BANKING AWARNESS FOR IBPS PO TOPIC SECURITY MARKET, OPEN MARKET OPERATIONS ,NBFC

What are the Open Market Operations (OMOs)?

OMOs are the market operations conducted by the Reserve Bank of India by way of sale/ purchase of Government securities to/ from the market with an objective to adjust the rupee liquidity conditions in the market on a durable basis. When the RBI feels there is excess liquidity in the market, it resorts to sale of securities thereby sucking out the rupee liquidity. Similarly, when the liquidity conditions are tight, the RBI will buy securities from the market, thereby releasing liquidity into the market.

5 (b) What is meant by buyback of Government securities?

Buyback of Government securities is a process whereby the Government of India and State Governments buy back their existing securities from the holders. The objectives of buyback can be reduction of cost (by buying back high coupon securities), reduction in the number of outstanding securities and improving liquidity in the Government securities market (by
buying back illiquid securities) and infusion of liquidity in the system. Governments make provisions in their budget for buying back of existing securities. Buyback can be done through an auction process or through the secondary market route, i.e., NDS/NDS-OM.

Real Time Gross Settlement (RTGS) system

RTGS system is a funds transfer mechanism for transfer of money  from one bank to another on a “real time” and on “gross” basis. This is the fastest possible money transfer system through the banking channel. Settlement in “real time” means payment transaction is not subjected to any waiting period. The transactions are settled as soon as they are processed. “Gross settlement” means the transaction is settled on one to one basis without bunching with any other transaction. Considering that money transfer takes place in the books of the Reserve Bank of India, the payment is taken as final and irrevocable.

Repo Rate

Repo rate is the return earned on a repo transaction expressed as an annual interest rate.

Repo/Reverse Repo

Repo means an instrument for borrowing funds by selling securities of the Central Government or a State Government or of such securities of a local authority as may be specified in this behalf by the Central Government or foreign securities, with an agreement to repurchase the said securities on a mutually agreed future date at an agreed price which includes interest for the fund borrowed.

Reverse Repo means an instrument for lending funds by purchasing securities of the Central Government or a State Government or of such securities of a local authority as may be specified in this behalf by the Central Government or foreign securities, with an agreement to resell the said securities on a mutually agreed future date at an agreed price which includes interest for the fund lent.

Residual Maturity

The remaining period until maturity date of a security is its residual maturity. For example, a security issued for an original term to maturity of 10 years, after 2 years, will have a residual maturity of 8 years.

Secondary Market

The market in which outstanding securities are traded. This market is different from the primary or initial market when securities are sold for the first time. Secondary market refers to the buying and selling that goes on after the initial public sale of the security.

d. State Development Loans (SDLs)

1.7 State Governments also raise loans from the market. SDLs are dated securities issued through an auction similar to the auctions conducted for dated securities issued by the Central Government (see question 3 below). Interest is serviced at half-yearly intervals and the principal is repaid on the maturity date. Like dated securities issued by the Central Government, SDLs issued by the State Governments qualify for SLR. They are also eligible as collaterals for borrowing through market repo as well as borrowing by eligible entities from the RBI under the Liquidity Adjustment Facility (LAF).

a. Treasury Bills (T-bills)

1.2 Treasury bills or T-bills, which are money market instruments, are short term debt instruments issued by the Government of India and are presently issued in three tenors, namely, 91 day, 182 day and 364 day. Treasury bills are zero coupon securities and pay no interest. They are issued at a discount and redeemed at the face value at maturity. For example, a 91 day Treasury bill of Rs.100/- (face value) may be issued at say Rs. 98.20, that is, at a discount of say, Rs.1.80 and would be redeemed at the face value of Rs.100/-. The return to the investors is the difference between the maturity value or the face value (that is Rs.100) and the issue price (for calculation of yield on Treasury Bills please see answer to question no. 26). The Reserve Bank of India conducts auctions usually every Wednesday to issue T-bills. Payments for the T-bills purchased are made on the following Friday. The 91 day T-bills are auctioned on every Wednesday. The Treasury bills of 182 days and 364 days tenure are auctioned on alternate Wednesdays. T-bills of  of 364 days tenure are auctioned on the Wednesday preceding the reporting Friday while 182 T-bills are auctioned on the Wednesday prior to a non-reporting Fridays. The Reserve Bank releases an annual calendar of T-bill issuances for a financial year in the last week of March of the previous financial year. The Reserve Bank of India announces the issue details of T-bills through a press release every week.

b. Cash Management Bills (CMBs)

1.3 Government of India, in consultation with the Reserve Bank of India, has decided to issue a new short-term instrument, known as Cash Management Bills (CMBs), to meet the temporary mismatches in the cash flow of the Government. The CMBs have the generic character of T-bills but are issued for maturities less than 91 days. Like T-bills, they are also issued at a discount and redeemed at face value at maturity. The tenure, notified amount and date of issue of the CMBs depends upon the temporary cash requirement of the Government. The announcement of their auction is made by Reserve Bank of India through a Press Release which will be issued one day prior to the date of auction. The settlement of the auction is on T+1 basis. The non-competitive bidding scheme (referred to in paragraph number 4.3 and 4.4 under question No. 4) has not been extended to the CMBs. However, these instruments are tradable and qualify for ready forward facility. Investment in CMBs is also reckoned as an eligible investment in Government securities by banks for SLR purpose under Section 24 of the Banking Regulation Act, 1949. First set of CMBs were issued on May 12, 2010.

c. Dated Government Securities

1.4 Dated Government securities are long term securities and carry a fixed or floating  coupon (interest rate) which is paid on the face value, payable at fixed time periods (usually half-yearly). The tenor of dated securities can be up to 30 years.

1. What is a Non-Banking Financial Company?

A Non-Banking Financial Company (NBFC) is a company a) registered under the Companies Act, 1956, b) its principal business is lending, investments in various types of shares/stocks/bonds/debentures/securities, leasing, hire-purchase, insurance business, chit business, and c) its principal business is receiving deposits under any scheme or arrangement in one lump sum or in installments. However, a Non-Banking Financial Company does not include any institution whose principal business is agricultural activity, industrial activity, trading activity or sale/purchase/construction of immovable property. (Section 45 I (c) of the RBI Act, 1934) . One key aspect to be kept in view is that the financial activity of loans/advances as stated in 45 I ( c) , should be for activity other than its own. In the absence of this provision, all companies would have been NBFCs.

2. What are systemically important NBFCs?

NBFCs whose asset size is of Rs.100 cr or more as per last audited balance sheet are considered as systemically important NBFCs. The rationale for such classification is that the activities of such NBFCs will have a bearing on the financial stability in our country.

B. Entities Regulated by RBI

3. Does the Reserve Bank regulate all financial companies?

No. Some financial businesses have specific regulators established by law to regulate and supervise them, such as, IRDA for insurance companies, Securities Exchange Board of India (SEBI) for Merchant Banking Companies, Venture Capital Companies, Stock Broking companies and mutual funds, National Housing Bank (NHB) for housing finance companies, Department of Companies Affairs (DCA) for Nidhi companies and State Governments for Chit Fund Companies. Companies which do financial business but are regulated by other regulators, are given specific exemption by the Reserve Bank from its regulatory requirements, such as, registration, maintenance of liquid assets, statutory reserves, etc. The Chart below gives the nature of activities and the concerned regulators.

4. What kind of specific financial companies are regulated by RBI?

The Reserve Bank of India regulates and supervises Non-Banking Financial Companies which are into the business of (i) lending (ii) acquisition of shares, stocks, bonds, etc., or (iii) financial leasing or hire purchase. The Reserve Bank also regulates companies whose principal business is to accept deposits. (Section 45I (c) of the RBI Act, 1934)

5. What are the powers of the Reserve Bank with regard to 'Non-Bank Financial Companies’, that is, companies that meet the 50-50 Principal Business Criteria?

The Reserve Bank has been given the powers under the RBI Act 1934 to register, lay down policy, issue directions, inspect, regulate, supervise and exercise surveillance over NBFCs that meet the 50-50 criteria of principal business. The Reserve Bank can penalize NBFCs for violating the provisions of the RBI Act or the directions or orders issued by RBI under RBI Act. The penal action can also result in RBI cancelling the Certificate of Registration issued to the NBFC, or prohibiting them from accepting deposits and alienating their assets or filing a winding up petition.

6. Why are insurance companies, stock broking and merchant banking companies, Nidhis, housing finance companies and Chit Fund Companies not regulated by the Reserve Bank of India?

These companies have been exempted from registration and other regulations of RBI in order to avoid dual regulation on them as they are regulated by other financial sector regulators.

7. Does the Reserve Bank have any statutory power vis a vis these exempted NBFCs?

It depends on the extent of exemption granted. Housing Finance Companies, for instance, are exempt from RBI regulations. Other entities like Chit Funds, Nidhi companies, Mutual Benefit companies, Insurance companies, Merchant Banking companies, Stock Broking companies, etc., are granted exemption from the requirements of registration, maintenance of liquid assets and statutory reserves. RBI though does not issue directions that could conflict with the directions issued by other financial regulators, viz., Housing Finance Companies are regulated by the National Housing Bank, Insurance Companies by IRDA, Stock broking, Merchant Banking Companies, Venture Capital Companies and companies that run Collective Investment Schemes and Mutual Funds are regulated by SEBI, Nidhi Companies are regulated by the Ministry of Corporate Affairs and Chit Fund Companies are under the regulatory ambit of the respective State Governments.

8. Does RBI regulate companies that carry on the financial activities as part of their business?

The Reserve Bank regulates and supervises companies which are engaged in financial activities as their principal business. Hence if there are companies engaged in agricultural operations, industrial activity, purchase and sale of goods, providing services or purchase, sale or construction of immovable property as their principal business and are doing some financial business in a small way, they will not be regulated by the Reserve Bank.

9. In respect of companies which do not fulfill the 50-50 criteria but are accepting deposits – do they come under RBI purview?

A company which does not have financial assets which is more than 50% of its total assets and does not derive at least 50% of its gross income from such assets is not an NBFC. Its principal business would be non-financial activity like agricultural operations, industrial activity, purchase or sale of goods or purchase/construction of immoveable property, and will be a non-banking non-financial company. Acceptance of deposits by a Non-Banking Non-Financial Company is governed by the Companies Acceptance of Deposits Rules, 1975. The Registrar of Companies in the State Governments administer the schemes.