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Thursday, 22 July 2021

Banking Questions & Answers 71 - VRK100 - 22Jul2021

Banking Questions & Answers 71

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(Prepared by RamaKrishna Vadlamudi, Hyderabad):

1) As per Reserve Bank of India (RBI), what rate of interest banks pay on overdue domestic term deposits?

Savings account rate or the contracted interest rate on matured term deposit, whichever is lower.

2) What are India's latest foreign exchange reserves?

USD 612 billion or Rs 46 lakh crore (approximate figure)--exact figure is USD 611.90 billion or Rs 45.67 lakh crore as on 9th of July, 2021.

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101 Questions & Answers for Bank Interview-VRK100-05Oct2011

101 Questions & Answers-Interview for Bank Promotions-VRK100-08Nov2010

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11) What is a Bad Bank?

In the Union Budget for 2021-22, the Government of India announced a proposal for setting up the National Asset Reconstruction Company Limited (NARCL), popularly termed as a “bad bank”, to consolidate and take over non-performing assets (NPA) from banks.

12) What is maximum limit of RBI's Liberalised Remittance Scheme (LRS) under which resident individuals can send money abroad?

Maximum limit is USD 250,000 per financial year (April to March in India)

13) As per RBI, what is a substandard advance?

A substandard advance is one, which remains non-performing for a period less than or equal to 12 months.

14) As per RBI, what are unclaimed deposits?

All accounts in India which have not been operated for 10 years.

15) What are risk weighted assets (RWA)?

Risk weighted assets are calculated as per risk weights given to each asset (funded/ non-funded) as per RBI norms.

16) What is credit risk?

When the credit quality of borrowers or counterparties is decreased, a bank is exposed to possible losses. This is the credit risk for banks.

17) How do you define short-term credit facilities?

Short term facilities are credit facilities (funded and / or non-funded) for less than one year.

18) What is a slippage in relation to NPAs?

Slippage refers to new accretion to non-performing assets (NPAs) during a period.

19) What is pre-shipment credit?

Pre-shipment credit means any bank loan or advance to an exporter for financing the manufacturing or packing of goods prior to shipment (basically, working capital expenses).

20) Is TDS (tax deduction at source) applicable on interest paid by bank on NRO (Non Resident Ordinary) accounts?

Yes, as per Income Tax Act. (TDS is not applicable on interest paid on NRE accounts).

21) What is the minimum term for which a bank customer has to make a fixed deposit which is eligible for Section 80C tax deduction?

Five years. And maximum amount is Rs 1.50 lakh in a financial year per individual.

22) What is a PSLC?

Priority sector lending certificates (PSLCs) are certificates that are issued against priority sector loans for banks. They allow banks to meet any shortfall in targets set by RBI under priority sector lending.

23) What is net interest income?

Net interest income is the difference between the interest income and the interest expenses.

24) What are bulk deposits?

Rupee term deposits of Rs. 1 Crore and above on which banks are permitted to offer differential rates of interest.

25) What is the minimum tenor of a term deposit?

It's seven days as per Reserve Bank of India.

26) What are the timings of RTGS?

RTGS (Real Time Gross Settlement) is available 24x7x365 (throughout all 24 hours, every day of the week and year) with effect from December 14, 2020.

27) Does Reserve Bank of India maintain IMPS (Immediate Payment Service)?

No. IMPS is maintained by NPCI (National Payments Corporation of India).

28) What is the maximum amount a customer can deposit in a PPF (Public Provident Fund) account?

Rs 150,000 in a financial year.

29) Which body recommends high-level public sector bank appointments to Government of India?

Banks Board Bureau, headquartered in Bombay.

30) What is the current rate of interest on India Post Office savings account?

Four per cent per annum.

31) What is the minimum threshold of default for filing CIRP (corporate insolvency resolution process) under IBC (Insolvency and Bankruptcy Code, 2016)?

Rs one crore (raised from Rs 1 lakh in March 2020)

32) Which company acquired Dewan Housing Finance Corp Ltd (DHFL) under CIRP (corporate insolvency resolution process) of IBC (Insolvency and Bankruptcy Code, 2016)?

Piramal Enterprises Ltd acquired DHFL in June 2021.

33) When was Reserve Bank of India (RBI) established?

RBI was established in 1935.

34) A bank's revaluation reserves are part of___:

Tier 1 capital. In March 2016, Reserve Bank of India allowed banks to treat revaluation reserves as part of Tier 1 capital, subject to conditions.

35) What is the maximum insured amount for bank deposits under DICGC (Deposit Insurance and Credit Guarantee Corporation)?

Rs 500,000 for each depositor in each bank.

36) A commercial paper can be issued for a minimum maturity of how many days?

Seven.

37) Name of the key financial ratio used by a bank for term loan (e.g., equipment finance).

DSCR. It is debt-service coverage ratio used for term loans.

38) What is the current statutory liquidity ratio (SLR) for banks set by RBI?

18 per cent.

39) What raw material is used for printing banknotes (paper currency) in India?

100% cotton is used for printing of banknotes in India.

40) Who has created Rupee Symbol?

The symbol for Indian Rupee was designed by Dr Dharmalingam Udaya Kumar.

41) How many public sector banks (PSBs) are there in India?

As of July 2021, there are 12 PSBs in India. They are: (please click on the image for better view) >

42) What is ‘paripassu’ charge?

A ‘paripassu’ charge gives lenders a right to the property on which a charge is created in proportion to the amount lent to the debtor.

43) When were interest rates on bank SB account deregulated?

Reserve Bank of India (RBI) deregulated savings bank deposit (SB) interest rates effective October 25, 2011.

44) Due to Corona Virus Pandemic, interest on interest charged by banks and NBFCs was waived by Govt of India in 2020. How much amount did Govt of India propose to spend on this?

Rs 6,500 crore.

45) What is the minimum threshold of default for filing CIRP (corporate insolvency resolution process) under IBC (Insolvency and Bankruptcy Code, 2016)?

Rs one crore (raised in March 2020 from Rs 1 lakh)

46) Which company acquired Essar Steel Ltd under CIRP (corporate insolvency resolution process) of IBC (Insolvency and Bankruptcy Code, 2016)?

ArecelorMittal Nippon Steel India Ltd.

47) What is IBBI?

The Insolvency and Bankruptcy Board of India. It regulates insolvency professionals and processes under IBC (Insolvency and Bankruptcy Code, 2016).

48) Who is the chairman of IBBI (The Insolvency and Bankruptcy Board of India)?

Dr M.S.Sahoo

49) What is the current interest rate offered for savings bank accounts by India's premier bank State Bank of India?

It is 2.70 per cent per annum, paid at quarterly rests.

50) When was MCLR (Marginal-cost of funds based lending rate) system introduced?

MCLR was introduced with effect from April 1, 2016. Base Rate System (BRS) was effective from July 1, 2010 and was replaced by MCLR. BPLR (Benchmark Prime Lending Rate) was effective from November 2003 and was replaced by BRS.

51) What is PCA framework?

PCA framework is Prompt Corrective Action process whereby Reserve Bank of India (RBI) takes action against troubled banks, when the fundamentals of a bank start deteriorating. PCA is based on certain parameters like, capital adequacy ratio, profitability, asset quality and leverage.

52) In case of fraud accounts, how much provisioning for the amount involved has to be made by banks as per RBI guidelines?

100% provisioning is needed for fraud accounts.

53) As part of Yes Bank Reconstruction Scheme approved by Government of India, bonds worth nearly Rs 8,400 crore issued by Yes Bank were written down in March 2020 causing huge loss to bondholders. Name the bonds.

Additional Tier 1 bonds or AT1 bonds.

54) To attract more deposits, a bank wants to pay interest on savings bank accounts at monthly rests. Can the bank pay interest at monthly rests?

Yes, it can. RBI mandates banks to pay interest on domestic savings bank accounts at quarterly or shorter intervals.

55) What is the maximum insured amount for bank deposits under DICGC?

Rs 500,000 for each depositor.

56) What is a quick ratio?

Quick ratio simply means current assets excluding inventories divided by current liabilities. It denotes the ability of a company or firm to meet short-term liabilities from the available liquid assets.

57) You are a branch manager of Union Bank of India. A valued customer of your branch approaches you for a personal loan against the security of your bank (Union Bank of India) shares. Can you give a loan against that shares?

No. As per Banking Regulation Act, 1949, a bank cannot sanction a loan against the security of its own shares.

58) As per nomination rules, the signature of a depositor in a nomination form is to be attested by how many witness(es)?

No witness is required. Only in case of illiterate depositors, signature of two witnesses is required.

59) Who regulates insolvency professionals and processes under IBC (Insolvency and Bankruptcy Code, 2016)?

IBBI or The Insolvency and Bankruptcy Board of India.

60) A 'digital signature' is defined under which Act?

Information Technology Act, 2000. A digital signature is authentication of any electronic record through an electronic method.

61) Name the governor of Reserve Bank of India who started Asset Quality Review (AQR) to clean up banks' balance sheets.

Raghuram Rajan in April 2015.

62) Is the following statement correct? Housing loans provided to banks' own employees can be included under priority sector advances.

Incorrect. Reserve Bank of India does not allow considering housing loans given to banks' own staff to be part of priority sector advances.

63) Under the MSMED Act (Micro,Small and Medium Enterprises Development Act, 2006), what is the definition of a small enterprise?

A small enterprise is an entity where the investment in Plant and Machinery or Equipment does not exceed Rs 10 crore and annual turnover does not exceed Rs 50 crore.

64) What is the risk weight for credit risk prescribed by Reserve Bank of India for a bank's investment in central government security?

Nil. Central government security carries sovereign guarantee, hence practically there is no default risk.

65) Which bank in India is the largest by market capitalisation?

HDFC Bank is India’s largest bank by market capitalisation with a market cap of Rs 799,000 crore, followed by ICICI Bank (Rs 452,600 crore) and State Bank of India (Rs 376,000 crore)—figures as at the end of 22nd of July, 2021.

66) What is the name of the QR (quick response) code recently developed by NPCI (National Payments Corporation of India), Visa, MasterCard and Amex?

Bharat QR. It is a common standard enabling merchants to accept payments without a POS (point of sale) machine introduced in India. It's world's first fully interoperable QR code payment system. It's a low-cost method. It was launched in February 2017.

67) What is the maximum amount of banknote that was demonetised in Independent India?

Rs 10,000 banknote was demonetised, along with Rs1,000- and Rs 5,000-notes, in January 1978.

68) What is the maximum amount that can be remitted through NEFT (National Electronic Fund Transfer) system?

No, there is no minimum or maximum limit imposed by the RBI (Reserve Bank of India) for funds transfer through NEFT system. NEFT works 24x7x365.

69) Which entity maintains and controls UPI (Unified Payments Interface) payment system in India?

NPCI or National Payments Corporation of India, which is an initiative of Reserve Bank of India (RBI) and Indian Banks’ Association (IBA).

70) What is the shareholding of State Bank of India in the paid-up capital of private sector bank Yes Bank Ltd?

It is 30 per cent as of 30th of June, 2021.

71) In the second week of July 2021, Reserve Bank of India (RBI) banned a credit card company from issuing cards to new customers. Name the card company.

MasterCard Inc. RBI banned MasterCard from issuing cards (debit, credit or prepaid) in India owing to non-adherence of RBI norms on data storage.

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Correction: Questions 49 and 53 were repeated elsewhere; hence they were replaced with new ones by me on 23Jul2021.

Disclosure: I've vested interested in Indian stocks and other investments. It's safe to assume I've interest in the financial products discussed, if any.

Disclaimer: The analysis and opinion provided here are only for information purposes and should not be construed as investment advice. Investors should consult their own financial advisers before making any investments. The author is a CFA Charterholder with a vested interest in financial markets.

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Tuesday, 9 February 2021

Fiscal Deficit and Its Indirect Monetisation by Reserve Bank of India - vrk100 - 09Feb2021

Fiscal Deficit and Its Indirect Monetisation by Reserve Bank of India

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Indirect monetisation of fiscal deficit by Reserve Bank of India (RBI) has been heavy since 2008-09, with OMO (open market operations) purchases by RBI peaking at 63 per cent of net market borrowing in 2018-19 (not to speak of scheduled commercial banks' support to Government of India via mandatory SLR or statutory liquidity ratio)--leading to crowding out of the private sector.

Rising fiscal deficit has become a thorny issue for India since 2008-09, with OMO purchases supporting Government to an extent of 40 per cent of net market borrowings. In the past 13 years, only in 2014-15 and 2017-18, there were net OMO sales by RBI. The details of RBI's OMO purchases are provided in the table given below (click on it for expanded view):

With open market operations, RBI purchases and sells government securities and treasury bills. It is one of the main instruments of sterilisation used by the RBI. OMO sales entail the permanent absorption of the liquidity. Through OMO purchases, RBI injects liquidity into the banking system. RBI conducts open market operations regularly.

Open Market Operations (OMO) by RBI are supposed to be two ways. Committee after committee have spoken against outright monetisation of fiscal deficit via OMO purchases--eroding RBI's credibility in discretionary liquidity management.

Practically, Government of India's fiscal deficits are financed by RBI's one-sided OMO buying (see image) & support from commercial banks through mandatory SLR (statutory liquidity ratio). On top of that, banks hold excess SLR securities leading to market distortions.

With the introduction of FRBM (Fiscal Responsibility and Budget Management) Act in 2004, RBI cannot participate in the primary issuance of government bonds. But RBI is still resorting to government debt financing through outright OMO purchases in the secondary market.

No other major central bank uses OMO (one-sided) as blatantly as RBI in yield curve management, though OMOs are not to be used for that. Bond prices are the building blocks of asset pricing--with such distortions how can market players be sure of pricing of other assets?

RBI uses OMO to bring down long term yields by resorting to buying of government bonds, which is practically yield curve management, also known as yield curve control (YCC). Lower bond yields help governments in borrowing money from markets at cheaper rates.

With automatic monetisation via large OMO purchases, Reserve Bank of India has been printing money leading to debasement of money (lowering the purchasing power of currency).

In financial markets, government bond (called G-Secs in India for short) yields are the starting point for pricing of other assets. For example, corporate bonds are priced as a spread over G-Sec yields. G-Sec yields are also used for pricing equities and others.

With this indirect monetisation of fiscal deficits, RBI loses its credibility in conducting monetary policy objectively--reflecting poorly on central bank independence.

Side note: In financial market operations, open market operations are termed as open mouth operations.

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Please check my comments posted below >

Primer on Market Stabilisation Scheme and Liquidity Management 02Dec2016

What is LAF Repo Rate 23Jul2013

Bank Rate and its relevance 23Jul2013

What are cash management bills 15Jun2010

What is Marginal Standing Facility 20Jul2013

References:

My tweet thread dated 08Feb2021 on the above topic can be accessed at: weblink

Yield curve control (YCC): St Louis Fed blog dated 11Aug2020

Jan2014 Urjit Patel Report on Monetary Policy Framework (MPF)

04Mar2013 Fiscal-Monetary Co-ordination in India : An Assessment

Disclosure: I've vested interest in Indian stocks. It's safe to assume I've interest in the stocks discussed, if any.

https://ramakrishnavadlamudi.blogspot.com/

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Friday, 2 December 2016

Primer on Market Stabilisation Scheme and Liquidity Management-VRK100-02Dec2016

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Primer on Market Stabilisation Scheme

and Liquidity Management

After a gap of six to seven years, MSS has become a buzzword in the financial space once again. Government of India today, based on the recommendation of the Reserve Bank of India, raised the MSS ceiling for financial year 2016-17 to Rs 600,000 crore from Rs 30,000 crore fixed earlier. The steep increase in MSS ceiling is necessary as banks have been receiving large amount of deposits following the currency ban on Rs 500 and Rs 1,000 bank notes with effect from November 9th.

So what is MSS? Simply put, MSS is an acronym for market stabilisation scheme. MSS is used by country's central bank RBI as a monetary policy instrument for liquidity absorption and/or injection. RBI already uses other tools like LAF Repo, Reverse Repo and CRR. Why doesn't RBI use these tools instead of MSS? What is the impact of MSS on fiscal deficit? I will try to answer them in this write-up.

1. What is MSS?

The Market Stabilisation Scheme (MSS) in an innovative sterilisation tool introduced by the RBI in 2004. It basically deals with the liquidity impact of surging capital flows, such as foreign direct investment (FDI) and foreign portfolio flows (FPI).

The MSS is an instrument for active liquidity and monetary management, in addition to other tools such as LAF repo rate, reverse repo rate and bank rate. It has enabled RBI to conduct exchange and monetary management operations in a flexible and stable manner.

2. Why did the Government increase the MSS ceiling steeply and suddenly?

The Government of India today raised the MSS ceiling to Rs 600,000 crore for the financial year 2016-17 from Rs 30,000 crore fixed earlier. The steep raise was expected for the past one or two weeks following the flood of money into bank deposits due to the currency ban on 8 November 2016.

This MSS instrument was used by RBI between 2004 and 2010 to first absorb liquidity of FII (now FPI) inflows into Indian securities and later inject liquidity into the financial system post the global financial crisis (GFC) that started in 2008. After the Lehman Brothers crisis, RBI started unwinding/de-sequestering of the MSS securities and released liquidity into the banking system, without expanding its balance sheet. The MSS outstanding balance has remained zero since 28 July 2010 till yesterday.

3. Will the Government use MSS money absorbed by RBI?

Issue of MSS bills/bonds by RBI leads to accretion of government deposits with the RBI, but they remain sterilised in the sense the government cannot use these MSS funds for its expenditure purposes. Amount raised under MSS will be kept in MSS cash account, which is separate from the normal cash account of the Central Government maintained with the RBI. Basically, RBI impounds these MSS funds.

4. What is the impact of issue of MSS securities on country's fiscal deficit?

The Market Stabilisation Scheme is backed by a corresponding equivalent amount of cash balances with the RBI. Amounts raised from MSS bills/bonds will not enter the Consolidated Fund of the Central Government.

As the funds raised under MSS would remain hoarded by the RBI in its books, there is no impact on the fiscal deficit of the Centre.

After MSS unwinding/de-sequestering, the money will be transferred from MSS cash account to the normal cash account of the Government. With the unwinding of MSS bills/bonds, the government will be able to use the money for its expenditure.

Interest due on MSS securities will be paid by the Central Government--to this extent MSS will impact the fiscal deficit of the government.

5. What type of instruments are issued under MSS?

Under the MSS, RBI issues dated securities and Treasury bills by way of auctions--either multiple price auction or uniform price auction up to a limit mutually agreed upon between the Government and RBI. They are marketable government securities eligible for statutory liquidity ratio (SLR), repo and LAF.

Today, the RBI issued 28-day cash management bills (CMBs) worth Rs 20,000 crore under the MSS, after raising the MSS ceiling for FY 2016-17 to Rs 600,000 crore.

6. What is the difference between LAF and MSS?

The Liquidity Adjustment Facility (LAF) is basically used for day-to-day liquidity management, while the MSS is used for semi-durable and durable mismatches.

The LAF is used for short-term liquidity purposes, whereas the MSS is used for funds of medium or long term nature. For greater transparency and stability in the financial markets, the RBI releases an indicative quarterly schedule for issuance of Treasury bills and dated securities.

7. Who will invest in MSS bills/bonds?

The participants in the auction of MSS bills/bonds are commercial banks, cooperative banks, financial institutions such as insurance companies, primary dealers, etc.

8. What other types of policy tools are used by RBI in its liquidity management?

LAF: The Liquidity Adjustment Facility (LAF) introduced in June 2000 is the primary tool used by the RBI for liquidity absorption (reverse repo) and injection (repo) for day-to-day purposes. It is generally used for temporary purposes, not for liquidity of enduring nature. The LAF enables the RBI to modulate short-term liquidity ensuring overnight call money rates move in the LAF corridor (between repo and reverse repo rates). The LAF repo rate has emerged as the policy signalling rate.

OMO: With open market operations, RBI purchases and sells government securities. It is the main instrument of sterilisation used by the RBI. OMO sales entail the permanent absorption of the liquidity.

Centre's surplus balance with RBI: The Central Government's surplus balance kept with the RBI also work as an instrument of sterilisation. As the RBI Act does not permit RBI to pay interest on such balances, these balances are invested in government securities held with the RBI.

CRR: Cash reserve ratio (CRR) is considered a blunt instrument for impounding liquidity of the banking system. Currently, CRR is kept at 4%. On 26 November 2016, RBI imposed an incremental CRR of 100% on increase in bank balances between 16 September 2016 and 11 November 2016. This additional CRR is a temporary step to manage excess liquidity arising from currency ban.

MSF: Marginal standing facility was introduced by the RBI in 2011. The MSF is an additional window provided by RBI to banks, so that the latter can borrow overnight funds from the RBI against their excess SLR (statutory liquidity ratio) holdings. MSF scheme is similar to the LAF-Repo scheme. The difference between MSF and LAF-Repo is that under MSF, banks will have to pay higher rate of interest to RBI for their borrowings as compared to LAF-Repo.

In addition to the above (MSS, LAF, OMO, Centre's surplus balance, CRR and MSF), RBI also uses SLR and bank rate as monetary policy tools.

Earlier, RBI used policy tools such as, prescribing deposit and lending rates of commercial banks, selective credit control (SCC) over sensitive commodities and sector-specific standing facilities. But over the years, it had stopped using them.

9. Who will bear these costs of sterilisation?

a) In case of cash reserve ratio (CRR) and incremental CRR, banks bear the costs as RBI doesn't pay any interest on such CRR balances.

b) Government of India bears the cost of interest in the case of MSS.

c) In case of LAF window, RBI bears the costs.

So the costs are shared among all the three players. Of course, the costs borne by RBI will reflect in its balance sheet by way of lower transfer of surplus to the government.

References:

On 02Dec2016 MSS ceiling raised to Rs 600,000 crore for 2016-17

MSS was launched on 23Feb2004

MOU between GOI and RBI for MSS 25Mar2004

Report of the Working Group on Instruments of Sterilisation 02Dec2003

Report of the Internal Group on LAF 13Jan2004

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Additional Information:

What are the indicators of liquidity in the Indian financial system?

a) Outstanding balances under LAF (repo and reverse repo) on a specific date

b) Outstanding balances under MSS on a specific date

c) Central government's surplus with the RBI on a specific date

What is LAF Repo Rate 23Jul2013

Bank Rate and its relevance 23Jul2013

What are cash management bills 15Jun2010

What is Marginal Standing Facility 20Jul2013

Disclosure: The author has a vested interest in the financial markets.

Disclaimer: The author is a CFA Charterholder (USA) and an investment professional. The views are personal. His views should not be construed as investment advice. Before making any investments, you are advised to consult your registered financial advisor. The author will in no way responsible for the decisions taken by readers.

Monday, 11 August 2014

What is Liquidity Coverage Ratio?-VRK100-11Aug2014

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Summary:

Banks, across the globe, have to maintain liquidity coverage ratio (LCR) as part of the Basel III norms. These norms are prescribed by the Bank for International Settlements. BIS a global body that acts as a bank for central banks.

Liquidity coverage ratio is the proportion of highly liquid assets that a bank should maintain to meet its liquidity needs in a 30-calendar day period. The LCR is calculated as a ratio of high-quality liquid assets to the total net cash outflows over the next 30 calendar days.

The LCR enables a bank to withstand any financial shocks, such as a run on its deposits, a credit rating downgrade or derivative-linked shocks. These global norms are being introduced effective 1^st of January, 2015 (see table above).

The 2007/2008 global financial crisis forced central banks to adopt more stringent liquidity requirements—in the form of the liquidity coverage ratio and net stable funding ratio—to manage liquidity risk in a better manner.

Let us discuss the background and more details of this liquidity coverage ratio.

Background:

During the 2007/2008 global financial crisis, banks and other financial institutions mismanaged their liquidity requirements. The collapse of Lehman Brothers drove home the importance of liquidity in the banking system. Banks could not liquidate their assets, leading to severe stress in the money markets.

Liquidity risk arises when securities cannot be purchased or sold without a significant loss in value. This risk is most acute in periods of unusually high market stress as happened during the global financial crisis.

With a view to managing such liquidity risks, the Basel Committee on Banking Supervision (BCBS) has introduced new measures, including the liquidity coverage ratio (LCR) and the net stable funding ratio (NSFR). The NSFR requires banks to fund their assets with more stable sources of funding—providing sustainable maturity structure of assets and liabilities over long term.

What is the need for an LCR?

Once LCR is implemented, banks will be in a better position to meet short-term emergency liquidity (cash) needs. The LCR bolsters a bank’s ability to withstand any financial and/or economic shocks in the short term. It will also reduce the risk of spillover from the financial sector to the real economy.

The Liquidity Coverage Ratio is a key component of the Basel III framework. Basel III norms are global regulatory standards on bank capital adequacy and liquidity endorsed by the G20 Leaders.

The LCR enhances the short-term resilience of banks to potential liquidity disruptions by ensuring that they have sufficient high-quality liquid assets to survive an acute stress scenario lasting for 30 days.

The stress scenarios may include: a run on the bank deposits; a bank losing its ability to raise unsecured funds; a credit rating downgrade; market-related stress and derivative-linked shocks.

How to Calculate the LCR?

As mentioned above, the liquidity coverage ratio is the proportion of highly liquid assets that a bank should maintain to meet its liquidity needs in a 30-calendar day period. The LCR is calculated as a ratio of high-quality liquid assets to the total net cash outflows over the next 30 calendar days.

The LCR has two components: the value of the stock of high-quality liquid assets (HQLAs) and total net cash outflows.

LCR = Stock of HQLA / Total net cash outflows over the next 30 calendar days

The LCR should be equal to or greater than 100 percent.

Banks, across the globe, have to maintain this LCR from 1 January 2015. With effect from 1 January 2015, the LCR will be 60% and rising in equal steps of 10% every year to reach the minimum of 100% LCR on 1 January 2019 as given below:


Effective	1Jan.2015	1Jan.2016	1Jan.2017	1Jan.2018	1Jan.2019

Minimum LCR	60%	70%	80%	90%	100%

Effective 1 January 1, 2019, the LCR should be minimum 100% (that is, the stock of HQLA should at least equal total net cash outflows) on an ongoing basis. However, during periods of financial stress, banks may use their high-quality liquid assets to tackle liquidity issues and thereby falling below 100 percent.

High-Quality Liquid Assets (HQLA):

Liquidity of an asset indicates the ability and ease with which it can be converted to cash. Liquid assets are those that can be converted to cash quickly in order to meet financial obligations. Liquid assets include cash, reserves kept with central bank and sovereign debt.

To remain viable, banks must have enough liquid assets to meet its near-term obligations, such as withdrawals by depositors.

Banks must hold a stock of HQLA to cover the total net cash outflows over a 30-day period under the prescribed stress scenario. These HQLAs must be unencumbered—that is free of any legal, regulatory or contractual restrictions.

The HQLA should have the fundamental characteristics of low risk; ease and certainty of valuation; low correlation with risky assets; and listed on a developed and a recognized exchange. And their market-related characteristics should be: active and sizeable market; low volatility; and flight to quality.

Level 1 and Level 2 Assets:

HQLA consist of Level 1 and Level 2 assets. Level 1 assets generally include cash, reserves kept with central bank, and certain marketable securities backed by sovereigns and central banks, among others. These assets are typically of the highest quality and the most liquid, and there is no limit on the extent to which a bank can hold these assets to meet the LCR.

Level 2 assets are comprised of Level 2A and Level 2B assets. Level 2A assets include, for example, certain government securities, corporate debt securities (including commercial paper) and covered bonds.

Level 2B assets include lower rated corporate bonds, residential mortgage backed securities (RMBS) and equities that meet certain conditions. Level 2 assets may not in aggregate account for more than 40% of a bank’s stock of HQLA. Level 2B assets may not account for more than 15% of a bank’s total stock of HQLA.

Level 2A and Level 2B assets are subject to haircuts ranging from 15% to 50%.

Total net cash outflows:

The term total net cash outflows is defined as the total expected cash outflows minus total expected cash inflows in the specified stress scenario for the subsequent 30 calendar days. Total expected cash outflows are calculated by multiplying the outstanding balances of various categories or types of liabilities and off-balance sheet commitments by the rates at which they are expected to run off or be drawn down.

Total expected cash inflows are calculated by multiplying the outstanding balances of various categories of contractual receivables by the rates at which they are expected to flow in under the scenario up to an aggregate cap of 75% of total expected cash outflows.

Total net cash outflows over the next 30 calendar days =

Total expected cash outflows – Min {total expected cash inflows; 75% of total expected cash outflows}

Frequency of calculation and reporting:

The LCR should be used on an ongoing basis to help monitor and control liquidity risk. The LCR should be reported to central banks at least monthly. However, central banks may increase the frequency to weekly or even daily at their discretion. The time lag in reporting should be as short as feasible and ideally should not surpass two weeks.

The LCR versus the SLR in the Indian context:

The Reserve Bank of India (RBI) issued the liquidity coverage ratio guidelines for Indian banks on 9 June 2014. These are more or less in line the norms prescribed by the Basel Committee on Banking Supervision.

Indian banks will have to maintain this LCR over and above the statutory liquidity ratio (SLR) prescribed by RBI. As the assets kept for LCR purpose are unencumbered, those assets will be outside of the SLR obligation.

While the purpose of LCR is to meet the short-term liquidity requirements, the purpose of SLR is long-term in nature. The SLR mainly serves three purposes in India:

o It serves as a solvency cushion for banks (ultimately, bank depositors) against any emergencies –like liquidity crisis, bank failures, etc

o It is used by the Central Government to raise money (government borrowings) cheaply from banks

o RBI uses it as a monetary policy tool to infuse (absorb) liquidity into (from) the banking system

With effect from 9 August 2014, the RBI cut the SLR for Indian banks by 50 basis points to 22 percent of net demand and time liabilities (NDTL). The latest SLR cut is expected to help Indian banks in meeting the new LCR norms.

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References:

RBINorms for Liquidity Coverage Ratio 9Jun2014

Basel III: Liquidity Coverage Ratio& other tools Jan2013

Disclaimer: The author is an investment analyst with a vested interest in the Indian stock markets. This is for information purposes only. This should not be construed as investment advice. Investors should consult their own financial advisers before taking any investment decisions. The author blogs at:

http://ramakrishnavadlamudi.blogspot.in/ http://www.scribd.com/vrk100

Tweets at @vrk100

Saturday, 20 July 2013

Update on Marginal Standing Facility-VRK100-20Jul2013


Rama Krishna Vadlamudi, HYDERABAD 20 July 2013
www.ramakrishnavadlamudi.blogspot.com

Indian rupee has been depreciating steeply against the US dollar ever since the US Federal Reserve has hinted at tapering its quantitative easing (QE3) programme. For the first time since its introduction in 2011, the Reserve Bank of India (RBI) has used its marginal standing facility (MSF) to control depreciation of Indian rupee against the US dollar. The measures initiated by RBI on 15 July 2013 to rein in rupee volatility are:

a). The MSF rate has been readjusted to 300 basis points (from the earlier 100 basis points) above the policy Repo rate under the Liquidity Adjustment Facility (LAF). As such, the MSF rate is raised to 10.25 per cent from 8.25 percent with effect from 16Jul2013.

b). Accordingly, Bank Rate has been raised to 10.25 percent with effect from 15Jul2013 (since 13Feb2012, Bank Rate has been made equal to MSF rate)

c). With effect from 17Jul2013, the total amount under RBI’s LAF is restricted to one percent of the net demand and time liabilities (NDTL) of the banking system, reckoned as Rs 75,000 crore

d). RBI would sell government securities to the tune of Rs 12,000 crore on 18Jul2013 as part of its open market operations (OMO)

What is Marginal Standing Facility (MSF)?

The MSF was started by RBI during the Annual Policy statement announced by it on 03 May 2011. The MSF facility was made effective from 09 May 2011.

The marginal standing facility is an additional window provided by RBI to banks, so that the latter can borrow overnight funds from RBI against their excess SLR (statutory liquidity ratio) holdings. MSF scheme is similar to LAF-Repo scheme. The difference between MSF and LAF-Repo is that under MSF, banks will have to pay higher rate of interest to RBI for their borrowings as compared to LAF-Repo.

Banks will look for the MSF window to borrow money from RBI once they exhausted all other avenues (like, call money market, LAF-repo window, Collateralized Borrowing and Lending Obligation or CBLO, market repo, etc.) for overnight money. Under exceptional circumstances, banks will borrow money through MSF window.

What are the Salient Features of MSF?

1. The Objective of MSF:

This facility is expected to contain volatility in the overnight inter-bank money market.

2. Eligibility:

All scheduled commercial banks (SCBs) are eligible to borrow from RBI under MSF.

3. Tenor and Amount:

With effect from 17Apr2012, Banks can borrow overnight funds up to two percent of their NDTL. In general, the borrowing is for one day except on Fridays when the facility will be for three days. Banks can continue to access the MSF even if they have excess SLR holdings. (Prior to 17Apr2012, banks were allowed to borrow funds up to one percent of their NDTL under MSF).

4. Rate of Interest:

With effect from 16Jul2013, banks under MSF have to pay interest at the rate of 300 basis points or three percentage points above the LAF-Repo rate. At present, LAF-Repo rate is 7.25 percent and as such, the MSF rate is 10.25 percent. So, whenever LAF-Repo rate is revised by RBI, the MSF rate will be revised accordingly. Prior to 16Jul2013, MSF rate was linked to 100 basis points above LAF-Repo rate.

5. Minimum Size:

Under MSF scheme, banks will have to make requests for a minimum of Rs one crore and in multiples of Rs one crore thereafter.

6. Eligible Securities:

They are Government of India Dated Securities/Treasury Bills and State Development Loans (SDL).

7. Margin Requirement:

A margin of five percent is required for GOI Dated Securities and Treasury Bills; and for SDLs, it is 10 percent. So, banks will have to offer Rs 105 (face value) worth of GOI Dated Securities and Treasury bills for a request of Rs 100; and Rs 110 (face value) worth of SDLs for a request of Rs 100.

MSF Rates since Beginning:

Graph showing the MSF rates since inception:

Special Repo Window for Mutual Funds:

RBI had on 17Jul2013 provided a special repo window whereby banks can avail funds from RBI to meet the liquidity requirements of mutual funds. Under this special repo window, banks can avail liquidity assistance from MSF up to 0.5 percent of NDTL, which is over and above the two percent (of NDTL) regular MSF window. This additional limit of 0.5 percent of NDTL will be available for a temporary period till further notice.

Off-beat Move by RBI:

By increasing MSF rate to curb rupee volatility, the RBI has acted in an off-beat manner to the surprise of market participants. Though the stated objective of RBI in raising MSF rate is to address exchange rate volatility, the market participants have interpreted the measure as raising short-term interest rates. The bond markets have panicked and bond prices have fallen sharply with bond yields shooting up much to the chagrin of investors. In the equity markets, banking stocks have fallen steeply due to liquidity squeeze and Treasury losses from bond portfolios.

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Reference: RBI

Disclaimer: The author is an investment analyst and freelance writer. His articles on financial markets and Indian economy can be reached at:

http://ramakrishnavadlamudi.blogspot.in/ or www. scribd.com/vrk100

Note: Please check the comment attached below, made on 05Dec2018 by me, for interest rate on MSF, which is now 25 basis points above the LAF Repo rate.