indicators in banking system
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An assignment submitted to Miss Sonali Patnaik, Faculty, VISWASS, BhubaneswarTRANSCRIPT
The Role of Financial Indicators in Banking System
AN ASSIGNMENT ON
“THE ROLE OF FINANCIAL INDICATORS IN THE BANKING SYSTEM”
Submitted to:
Ms. SONALI PATTNAIK
Faculty,
P.G. Deptt. of Finance, VISWASS
Submitted by:
Ms. SHRADHANJALEE PANDA, MFC, 2nd Year
Ms. SUBHADRA NYAYAPATHI, MFC, 2nd Year, and
Mr. SANTOSH KUMAR SAHOO, MFC, 2nd Year
VIVEKANANDA INSTITUTE OF SOCIAL WORK AND SOCIAL SCIENCES
(AFFILIATED TO UTKAL UNIVERSITY)
BAPUJI NAGAR, BHUBANESWAR-751009
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The Role of Financial Indicators in Banking System
INTRODUCTION
India has had a long history of banking in so far as purveying of credit is concerned.
There are references to lending for interest and the social-religious sanctions governing the
norms relating to these activities even in the ancient Indian scriptures like Manusmriti and
Arthasastra. However, some Madras-based officers of the East India Company as it is
understood today attempted the establishment of banking of the western-type only as early as
1683.
Today Indian banking has come a long way since then in terms complexity of operations
and the elaborates of the structure. The Indian banking structure comprises a heterogeneous
mass covering a wide spectrum ranging from the unorganized indigenous bankers at the one
end to the foreign banks at the other. Unlike a small drop of water that has the ability to create
waves on the entire surface of a pond, likewise there are some financial indicators that affect
the total banking system and impact the operations and solvency of the banking industry. These
indicators play an important role for the smooth and sustainable functioning and growth of the
banking system as well as the economy as a whole.
FINANCIAL INDICATORS AND THEIR ROLE IN BANKING SYSTEM
In this fast changing world of LPG (Liberalisation, Privatisation and Globalisation) where
hundreds of “Lehman Brothers” became bankrupt within a fraction of moment, it has became
necessary to look in to the financial market and towards the financial indicators to formulate
proactive as well as reactive strategies. Some of the most effective indicators playing an
important role in the banking system are:
1. The Cash Reserve Ratio (CRR)
2. The Statutory Liquidity Ratio (SLR)
3. The Bank Rate
4. Repo Rate and Reverse Repo Rate
5. Capital Adequacy Ratio
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The Role of Financial Indicators in Banking System
6. Prime Lending Rate (PLR)
7. Call Rate
8. Coupon Rate
9. The MIBID and MIBOR
10. Priority Sector Lending (PSL)
11. Gold Price
12. Gross Domestic Product (GDP)
13. Exchange Rate
14. Rate of Inflation
15. Rate of Savings
16. Stock Market Indices
The indicators and the role they play in the banking system are discussed below:
1. CASH RESERVE RATIO (CRR)
CRR is the amount of cash reserve that is required to be maintained by every bank in
India, (other than a scheduled bank) by way of cash reserve either with itself or in
current with RBI, SBI, or any other notified bank or partly with itself and partly in such
current account.
It is computed as a percentage on the total Demand and Time Liabilities (DTL) of the
bank.
It’s a statutory requirement stipulated under section 18 of the Banking Regulation Act,
1949.
Presently, the CRR is 5% as fixed by the RBI.
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The Role of Financial Indicators in Banking System
Role of CRR:
If the RBI wants to put a check on credit expansion, it raises the CRR,
conversely when it is required to induce, to facilitate credit expansion, the
CRR is lowered.
The main purpose of the CRR is to safeguard the liquidity position of the
banks in the interest of the depositors.
It’s a technique that is used by RBI as a monetary instrument to control the
money supply in the economy.
At the time of inflation, to curtail money supply from the economy the CRR is
increased and at the time of deflation to provide much money to the economy
the CRR is minimized.
High CRR is resulting in impounding the cash resources of the banks and
their ability to expand credit.
2. STATUTORY LIQUIDITY RATIO (SLR)
Statutory Liquidity Ratio or SLR refers to the amount that all banks require to maintain in
cash or in the form of Gold (valued at a price not exceeding the current market price) or
approved securities (Unencumbered approved securities like bond and shares of
different companies including Government securities or Gilts priced by RBI).
The quantum is specified as some percentage of the total demand and time liabilities
(i.e. the liabilities of the bank which are payable on demand anytime, and those liabilities
which are accruing in one month’s time due to maturity) of the bank.
Presently the SLR is 24% with effect from 8 November, 2008.
SLR plays an important role;
To restrict the expansion of bank credit.
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The Role of Financial Indicators in Banking System
To augment the investment of the banks in Government securities.
To ensure solvency of banks by maintaining liquidity.
3. BANK RATE
Bank Rate, also referred to as the discount rate, is the rate of interest which a central
bank charges on the loans and advances that it extends to commercial banks and other
financial intermediaries.
Changes in the bank rate are often used by central banks to control the money supply.
A central bank adjusts the supply of currency within national borders by adjusting the
bank rate.
When the central bank reduces the bank rate, it increases the attractiveness for
commercial banks to borrow, thus increasing the money supply.
When the central bank increases the bank rate, it decreases the attractiveness for
commercial banks to borrow, consequently decreasing the money supply.
4. REPO RATE AND REVERSE REPO RATE
Repo comes from the repurchasing agreement. Repos are classified as a money-market
instrument that is usually used to raise short-term capital.
Whenever the banks have any shortage of funds they can borrow it either from Reserve
Bank of India |RBI] or from other banks. The repo rate is the rate at which the banks
borrow these excess funds. The borrowing bank mortgages its government securities to
carry out this loan transaction.5
The Role of Financial Indicators in Banking System
A reduction in the repo rate will help banks to get money at a cheaper rate. When the
repo rate increases borrowing from RBI becomes more expensive.
A reverse repo is simply the same repurchase agreement from the buyer's viewpoint, not
the seller's. Hence, the seller executing the transaction would describe it as a "repo",
while the buyer in the same transaction would describe it a "reverse repo".
So "repo" and "reverse repo" are exactly the same kind of transaction, just described
from opposite viewpoints.
In a reverse repo Reserve Bank borrows money from banks by lending securities. The
interest paid by Reserve Bank in this case is called reverse repo rate.
5. CAPITAL ADEQUACY RATIO
Capital adequacy ratio (CAR), also called Capital to Risk (Weighted) Assets
Ratio (CRAR), is a ratio of a bank's capital to its risk. National regulators track a
bank's CAR to ensure that it can absorb a reasonable amount of loss and are complying
with their statutory capital requirements.
There are two types of capital which are measured: tier one capital, which can absorb
losses without a bank being required to cease trading, and tier two capital, which can
absorb losses in the event of a winding-up and so provides a lesser degree of protection
to depositors.
It can be calculated as:
Capital adequacy ratio is the ratio which determines the capacity of the bank in terms of
meeting the time liabilities and other risk such as credit risk, operational risk, etc.
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The Role of Financial Indicators in Banking System
In the most simple formulation, a bank's capital is the "cushion" for potential losses,
which protect the bank's depositors or other lenders.
Banking regulators in most countries define and monitor CAR to protect depositors,
thereby maintaining confidence in the banking system.
6. PRIME LENDING RATE (PLR)
Prime lending rate is the rate of interest at which banks lend to their credit-worthy or
favoured customers. It is treated as a benchmark rate for most retail and term loans.
The RBI does not set these rates, but in a broad way stipulates the interest rates in the
economy. The banks are at liberty to lend at a rate above or below the RBI’s.
The PLR is influenced by RBI’s policy rates — the repo rate and cash reserve ratio —
apart from the bank’s policy. In simple words, availability of funds in the banking system
and demand for credit by consumers (both retail and industrial) determine what the PLR
should be.
Excessive money in the economy leads to inflationary trends. To control inflation,
government may curb the money supply by increasing the lending rates or PLR. When
RBI increases the PLR, banks may follow suit, making borrowing a costlier affair.
This hike in lending rates is bound to negatively impact businesses/industries which
depend on banks for their working capital and expansion requirements.
A lower rate increases liquidity by making all loans (fixed or floating) less expensive and,
therefore, easier to access.
Private Banks, which usually lend at rates higher than the nationalised banks are
expected to follow suit. This cut reduces the cost of term loans for corporate houses.
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The Role of Financial Indicators in Banking System
Normally, deposit rates follow lending rates. When lending rates fall, one can expect a
slash in deposit rates from banks too. So, risk-averse investors may soon have to look
out for better return yielding investments, as bank deposits may lose sheen.
7. CALL RATE
Call Rate refers to the interest rate on short-term secured loans that can be called, or
cancelled, by giving a 24-hour notice. It is the inter-bank interest rate on funds that are
not deposited for a fixed period.
The fluctuations in the call rate makes the short-term credits cheap or costly ultimately
affecting the corporate as well as the trading firms to charge more on their products as
indirect cost. Hence, it increases the cost of production and the price of the product as
well.
8. COUPON RATE
The coupon or coupon rate of a bond is the amount of interest paid per year expressed
as a percentage of the face value of the bond. It is the interest rate that a bond issuer
will pay to a bondholder.
There is a direct relationship between bank deposits and the coupon rate. When the
coupon rate at quite more, then people will not go for depositing their money in their
saving accounts. Hence, the revenue of the banks hamper.
In the case where the coupon rate is quite low, no one will go for investing in debt
instruments and will deposit in their bank accounts enhancing the liquidity of the bank.
9. THE MIBID AND THE MOBOR
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The Role of Financial Indicators in Banking System
The MIBID stands for Mumbai Inter-Bank Bid Rate where as MIBOR stands for Mumbai
Inter-Bank Offer Rate.
The MIBID/MIBOR is a rate that is fixed by commercial banks for giving over-night
credits from its surplus deposits to the banks which have deficit to balance the trading of
the day. Generally, it is provided for a night (24 hours).
These are used as bench mark rate for majority of deals struck for Interest Rate Swaps,
Forward Rate Agreements, Floating Rate Debentures and Term Deposits.
10. PRIORITY SECTOR LENDING
Some areas or fields in a country depending on its economic condition or government
interest are prioritized and are called priority sectors i.e industry, agriculture and banks
are directed by the central bank or government that loans must be given on reduced
interest rates with discounts to promote these fields. Such lending is called priority sector
lending.
Due to such provisions, the banks provide credit to the under-developed sectors at a
lower rate which affects the profitability of the banks increasing their default/credit risk.
There is much possibility of NPA ( Non-Performing Asset) making the banks’ balance
sheet not so attractive.
On a contrary, due to PSL the bank is able to catch all sectors of the economy by
increasing its revenue and stability. It contributes a lot for the equitable and sustainable
development of the economy.
If the PSL will be more then to divert the loss and risk occurred by such lending the
banks may increase their bank rates that will ultimately affect the banking system
making the borrowing more costly.
11. GOLD PRICE
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The Role of Financial Indicators in Banking System
As Indians have a sentimental relation with gold, a mare fluctuation in gold price affects
the entire economy.
When people find that the gold price is at a minimum stage, they buy gold by using the
savings account balance even if by taking loans.
So at this point of time, by considering other points the banks may regulate their rates
and policies to cope such situation.
12. GROSS DOMESTIC PRODUCT (GDP)
GDP is a basic measure of a country's economic performance and is the market value of
all final goods and services made within the borders of a nation in a year.
It is a fundamental measurement of production and is very often positively correlated
with the standard of living.
It can be calculated as:
GDP = private consumption + gross investment +
government spending + (exports − imports)
More GDP indicates better standard of living. It Shows that there is much more
production in the economy and the economic condition of the people is good.
If so, then no one will go for taking loan from banks. Ultimately, the banks will go for
reducing the bank rate as there is a little demand for taking loans in the market.
In a nut-shell, the revenues of the banks will reduce, but there is a possibility of increase
in long term loans for growth and development.
13. EXCHANGE RATE
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The Role of Financial Indicators in Banking System
The Exchange Rate (also known as the Foreign-exchange rate or Forex rate or FX rate)
between two currencies specifies how much one currency is worth in terms of the other.
It is the value of a foreign nation’s currency in terms of the home nation’s currency.
As now-a-days monetary transactions are made in the global financial market under
international participation, all the economies are now connected with each other.
When the exchange rate reduces indicating appreciation in the home currency, the
banks will find it cheap to bring money from the overseas. As a result the liquidity
position and availability of cash will increase with the bank increasing its solvency and
credit giving capacity.
At the time of appreciation of home currency, the importers find it the right time to settle
their outstanding with foreign parties. So the banks should make provision for excess
amount to face the situation.
14.RATE OF INFLATION
The inflation rate is a measure of inflation, the rate of increase of a price index (for
example, a consumer price index).It is the percentage rate of change in price level over
time.
In case of inflation, there is a rise in the general level of prices of goods and services in
an economy over a period of time. When the price level rises, each unit of currency buys
fewer goods and services.
Consequently, inflation is also an erosion in the purchasing power of money – a loss of
real value in the internal medium of exchange and unit of account in the economy.
In the case of high inflation, people need more money for their livelihood. So more
people will go for taking loan.
Controversially, at the time of inflation there is much more money in the economy than
the demand. So, no one will go for loan. So to attract borrowers, the bank has to think to
reduce the bank rate.
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The Role of Financial Indicators in Banking System
On the other hand, if there is deflation when there is a scarcity of money in the economy
to purchase the products, to cope with the situation the interest rate on deposites is
increased to attract more and more deposites.
In case of high deflation, the banks have to take loans from the central bank and act as a
stimulator by providing finance to all the suffered sectors to tackle the unfavourable
economic condition.
15. THE SAVINGS RATE
Savings Rate refers to the amount that a common man saves per Rs.100 of his
earnings.
If the savings rate will be more, then a huge liquidity can be found out in the economy.
As everyone have some savings, people will not go to banks to take loans. As a result,
the interest rate on various loans will decrease by making the bank loans cheap.
To attract more savings to be deposited in it, the banks increase the interest rate on
deposits.
If the saving rate is high, it can be concluded that the consumption has been minimized.
It means there is a increase in the exports if the production remains constant. Ultimately
due to more export the foreign reserve will increase and the exchange rate of the foreign
currencies will decrease due to appreciation of the Indian Rupee.
Due to this appreciation the commercial banks can avail foreign currency loans at a
cheaper rate.
On the other hand, if the savings rate is very low/negative, it means people spent more
than their income then the banks will increase their interest rates to give loans as people
want much money to spent.
16. STOCK MARKET INDICES
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The Role of Financial Indicators in Banking System
A common man holding a bag full of cash while going to the bank to deposit in his
account if finds that the stock market is growing and there is a possibility of getting much
return by investing on that; he is a full who believes that the man will deposit with the
bank after knowing that.
When the stock market indices show a bullish trend, people hesitate to deposit in bank
accounts with a nominal return. It affects the Cash inflow of the bank.
At the time of bearish trend, investors don’t want to loose more. They used to close their
position and safeguard their investment in their bank accounts. It increases the cash
inflow of the bank.
Corporate houses similarly when found that the market is booming, they hesitate to take
long-term loans from banks for their expansion and diversification. Rather they go for
fresh issue of equity shares at a high premium.
CONCLUSION
As a grape-vine, all the financial indicators are inter-linked with each other and affect the
entire banking system directly as well as indirectly. A small fluctuation in any of them impacts
the economic and monetary position of the banks. Therefore, it can rightly be said that the
complex banking system that we see never stand in a vaccume. To make the two sides parallel
and to merge the individual objectives of the banking system and the economy, it is a necessity
to look in to certain barometers those can indicate the temperature of the entire financial
system, by playing a lion’s role for its growth and development. In this sense, it is quite difficult
to find anything else other than these financial indicators to act like barometers…!!
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