Friday, May 22, 2009

DO YOU KNOW HOW RBI ENSURES THAT YOUR BANKER STAYS HONEST?

While putting our hard earned money in our bank accounts we feel safe and secure knowing fully that our money is safe with the bank. This is primarily because of the stellar role played by our central bank namely Reserve Bank of India. RBI , as a central bank , ensures that all the banks are financially sound and solvent. It is also the guardian of the customer's interest. Managing such huge network of banks with their ever increasing branches is not an easy task . Just to put things in perspective, State Bank Of India alone has over 11000 branches in the country. RBI has to ensure that the interest of every single customer of each these branches is safeguarded. So how does RBI manages to accomplish all this ? What are the things that it does in order to ensure that your and my money is safe at our respective banks.The following are the few of the important things RBI does in order to achieve this goal.
1. Regulating entry of banks - RBI, by virtue of being the Central Bank of the country, acts as a regulator to all the banks and NBFCs operating in India. It does look at each of the bank's request for a banking license very carefully and only after careful evaluation and due diligence , the RBI allows banks to operate in India. Foreign banks find it even more difficult to get an entry in India as of now, considering that Indian financial system is not yet fully open and globalised.As far as Indian banks are concerned, even they need to have proper permission from RBI before opening any new branch. RBI intends to ensure that banks growth is in a phased and controlled manner.
2.By regulating via CRR,SLR,repo rate,reverse repo rate etc - RBI also keeps a check on the various aspects of the economy and banks health by managing its monetary policy. Increase in inflation tends to reduce the purchasing power of people's savings and RBI tends to tackle this by reducing key rates, while it keeps a check on bank's financial stability by regulating its CRR, SLR etc. Few of the common monetary policy variables with RBI are
Cash Reserve Ratio (CRR) -This is the amount of money that the banks have to necessarily park with the RBI. The base of this is the total of the deposits that a bank has. The RBI pays the bank interest on the amount parked with it.
Statutory Liquidity ratio(SLR)-The amount of liquid assets, such as cash, precious metals or other short-term securities, that a financial institution must maintain in its reserves. The statutory liquidity ratio is a term most commonly used in India.
Repo Rate - Repo rate is the rate at which banks borrow funds from the RBI to meet the gap between the demand they are facing for money (loans) and how much they have on hand to lend. If the RBI wants to make it more expensive for the banks to borrow money, it increases the repo rate; similarly, if it wants to make it cheaper for banks to borrow money, it reduces the repo rate.
Reverse Repo rate -This is the exact opposite of repo rate. The rate at which RBI borrows money from the banks (or banks lend money to the RBI) is termed the reverse repo rate. The RBI uses this tool when it feels
there is too much money floating in the banking system.If the reverse repo rate is increased, it means the RBI will borrow money from the bank and offer them a lucrative rate of interest. As a result, banks would prefer to keep their money with the RBI (which is absolutely risk free) instead of lending it out (this option comes with a certain amount of risk). Consequently, banks would have lesser funds to lend to their customers. This helps stem the flow of excess money into the economy
3.By mandating a limit on investment to risky industries and sectors - In order to ensure that the money deposited by the customers are invested wisely by banks, RBI also , sometimes mandates a ceiling only upto which a bank can invest in a particular industry. For example, recently RBI had advised banks to be cautious towards realty sector lending as it was perceived to be relatively risky. On the other hand, it also makes banks lend to few sectors on priority basis.
4. By carrying out compliance and quality audits- RBI has laid down rules and regulations for banks . Each and every bank is required to follow these regulations while running the branch operations. These rules and regulations are meant to protect the customers interest while keeping the bank's balance sheet in good health. To ensure that each and every bank is following these rules and regulations while discharging their duty, RBI carries out compliance audits regularly where it checks the process compliance on part of the bank. It also checks the books of accounts for any irregularity. if any violation or irregularity is noticed, banks are expected to take note of that and are required to resolve that in a time bound manner.
5. By releasing financially unsound banks - RBI also comes out with an advisory where it lists down the names of banks which are financially not sound and advises customers to stay away from these banks.This is done to ensure that such banks do not continue to operate .
6. By getting insolvent bank to merge with a large bank - At times, even after doing everything, banks fail. It is a reality and one needs to tackle this as well. Sometimes RBI compensates every customer of a bank which went bust upto a maximum of Rs 100000 or his actual savings whichever is higher. But RBI has in the past also tried to salvage the situation by getting the insolvent bank to merge with a large financially sound bank/ This ensures that the new entity is a larger one and the customers of the old bank do not suffer. An example which comes to our mind is the case of Global Trust bank into Oriental Bank Of Commerce following the insolvency of GTB.
RBI does a whole host of other things as well to ensure that the money we put with our neighbourhood banker is not only growing and earning interest but is also completely safe and secure. We owe it to the RBI on this .

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