are legal or illegal
RBI known as lender of last resort means

It lends to banks when they are in crisis/becoming insolvent
Also, it lends to banks at all times by supplying it with much needed liquidity when no one else is willing to extend credit to that bank

RBI Balance Sheet

It is usual practice that some part of the net surplus of RBI is taken out and transferred to RBI Reserves and the remaining part of the net surplus would be transferred to Central Govt as Dividend
Since FY14, RBI transferring 99.99% of the total surplus to Centre as dividend (Almost total surplus transfer)

The rest 0.01% is transferred to RBI reserves which is built cumulatively over the years

Reserves of RBI

Total reserves of RBI include

Contingency fund
Currency and Gold Revaluation Reserve CGRA
Investment revaluation account
Asset Development fund

FY 2017-18, Total reserves of RBI out of total assets stand at 28.92%
Bulk of RBI reserves are under two heads

Contingency fund - 2.32L crore - 6.4% of total assets
Currency and Gold Revaluation Reserve CGRA - 6.9L crore - 19.11% of total assets

Why reserves

Monetary, financial and external stability risks is the country’s savings for a ainy day’ (a monetary/ financial stability crisis)Also required to cover credit risk and operational risk

Why CGRA Currency and Gold Revaluation Reserve

The CGRA is meant to cover a situation where the rupee appreciates against one or more of the currencies in the basket — and the basket h several currencies ranging from the dollar to the euro and the yen — or if there is a decline in the rupee value of gold.

Why Contingency Reserve

The contingency reserve is meant to cover depreciation in the value of the RBI holdings of government bonds domestic and foreign if yields rise and their prices fall, unprecedented forex and gold fluctuations
The reserve is also meant to cover expenses from extraordinary events such as demonetisation, tsunami, unforeseen contingencies such as Black Swan events – the collapse of Lehman Bank in U A or any other bank which may endanger economic stability of the bank
money market operations , currency printing expenses in a year of insufficient income
contingency reserve supports the mother of all guarantees — the centr bank’s role as the lend of the last resort.
The reserve is also a cover for the deposit insurance fund given that the Deposit Insurance and the Credit Guarantee Corporation (DICGC) is a wholly owned subsidiary of the RBI

Bimal Jalan Expert Committee report to review the extant Economic Capital Framework

Constituted by RBI
Terms of reference

to review the extant Economic Capital Framework of the RBI (reserves, buffers, risk provisioning, profit distribution policy)
Treatment of surplus reserves created out of realized gains

Report Recommendations

RBI's Economic Capital

Two components - Realized equity and Revaluation balance
Realized equity

were primarily built up from retained earnings
could be used for meeting all risks/ losses

Revaluation balance

They represent unrealized valuation gains
As they are unrealized, they cannot be distributable
They could be used as risk buffers against market risks
Further, surplus in revaluation balances over market risk provisioning requirements for covering shortfall in risks is not permitted

Recommended RBI to modify its balance sheet to show this distinction b/w realized equity and revaluation balance

Risk provisioning for market risk

Committee has recommended the adoption of Expected Shortfall (ES) methodology under stressed conditions for measuring RBI's market risk
Previously, RBI uses Stressed-Value at Risk methodology

Size of Realized equity

Committee recognized the importance of maintaining reserves/provisioning for monetary, financial and ext ernal stability risks and also to cover credit risk and operational risk
Committee recommended that Contingent Risk Buffer (CRB) to be maintained within 5.5% to 6.5 % of the RBI’s balance sheet

4.5 to 5.5 % for monetary and financial stability risks
1.0 % for credit and operational risks

In addition to the above Contingent Risk Buffer CRB, any shortfall in revaluation balances vis-à-vis the market risk would add up to the realized equity
i.e. size of realized equity = CRB + shortfalls in revaluation balances vis-à-vis the market risk

Surplus distribution policy

Surplus distribution policy should be based on the level of realized equity to be maintained by the RBI, within the overall level of its economic capital
Previously, it is based on total economic capital level alone
If realized equity is above its requirement (CRB + shortfall vis-à-vis the market risk) , the entire net income may be transferable to the Government
If it is below the lower bound of requirement, risk provisioning will be made to the extent necessary and only the residual net income (if any) transferred to the Government.
If it is within the range of CRB, i.e., 6.5 to 5.5 percent of the balance sheet, the Central Board will decide on the level of risk provisioning.

RBI acceptance

The RBI Central Board decided to maintain the realized equity level at 5.5 per cent of balance sheet
Available realized equity stood at 6.8 per cent of balance sheet and the excess would be transferred to Govt.
Total 1,76,051 crore would be transferred to Govt.

As per the revised Economic Capital Framework (ECF), 52,637 crore of excess provisions identified
For the year 2018-19, RBI has 1,23,414 crore of surplus

RBI regulates

As per,

RBI Act 1934

Banking Regulation Act 1949

Banking Regulation (Amendment) Act 2017

Banking Laws (Application to Co-operative Societies) Act, 1965

Regulates

Banks

Scheduled commercial - full regulation by RBI
RRB - RBI and NABARD [RRB Act 1976]
Cooperatives

Urban - Banking operations by RBI, administration by Registrar of Cooperative Society
Rural - Banking operations by RBI and NABARD and administration by Registrar of Cooperative Society

Primary Agricultural Credit Society- Not regulated by RBI
StCBs/DCCBs/ - Banking operations by RBI and NABARD and administration by Registrar of Cooperative Society

Local Area Banks, Small Finance Banks, Payment Banks

Non-Banking Financial Institutions

FI

AIFI - NABARD, SIDBI, EXIM Bank, NHB

Primary Dealers- must get license from RBI
NBFC

Mudra bank
Asset Finance companies
Infrastructure finance companies
Loan company
Infrastructure Debt Fund
Investment companies that borrow and invest in securities/funds
Core investment companies
NBFC Account aggregator (consolidated overview of financial assets)
Peer to Peer lending Companies
Chit fund companies
Micro Finance institutions
FINTECH companies
Residuary NBFCs

Prompt Corrective Action framework PCA

The PCA framework specifies the trigger points or the level in which the RBI will intervene with corrective action.

Parameters

Capital to Risk weighted Asset Ratio (CRAR) - Capital ( <9% - will be triggered )

Net Non-Performing Assets (NPA) - Asset Quality ( >10

% - will be triggered )

Return on Assets (RoA) - Profitability (<0.25% - will be triggered
Leverage ratio - Debt to Equity Ratio

How much capital comes from debt(loans)
Important as it shows the proportion of debt and equity in financing their operations
Assesses the ability of a company to meet its financial obligations.
For example, Macy's has $15.53 billion in debt and $4.32 billion in equity, as of fiscal year ended 2017. The company's debt-to-equity ratio is $15.53 billion / $4.32 billion = 3.59. Macy's liabilities are 359% of shareholders' equity which is very high for a retail company.
Relax in Leverage ratio means banks can lend more

Possible Actions

Recapitalization,
Restrictions on borrowing from inter-bank market
Restrictions to merge/amalgamate/liquidate the bank
Impose moratorium on the bank if its CRAR does not improve beyond etc.
Halting branch expansion
Stopping dividend payments

Applicability of PCA

Applies only to Scheduled Commercial banks(domestic and foreign) and small banks, local area banks and payment banks
Not applicable to RRB, Cooperative banks, NBFC, FI

However, Under Supervisory Action Framework (SAF) of RBI for Urban Cooperative Banks, they are subjected to measures similar to PCA
Oct 2018, PCA was contentious b/w RBI and Govt

Govt wants PCA to be relaxed for some sectors so that some banks will be out of PCA
Thereafter, RBI decided that RBI Board for Financial Supervision will review the norms and take a call if some of the parameters like net nonperforming asset (NPA ratio could be relaxed so that some of the banks come out of the PCA.

Supervisory Action Framework SAF

RBIs action framework that is applicable to Urban Cooperative Banks
Parameters

Capital adequacy ratio (CAR) falls below 9%.
Net non-performing assets exceed 6% of net advances.
Losses for two consecutive financial years or have accumulated losses on their balance sheets

E-Kuber

is Core Banking Solution of Reserve Bank of India.
E-Kuber provides the provision of a single current account for each bank across the country, with decentralised access to this account from anywhere-anytime using portal based services in a safe manner.
Through this platform, RBI auctions Govt securities

Ways and Means Advances WMA

WMA is a mechanism used by Reserve Bank of India (RBI) under its credit policy to help Govts to tide over temporary mismatches in the cash flow of their receipts and payments.

All state Governments are required to maintain a minimum reserve balance with RBI but there is no fixed minimum reserve

RBI makes WMA to the state governments for a period of 90 Days
Special WMA - If the state govts takes WMA against collateral Govt securities, it is called Special WMA
Normal WMA - If the state govts takes WMA not against any security ,it is called normal WMA.

WMA provided based upon the three-year average of actual revenue and capital expenditure of the state
If WMA limits are exceeded, it is called Overdraft

A state Government can withdraw an overdraft for maximum of 14 days consecutively (max 36 days in a quarter)
Rate of interest is linked to repo rate

RBI Governor removal

According to the RBI Act, there is no security of tenure for the Governor. He can be removed without any reason, if the government wishes to
There is a provision in the act that the government has the right to give directions to the RBI and tell it what it should do ( Section 7 of RBI act )