Commercial Bank

Bank Rate

It is the rate at which the Central Bank of a country makes advances against approved securities, or purchases eligible bills of exchange and other commercial papers, to provide financial accommodation to banks or other specified groups of institutions.

Sec. 49 of RBI Act defines Bank Rate as “the standard rate at which it (the Reserve Bank) is prepared to buy or rediscount bills of exchange or other commercial papers eligible for purchase under this Act.”

Bank Rate (Discount Rate) affects both cost & the availability of credit. Availability of credit is restricted by limiting the type & nature of bills eligible for rediscounting. The effectiveness of Bank Rate as a credit control measure is very limited in India, as banks are now free to rate of interest as per their discretion.

Liquidity Adjustment Facility (LAF)

Introduced from June 5, 2000, as per the recommendation of Narasimham Committee the Liquidity Adjustment Facility helps RBI to provide short term liquidity support to banks. Liquidity Adjustment Facility operates through Repo and Reverse Repo auctions.

In Repo, RBI lends money to banks and primary dealers against securities for short term. When a bank is in need of funds it can use the facility of Repo provided by the RBI and borrow money at Repo rate. RBI goes for repo auctions for injection of liquidity. Repo means repurchase. In a repo transaction the RBI purchases securities from the banks and thus lends money with the condition that the bank will buy back such securities after a specified period which may vary form 1 day to 14 days.

When the RBI wants to increase short term liquidity in the market it reduces the repo rate.

In Reverse Repo, RBI borrows and banks lend against securities for short term. When bank has surplus funds, it can use the facility of Reverse Repo and lend money to RBI by way of purchase of government securities for short term. RBI goes for Reverse Repo auctions for absorption of liquidity from the market.

Prompt Corrective Action

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From December 2002 the RBI has introduced the concept of the Prompt Corrective Action. This principle has been introduced by RBI as per the core principle of banking supervision formulated by the Basle Committee on Banking Supervision.

It is a supervisory tool in the hands of the Central bank to prevent bank failures by taking timely action in case the bank is showing distress signals.

The RBI will subject a bank to prompt corrective action if certain parameters cross the Trigger Points. The trigger points are: (i) CRAR becomes less than 9%, (ii) Net NPA goes beyond 10%, (iii) Return on Assets [ROA] becomes less than 0.25%.

When a bank reaches these trigger points the RBI takes certain mandatory actions like restricting the bank from expanding its risk weighted assets, on opening new branches, accepting high cost deposits etc.

CAMELS Rating of banks

As per the recommendation of the S. Padmanabhan committee, in 1995, RBI introduce the CAMELS rating model for rating banks on a five point scale from A to E indicating in descending order the soundness of banks. In CAMELS rating model C stands for Capital Adequacy. A for Asset quality, M for Management of the bank, E for Earning, L for Liquidity and S for System and Control.

In case of foreign banks the rating is based on four parameters called CACS; where C stands for Capital Adequacy, A for Asset quality, C for Compliance and s for System and Control.

Statutory Requirement

As per the section 42 (1) of the Reserve Bank of India Act, 1934 all scheduled banks are required to keep cash reserve with the Reserve Bank of India.

They have to keep this cash reserve by maintaining balance in their current account(s) with the RBI.

The amount of cash reserve to be kept is a certain percent of the total Net Demand and Term Liabilities [NDTL] of the bank concerned. This percentage is varied by notification by RBI from time to time

This percentage is also called the Cash Reserve Ratio i.e. CRR. With effect from April 24, 2010 the CRR is 6% of the NDTL. This percentage can be varied by the RBI from time to time by notification. As

per the amendment of the Reserve Bank of India Act sec 42 (1), which has come into effect from April 1, 2007 the RBI has now authority to vary the CRR without any limit. [Prior to this amendment the RBI had power to vary the CRR within the floor limit of 3% and ceiling of 20%]

Besides the normal CRR, the Act permits RBI to stipulate vide Sec. 42 (1A) additional Cash Reserve on the incremental Net Demand and Term Liabilities from a particular date. The rate of additional cash reserve to be maintained is

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to be notified by RBI. At present there is no stipulation to maintain additional cash reserve.

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