indian finacial system
TRANSCRIPT
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JAIIB (Module A)
Indian Financial System
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Financial System
An institutional framework existing in a country to
enable financial transactions
Three main parts
Financial assets (loans, deposits, bonds, equities, etc.)
Financial institutions (banks, mutual funds, insurance
companies, etc.)
Financial markets (money market, capital market, forex
market, etc.) Regulation is another aspect of the financial system
(RBI, SEBI, IRDA, FMC)
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Financial assets/instruments
Enable channelising funds from surplus units to
deficit units
There are instruments for savers such as deposits,
equities, mutual fund units, etc. There are instruments for borrowers such as loans,
overdrafts, etc.
Like businesses, governments too raise funds
through issuing of bonds, Treasury bills, etc.
Instruments like PPF, KVP, etc. are available to
savers who wish to lend money to the government
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Financial Institutions
Includes institutions and mechanisms which
Affect generation of savings by the community
Mobilisation of savings
Effective distribution of savings
Institutions are banks, insurance companies,
mutual funds- promote/mobilise savings
Individual investors, industrial and trading
companies- borrowers
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Financial Markets
Money Market- for short-term funds (lessthan a year)
Organised (Banks)
Unorganised (money lenders, chit funds, etc.)
Capital Market- for long-term funds
Primary Issues Market Stock Market
Bond Market
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Organised Money Market
Call money market
Bill Market
Treasury bills Commercial bills
Bank loans (short-term)
Organised money market comprises RBI,
banks (commercial and co-operative)
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Purpose of the money market
Banks borrow in the money market to:
Fill the gaps or temporary mismatch of funds
To meet the CRR and SLR mandatory
requirements as stipulated by the central bank To meet sudden demand for funds arising out of
large outflows (like advance tax payments)
Call money market serves the role ofequilibrating the short-term liquidity positionof the banks
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Call money market (1)
Is an integral part of the Indian money marketwhere day-to-day surplus funds (mostly ofbanks) are traded.
The loans are of short-term duration (1 to 14days). Money lent for one day is called callmoney; if it exceeds 1 day but is less than 15days it is called notice money. Money lent
for more than 15 days is term money
The borrowing is exclusively limited to banks,who are temporarily short of funds.
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Call money market (2)
Call loans are generally made on a clean basis- i.e.
no collateral is required
The main function of the call money market is to
redistribute the pool of day-to-day surplus funds ofbanks among other banks in temporary deficit of
funds
The call market helps banks economise their cash
and yet improve their liquidity
It is a highly competitive and sensitive market
It acts as a good indicator of the liquidity position
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Call Money Market Participants
Those who can both borrow and lend in themarket RBI (through LAF), banks andprimary dealers
Once upon a time, select financial institutionsviz., IDBI, UTI, Mutual funds were allowed inthe call money market only on the lendersside
These were phased out and call moneymarket is now a pure inter-bank market(since August 2005)
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Developments in Money
Market
Prior to mid-1980s participants depended heavily onthe call money market
The volatile nature of the call money market led to
the activation of the Treasury Bills market to reducedependence on call money
Emergence of market repo and collateralisedborrowing and lending obligation (CBLO)instruments
Turnover in the call money market declined from Rs.35,144 crore in 2001-02 to Rs. 14,170 crore in2004-05 before rising to Rs. 21,725 crore in 2006-07
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Bill Market
Treasury Bill market- Also called the T-Bill market These bills are short-term liabilities (91-day, 182-day, 364-
day) of the Government of India
It is an IOU of the government, a promise to pay the stated
amount after expiry of the stated period from the date ofissue
They are issued at discount to the face value and at theend of maturity the face value is paid
The rate of discount and the corresponding issue price aredetermined at each auction
RBI auctions 91-day T-Bills on a weekly basis, 182-day T-Bills and 364-day T-Bills on a fortnightly basis on behalf ofthe central government
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Money Market Instruments (1)
Money market instruments are those which
have maturity period of less than one year.
The most active part of the money market is
the market for overnight call and term money
between banks and institutions and repo
transactions
Call money/repo are very short-term moneymarket products
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Money Market Instruments(2)
Certificates of Deposit
Commercial Paper
Inter-bank participation certificates
Inter-bank term money
Treasury Bills
Bill rediscounting
Call/notice/term money CBLO
Market Repo
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Certificates of Deposit
CDs are short-term borrowings in the form of UPN issued by allscheduled banks and are freely transferable by endorsement anddelivery.
Introduced in 1989
Maturity of not less than 7 days and maximum up to a year. FIsare allowed to issue CDs for a period between 1 year and up to 3years
Subject to payment of stamp duty under the Indian Stamp Act,1899
Issued to individuals, corporations, trusts, funds and associations They are issued at a discount rate freely determined by the
market/investors
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Commercial Papers
Short-term borrowings by corporates, financial institutions,primary dealers from the money market
Can be issued in the physical form (Usance Promissory Note) ordemat form
Introduced in 1990 When issued in physical form are negotiable by endorsement
and delivery and hence, highly flexible
Issued subject to minimum of Rs. 5 lacs and in the multiple of Rs.5 lacs after that
Maturity is 7 days to 1 year Unsecured and backed by credit rating of the issuing company
Issued at discount to the face value
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Market Repos
Repo (repurchase agreement) instruments enablecollateralised short-term borrowing through theselling of debt instruments
A security is sold with an agreement to repurchase it
at a pre-determined date and rate Reverse repo is a mirror image of repo and reflects
the acquisition of a security with a simultaneouscommitment to resell
Average daily turnover of repo transactions (otherthan the Reserve Bank) increased from Rs.11,311crore during April 2001 to Rs. 42,252 crore in June2006
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Collateralised Borrowing and
Lending Obligation (CBLO)
Operationalised as money market instruments bythe CCIL in 2003
Follows an anonymous, order-driven and online
trading system On the lenders side main participants are mutual
funds, insurance companies.
Major borrowers are nationalised banks, PDs and
non-financial companies The average daily turnover in the CBLO segment
increased from Rs. 515 crore (2003-04) to Rs. 32,390 crore (2006-07)
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Indian Banking System
Central Bank (Reserve Bank of India)
Commercial banks (222)
Co-operative banks
Banks can be classified as: Scheduled (Second Schedule of RBI Act, 1934) - 218
Non-Scheduled - 4
Scheduled banks can be classified as:
Public Sector Banks (28) Private Sector Banks (Old and New) (27)
Foreign Banks (29)
Regional Rural Banks (133)
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Indigenous bankers
Individual bankers like Shroffs, Seths, Sahukars,
Mahajans, etc. combine trading and other business
with money lending.
Vary in size from petty lenders to substantial shroffs Act as money changers and finance internal trade
through hundis (internal bills of exchange)
Indigenous banking is usually family owned
business employing own working capital
At one point it was estimated that IBs met about
90% of the financial requirements of rural India
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RBI and indigenous bankers (1)
Methods employed by the indigenous bankers are
traditional with vernacular system of accounting.
RBI suggested that bankers give up their trading
and commission business and switch over to thewestern system of accounting.
It also suggested that these bankers should develop
the deposit side of their business
Ambiguous character of the hundi should stop
Some of them should play the role of discount
houses (buy and sell bills of exchange)
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RBI and indigenous bankers (2)
IB should have their accounts audited by certified
chartered accountants
Submit their accounts to RBI periodically
As against these obligations the RBI promised toprovide them with privileges offered to commercial
banks including
Being entitled to borrow from and rediscount bills with RBI
The IBs declined to accept the restrictions as well as
compensation from the RBI
Therefore, the IBs remain out of RBIs purview
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Development Oriented
Banking
Historically, close association between banks and
some traditional industries- cotton textiles in the
west, jute textiles in the east
Banking has not been mere acceptance of depositsand lending money; included development banking
Lead Bank Scheme- opening bank offices in all
important localities
Providing credit for development of the district
Mobilising savings in the district. Service area
approach
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Progress of banking in India (1)
Nationalisation of banks in 1969: 14 banks were
nationalised
Branch expansion: Increased from 8260 in 1969 to
71177 in 2006 Population served per branch has come down from
64000 to 16000
A rural branch office serves 15 to 25 villages within
a radius of 16 kms
However, at present only 32,180 villages out of 5
lakh have been covered
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Progress of banking in India (2)
Deposit mobilisation:
1951-1971 (20 years)- 700% or 7 times
1971-1991 (20 years)- 3260% or 32.6 times
1991- 2006 (11 years)- 1100% or 11 times
Expansion of bank credit: Growing at 20-30%p.a. thanks to rapid growth in industrial andagricultural output
Development oriented banking: priority sectorlending
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Progress of banking in India (3)
Diversification in banking: Banking has
moved from deposit and lending to
Merchant banking and underwriting
Mutual funds
Retail banking
ATMs
Internet banking Venture capital funds
Factoring
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Profitability of Banks(1)
Reforms have shifted the focus of banks from
being development oriented to being
commercially viable
Prior to reforms banks were not profitable
and in fact made losses for the following
reasons:
Declining interest income Increasing cost of operations
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Profitability of banks (2)
Declining interest income was for the
following reasons:
High proportion of deposits impounded for CRR
and SLR, earning relatively low interest rates
System of directed lending
Political interference- leading to huge NPAs
Rising costs of operations for banks wasbecause of several reasons: economic and
political
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Profitability of Banks (3)
As per the Narasimham Committee (1991) the
reasons for rising costs of banks were:
Uneconomic branch expansion
Heavy recruitment of employees Growing indiscipline and inefficiency of staff due to trade
union activities
Low productivity
Declining interest income and rising cost of
operations of banks led to low profitability in the 90s
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Bank profitability: Suggestions
Some suggestions made by NarasimhamCommittee are:
Set up an Asset Reconstruction Fund to take over
doubtful debts SLR to be reduced to 25% of total deposits
CRR to be reduced to 3 to 5% of total deposits
Banks to get more freedom to set minimum
lending rates Share of priority sector credit be reduced to 10%
from 40%
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Suggestions (contd)
All concessional rates of interest should be removed
Banks should go for new sources of funds such as
Certificates of Deposits
Branch expansion should be carried out strictly oncommercial principles
Diversification of banking activities
Almost all suggestions of the Narasimham
Committee have been accepted and implemented in
a phased manner since the onset of Reforms
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NPA Management
The Narasimham Committeerecommendations were made, among otherthings, to reduce the Non-Performing Assets
(NPAs) of banks To tackle this the government enacted the
Securitization and Reconstruction ofFinancial Assets and Enforcement of Security
Act (SARFAESI) Act, 2002 Enabled banks to realise their dues without
intervention of courts
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The Indian Capital Market (1)
Market for long-term capital. Demand comes
from the industrial, service sector and
government
Supply comes from individuals, corporates,
banks, financial institutions, etc.
Can be classified into:
Gilt-edged market
Industrial securities market (new issues and stock
market)
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The Indian Capital Market (2)
Development Financial Institutions
Industrial Finance Corporation of India (IFCI)
State Finance Corporations (SFCs)
Industrial Development Finance Corporation (IDFC) Financial Intermediaries
Merchant Banks
Mutual Funds
Leasing Companies Venture Capital Companies
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Industrial Securities Market
Refers to the market for shares anddebentures of old and new companies
New Issues Market- also known as theprimary market- refers to raising of newcapital in the form of shares and debentures
Stock Market- also known as the secondarymarket. Deals with securities already issuedby companies
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Financial Intermediaries (1)
Mutual Funds- Promote savings and mobilise fundswhich are invested in the stock market and bondmarket
Indirect source of finance to companies
Pool funds of savers and invest in the stockmarket/bond market
Their instruments at savers end are called units
Offer many types of schemes: growth fund, incomefund, balanced fund
Regulated by SEBI
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Financial Intermediaries (2)
Merchant banking- manage and underwrite new
issues, undertake syndication of credit, advise
corporate clients on fund raising
Subject to regulation by SEBI and RBI SEBI regulates them on issue activity and portfolio
management of their business.
RBI supervises those merchant banks which are
subsidiaries or affiliates of commercial banks
Have to adopt stipulated capital adequacy norms
and abide by a code of conduct
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Conclusion
There are other financial intermediaries such
as NBFCs, Venture Capital Funds, Hire and
Leasing Companies, etc.
Indias financial system is quite huge and
caters to every kind of demand for funds
Banks are at the core of our financial system
and therefore, there is greater expectationfrom them in terms of reaching out to the vast
populace as well as being competitive.
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Money
Money is any good that is widely used and
accepted in transactions involving the transfer
of goods and services from one person to
another.
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Types of money
Commodity money-is a good whose value
serves as the value of money. Gold coin are
example of it.
Flat money- flat money is a good, the value of
which is less than the value it represents as
money, e.g. dollar bill.
Bank money-consists of the book credit thatbank extend to their depositors. Transactions
made using cheques drawn on deposits held
at banks involve the use of bank money.
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Definition of money
Crowther stats that Anything that is generallyaccepted as a means of exchange and that at
the same time acts as a measure and as a
store value. This definition covers three major function of
money that is exchange, measure of value
and store of value.
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Function of Money
Prof. Kenley has divided money in the followingthree heads:
Primary functions-
(1) Medium of Exchange- to facilitate transactions. With out money all transaction would be conducted
by barter.
(2) Measure of value.
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Money
Secondary functions-
Standard for deferred payments- payment that
have to be made at later stage.
Store of value- in order to be a medium ofexchange, money must hold its value over time; it
must be a store of value.
Transfer of value- it also use as a transfer of due
from one place to other.
Money as liquid assets.
Money as guarantor of solvency- e.g. bank pay
deposit to depositors.
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Money
Money as a bearer of options
Unit of accounts
Contingent functions- beside other primaryand secondary functions, money also play
four contingent functions-
Distributor of joint product
Equalizer of marginal and productivity
Basic of credit
Give generic value to capital and wealth
T f
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Types of money
On the basic of Accountability Legal tender-(1) limited legal tender eg. Coins (2)
Unlimited legal tender
Optional money-is a non legal tender eg. Like
cheques, Bank OD, are option money. On the basic of material used-(A) Metallic Money-
mainly Standard money or token money.
(a) Standard money- also know as fully bodied
money. It generally made through gold and silver.
(b) Tokan Money-its face value is always higher
than its intrinsic value and fully under control of
GOI. One Rupee is example of it.
P
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Paper money-
(B) Paper money- it made of paper.
(1)Representative paper money-such type of money isfully backed by gold or silver and is redeemable at the
option of the holder in gold, e.g. American gold and
silver certification (1927).
(2)Convertible paper money-this type of money isconvertible into standard corns at any time at the
option of holder. 100% of backup not require.
(3) Non-convertible paper money-e.g. one rupee
(4) Flat money- its another type of non-convertiblepaper money which is generally issued without any
back of gold, silver or government securities.
It is issued by GOI under extra circumstances. E.g.
German mark issued after World War one.
4 Money and Near Money the liquidity
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4. Money and Near Money- the liquidity
basic & 5. Credit money or Bank Money
(a) Liquid form of Money: Money has aqualify of general acceptability which makes
it, most liquid of assets. E.g. coins, currency
and bank money are the most liquid form of
money or 100% liquid. (2) Near- Money: Certain assets not as liquid
as money but can be easily convertible in to
money, e.g. are NSD, FD, Share etc. thistype of money can be call Near money
Quasi-Money orLiquidMoney.
5. Credit Money
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Demand for Money
Transactions motive- most transactiondemand money for exchange.
Precautionary Motive- people of demand
money as precaution against future. Speculative Motive- Money is like an assets.
the demand for an assets depends on both
its ROI and opportunity cost.
Importance of Money Capitalistic
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p y p
Economic
Capitalistic economic recognizes the right ofindividual property.
It is free from all government control.
All factors of production are owned, controlled& operated by private entrepreneurs.
Profit motive is prime motive in capitalistic
economic.
Money is the blood of capitalistic economic.
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Importance of Money Capitalistic
Economic
Consumer can make a ration be choice ofgoods- price mechanism help in their
decision.
Production decisions are based on money. Money simplifies the distribution system-
share of remuneration.
Decision regarding saving and spending. Price mechanism regulates the flow of
investment.
Money is the basis of credit which is soul of
Importance of money in
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Importance of money in
socialistic economic
A socialist economic is one in which alleconomic activities are planned, controlled and
guided by Government or its agencies.
In this type of economic, there is no free market
as no right of property to individual.
Socialists believe that money is the root cause of
exploitation of labour by capitalist.
In this economic money would be abolished and
goods would be exchanged for goods.
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Importance of money in
socialistic economic
Guide to economic activities.
Allocation of resources. Distribution of Income
Importance of Money in a
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Importance of Money in a
planned economic
It has a important role to play in a developing
planned economic. It generally followed in underdeveloped
countries.
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Interest
In economics, interest is considered the price
of credit.
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Interest
Interest is a fee paid on borrowed assets.
It is the price paid for the use of borrowed
money or, money earned by deposited funds.
Assets that are sometimes lent with interest
include money, shares, consumer goods
through hire purchase, major assets such as
aircraft, and even entire factories in financelease arrangements.
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Interest
Interest can be thought of as "rent of money".
When money is deposited in a bank, interest
is typically paid to the depositor as apercentage of the amount deposited; when
money is borrowed, interest is typically paid
to the lender as a percentage of the amountowed.
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Types of Interest
Simple interest
Simple interest is calculated only on the principle
amount, or on that portion of the principle amount that
remains unpaid.
For example, imagine that a credit card holder has an
outstanding balance of Rs. 2500 and that the simple
interest rate is 12.99% per annum. The interest added at
the end of 3 months would be,
and he would have to pay Rs. 2581.19 to pay off the
balance at this point.
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Compound interest
Compound interest is very similar to simple
interest; however, with time, the difference
becomes considerably larger.
This difference is because unpaid interest is
added to the balance due.
Put another way, the borrower is charged
interest on previous interest. Assuming that no part of the principal or
subsequent interest has been paid, the debt
is calculated by the following formulas:
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Compound interest
For example, if the credit card holder above
chose not to make any payments, the interest
would accumulate
So, at the end of 3 months the credit card
holder's balance would be Rs. 2582.07 and
he would now have to pay Rs. 82.07 to get it
down to the initial balance.
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Fixed and floating rates
Commercial loans generally use simple interest,
but they may not always have a single interest
rate over the life of the loan.
Loans for which the interest rate does notchange are referred to as fixed rate loans.
Loans may also have a changeable rate over
the life of the loan based on some reference rate
(such as LIBOR and EURIBOR), usually plus (or
minus) a fixed margin.
These are known as floating rate, variable rate
or adjustable rate loans.
Flat Rate Loans and the Rule of
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Flat Rate Loans and the Rule of
78s:
Some consumer loans have been structured as flat rateloans, with the loan outstanding determined by allocating
the total interest across the term of the loan by using the
"Rule of 78s" or "Sum of digits" method.
Seventy-eight is the sum of the numbers 1 through 12,
inclusive.
The practice enabled quick calculations of interest in the
pre-computer days.
In a loan with interest calculated per the Rule of 78s, the
total interest over the life of the loan is calculated as
either simple or compound interest and amounts to the
same as either of the above methods.
Market interest rates
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Market interest rates There are markets for investments (which
include the money market, bond market, as wellas retail financial institutions like banks) set
interest rates.
Each specific debt takes into account the
following factors in determining its interest rate:
Opportunity cost
Inflation
Default Default Interest
Length of time
What is CRR repo and reverse
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What is CRR, repo and reverse
repo rate?
Cash reserve Ratio (CRR) is the amount of funds that
the banks have to keep with the RBI.
If the central bank decides to increase the CRR, the
available amount with the banks comes down.
The RBI uses the CRR to drain out excessive money
from the system.
Commercial banks are required to maintain with
the RBI an average cash balance, the amount of which
shall not be less than 3% of the total of the Net Demand
and Time Liabilities (NDTL), on a fortnightly basis and
the RBI is empowered to increase the rate of CRR to
such higher rate not exceeding 20% of the NDTL.
What is Reverse Repo rate?
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What is Reverse Repo rate?
Reverse Repo rate is the rate at whichthe RBI borrows money from commercial banks.
Banks are always happy to lend money to the
RBI since their money are in safe hands with a
good interest.
An increase in reverse repo rate can prompt
banks to park more funds with the RBI to earn
higher returns on idle cash. It is also a tool which can be used by the RBI to
drain excess money out of the banking system.
What is a Repo Rate?
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What is a Repo Rate?
The rate at which the RBI lends money tocommercial banks is called repo rate. It is an
instrument ofmonetary policy. Whenever
banks have any shortage of funds they can
borrow from the RBI.
A reduction in the repo rate helps banks get
money at a cheaper rate and vice versa. The
repo rate in India is similar to the discountrate in the US.
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