Indian Financial System

India’s GDP
 India GDP for 2022-23 is estimated at Rs.2.72 crore, Crore (about US$3.30
trillion)) or INR 272.41 trillion (All are nominal numbers)

 Real GDP in FY 2023: According to the data, the growth in GDP at constant
prices (2011-12), also known as real GDP, during FY 2023 is estimated to
attain a level of INR 160.06 trillion (US$1.90 trillion), as against the First
Revised Estimate of INR 149.26 trillion (US$1.75 trillion) for FY 2022.

 Three major contributors are Agriculture, Manufacturing & Services.

 Services sector is about 60% of GDP.

 Manufacturing & other tangible sectors such as mining & quarrying &
construction etc. is about 25% of GDP.

 Agriculture sector is about 14-15% of GDP.

Indian Financial System
Classification of Banks
Classification of Banks

 Central Bank- Reserve Bank of India (RBI) To Control other

Banks & Economy

To accept Deposit & Lend to

 Commercial Banks (CB) Individual & Corporate Clients e.g.
ICICI Bank, Bank of Baroda

 Industrial & Development Banks Similar to CB’s except major focus

is on Industrial Development

 Co-operative Banks Similar to CB’s except they have to abide by

different laws & they are generally smaller in
operation & size. e.g. Sarswat Bank

 International Banks Similar to CB’s only difference big nation of

origin. e.g. Citi Bank
 Merchant Banks – e.g. Goldman Sachs, Morgan Stanley
Central Bank- Reserve Bank of India (RBI)
Reserve Bank of India (RBI)

 Banker’s bank or the Central bank of India.

 It formulates, implements and monitors the monetary policy as well as it

has to ensure an adequate flow of credit to productive sectors.

 RBI preliminary responsibility is to control the Inflation in the at the same

time stimulate Growth in the economy and provide Stability.

 RBI does it through various Policy Rates and Reserve ratios.

 The current Governor of RBI is Shaktikanta Das

Policy Rates
Policy Rates-

Bank Rate : 6.75%

Rate of interest which RBI charges on the loans and advances to a commercial bank.

Repo Rate : 6.5%

Rate at which the RBI lends money to commercial banks.

Bank Rate Vs Repo Rate

Bank Rate is not against Government Securities as a collateral whereas in case of Repo Government
Securities are kept as a collateral hence the higher rate.

Marginal Standing Facility rate or MSF rate in India is 6.75%.

MSF was introduced in 2011-12. This is the rate at which the banks can pledge government securities for
gaining liquidity in situations when the liquidity is dried up. This is Overnight Lending

Reverse Repo Rate : 3.35%

Rate at which the RBI borrows money from commercial banks.

Reserve Ratios
Cash Reserve Ratio (CRR) : 4.5%

Per cent of their deposits which all types of banks hold with RBI in the form of
cash.

Currently RBI does not pay any interest on CRR deposit to banks.

CRR Liquidity or Money flow in the system

CRR Liquidity or Money flow in the system

Statutory Liquidity Ratio (SLR) : 18 %

The ratio which every bank has to maintain it’s Net Demand and Time Liabilities as
liquid assets in the form of cash, gold and un-encumbered approved securities such
as government securities.

Banks generally earn some interest on SLR holdings. (Near about 7% as on July’23)
Banking Operation in India
Objective of Banks

• Loan should be given to productive sectors/individuals.

• Lending should be done at a reasonable interest rates.

• To provide security & value added services to the customers.

• To Facilitate the growth of Individuals, Industry & the economy at large.

• To facilitate activities such as agriculture, education, low cost housing through

priority sector lending.
Bank Deposits

1) Demand Deposits

These are deposits which the customer can get back on demand or which are
placed for very short time periods.

Two Major types of Demand Deposits

Saving Account Deposit

Rate of Interest (i.e. cost of funds to bank is 3% +)

Current Account Deposit

Rate of Interest (i.e. cost of funds to bank is 0%)

CASA (Current Account + Saving Account)

 Low Cost Deposits for

banks (i.e. Least cost of
funds)

 Return earned by a
depositor is lower.

 If current inflation is
close to 6% then
depositor gets negative
returns from CASA.

Source:
https://finmedium.com/2020/10/compariso
n-private-banks-in-india/
Bank Deposits
Term Deposits

• These are deposits that are

maintained for a fixed term.

• The time period can be anything

from 7 days to 10 years.

• Benefit of term deposits is that

the interest rate would be higher.

• Weakness is that if the investor

needs the money earlier, he bears
a penalty. He will earn 1% less
than what the deposit would
otherwise have earned.
Bank Credit

For Individuals

 Credit Card

 Personal Loan

 Vehicle Finance

 Home Finance
Bank Credit

For Business

 Cash Credit ( Working Capital)

 Term Loan / Project Finance

 Bank Overdraft – (Amount more than what is lying in current

account)
Lending Rates

Base Rate:

• Definition: Base rate is the minimum rate set by the Reserve Bank of
India below which banks are not allowed to lend to its customers.

• Description: Base rate is decided in order to enhance transparency in

the credit market and ensure that banks pass on the lower cost of fund
to their customers. Loan pricing will be done by adding base rate and a
suitable spread depending on the credit risk premium

Lending Rate :

A lending rate is the rate at which banks lend to their customers. The actual
lending rates charged to borrowers would be the base rate plus borrower-
specific charges, which include product-specific operating costs, credit risk
premium and tenor premium. So, it differs across various segments
Latest Base Rates for some of the leading Banks in January 2022 as per
https://www.bankbazaar.com/
Name Of The Bank Current Base Rate
Axis Bank 7.30%
Canara Bank 8.80%
HDFC Bank 7.40%
Dhanlaxmi Bank 9.80%
Andhra Bank/Union Bank 8.40%
SBI (State Bank of India) 7.45%
Bank of Baroda 8.15%
Karnataka Bank 8.70%
IDBI Bank 9.65%
Kotak Mahindra Bank 7.40%
PNB (Punjab National Bank) 8.50%
Union Bank of India 8.40%
Syndicate Bank/Canara Bank 8.80%
Corporation Bank/Union Bank 8.40%
Bank of India 8.80%
Oriental Bank of Commerce/PNB 8.50%
Punjab & Sind Bank 9.70%
Catholic Syrian Bank 9.50%
RBL Bank 8.55%
Bank of Maharashtra 9.40%
Applicability of the Base Rate
• Every loan category should be priced based on the base rate that has been set by the Reserve Bank of India. But
a few loans can be priced without referring to the current base rate. These include the Differential Rate of
Interest (DRI) advances, loans to a bank’s depositor on their deposits, and loans to a bank’s employees.
• The base rate set by the central bank or the RBI also serves as a reference benchmark for the floating rate of a
loan.
• Any modifications in the base rate are applicable to all the existing loans that are associated with the current
base rate.
• The base rate set by the central bank is always minimum. Therefore, no bank is allowed to give a rate below
than what is set to its customers.
• New borrowers: Since October 1, 2019, RBI has mandated banks to link the interest rates of home loans to an
external benchmark. Most banks have used the repo rate as the benchmark for their home loans. Interest rates
of these home loans will move in tandem with the external benchmark it is linked to, like the repo rate.
With repo rate being at the lowest level seen in the last two decades and RBI continuing to maintain status quo,
home loan interest rates are likely to continue to be at lower levels, and hike in rates is not expected to happen
soon.
Existing borrowers: Existing borrowers will continue to pay their EMIs at the same interest rate. However, they
must check under which regime their home loan is currently running. Borrowers who have taken loans before
October 2019 will have their loans linked to a different interest rate regime i.e., BPLR, Base rate, or MCLR.
If your home loan falls under any of these regimes, then it is likely that you are paying a higher interest rate
than what is currently offered on an external benchmark linked home loan. In such a scenario, you can ask your
bank to switch your loan to an external benchmark-linked one by paying administrative fee. You can also
consider switching to a new lender if your current lender is not allowing you to switch to an external
benchmarked linked loan.
Net Interest Income / Net Interest Margin
Net Interest Income :

• Net interest income (NII) is the difference between revenues generated

by interest-bearing assets and the cost of servicing (interest-burdened)
liabilities

• NII = (interest payments on assets) − (interest payments on liabilities)

Net Interest Margin :

• Net interest margin (NIM) is a measure of the difference between the

interest income generated by banks or other financial institutions and
the amount of interest paid out to their lenders (for example, deposits),
relative to the amount of their (interest-earning) assets

• It is similar to the gross margin of non-financial companies.

Non-Performing Assets (NPA’s)
Non Performing Assets (NPA)

• NPA’s occur when the borrower is unable or unwilling to pay .

• Expected payment from borrower consist of both interest & principle

repayment.

• Such debt should not be shown as regular debt .

• So RBI has laid down strict guidelines for definition and classification of
NPA’s.

• Definition: A non performing asset (NPA) is a loan or advance for which

the principal or interest payment remained overdue for a period of 90
days.
Definition of NPA

An NPA is a loan or advance where:

• Term Loan – interest and / or installment of principal remains overdue for

more than 90 days.

• Overdraft / Cash credit - account is out of order i.e.

• Outstanding balance remains continuously in excess of the sanctioned limit /
drawing power;
• Outstanding balance is within the sanctioned limit / drawing power, but there
are no credits continuously for 90 days as on the date of balance sheet, or the
credits are not enough to cover the interest debited during the same period.
• Bills purchased and discounted – bill remains overdue for more than 90 days.
• Short duration crops (crop season is up to a year) – installment of principal or
the interest thereon remains overdue for two crop seasons.
• Long duration crops - installment of principal or the interest thereon remains
overdue for one crop season.
Classification of NPA’s
NPA Categories
• Standard Assets : A standard asset is a performing asset. Standard
assets generate continuous income and repayments as and when they
fall due. Such assets carry a normal risk and are not NPA in the real
sense. So, no special provisions are required for Standard Assets.
• Description: Banks are required to classify NPAs further into
Substandard, Doubtful and Loss assets.
• A non performing asset (NPA) is a loan or advance for which the
principal or interest payment remained overdue for a period of 90
days.
• Sub-Standard Assets: An asset that has remained NPA for up to 12
months.
• Doubtful Assets: An asset that has remained sub-standard for up to 12
months.
• Loss Assets: An asset that the bank or its auditors or the RBI has
identified as a loss, but the amount has not been written off entirely.
Provision for NPA’s
Special Mention Accounts (SMA)
1. Special Mention Accounts are those assets/accounts that shows symptoms of bad asset
quality in the first 90 days itself or before it being identified as NPA.
2. The classification of Special Mention Accounts (SMA) was introduced by the RBI in
2014, to identify those accounts that has the potential to become an NPA/Stressed
Asset.
3. Logic of such a classification is because some accounts may turn NPA soon. Here, an
early identification will help to tackle the problem better. There are four types of
Special Mention Accounts – SMA-NF, SMA 0, SMA1 and SMA 2.
4. The Special Mention Accounts are usually categorized in terms of duration. For
example, in the case of SMA -1, the overdue period is between 31 to 60 days. On the
other hand, an overdue between 61 to 90 days will make an asset SMA -2.
5. But some ‘Special Mention’ assets are identified on the basis of other factors that
reflect sickness/irregularities in the account (SMA -NF).
6. In the case of SMA -NF, non-financial indications about stress of an asset is
considered.
SMA Classification
SMA Sub Category Classification basis

SMA – NF Non-financial (NF) signals of stress, Special Mention’ category of

assets is not only on the basis of non-repayment or overdue
position but also due to other factors that reflect
sickness/irregularities in the account (SMA -NF)

SMA-0 Principal or interest payment not overdue for more than 30 days
but account showing signs of incipient stress, Delay of 90 days or
more in (a) submission of stock statement / other stipulated
operating control statements or (b) credit monitoring or financial
statements or (c) non-renewal of facilities based on audited
financials.
SMA- 1 Principal or interest payment overdue between 31-60days.

SMA – 2 Principal or interest payment overdue between 61-90 days.

Moratorium
A moratorium on something is a temporary stopping of an activity, especially by an official
agreement, according to the Oxford Dictionary.

A moratorium is a temporary suspension of activity until future events warrant lifting of the
suspension or related issues have been resolved. Moratoriums are often enacted in response
to temporary financial hardships.

As a relief measure for people in view of the coronavirus pandemic, the Reserve Bank of India
(RBI) allowed a three-month moratorium on term-loan and credit card repayments. Lending
institutions were directed to defer the EMIs of their customers opting for this moratorium
scheme

he RBI on March 27, 2020, said all lending institutions, including banks and housing finance
companies, will have to give their borrowers a three-month moratorium on term loans. The
moratorium was for payment of all instalments falling due between March 1 and May 31,
2020.

According to the RBI, the deferred instalments under the moratorium would include the
following payments falling due between the said period:

a) principal and/or interest components;b) bullet repayments; c) equated monthly nstalments

(EMIs);) credit card dues.
Moratorium Critical Points to remember
If a customer has the liquidity, they should not opt for a moratorium. Repaying the loan
amount is advised as interest continues to accrue on the loan amount even during the
moratorium period. Repaying helps reduce the interest cost

This is not a waiver but a deferment of EMIs in such a way that the repayment tenure and due
dates are extended by 3 months from the expiry of the moratorium.

The moratorium includes both the interest and principal component of your EMI.
Gross NPA vs. Net NPA

 Gross NPA is a advance which is considered irrecoverable,

for. bank has made provisions, and which is still held in
banks' books of account.

 Net NPA = Gross NPA - (Balance in Interest Suspense

account + DICGC/ECGC claims received and held pending
adjustment + Part payment received and kept in suspense
account +Total provisions held)
Basel II & Basel III norms

• Basel III is a comprehensive set of reform measures, developed by the

Basel Committee on Banking Supervision (BCBR), to strengthen the
regulation, supervision and risk management of the banking sector.

• Basel III is only a continuation of effort initiated by the Basel Committee

on Banking Supervision to enhance the banking regulatory framework
under Basel I and Basel II.

• Objective of Basel III norms is to improve the banking sector's ability to

deal with financial and economic stress, improve risk management and
strengthen the banks' transparency.
3 Pillars of Basel II & Basel III norms

• Pillar 1 : Minimum Regulatory Capital Requirements based on Risk

Weighted Assets (RWAs) : Maintaining capital calculated through credit,
market and operational risk areas.

• Pillar 2 : Supervisory Review Process : Regulating tools and frameworks for

dealing with peripheral risks that banks face.

• Pillar 3: Market Discipline : Increasing the disclosures that banks must

provide to increase the transparency of banks
Major Features of Basel III
• Better Capital Quality: Better quality capital means the higher loss-
absorbing capacity. This in turn will mean that banks will be stronger,
allowing them to better withstand periods of stress.

• Capital Conservation Buffer: Banks will be required to hold a capital

conservation buffer of 2.5%. The aim of asking to build conservation
buffer is to ensure that banks maintain a cushion of capital that can be
used to absorb losses during periods of financial and economic stress.

• Countercyclical Buffer: The countercyclical buffer has been introduced

with the objective to increase capital requirements in good times and
decrease the same in bad times. The buffer will slow banking activity
when it overheats and will encourage lending when times are tough i.e. in
bad times. The buffer will range from 0% to 2.5%, consisting of common
equity or other fully loss-absorbing capital.
Major Features of Basel III
• Minimum Common Equity and Tier 1 Capital Requirements : The
minimum requirement for common equity, the highest form of loss-
absorbing capital, has been raised under Basel III from 2% to 4.5% of total
risk-weighted assets. The overall Tier 1 capital requirement, consisting of
not only common equity but also other qualifying financial instruments,
will also increase from the current minimum of 4% to 6%. Although the
minimum total capital requirement will remain at the current 8% level, yet
the required total capital will increase to 10.5% when combined with the
conservation buffer.

• Leverage Ratio: A review of the financial crisis of 2008 has indicted that
the value of many assets fell quicker than assumed from historical
experience. Thus, now Basel III rules include a leverage ratio to serve as a
safety net. A leverage ratio is the relative amount of capital to total assets
(not risk-weighted). This aims to put a cap on swelling of leverage in the
banking sector on a global basis. 3% leverage ratio of Tier 1 will be tested
before a mandatory leverage ratio is introduced in January 2018.
Major Features of Basel III
• Liquidity Ratios: Under Basel III, a framework for liquidity risk management
will be created. A new Liquidity Coverage Ratio (LCR) and Net Stable Funding
Ratio (NSFR) are to be introduced in 2015 and 2018, respectively.

I. Liquidity Coverage Ratio (LCR)

 The ratio of the stock of high quality liquid assets to expected net cash
outflows over the following 30 days. (having at least 100% coverage)
 The Liquidity coverage ratio is designed to ensure that financial
institutions have the necessary assets on hand to ride out short-term
liquidity disruptions.
 Highly-liquid assets include Cash or Treasury bonds

II. Net Stable Funding Ratio (NSFR)

 The ratio of available stable funding to required stable funding over a
one year time horizon, assuming a stressed scenario.
Comparison of Basel II and Basel III

Under
Requirements Basel II Basel III
Minimum Ratio of Total Capital To RWAs 9% 11.50%
4.50% to
Minimum Ratio of Common Equity to RWAs 2% 7.00%
Tier I capital to RWAs 5.5% 6.00%
Capital Conservation Buffers to RWAs None 2.50%
Leverage Ratio None 3.00%
Countercyclical Buffer None 0% to 2.50%
100% from
Minimum Liquidity Coverage Ratio None April 1 ,2021
90% from
October
Minimum Net Stable Funding Ratio None 1 ,2021
Risk Weighted Assets for the bank

• RBI assigns risk weights to various assets that bank have depending
upon their probability of default.

e.g. Cash, balances with RBI has 0% risk weight whereas NPA
Investment purchased from other banks has 100% risk weight.

• In India banks are expected to maintain a CAR of 9% and capital

conservation buffer of 2.5% of risk weighted Assets.

• So effective CAR for Indian Banks is 11.5%.

• Moreover RBI has said the common equity in tier-I capital must be 5.5
per cent of risk weighted assets and the minimum tier-I CAR must be
seven per cent.
Tier 1 & Tier 2 Capital
• CAR is the ratio of Bank’s Tier 1 plus tier 2 Capital to the total risk
weighted Assets of the bank.

Tier 1 or Core Capital for the Bank

• Equity Capital
• Disclosed Reserves (or Retained Earnings)
• Non-redeemable Non-cumulative preferred stock

Tier 2 Capital for the Bank

• Undisclosed Reserves
• General Loss Reserves
• Subordinated term debt, and more.