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BASEL III COMPLIANCE OF THE PSBS & RRBS
The capital to risk weighted assets ratio (CRAR) of the scheduled commercial banks of India was 13.02 per cent by March 2014 (Basel-III) falling to 12.75 per cent by September 2014. The regulatory requirement for CRAR is 9 per cent for 2015. The decline in capital positions at aggregate level, however, was on account of deterioration in capital positions of PSBs. While the CRAR of the scheduled commercial banks (SCB) at 12.75 per cent as of September 2014 was satisfactory, going forward the banking sector, particularly PSBs will require substantial capital to meet regulatory requirements with respect to additional capital buffers.
In order to make the PSBs and RRBs compliant to the Basel III norms,49 the government has been following a recapitalisation programme for them since 2011–12. A High Level Committee on the issue was also set up by the government which has suggested the idea of ‘non-operating holding company’ (HoldCo) under a special Act of Parliament (action is yet to come regarding this).
Meanwhile, the government has infused three tranches of capital into the banks (infused funds go to the RRBs, too through the PSBs under whom they fall) upto March 2015:
(i) Rs. 12,000 crore infused during 2012–13 in seven PSBs.
(ii) Rs. 12,517 crore infused in 2013–14 in 8 PSBs.
(iii) In 2014–15, the PSBs were recapitalised with Rs. 6,990 crore. This capital infusion was based on some new criteria— asset quality , efficiency and strength of the banks.
(iv) During 2015–16, the government released Rs. 19,950 crore to 13 PSBs
(Economic Survey 2015–16).
(v) For the year 2016-17, the government has announced a sum of Rs. 25,000 crore for the purpose of recapitalising the PSBs (Union Budget 2016–17).
Given the deterioration in asset quality and gradual implementation of Basel III norms, PSBs will have to improve their capital positions to meet unforeseen losses in future. The estimated capital requirement (excluding internal generated profit) for the next four years up to 2018-19 is likely to be about Rs. 1,80,000 crore. Of this total requirement, the Government of India proposes to make Rs. 70,000 crore available out of budgetary allocations during 2016–17 and 2017–18.
In every economy it is necessary for the central bank to know the stock (amount/level) of money available in the economy only then it can go for suitable kind of credit and monetary policy. Saying simply, credit and monetary policy of an economy is all about changing the level of the money flowing in the economic system. But it can be done only when we know the
real flow of money. That’s why it is necessary to first assess the level of money flowing in the economy.
Following the recommendations of the Second Working Group on Money Supply (SWG) in 1977, RBI has been publishing four monetary aggregates (component of money), viz., M1, M2, M3 and M4
(are basically short terms for Money-1, 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.
M 2 = M1+ Demand deposits of the post offices (i.e., saving schemes’ money).
M 3 = M1+ Time/Term deposits of the Banks (i.e., the money lying in the Recurring Deposits & the fixed Deposits).
M 4 = M3+ total deposits of the post offices (both, Demand and Term/Time Deposits).
Now the RBI has started50 publishing a set of new monetary aggregates following the recommendations of the Working Group on Money Supply: Analytics and Methodology of Compilation (Chairman, Dr. Y. V. Reddy) which submitted its report in June 1998. The Working Group recommended compilation of four monetary aggregates on the basis of the balance sheet of the banking sector in conformity with the norms of progressive liquidity: M ♤ (monetary base), M1 (narrow money), M2 and M3 (broad money). In addition to the monetary aggregates, the Working Group had recommended compilation of three liquidity aggregates namely, L1, L2 and L3, which include select items of financial liabilities of non-depository financial corporations such as development financial institutions and non-banking financial companies accepting deposits from the public, apart from post office savings banks. The New Monetary Aggregates are as given below:
Reserve Money (M0) = Currency in circulation + Bankers’ Deposits with the RBI + ‘Other’51 deposits with the RBI.
Narrow Money (M1) = Currency with the Public + Demand Deposits with
the Banking System + ‘Other’ deposits with the RBI. M2 = M1 + Savings Deposits of Post-office Savings Banks.
Broad Money (M3) = M1 + Time Deposits with the Banking System.
M4 = M3 + All deposits with Post Office Savings Banks (excluding National Savings Certificates).
While the Working Group did not recommend any change in the definition of reserve money and M1, it proposed a new intermediate monetary aggregate to be referred to as NM2 comprising currency and residents’ short- term bank deposits with contractual maturity up to and including one year, which would stand in between narrow money (which includes only the non- interest-bearing monetary liabilities of the banking sector) and broad money (an all-encompassing measure that includes long-term time deposits). The new broad money aggregate (referred to as NM3 for the purpose of clarity) in the Monetary Survey would comprise, in addition to NM2, long-term deposits of residents as well as call/term borrowings from non-bank sources, which have emerged as an important source of resource mobilisation for banks. The critical difference between M3 and NM3 is the treatment of non-resident repatriable fixed foreign currency liabilities of the banking system in the money supply compilation.
There are two basic changes in the new monetary aggregates. First, since the post office bank is not a part of the banking sector, postal deposits are no longer treated as part of money supply, as was the case in the extant M2 and M4. Second, the residency criterion was adopted to a limited extent for compilation of monetary aggregates. The Working Group made a recommendation in favour of compilation of monetary aggregates on residency basis. Residency essentially relates to the country in which the holder has a centre of economic interest. Holdings of currency and deposits by the non-residents in the rest of the world sector, would be determined by their portfolio choice. However, these transactions form part of balance of payments (BoP). Such holdings of currency and deposits are not strictly related to the domestic demand for monetary assets. It is therefore argued that these transactions should be regarded as external liabilities to be netted from foreign currency assets of the banking system. However, in the context of
developing countries such as India, which have a large number of expatriate workers who remit their savings in the form of deposits, it could be argued that these non-residents have a centre of economic interest in their country of origin. Although in a macro-economic accounting framework all non-resident deposits need to be separated from domestic deposits and treated as capital flows, the underlying economic reality may point otherwise. In the Indian context, it may not be appropriate to exclude all categories of non-resident deposits from domestic monetary aggregates as non-resident rupee deposits are essentially integrated into the domestic financial system. The new monetary aggregates, therefore, exclude only non-resident repatriable foreign currency fixed deposits from deposit liabilities and treat those as external liabilities. Accordingly, from among the various categories of non-resident deposits at present, only Foreign Currency Non-Resident Accounts (Banks) [FCNR(B)] deposits are classified as external liabilities and excluded from the domestic money stock. Since the bulk of the FCNR(B) deposits are held abroad by commercial banks, the monetary impact of changes in such deposits is captured through changes in net foreign exchange assets of the commercial banks. Thus, now the new monetary aggregates NM2 and NM3 as well as liquidity aggregates L1, L2, and L3 have been introduced, the components of which are elaborated as follows:
NM1 = Currency with the Public + Demand Deposits with the Banking System + ‘Other’ Deposits with the RBI.
NM2 = NM1 + Short Term Time Deposits of Residents (including the contractual maturity of one year).
NM3 = NM2 + Long-term Time Deposits of Residents + Call/Term Funding from Financial Institutions.
L1 = NM3 + All Deposits with the Post Office Savings Banks (excluding National Savings Certificates)
L2 = L1 + Term deposits with Term Lending Institutions and Refinancing Institutions (FIs) + Term Borrowing by FIs + Certificates of Deposit issued by FIs
L3 = L2 + Public Deposits of Non-Banking Financial Companies.
Data on M ♤ are published by the RBI on weekly basis, while those for M1
and M3 are available on fortnightly basis. Among liquidity aggregates, data on L1 and L2 are published monthly, while those for L3 are disseminated quarterly. The working group advised for the quarterly publication of Financial Sector Survey to capture the dynamic linkages between banks and rest of the organised financial sector.
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.
In banking terminology, M1 is called narrow money as it is highly liquid and banks cannot run their lending programmes with this money.
The money component M3 is called broad money in the banking terminology. With this money (which lies with banks for a known period) banks run their lending programmes.
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 of India, 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 per cent in 2009–10.
The central banks of all the countries are empowered to issue the currency. The currency issued by the central bank is called ‘high power money’ because it is generally backed by supporting ‘reserves’ and its value is guaranteed by the government and it is the source of all other forms of money. The currency issued by the central bank is, in fact, is a liability of the central bank and the government. In general, therefore, this liability must be backed by an equal value of assets consisting mainly, gold and foreign exchange reserves. In practice, however, most countries# have adopted a ‘minimum reserve system’.
Under the minimum reserve system the central bank is required to keep a certain minimum ‘reserve of gold and foreign securities and is empowered to issue currency to any extent. India adopted this system in October 1956. The RBI was required to hold a reserve worth of only
Rs 515 crore consisting of foreign securities worth Rs 400 crore and gold worth Rs 115 crore. In 1957, however, the minimum reserves were further reduced to only gold reserve of Rs 115 crore and the rest in the form of rupee securities, mainly due to the scarcity of foreign exchange to meet essential import bill. A gold reserve of Rs. 115 crore against the currency of Rs. 17,00,000 crore in circulation today, makes only 0.7 per cent reserve which is of no consequence. This makes the Indian currency system a ‘managed paper currency system’. In India, there are two sources of high power money supply:
(i) RBI; and
(ii) Government of India.
The RBI issues currency notes of rupees 2, 5, 10, 20, 50, 100, and 2000 denominations which RBI calls as the ‘Reserve Money’. The RBI issues currency of one rupee notes and coins including coins of smaller denominations on behalf of the Government of India which accounts for around 2 per cent of the total high power money.
The RBI 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).
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.
At end March 2012, the money multiplier (ratio of M3 to M0) was 5.2, higher than end-March 2015, due to cumulative 125 basis point reduction in CRR. During 2012–13, the money multiplier generally stayed high reflecting again, the CRR cuts. As on 31 December, 2014, the money multiplier was 5.5 compared with 5.2 on the corresponding date of the previous year (Economic
Survey 2014–15).
Advising borrowers to overcome their debt burden and improve money management skills is credit counselling. The first such well-known agency was created in the USA when credit granters created National Foundation for Credit Counselling (NFCC) in 1951.52
India’s sovereign debt is usually rated by six major sovereign credit rating agencies (SCRAs) of the world which are :
(i) Fitch Ratings,
(ii) Moody’s Investors Service,
(iii) Standard and Poor’s (S&P),
(iv) Dominion Bond Rating Service (DBRS),
(v) Japanese Credit Rating Agency (JCRA), and
(vi) Rating and Investment Information Inc., Tokyo (R&I).
As on 15 January, 2013 most of these rating agencies have put India under ‘stable’ category in foreign and local currencies barring Fitch and S&P which have put its foreign currency
in ‘negative’ category. The government is taking a number of steps to improve its interaction
with the major SCRAs so that they make informed decisions as the Economic Survey 2012–13 says.
To assess the credit worthiness (credit record, integrity, capability) of a prospective (would be) borrower to meet debt obligations is credit rating. Today it is done in the cases of individuals, companies and even countries. There are some world-renowned agencies such as the Moody’s,
S & P. The concept was first introduced by John Moody in the USA (1909). Usually equity share is not rated here. Primarily, ratings are an investor service.
Credit rating was introduced in India is 1988 by the ICICI and UTI, jointly.
The major credit rating agencies of India are:
(i) CRISIL (Credit Rating Information of India Ltd.) was jointly promoted by ICICI and UTI with share capital coming from SBI, LIC, United India Insurance Company Ltd. to rate debt instrument—debenture. In April 2005 its 51 per cent equity was acquired by the US credit rating agency S & P—a McGraw Hill Group of Companies.
(ii) ICRA (Investment Information and Credit Rating Agency of India Ltd.) was set up in 1991 by IFCI, LIC, SBI and select banks as well as financial institutions to rate debt instruments.
(iii) CARE (Credit Analyses and Research Ltd.) was set up in 1993 by IDBI, other financial institutions, nationalised banks and private sector finance companies to rate all types of debt instruments.
(iv) ONICRA (Onida Individual Credit Rating Agency of India Ltd.) was set up by ONIDA finance (a private sector finance company) in 1995 to rate credit-worthiness of non-corporate consumers and their debt instruments, i.e., credit cards, hire-purchase, housing finance, rental agreements and bank finance.
(v) SMERA (Small and Medium Enterprises Rating Agency) was set up in September 2005, to rate the overall strength of small and medium enterprises (SMEs)—the erstwhile SSIs. It is not a credit rating agency precisely, but its ratings are used for this purpose, too. A joint venture of SIDBI (the largest share-holder with 22 per cent stake), SBI, ICICI Bank, Dun & Bradstreet (an international credit information company), five public sector banks (PNB, BOB, BOI, Canara Bank, UBI with 28 per cent stake together) and CIBIL (Credit Information Bureau of India Ltd.).
A general credit rating service not linked to any debt issue is also availed by companies—already offered in India by rating agencies— CRISIL calls such ratings as Credit Assessment.53 International rating agencies such as Moody’s, S & P also undertake sovereign ratings, i.e., of countries—highly instrumental in external borrowings of the countries.
Individuals are also covered by credit appraisal which is on useful information for the consumer credit firms. To maintain a database on the credit records of individuals the credit Information Bureau of India Limited (CIBIL) was set up in May 2004 which makes credit informations available to banks and financial institutions about prospective individual borrowers54