Introduction

since last few years, most of the exams have asked barely 1-2 MCQs from the Finance, capital market and share market topics, therefore, we will only try to gather a working knowledge about these topics rather than pursuing technical accuracy or academic excellence

Brief

A financial market is a market in which people trade financial securities, commodities, and value at low transaction costs and at prices that reflect supply and demand. Securities include stocks and bonds, and commodities include precious metals or agricultural products

Types of financial markets

Within the financial sector, the term "financial markets" is often used to refer just to the markets that are used to raise finance:
for long term finance, the Capital markets;
for short term finance, the Money markets.
In Indian context - Short term is less than 365 days & long term means more than 365 days.

Another common use of the term is as a catchall for all the markets in the financial sector, as per examples in the breakdown below.
Capital markets which to consist of:
1> Stock markets, which provide financing through the issuance of shares or common stock, and enable the subsequent trading thereof.
2> Bond markets, which provide financing through the issuance of bonds, and enable the subsequent trading thereof.
3> Commodity markets, which facilitate the trading of commodities.
4> Money markets, which provide short term debt financing and investment.
5> Derivatives markets, which provide instruments for the management of financial risk.[1]
6> Futures markets, which provide standardized forward contracts for trading products at some future date; see also forward market.
7> Foreign exchange markets, which facilitate the trading of foreign exchange.
8> Spot market
9> Interbank lending market

1> Stock markets

The stock market is a financial market that enables investors to buy and sell shares of publicly traded companies. The primary stock market is where new issues of stocks are first offered. Any subsequent trading of stock securities occurs in the secondary market.

2> Bond markets

A bond is a security in which an investor loans money for a defined period of time at a pre-established rate of interest. Bonds are not only issued by corporations but may also be issued by municipalities, states and federal governments from around the world. Also referred to as the debt, credit or fixed-income market, the bond market also sells securities such as notes and bills issued from the United States Treasury

3> Commodity markets

A commodity market is a market that trades in primary economic sector rather than manufactured products. Soft commodities are agricultural products such as wheat, coffee, cocoa, fruit and sugar. Hard commodities are mined, such as gold and oil. Investors access about 50 major commodity markets worldwide with purely financial transactions increasingly outnumbering physical trades in which goods are delivered

4> Money markets

A money market is a portion of the financial market that trades highly liquid and short-term maturities. The intention of the money market is for short-term borrowing and lending of securities with a maturity typically less than one year. This financial market trades certificates of deposit, banker’s acceptances, certain bills, notes and commercial paper.

5> Derivatives markets

The derivatives market is a financial market that trades securities that derive its value from its underlying asset. The value of a derivative contract is determined by the market price of the underlying item. This financial market trades derivatives including forward contracts, futures, options, swaps and contracts-for-difference

6> Futures markets

A futures market is an auction market in which participants buy and sell commodity and futures contracts for delivery on a specified future date. Examples of futures markets are the Bombay Stock Exchange (BSE) etc. like most other markets, futures exchanges are mostly electronic.

7> Foreign exchange markets

The foreign exchange market (Forex, FX, or currency market) is a global decentralized or over-the-counter (OTC) market for the trading of currencies. This market determines the foreign exchange rate. It includes all aspects of buying, selling and exchanging currencies at current or determined prices. In terms of trading volume, it is by far the largest market in the world, followed by the Credit market

8> Spot market

The spot market or cash market is a public financial market in which financial instruments or commodities are traded for immediate delivery. It contrasts with a futures market, in which delivery is due at a later date.

9> Interbank lending market

The interbank lending market is a market in which banks extend loans to one another for a specified term. Most interbank loans are for maturities of one week or less, the majority being overnight. Such loans are made at the interbank rate (also called the overnight rate if the term of the loan is overnight). A sharp decline in transaction volume in this market was a major contributing factor to the collapse of several financial institutions during the financial crisis of 2007.

Non Banking Financial Company (NBFC)

A Non Banking Financial Company (NBFC) is a company registered under the Companies Act, 1956 of India, engaged in the business of loans and advances, acquisition of shares, stock, bonds hire-purchase, insurance business or chit business but does not include any institution whose principal business includes agriculture, industrial activity or the sale, purchase or construction of immovable property

Difference between NBFCs & Banks

NBFCs perform functions similar to that of banks but there are a few differences-
1> An NBFC cannot accept Demand Deposits,
2> An NBFC is not a part of the payment and settlement system and as such,
3> An NBFC cannot issue Cheques drawn on itself, and
4> Deposit insurance facility of the Deposit Insurance and Credit Guarantee Corporation is not available for NBFC depositors, unlike banks,
5> An NBFC is not required to maintain Reserve Ratios (CRR, SLR etc.)
6> An NBFC cannot indulge Primarily in Agricultural, Industrial Activity, Sale-Purchase, Construction of Immovable Property
7> Foreign Investment allowed up to 100%.
8> Provides Banking services to People without holding a Bank license

Micro Finance Institutions - MFIs

Micro Finance Institutions, also known as MFIs, a microfinance institution is an organization that offers financial services to low income populations. Almost all give loans to their members, and many offer insurance, deposit and other services. A great scale of organizations are regarded as microfinance institutes. They are those that offer credits and other financial services to the representatives of poor strata of population (except for extremely poor strata)

MFIs of India

Forbes magazine named seven microfinance institutes in India in the list of the world's top 50 microfinance institutions.
Bandhan, as well as two other Indian MFIs—Microcredit Foundation of India (ranked 13th) and Saadhana Microfin Society (15th) – have been placed above Bangladesh-based Grameen Bank (which along with its founder Mohammed Yunus, was awarded the Nobel Prize). Besides Bandhan, the Microcredit Foundation of India and Saadhana Microfin Society, other Indian entries include Grameen Koota (19th), Sharada's Women's Association for Weaker Section (23rd), SKS Microfinance Private Ltd (44th) and Asmitha Microfin Ltd (29th)

mutual funds in india

A mutual fund is a professionally-managed investment scheme, usually run by an asset management company that brings together a group of people and invests their money in stocks, bonds and other securities

Introduction to Mutual Funds

As an investor, you can buy mutual fund 'units', which basically represent your share of holdings in a particular scheme. These units can be purchased or redeemed as needed at the fund's current net asset value (NAV). These NAVs keep fluctuating, according to the fund's holdings. So, each investor participates proportionally in the gain or loss of the fund.

All the mutual funds are registered with SEBI. They function within the provisions of strict regulation created to protect the interests of the investor.

The biggest advantage of investing through a mutual fund is that it gives small investors access to professionally-managed, diversified portfolios of equities, bonds and other securities, which would be quite difficult to create with a small amount of capital.

Asset Management companies (AMC)

1> Specialized institutions pooling money from the public & investing in the stock market based on research, past trends, company performance etc. to maximize investors profit
2> Mutual funds do not eliminate risk but minimize the risk in term of risk appetite & allow for sharing of risk
3> Mutual funds make profit only when market is moving up
4> Any investor is welcomed for e.g. SBI mutual fund requires minimum investment of Rs. 100 only
5> Strict SEBI regulation with no leverage provided → Has to deal with money in hand
6> Managed by MF managers (Asset management companies) for certain commission %

Mutual funds types

Portfolio type → Equity, Debt, Gilt edged fund, Real estate fund

Income vs risk type
Growth Fund → 80 (Equity) + 20 (Debt)
Balance Fund → 50 (Equity) + 50 (Debt)
Income Fund → 20 (Equity) + 80 (Debt)

Hedge funds (Alternative Investment fund)

>> Hedge fund is a similar investment game as mutual funds, where High net worth individuals pool their money into high risky games to earn high return on investment.
>> Trading-techniques are far more complex than mutual funds
>> Hedge funds can make money even with share market going down.
>> SEBI → Indian hedge fund to starts from 1 crore rupees; Foreign (offshore) hedge fund to start with 5 lakhs dollars
>> Not so strict SEBI regulation with leverage provided twice the amount but only for 2 days viz. T + 2

How Hedge funds make money

>> Short selling
>> Leverage
>> Arbitrage

Short selling

Sell a large quantity of shares in the market at once which supposedly decrease the value of share as a result of mass selling.
Now, as soon as value of share falls, hedge fund managers buy sold quantity of shares & make profit.

Leverage

Borrowing money to trade in shares beyond your limit to get good returns
But if market follows opposite steps against your move then may be risky

Arbitrage

Profit from the price difference of securities between the two markets

capital Arrangement from outside India to expand Business

1> External commercial borrowing (ECB)
2> American Depository Receipt (ADR)
3> Global Depositary Receipt (GDR)
4> Indian Depository Receipt (IDR)

1> External commercial borrowing (ECB)

>> As the name suggest, it is when Indian company borrows money from external (non-Indian / foreign) sources for minimum average 3 years
>> Money is borrowed from foreign lenders via bank loans, fixed rate bonds, non-convertible shares, optionally convertible or partially convertible preference shares etc.
>> ECB money cannot be used to trade in share market or real-estate speculation or to acquire another company

Positive side of ECB

>> If American and European economy is not performing well, their banks and lenders will not find local borrowers even at dirt cheap interest rate.
>> So in this scenario, an Indian company can borrow money from abroad, at a lower interest rate than in India & everyone wins

Negative side of ECB

>> In ECB, the borrower has to repay in foreign currency (usually dollar)
>> So If Rupee sharply weakens dollar let’s say from 1$ = Rs. 50 to 1$ = Rs. 60
>> Then Indian borrower will have to pay more amount of rupees to repay the same amount of loan he previously took

2> American Depository Receipt (ADR)

>> ADR is method of trading non-U.S. stocks on U.S. exchanges
>> Suppose, Indian company wants to raise money from America, by issuing shares in American stock exchange
>> But then Indian company will have to maintain accounts according to American standards
>> Hence to prevent this problem, Indian company gives its shares to American bank
>> American bank gives Indian company certain receipts, called ADR in return of those shares
>> Now Indian company can trade those ADR receipts in American share market, to raise money
>> But Indian company will have to pay dividends to investors in Dollars
>> ADR is two way fungible, Meaning, (from American investor’s point of view) if you’ve ADR, you can convert it into the underlying shares of that (foreign / Indian) company

3> Global Depositary Receipt (GDR)

>> Serve as same function like ADR, but on Global scale
>> Helps third world countries to raise money from the stock exchanges of developed countries
>> Several international banks such as JPMorgan, Citigroup, Deutsche Bank, Bank of New York issue GDRs

4> Indian Depository Receipt (IDR)

>> As ADR (American depository receipt) is from America’s point of view, Similarly, IDR (Indian depository receipt) is from India’s point of view
>> It allows a foreign company to raise money from Indian financial market
>> As part of financial reforms, IDR (Indian depository receipts) are also made two ways fungible

Stock Markets

A stock exchange is an organization which provides a platform for trading shares- either physical or virtual. The origin of the stock, market dates back to the 13th/14th Century, when the Amsterdam Stock Exchange was first set up. In a stock exchange, investors through stock brokers buy and sell shares in a wide range of listed companies. A given company may list in one or more exchanges by meeting and maintaining the listing requirements of the stock exchange

Stock Exchanges in India

The first company that issued shares was the VOC or Dutch East India Company in. the early 17th century (1602). Since then we have come a long way. With over 2.5 Crore shareholders today, India has the third largest investor base in the world after the USA and Japan. Over 9,000 companies are listed on the stock exchanges, which are serviced by approximately 7,500 stockbrokers. The Indian capital market is significant in terms of the degree of development, volume of trading and its tremendous growth potential.
Stock exchanges provide an organised market for transactions in securities and other securities. There are 24 stock exchanges in the country, 21 of them being regional ones with allocated areas

Bombay Stock Exchange - BSE

The Bombay Stock Exchange, or BSE) is the oldest stock exehange in Asia located at Dalal Street in Mumbai, India. Established in the year 1875, it is the largest securities exchange in India with more than 6,000 listed Indian companies. BSE is also the fifth largest exchange in the world with market capitalization of US $1.6 trillion (2011). About 5000 companies are listed on the BSE

Sensex

Sensex or Sensitive Index is a value-weighted index composed of 30 companies with the base 1978- 1979 = 100. It consists of the 30 largest and most actively traded blue chip stocks, representative of various sectors, on the Bombay Stock Exchange.

Demutualization

Demutualization is when management and ownership are separated. Ownership is divested from the brokers and the company becomes a public company. All stock exchanges are to be demutualised according to the Government law made in 2004. Demutualization, thus means that ownership, management and trading rights are separated in a stock exchange.

SEBI - Securities and Exchange Board of India

The capital markets in India are regulated by the Securities and Exchange Board of India. (SEBI) It was established in 1988 and given a statutory basis in 1992 on the basis of the Parliamentary Act- SEBI Act 1992 to regulate and develop capital market. SEBI regulates the working of stock exchanges and intermediaries such as stock brokers and merchant bankers, accords approval for mutual funds, and registers Foreign Institutional Investors who wish to trade in Indian scrips.

Capital Market Reforms

Since 1991 when the Government launched economic reforms, the following measures were taken.
SEBI given statutory status- that is Act of Parliament
Electronic trade
Rolling settlement to reduce speculation
FIIs are permitted since 1992
setting up of clearing houses
settlement guarantee funds at all stock exchanges
compulsory dematerialization of share certificates so as to remove problems associated with paper trading; and speed up the transfer
clause 49 of the listing agreement for corporate governance
restrictions on PNs

Primary Market

The primary market is that part of the capital markets that deals with the issuance of new securities directly by the company to the investors. Companies, governments or public sector institutions can obtain funding through the sale of a new stock or bond issue.

Secondary Market

The secondary market is the financial market for trading of securities that have already been issued in an initial public offering. Once a newly issued stock is listed on a stock exchange, investors and speculators can trade on the exchange as there are buyers and sellers

IPO

In the case of a new stock issue, this sale is called an initial public offering (IPO).

Commodity Exchanges

Commodity exchanges are institutions which provide a platform for trading in ‘commodity futures’ just as how stock markets provide space-for trading in equities and their derivatives. They thus play a critical role in price discovery where several buyers and sellers interact and determine the most efficient price for the product
There are two types of commodity exchanges in the country: national level and regional. There are five national exchanges
>> National Commodity & Derivatives Exchange Limited (NCDEX)
>> Multi Commodity Exchange of India Limited (MCX)
>> National Multi-Commodity Exchange of India Limited (NMCEIL)
>> ACE Derivatives and Commodity Exchange
>> Indian Commodity Exchange (ICEX)

FIIs - Foreign institutional investors

Foreign institutional investors are organizations which invest huge sums of money in financial assets - debt and shares- of companies and in other countries- a country different from the one where they are incorporated. They include banks, insurance companies retirement or pension funds hedge funds and mutual funds.
Foreign individuals are not allowed to participate on their own but go through FIIs

Participatory Notes

Participatory notes are instruments used for making investments in the stock markets. In India, foreign institutional investors (FIIs) use these instruments for facilitating the participation of overseas funds like hedge funds and others who are not registered with the SEBI and thus are not directly eligible for investing in Indian stocks.

Insider Trading

Insider trading occurs when any one with information related to strategic and price-influencing information purchases or sells stocks so as to make speculative profits.

Monetary Policy

although both inflation and deflation are bad for economy, deflation is worse and policymakers always have to guard against possible deflationary tendencies. In this respect, inflation becomes a necessary evil. One of the major adverse effect of inflation is due to uncertainty it creates in the minds of investors and risk of hyperinflation. Policymakers therefore want low and stable inflation in the economy.

What that target level should be is decided either by parliament by law or informally by govt and central bank. As we saw inflation helps in labour market adjustment and as emerging economies undergo rapid transition, slightly higher inflation helps in that adjustment. For this reason. while inflation target is about 2% in developed economies, it is 4-5% in developing economies.

As the name suggests it is policy formulated by monetary authority i.e. central bank which happens to be RBI in case of India.
It deals with monetary i.e money matters i.e. affects money supply in the economy.
Eg. CRR,SLR,OMO,REPO etc

SLR - Statutory Liquidity Ratio

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

CRR - Cash Reserve Ratio

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

fiscal policy

It is formulated by finance ministry i.e. government. It deals with fiscal matters i.e. matters related to government revenues and expenditure.

Revenue matters

ax policies, non tax matters such as divestment, raising of loans, service charge etc

Expenditure matters

ubsidies, salaries, pensions, money spent on creation of capital assets such as roads, bridges etc.

Why RBI formulates monetary policy

to control inflation, RBI will have to decrease money supply or increase cost of fund so that people do not demand goods and services

dear money policy or contractionary monetary policy

Money becomes costlier when interest rate rises and when RBI makes money to become costlier or dearer, it is said to be following dear money policy. As money supply decreases in the economy, i.e. contraction in money supply, it is also known as contractionary monetary policy.

negative effects of dear money policy

Businesses postpone expansion due to high cost of credit and investment comes down in the economy which drags down growth rates and hurts employment. That’s the reason why corporates and government always clamour for policies which lead to interest rate cuts such as reduction in CRR, SLR. Investment is thus negatively correlated with higher interest rates.

Open market operations (OMO)

RBI buys and sells government securities in the open market to control money supply.

Govt security is a type of debt instrument on which govt pays regular interest. As chances of default on govt securities is practically zero, they are also called gilt-edges securities

Liquidity Adjustment Facility (LAF)

RBI uses such instruments to adjust liquidity and money supply.

REPO rate – REpurcahse Obligation

Rate at which banks buy from RBI on a short term basis

Banks have to put govt. securities as collateral and buy those securities back at the end of prescribed period, generally overnight

Reverse Repo

as the name suggests is reverse of repo i.e. rate RBI pays to banks to park excess funds into RBI.

Reverse repo is linked to repo with,

Reverse repo = repo – 1

Recent Changes in Monetary Policy

Effective May 3, 2011, based on the recommendations of the Working Group on Operating Procedure of Monetary Policy, the operating framework of monetary policy has been refined with the following changes:
(i) The repo rate has been made the only independently varying policy rate. In Bi-monthly Credit & Monetary Policy for
2014-15, the RBI has announced to introduce 'term repos', too (which will have provisions for more than 'one-day' borrowing in the short-term market).
(ii) A new marginal standing facility (MSF) has been instituted, under which SCBs have been allowed to borrow overnight at their discretion, up to 1 per cent of their respective NDTL, at 100 basis points above the repo rate (the gap between 'repo' and 'MSF' rates was though changed by the RBI many times till April 2014). The revised MSF reverse repo corridor has been defined with a fixed width of 200 bps with the repo rate placed in the middle of the corridor (fluctuates as per the gap between the 'repo' and the MSF rates).
(iii) The reverse repo rate has been placed 100 bps below and the MSF rate 100 bps above the repo rate (fluctuates as per the gap between the 'repo' and the MSF rates).
In Bi-monthly Credit & Monetary Policy
for 2014-15, the RBI has announced to introduce 'term reverse repos', too (which will have provisions for more than 'one­ day' lending-parking of funds by banks with the RBI-in theshort-term market).

It is expected that the fixed interest rate corridor, set by the MSF rate and reverse repo rate, by reducing uncertainty and avoiding difficulties in communication associated with a variable corridor, will help in keeping the overnight average call money rate close to the repo rate. Similarly, the introduction of 'term repos' and 'term reverse repos' will provide stability element in the market together with better signalling through the loan market in the economy.

Marginal Standing Facility (MSF)

MSF is a new scheme announced by the RBI in its Monetary Policy, 2011-12 which came into effect from May, 2011. Under this scheme, banks can borrow overnight upto 1 per cent of their net demand and time liabilities (NDTL) from the RBI, at the interest rate 1 per cent (100 basis points) higher than the current repo rate. In an attempt to strengthen rupee and checking its falling exchange rate, the RBI increased the gap between 'repo' and MSF to 3 per cent (late July 2013)

committee on Financial System (CFS)

a high level committee on Financial System (CFS) was set up on August 14, 1991 to examine all aspects relating to structure, organisation,function and procedures of the financial system-based on its recommedations, a comprehensive reform of the banking system was introduced in the fiscal 1992- 93

Recommendations of the Committee

1. On Directed Investment
2. On Directed Credit Programme
3. On the Structure of Interest Rates
4. On Structural Reorganisation of the Bank
5. Asset Reconstruction Companies/Fund

1. On Directed Investment

The RBI was advised not to use the CRR as a principal instrument of monetary and credit control, in place it should rely on open market operations (OMOs) increasingly. Two proposals advised regarding the CRR:
(i) CRR should be progressively reduced from the present high level of 15 per cent to 3 to 5 per cent; and
(ii) RBI should pay interest on the CRR of banks above the basic minimum at a rate of interest equal to the level of banks, one year deposit.
Concerning the SLR it was advised to cut it to the minimum level (i.e., 25 per cent) from the present high level of 38.5 per cent in the next 5 years (it was cut down to 25 per cent in October 1997). The government was also suggested to progressively move towards market-based borrowing programme so that banks get economic benefits on their SLR investments.
These suggestions were directed to the goal of making more funds available to the banks, converting idle cash for use, and cutting down the interest rates banks charge on their loans

2. On Directed Credit Programme

Under this sub-title the suggestions revolved around the compulsion of priority sector lending (PSL) by the banks:
(i) Directed credit programme should be phased out gradually. As per thecommittee, agriculture and small scale industries (SSis) had already grown to a mature stage and they did not require any special support; two decades of interest subsidy were enough. Therefore, concessional rates of interest could be dispensed with.
(ii) Directed credit should not be a regular programme-it should be a case of extraordinary support to certain weak sections-besides, it should be temporary, not a permanent one.
(iii) Concept of PSL should be redefined to include only the weakest sections of the rural community such as marginal farmers, rural artisans, village and cottage industries, tiny sector, etc.
(iv) The "redefined PSL" should have 10 per cent fixed of the aggregate bank credit.
(v) The composition of the PSL should be reviewed after every 3 years.

3. On the Structure of Interest Rates

The major recommendations on the structure of interest rates are:
(i) Interest rates to be broadly determined by market forces;
(ii) All controls of interest rates on deposits and lending to be withdrawn;
(iii) Concessional rates of interest for PSL of small sizes to be phased out and subsidies on the IRDP loans to be withdrawn;
(iv) Bank rate to be the anchor rate and all other interest rates to be closely linked to it; and
(v) The RBI to be the sole authority to simplify the structure of interest rates.

4. On Structural Reorganisation of the Bank

For the structural reorganisation of banks some major suggestions were given:
(i) Substantial reduction in the number of the PSBs through mergers and acquisitions-to bring about greater efficiency in banking operations;
(ii) Dual control of RBI and Banking Division (of the Ministry of Finance) should go immediately and RBI to be made the primary agency for the regulation of the banking system;
(iii) ThePSBsto bemadefreeandautonomous;
(iv) The RBI to examine all the guidelines and directions issued to the banking system in the context of the independence and autonomy of the banks;
(v) Every PSB to go for a radical change in work technology and culture, so as to become competitive internally and to be at par with the wide range of innovations taking place abroad; and
(vi) Finally, the appointment of the Chief Executive of Bank (CMD) was suggested not to be on political considerations but on professionalism and integrity. An independent panel of experts was suggested which should recommend and finalise the suitable candidates for this post.

5. Asset Reconstruction Companies/Fund

To tackle the menace of the higher non­ performing assets (NP As) of banks and financial institutions, the committee suggested setting up of asset reconstruction companies/funds (taking clue from the US experience).
The committee directly blamed the Government of India (Gol) and the Ministry of Finance for the sad state of affairs of the PSBs. These banks were used and abused by the Gol, the officials, the bank employees and the trade unions, the report adds. The recommendations were revolutionary in many respects and were opposed by the bank unions and the leftist political parties.
There were some other major suggestions of the committee which made it possible to get the following24 things done by the government:
(i) opening of new private sector banks permitted in 1993;
(ii) prudential norms relating to income recogmt10n, asset classification and provisioning by banks on the basis of objective criteria laid down by the RBI;
(iii) introduction of capital adequacy norms (i.e., CAR provisions) with international standard started;
(iv) simplification in the banking regulation (i.e., via board for financial supervision in 1994); etc.

Non-Performing Assets (NPAs)

Non-Performing Assets (NPAs) are the bad loam of the banks. The criteria to identify such assets have been changing over the time. In order to follow international best practices and to ensure greater transparency, the RBI shifted to the current policy in 2004. Under it, a loan is considered NPA if it has not been serviced for one term (i.e., 90 days). This is known as '90 day' overdue norm. For agriculture loans the period is tied with the period of the concerned crops-ranging from two crop seasons to one year overdue norm .30
NP As were classified into three types:
(a) Sub-standard: remaining NPAs for less than or equal to 18 months;
(b) Doubtful: remaining NPAs for more than 18 months;
(c) Loss assets: where the loss has been identified by the bank or internal/external auditors or the RBI inspection but the amount has not been written off

Capital Adequacy Ratio (CAR)

At first sight bank is a business or industry a segment of the service sector in any economy. But the failure of a bank may have far greater damaging impact on an economy than any other kind of business or commercial activity. Basically, modern economies are heavily dependent on banks today than in the past-banks are today called the backbone of economies. Healthy functioning of banks is today essential for the proper functioning of an economy. As credit creation (i.e., loan disbursals) of banks are highly risky business, the depositors' money depends on the banks' quality of lending. More importantly, the whole payment system, public as well as private, depends on banks. A bank's failure has the potential of creating chaos in an economy. This is why governments of the world pay special attention to the regulatory aspects of the banks. Every regulatory provision for banks tries to achieve a simple equation, i.e.,
"how the banks should maximise their credit creation by minimising the risk and continue functioning permanently". In the banking business risks are always there and cannot be made 'zero'-as anyloan forwarded to any individual or firm (irrespective of their credit-worthiness) has the risk of turning out to be a bad debt (i.e., NPA in Jndia)-the probability of this being 50 per cent. But banks must function so that economies can function. Finally, the central banks of the world started devising tools to minimise the risks of banking at one hand and providing cushions (shock-absorbers) to the banks at the other hand so that banks do not go bust (i.e., shut down after becoming bankrupt). Providing cushion/ shock-absorbers to banks has seen three major developments:
(i) The provision of keeping a cash ratio of total deposits mobilised by the banks (known as the CRR in India);
(ii) the provision of maintaining some assets of the deposits mobilised by the banks with the banks themselves in non-cash form (known as the SLR in India); and
(iii) The provision of the capital adequacy ratio (CAR) norm.

Why to maintain CAR?

The basic question which comes to mind is as to why do the banks need to hold capital in the form of CAR norms? Two reaso ns42 have been generally forwarded for the same:
(i) Bank capital helps to prevent bank failure, which arises in case the bank cannot satisfy its obligations to pay the depositors and other creditors. The low capital bank has a negative net worth after the loss in its business. In other words, it turns into insolvent capital, therefore, acts as a cushion to lessen the chance of the bank turning insolvent.
(ii) The amount of capital affects returns for the owners (equity holders) of the bank

Basel Accords

Introduction

The Basel Accords are three sets of banking regulations (Basel I, II and III) set by the Basel Committee on Bank Supervision (BCBS), which provides recommendations on banking regulations in regards to capital risk, market risk and operational risk. The purpose of the accords is to ensure that financial institutions have enough capital on account to meet obligations and absorb unexpected losses

History

The BCBS was founded in 1974 as a forum for regular cooperation between its member countries on banking supervisory matters. The BCBS describes its original aim as the enhancement of "financial stability by improving supervisory knowhow and the quality of banking supervision worldwide." Later on, it turned its attention to monitoring and ensuring the capital adequacy of banks and the banking system.

Basel I

The first Basel Accord, known as Basel I, was issued in 1988 and focuses on the capital adequacy of financial institutions. The capital adequacy risk (the risk that a financial institution will be hurt by an unexpected loss), categorizes the assets of financial institutions into five risk categories (0%, 10%, 20%, 50% and 100%). Under Basel I, banks that operate internationally are required to have a risk weight of 8% or less.

Basel II

The second Basel Accord, called Revised Capital Framework but better known as Basel II, served as an update of the original accord. It focuses on three main areas: minimum capital requirements, supervisory review of an institution's capital adequacy and internal assessment process, and

effective use of disclosure as a lever to strengthen market discipline and encourage sound banking practices including supervisory review. Together, these areas of focus are known as the three pillars.

Basel III

In the wake of the Lehman Brothers collapse of 2008 and the ensuing financial crisis, the BCBS decided to update and strengthen the Accords. It saw poor governance and risk management, inappropriate incentive structures and an overleveraged banking industry as reasons for the collapse. In July 2010, an agreement was reached regarding the overall design of the capital and liquidity reform package. This agreement is now known as Basel III.

Basel III is a continuation of the three pillars, along with additional requirements and safeguards, including requiring banks to have minimum amount of common equity and a minimum liquidity ratio. Basel III also includes additional requirements for what the Accord calls "systemically important banks," or those financial institutions that are colloquially called "too big to fail."

The implementation of Basel III has been gradual and began in January 2013. It is expected to be completed by Jan. 1, 2019.

Stock of Money

All the money held with public, RBI as well as government is called Total Stock of Money. Money Supply is that part of this Total Stock of Money which is with public.
By public we refer to the households, firms, local authorities, companies etc.
Thus, public money does not include the money held by the government and the money held as CRR with RBI and SLR with themselves by commercial banks. The reason of excluding the above two categories from money supply is that this money held by the Government and RBI is out of circulation.

Thus, we can conclude that the money in circulation is the money supply. This money may be in the following forms:
>> Currency Notes and Coins
>> Demand Deposits such as Saving Banks Deposits ,
>> Other Deposits such as Time Deposits / Term Deposits / Fixed Deposits
>> Post Office Saving Accounts
>> Cash in Hand (Except SLR) and Deposits of Banks in other Banks / RBI (except CRR)
In other way, this money has two components viz. Currency Component and Deposit Component. Currency Component consist of all the coins and notes in the circulation, while Deposit component is the money of the general public with the banks, which can be withdrawn by them using cheques, withdrawals and ATMs. Deposit can be either Demand Deposit or Time Deposit

Following the recommendations of the Second Working Group on Money Supply (SWG) in 1977, RBI has been publishing four monetary aggregates (component of money)- M1 , M 2 , M 3 and M 4 (are basically short terms for Money-I, Money-2, Money-3 and Money-4) besides the Reserve Money. These components used to contain money of differing liquidities:
M1 = Currency & coins with people + Demand deposits of Banks (Current & Saving Accounts) + Other deposits of the RBI.
M2 =M1 + Demand deposits of the post offices (i.e., saving schemes' money).
M3 =M1 + Time/Term deposits of the Banks (i.e., the money lying in the Recurring Deposits & the fixed Deposits).
M4 = M3 + total deposits of the post offices(both, Demand Deposits and Term/Time ).

Liquidity of Money

As we move from M1 to M4 the liquidity (inertia, stability, spendability) of the money goes on decreasing and in the opposite direction, the liquidity increases.

Narrow Money (M1)

At any point of time, the money held with the public has two most liquid components
>> Currency Component: This consists of all the coins and notes in the circulation
>> Demand Deposit Component: Demand Deposit component is the money of the general public with the banks, which can be withdrawn by them using cheques, withdrawals and ATMs.
The above two components i.e. currency component and demand deposit component of the public money is called Narrow Money and is denoted by the RBI as M1. Thus,
M1 = Currency with the public + Demand Deposits of public in Banks
When a third component viz. Post office Savings Deposits is also added to M1, it becomes M2.
M2 = M1 + Post Office Savings.

Broad Money

Narrow money is the most liquid part of the money supply because the demand deposits can be withdrawn anytime during the banking hours. Time deposits on the other hand have a fixed maturity period and hence cannot be withdrawn before expiry of this period. When we add the time despots into the narrow money, we get the broad money, which is denoted by M3

Money Supply

In general discussion we usually use money supply to mean money circulation, money flow in the economy. But in banking and typical monetary management terminology the level and supply of M3 is known as money supply. The growth rate of broad money (M3 ) , i.e., money supply, was not only lower than the indicative growth set by the Reserve Bank oflndia but it also witnessed continuous and sequential deceleration in the last 7 quarters and moderated to 11.2 per cent by December 2012. Aggregate deposits with the banks were the major component of broad money counting for over 85 per cent remaining almost stable. The sources of broad money are net bank credit to the government and to the commercial sector. These two together accounted for nearly 100 per cent of the broad money in 2012-13, compared to 89 percent in 2009-10.

Minimum Reserve

TheRBI is required to maintain a reserve equivalent of Rs. 200 crores in gold and foreign currency with itself, of which Rs. 115 crores should be in gold. Against this reserve, the RBI is empowered to issue currency to any extent. This is being followed since 1957 and is known as the Minimum Reserve System (MRS).

Reserve Money

The gross amount of the following six segments of money at any point of time is known as Reserve Money (RM) for the economy or the government:
(i) RBI's net credit to the Government;
(ii) RBI's net credit to the Banks;
(iii) RBI's net credit to the commercial banks;
(iv) net forex reserve with the RBI;
(v) government's currency liabilities to the public;
(vi) net non-monetary liabilities of the RBI.
RM=1+2+3+4+5+6
As per the Economic Survey 2014-15, the rate of growth of reserve money comprising currency in circulation and deposits with the RBI (bankers and others) decelerated from an average of 17.8 per cent in 2014-15 to 4.3 per cent in 2013-14. Almost the entire increase in the reserve money of Rs. 3.258 billion between the period consisted of increase in currency in circulation. As sources of reserve money, net RBI credit to the government and increase in net financial assets of the RBI contributed to the growth of base money.