What has the RBI done?

On Saturday, November 1 2008 the RBI cut CRR by 100 basis points (50 bps effective October 25 and 50 bps effective November to 5.5%. Further the repo rate was reduced by 50 bps to 7.5%.

It also cut banks’ statutory liquidity ratio (SLR) by 1 percentage point to 24 percent of their deposits.

What are repo/reverse repo rates, CRR rate and SLR?

Repo and reverse repo rates are the tools of liquidity management. The RBI uses these measures either to inject liquidity into the system when the liquidity conditions in the markets are tight or suck out liquidity, when there is excess liquidity in the system.

Why does the RBI do this?

Excess liquidity in the system stokes up inflation. Higher inflation leads to higher prices, which in turn leads to lower demand adversely affecting the overall economic growth. In times like these, to control inflation, RBI sucks out liquidity from the market, thus reducing the money supply.
Similarly, tighter liquidity means banks have less money with them to lend, which forces them to raise interest rates. Raising rates leads to consumers postponing their purchases; businesses deferring their expansion plans, thus reducing the aggregate demand, adversely affecting the economic growth.

Thus it is the RBI’s prerogative to manage inflation without compromising on growth.

How does the RBI do this?

Simply defined, the repo rate is the rate at which RBI buys securities from the banks and lends them money. When the liquidity in the markets is tight, the RBI reduces the rate at which it lends to the banks to incentivise banks to borrow more money from them. Thus banks have more money with them to lend to consumers and businesses giving an impetus to economic growth.
Also, changes in repo rates have a direct bearing on other interest rates like your bank FD rates, home loan rates, and so on.

Cash Reserve Ratio (CRR): Banks are mandated to keep certain percentage of their deposits with RBI. This is the CRR. Thus, an increase in the CRR leads to banks parking more money with RBI reducing the funds available with banks.
On the other hand a reduction in the CRR keeps more money with banks boosting liquidity in the markets.

To put it simply, the repo rate is a rate management tool, whereas the CRR is a liquidity management tool of the RBI.

SLR: It is the amount that a bank has to maintain in the form of cash, gold, or approved securities. The quantum is specified as some percentage of a bank’s total demand and time liabilities i.e., the liabilities that are payable on demand anytime, and those liabilities that are accruing in one month’s time due to maturity. This ratio is fixed by the RBI.

What is the current scenario?

In line with its global peers, the RBI also was forced to reverse its tight monetary policy that was being followed to control inflation, to solve the problems arising due to shortfall of funds. Domestic events like advance tax payments, regulatory intervention by the RBI in forex markets to stabilize the depreciating rupee, (aggravated by merciless selling by FIIs in Indian equities) created a huge liquidity crunch in the markets. The liquidity shortage drove up the overnight call rates (rate at which banks give money to each other for short term needs) shooting up to over 20% levels. Banks raised their benchmark prime lending rate (PLR) and were reluctant to disburse loans against the sanctioned limits owing to the liquidity crunch. To cool off this liquidity crunch, the RBI in its credit policy on October 24 announced a 250 bps cut in CRR and 100 bps cut in repo rate. The cuts effectively added around Rs 1, 30,000 crore to the system. When even this was not enough to tackle the ongoing liquidity crunch, the RBI further announced a slew of rate cuts on Saturday.

• It cut CRR by 100 basis points (50 bps effective October 25 and 50 bps effective November to 5.5%. Further the repo rate was reduced by 50 bps to 7.5%.
• It cut SLR by 1 percentage point to 24 percent of their deposits.

If one considers the macro data points, the conditions for easing monetary policy appear favorable owing to:

1. Inflation showing signs of peaking out
2. Oil prices continuing their southward journey
3. Slowing economic growth

The one percentage point cut in CRR is set to release additional liquidity of Rs 40,000 crore into the system.

The SLR cut would inject about Rs 40,000 crore into the banking system.

The RBI now expects banks to pass on the benefit of rate cuts to final consumers in the form of lower interest rates on housing loans and personal loans to boost consumption and revive the slowing economy. Some of the banks have already reacted positively by proactively cutting the benchmark PLR.

Impact on equity markets:
The RBI move was a welcome trigger for the stock market, albeit a short-term one, as we saw the markets rallying from the lows of 7700 to 10600. As expected, banking stocks contributed the lion’s share to the rally on the expectation that lower rates will boost consumption demand positively affecting the margins of the banking sector. Also, a cut in CRR (on which banks don’t get any interest) and SLR would enable banks to earn higher margin on released funds.

Kapil Mokashi is an Associate Financial Planner, working with Sharekhan Ltd. as an equity advisor.

Things have been happening so suddenly. It was a while before I realized I am almost stuck in a trap (or at least to me it seemed to be so). I am not much of a savings person. I use my credit card a lot.

The only saving grace seems to be that I have taken no loans and I have no liability.
Otherwise I’d be stuck in a debt trap. With no way to know how to get myself out of it. Let’s just say that I am one of the “lucky” ones. What about those who are not so lucky? What can they do when in a debt trap?

One option is to go to a financial advisor or consultant. But, they can be expensive.
The better solution is to approach a credit counseling center. There are several credit counseling centers in cities across India.

Some banks also have own credit counseling centers too, such as the Bank of India-sponsored Abhay, at Dadar in Mumbai. This agency, the first of its kind, also has centers in Gumla (Jharkhand), Wardha, and Chennai.

ICICI Bank’s credit counseling centre, Disha has centers at Ahmedabad, Hyderabad, Vijayawada, Kanpur, Delhi, Chennai, and Kolkata.

These centers will help you chart out a plan to repay your debts. You can swap your high cost borrowings for low cost debt. Interest rates may be bought down to as low as 18 per cent for levels such as 36 per cent in some cases.

These centers can also help you restructure the loan portfolios and formulate repayment plans. They may also help borrowers negotiate with banks for restructuring debts.

Here are the addresses:

• Abhay (Bank of India), 61 A, Sadanand, 1st Floor, Above Bank of India Branch, Gokhale Road (north), Dadar (West), Mumbai- 4000 028. Call 022-24221843.
• Disha (ICICI Bank), Prince Apartments, Ground Floor, Karani Lane, Ghatkopar (West), Mumbai 4000 028. Call 65971815/86/87. Visit www.dishfc.org
• Union Mitra (Union Bank of India), Union Bank Bhavan, 239, Vidhan Bhavan Marg, Nariman Point, Mumbai- 400021. Call 022-22896502.

For some of us, who have seen the recently released movie EMI, newspaper reports about recovery agents may seem to be some sort of a controversy set to malign the profession and the banks involved. ‘Sattar’ in the movie might as well be confused with some angelic figure; falls in love with a debtor, Prerna… bye bye Prerna’s debt…

In real life, recovery gents, the process, and the very fact that you are a defaulter can be a serious pain in the posterior.

How do banks recover loans?
Banks have appointed special recovery agencies for loan recovery. These agencies could be either on contract or commission.
Some banks may start the process of loan recovery after a single defaults, other may wait for at least two such instances. The process begins with calls to the borrower. And, what follows is the field recovery process, which involves face-to-face interaction.

Are there any rules for recovery agents?
We have read countless newspaper reports about how the recovery agents come to a defaulter’s house or office at all god-forsaken hours. A bank’s representative is to contact the borrower between 7 am and 7 pm, unless one needs to visit a borrower at odd hours and occasions such as continuous irregularity in the accounts.
Agents also should avoid making calls or show up to meet the person concerned on inappropriate occasions such as mourning in the family or such other occasions for making calls/visits to collect dues.

The agents are required to carry proper identification and carry the concerned bank’s or agency’s authority letter. The agent should display the letter as and when required.

Before the recovery agent is sent across, the bank needs to have given sufficient notice (as prescribed by law) to the borrower before the filed recovery process is initiated. These are just a few of the guidelines.

Notorious Fame
What is it that the ‘agents’ are famous for?

Most agents are known to threaten people and verbally abuse and threaten the defaulters, despite bank’s directions. Some may threaten or actually use third-degree treatment on the borrowers.

Lucky, a recovery agent from Delhi told CNN-IBN in an interview that some recovery agents not only used lathis for recovery, but also their Mausers. These agents may stop a defaulter’s car on gunpoint and beat him up.

These recovery agents are not on any bank’s rolls but stand to get a hefty cut of booty they help recover.

Another recovery agent decided to take law in his hands and turned robber to recover the loan. In September 2008, in Pune, recovery agent Nitin Narayan Chavan robbed Gita Buremukla (25) of jewelry worth Rs 35,000.

This HSBC Bank recovery agent met Buremukla and informed her that there was a loan outstanding. She informed him that the person who had taken the loan no longer lived on the address, a Mr. K. Rambabu.

That didn’t satisfy the agent. The agent came back the next day to Buremukla’s house and entered it on the pretext of drinking some water. Note, recovery guidelines say that the recovery agent can’t gain forceful entry into a defaulter’s house.

Chavan locked the main door and threatened Gita with a knife and forcibly took her mangalsutra worth Rs 35,000.

We read it in the papers, see it in the news, hear about it everyday - ABC bank has gone bust; they are waiting for XYZ bank to be taken over etc.

What is happening with these companies and how did it all start?

Let us look at the basics of how this started.

For banks (lenders): About four years ago, banks came up with a new financial product and found that they could package the loans or other assets on their balance sheet and sell them in return for immediate liquidity. This would give them liquid funds which could be lent further to increase business.

Hence, with more funds at their disposal, they started lending more money, even to people who would not have been eligible borrowers otherwise. Loans were made to to people who did not have perfect or good credit history or a steady income stream; these were called sub-prime loans. Slowly various others such products related to loans were created and gained popularity; these products had higher risk but also higher returns for banks.
Meanwhile property prices were soaring. A look at the statistics shows property prices in the US (where this problem is the biggest) rose 53% in the five years ended December 2007. People, on the other hand, had started buying more homes with mortgage loans, now easily available from banks. The rise in property prices was not entirely due to healthy demand and supply factors, but more due to this easily available money. This fueled the construction industry, property markets, etc.

For investing companies (which included banks): The loans that were packaged (securitized) and sold by banks were held as collateral against which securities were issued to investors (which are generally financial companies). These securities, called asset backed securities (ABS), could be traded in the secondary market. The repayments on the loans that were held as the collateral would provide for returns and principal repayment to these investors.

Start of the crisis: As interest rates kept increasing, the monthly installments payable by mortgage loan borrowers started rising. Slowly, borrowers started defaulting on their loan repayments. This raised the level of non-performing assets or problem loans for banks.
These defaults also led to disturbance in the cash flow to ABS investors. The risks related to this type of securities increased and their market value consequently decreased. The investors started incurring losses which decreased the viability of these securities. Soon the market for these securities slackened and losses (both realized and marked to market) started eating into investors’ profits and affected capital negatively.
Besides, banks could no longer easily securitize their assets. This led to lower availability of funds and hence low business volumes. Since loan disbursement was now selective, investment in property was lower and property prices started declining due to lack of demand. This in turn decreased the value of collateral for mortgage loans given by banks and increased the risk attached.

Securitization of loans led to more funds with banks, higher and riskier lending, defaults on repayments, losses for banks and ABS investors which made a large hit on profits and capital. All these things were hence interlinked and one after the other led to weakening of the entire system.

Thanks to the more-than-adequate regulation by the RBI this has not happened in India. However, let’s see how much this affects Indian Banks and the economy indirectly.

Check out this news story:

http://sify.com/finance/fullstory.php?id=14754431

The story is about banks, who seeing their interest incomes fall, are all set to increase the merchant fees on their Point of Sales (POS) machines.

How did it come to banks hiking the merchant fees on the POS?

The obvious reason behind this is that RBI has hiked CRR and repo rate. So for banks to lend money without charging any interest rate to the card holder for a period of 40 to 50 days (the period of credit) is becoming more and more difficult. The banks had to make some adjustment to cope with this rising interest rate scenario, and this POS rate hike was one way of doing it.

Another reason could be to cover the increase in the non-performing assets (NPA) of the credit card industry. As of now, banks are finding it difficult to control the rise in credit card payment defaults. While the hike will not help to entirely cover the defaults, it could help by defraying some of the losses – a higher POS charge might force the merchant to tap into a more financially sound clientele, thereby reducing defaults.

While those of you who are wondering what does F.D have to do with life insurance…Beware…you could be a victim of it.

As it happened with Mr. Mangesh Pai who went to the largest private sector bank to rollover his F.D maturity into another F.D; he landed up rolling over his maturity amount into a life insurance policy instead. He was told by a bank officer that this would be like a F.D with life insurance cover and 10% interest minimum. Mr. Mangesh found it attractive and signed the papers.

Being a busy heart surgeon, he didn’t get time to go through the papers he got after few days until to his surprise he got notice from insurance company intimating payment for renewal premium after a year. He started wondering “when did he buy this company’s insurance policy, that too with such a huge premium?” (his F.D maturity was huge). While digging through all his financial papers in his file, he found that he was cheated and been sold a life insurance policy instead of F.D which he wanted. Moreover the policy has annual premium paying term of 20 years. He further found out that it was a ULIP with 35% charges and very low life cover. He has filed complaint with RBI and is fighting against the bank.

With thirst of earning huge commissions, bank hire people mostly young who have inadequate knowledge and experience on insurance. These people with tag of “Financial Advisor” or “Relationship Officer” are given targets and incentives. On the verge of achieving those targets and earning incentives, they tend to mis-sell in a big way. Same is the case with “Relationship Managers” of most broking firms. They are trained for aggressive sales and thus have only one thing in mind…sell insurance to anyone anyhow and achieve targets. The ultimate losers? Consumers. Beware…

In another case, Mrs. Priya Arora got call from a MNC bank where she holds a credit card. Despite showing no interest in an insurance product being pitched to her, she found insurance premium being debited in her credit card bill. Mr. Ahmed who went to a public sector bank for opening a savings a/c was asked to take an insurance policy. “You need to take this product along with a/c opening,” said an officer at the bank.

While the advent of private life insurance companies have definitely increased insurance penetration in India which is still very low, it has also definitely increased mis-selling of insurance products. With increasing number of insurance companies so are increasing number is insurance agents. Companies are hiring agents very aggressively to boost sales as a result of which you will find many college students, housewives, doctors, teachers, and people with part time jobs as insurance agents who sells insurance part time merely to earn some extra buck. These people lack knowledge, skills and experience; result of which – wrong product being sold or mis-selling. Insurance agents merely push the product which is earning them higher commission irrespective of weather such product meets your needs and requirements or not. As is happened with Mr. Kamlesh the only earning member in the family who ended up paying 70000 p.a merely for 5 lakh of insurance cover, most of them are ULIPs with high charges. Being bread earner of the family he should have been given much higher life insurance coverage at a lower premium.

Most of the agents typically are trained on only two or three ULIP products and they sell only those products. If you ask such agents about an endowment or term plans most of them don’t know much about it and they will try to convince you that this or that ULIP product is better, that it has given 30% returns in last 5 years.

It is recommendable to avoid buying insurance from part time agents primarily because you may be victim of the wrong product which may not meet your needs, you would suffer from bad service from the agent and secondarily this is their part time work, they would be out of it anytime and then you would be all lost.

So shouldn’t we buy insurance at all? If we have to, where do we get it from?

While life insurance cover is one of the most important things to have for an earning member of the family, we need to determine goals, requirements and how much insurance do we need. Typically, when we think of buying insurance we ourselves don’t know how much cover we should take. Most of us decide it on the premium. We opt of whatever Insurance cover we get on lower premium. Some of us just opt for whatever cover the agent says. Most of us land up being underinsured. You need to look upon various aspects such as cost of living, expected cost of living, your income and increase in your earnings, your dependents etc. before taking a cover.

“It’s a complex process, I don’t have time, skills, and expertise to access all these factors and determine my insurance need!”

You need not - hire a Certified Financial Planner (CFP). The role of a qualified Financial Planner is to look at all aspects of your lifestyle, goals, and requirements and develop a financial strategy suitable for you. The recommended strategy should help you reach your goals effectively and efficiently. Insurance Planning is a part of it in which they would recommend you how much insurance you should have and what mix of products you should opt for viz. term plans, ULIPs etc which would make you financially secure and help you meet your requirements and goals. Once you have a plan designed by a CFP, you can buy various kind of insurance products as recommended by him/her. This will help you getting what you actually need and not what actually an insurance agent needs.

Do not fall in pit of aggressive insurance agents or bank officers who may sell you a ULIP with high charges and low cover. It would be very difficult for you to get out of it!!

Get a strategy and plan developed by a CFP and be financially secure.

Happy Financial Freedom!

In India, as per regulation, every bank must park a certain amount with the Reserve Bank of India (RBI). This amount is a certain percentage of the total customer deposits held by the bank. This ratio of the cash held at the bank to the reserve at the RBI is called the Cash Reserve Ratio (CRR).

The RBI pays a certain amount of interest to the bank on these reserves.

The ratio is used as an effective tool in monetary policies of the country, regulating the money supply in the economy and thereby curbing inflation. It also helps in meeting the banks’ withdrawal demands.

For instance, if the CRR is 10%, a bank with deposits to the tune of Rs. 1 crore has to deposit Rs. 10 lakh at the RBI.

Let us put this in simple words: When a person like you and me require money we approach a bank or financial institution which lends us money at a certain rate of interest; similarly when our banks are in need of money they approach the Reserve Bank of India who lends money to banks at a certain rate which is known as the Repo rate.

Currently the RBI has increased the Repo rate to 8% due to which borrowing money from RBI has become expensive for banks.

How do investors benefit?

Well, with the rise in the Repo rate, banks have increased the deposit interest rates also, especially to bulk investors. Bulk investors had started bargaining for better rates since inflation has touched an all time high of 8.75%. They argued that their returns were negative to which banks have responded favorably by offering interest of 9.25% to 9.5% to bulk investors and around 9.25% to 9.7% on certificates of deposit (CDs).

Even retail investors are offered around 8.75% to 9% on term deposits of 1 to 3 years.