Funding and Regulatory Aspects: CAIIB Paper 2 (Module C), Unit 3

Funding and Regulatory Aspects: CAIIB Paper 2 (Module C), Unit 3

Dear Bankers,
We all know that CAIIB exams are conducted by the Indian Institute of Banking and Finance (IIBF).  CAIIB is said to be one of the difficult courses to be cleared for the bankers. But we assure you that with the help of our “CAIIB study material”, you will definitely clear the CAIIB exam.
CAIIB exams are conducted twice in a year. Candidates should have completed JAIIB before appearing for CAIIB Exam. Here, we will provide detailed notes of every unit of the CAIIB Exam on the latest pattern of IIBF.
So, here we are providing “Unit 3: Funding and Regulatory Aspects” of “Module C: Treasury Management” from “Paper 2: Bank Financial Management (BFM)”

Reserve Assets: CRR and SLR

The Reserve Bank of India is the Note Issuing Authority, that is, the currency in circulation is directly controlled by RBI. However, the currency is only cash component of money in circulation, and in that, it is only a small part of the total money. The cash deposited in banks in turn is lent by the banks, which increases supply of money. If part of the money, so borrowed, is held in a deposit account with the bank, the chain of relending and creating new deposits will continue. It is not only cash, but near cash instruments like cheques and credit cards also add to the money supply (e.g. money spent on credit card is deposited with a bank, adding further money). Creation of money in this fashion is called the money multiplier effect.

Main components of DTL are:

  • Demand deposits (held in current and savings accounts, margin money for LCs, overdue fixed deposits etc.).
  • Time deposits in fixed deposits, recurring deposits, reinvestment deposits etc.).
  • Overseas borrowings.
  • Foreign outward remittances in transit (FC liabilities net of FC assets).
  • Other demand and time liabilities (accrued interest, credit balances in suspense account etc.).

Scheduled Commercial Banks are exempted from maintaining CRR on the following liabilities:

  • Liabilities to the banking system in India as computed under clause (d) of the explanation to Section 42(1) of the RBI Act, 1934.
  • Credit balances in ACU (US$) Accounts.
  • Demand and Time Liabilities in respect of their Offshore Banking Units (OBUs).
  • The eligible amount of incremental FCNR (B) and NRE deposits of maturities of three years and above from the base date of July 26, 2013, and outstanding as on March 7, 2014, till their maturities/ pre-mature withdrawals.
  • Minimum of Eligible Credit (EC) and outstanding Long term Bonds (LB) to finance Infrastructure Loans and affordable housing loans.

The following liabilities are excluded from the CRR stipulation:

  • Paid-up capital, reserves, retained profits, refinance availed from RBI, and apex financial institutions like NABARD and SIDBI.
  • Net income tax provision.
  • Claims received from DICGC, ECGC, Insurance Company (Towards ad-hoc settlement), Court Receiver etc.
  • Liabilities arising on account of utilization of limits under Bankers Acceptance Facility.
  • District Rural Development Agency (DRDA) subsidy of Rs. 10,000/- kept in Subsidy Reserve Fund account in the name of Self Help Groups.
  • Subsidy released by NABARD under Investment Subsidy Scheme for Construction/Renovation/ Expansion of Rural Godowns.
  • Net unrealized gain/loss arising from derivatives transaction under trading portfolio; Income flows received in advance such as annual fees and other charges which are not refundable.
  • Bill rediscounted by a bank with eligible financial institutions as approved by RBI.

The SLR is to be maintained in the form of the following assets:

  • Cash balances (excluding balances maintained for CRR).
  • Gold (valued at price not exceeding current market price).
  • Approved securities valued as per norms prescribed by RBI,

Liquidity Adjustment Facility (LAF)

The Liquidity Adjustment Facility is the principal operating instrument of Reserve bank’s monetary policy. While CRR and SLR help changes in the stance of monetary policy on a more permanent basis LAF is used to monitor day-to-day liquidity in the market.

LAF refers to RBI lending funds to banking sector through Repo instrument. RBI also accepts deposits from banks under Reverse Repo. The process of purchase and sale of government securities, with agreement to sell-back or repurchase respectively, within a predetermined period, has already been referred to in the previous chapter. While banks can engage in repo transactions with other banks/institution, LAF refers exclusively to repo transactions with RBI. Bids have to be submitted for a minimum amount of Rs. 5 crore and in multiples of Rs. 5 crore thereafter.

In order to help banks, to wade through the liquidity constraints, RBI has taken the following measures on February, 3, 2015:

  • Continue to provide liquidity under overnight repos (fixed rate repo) of 0.25% of bank-wise NDTL at the LAF repo rate.
  • Introduced a new window called Variable Rate Repo. Under this window liquidity would be provided for 7 days, 14 days and 28 days. This is also called as Term Repos. The limit fixed by RBI, is under this window, is 0.75% of NDTL of the banking system. Interested banks can avail funds under this route by quoting a rate which should be equal to or above the Repo Rate. The bank which has quoted the highest yield stands a better chance of getting funds under this window.
  • RBI has also phased out the Export Credit Refinance facility.

Payment and Settlement Systems

Payment and settlement systems play a vital role in the development of financial markets. The important reforms relevant to treasury operations include the following:

  • Real Time Gross Settlement System (RTGS) has been fully activated by RBI from October 2004. RTGS is a paperless clearing system, where settlements are on gross basis, rather than day-end net settlement of cheques in a clearing house. All inter-bank payments and customer remittances (currently minimum Rs. 2 lakhs) are settled instantly under the RTGS. Banks’ accounts with all the branch offices of RBI are also integrated. Almost all the urban centres of public and private sector banks are already participating in the RTGS.
  • Negotiated Dealing System is an electronic platform for facilitating dealing in government securities and money market instruments. RBI had introduced the NDS in February 2002, in order to achieve a) automatic electronic reporting and settlement process b) auctions on electronic platform and c) a trading platform for trading in Government securities on a negotiated basis (telephone based trading), as well as quote-driven mechanism. The NDS membership is open to banks, primary dealers, mutual funds, financial institutions and insurance companies, who maintain SGL account with RBI, and also those who have constituent SGL accounts through banks/depository institutions.
  • FX Clear is a forex dealing system developed by CCIL for foreign exchange transactions (USD) INR as well as cross currencies). Currently CCIL is providing straight through processing (STP) for USD/INR, and CCIL as an intermediary settles inter-bank USD/Rupee as well as cross currency deals on net basis, so that individual banks need not exchange payments for each transaction.
  • Depository Institutions like NSDL (National Securities Depository Ltd.) and CSDL (Central Securities Depository Ltd.) provide delivery vs. payment (DVP) for secondary market deals in equity and debt paper. The securities and funds are cleared by their respective clearing houses. Since the funds transfer and securities transfer takes place between the buyer and seller on the electronic platform simultaneously, the settlement risk is eliminated.
  • NEFT and on-line Payments All inter-bank and intra-bank remittances can now be effected on the same day by electronic funds transfer using the National Electronic Funds transfer system introduced by RBI. RBI has developed Structured Financial Messaging System (SFMS) – similar to SWIFT adopted by banks for international funds transfer etc. – where interbank transfers are sorted out and cleared by National Clearing Cell of RBI. Banks which are fully computerized can access any account at any branch on line and debit/credit funds, instantly for inter-bank transfers, without using paper.

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