Chapter 4 Regulation of Banking Business – CS Professional Banking Law and Practice Notes is designed strictly as per the latest syllabus and exam pattern.
Regulation of Banking Business – CS Professional Banking Law and Practice Study Material
Question 1.
Differentiate the following in brief:
(i) Repo Rate and Reverse Repo Rate.
(ii) Universal Banking and Virtual Banking.
(iii) “Red Clause” Credit and “Green Clause” Credit.
(iv) Certificate of Deposit and Commercial Paper.
(v) Special endorsement and Restrictive endorsement. (Dec 2018, 10 marks each)
Answer:
(i) Repo Rate and Reverse Repo Rate
| Repo Rate | Reverse Repo Rate |
| Repo Rate also known as the benchmark interest rate is the rate at which the RBI lends money to the banks for a short term. RBI purchase Government securities from Bank, payment are made to banks, inject liquidity in the market. | Reverse Repo Rate is the short term borrowing rate at which RBI borrows money from banks. RBI sells Government Securities in the market. It provides short term avenues to banks to park their surplus funds. Absorbs liquidity from the market. |
(ii) Universal Banking and Virtual Banking
| Universal Banking | Virtual Banking |
| Universal banks refer to the banks which offer a wide range of financial services apart from the traditional function of accepting deposits and granting of loans by commercial banks.
In universal banking, large banks operate extensive networks of branches, provide many services, hold several claims on firms including equity and participate directly; in the corporate management of firms which depend on banks for funds. Universal banking is combination of commercial banking, investment banking, insurance and various other activities. |
Under the branch banking system the large banks operate through a large number of branches. There is personal direct relationship between the banker and the customer. But under virtual banking while the banks are trying to strengthen customer relationship, the customers are slowly moving away from the traditional branch banking. The important types of virtual banking services include ATMs, POS, Internet Banking, Mobile Banking, Smart Cards etc. With the help of these modern devices, the customers can transact banking business from anywhere in the world. |
(iii) “Red Clause” Credit and “Green Clause” Credit
| “Red Clause” Credit | “Green Clause” Credit |
| In a Letter of Credit a special clause allows the beneficiary (exporter) to avail of a pre-shipment advance (a type of export finance granted to an exporter, prior to the export of goods). This special clause used to be printed (highlighted in red colour, hence it is called “Red Clause” Credit. | The exporter is entitled for an advance for storage (warehouse) facilities of goods. The advance would be granted only when the goods to be shipped have been ware-housed, and against an undertaking by the exporter that the transportation documents would be delivered by an agreement date. |
(iv) Certificate of Deposit (CD) and Commercial Paper (CP)
| Certificate of Deposit (CD) | Commercial Paper (CP) |
| A certificate of deposit (which is also a money market instrument) is issued by a bank. It is issued at discount to be redeemed at par on the maturity date. | Commercial papers are issued by companies with high credit ratings, in the form of promissory notes, at discount but repayable at par, to their holder at maturity. Commercial papers are money market instruments and issued as per the guidelines of the Reserve Bank of India. |
(v) Special Endorsement and Restrictive Endorsement
| Special Endorsement | Restrictive Endorsement |
| When the endorser adds a direction to pay the amount mentioned in the instrument to or to the order of a specified person, the endorsement is said to be in full or special endorsement, and the persons specified is called the endorsee of the instrument. Suppose, a cheque is drawn in favour of ‘A’ and he wants to transfer it in favour of ‘B’, then ‘A’ should write at the back of the cheque as follows.
“Pay to ‘B’ or his order” |
An endorsement is restrictive when it prohibits further negotiation of the instrument or stipulates that it should be dealt with only in the manner directed in the endorsement.
For example:
|
Question 2.
Time Deposits of Bank’ and ‘Certificate of Deposits’ are one and the same. Do you agree with it? If your answer is ‘YES’ mention the points of similarity and if your answer is ‘NO’ mention the points which differentiate a ‘Certificate of Deposits’ from Time Deposits of Bank’. (Aug 2021, 3 marks)
Answer:
No. I do not agree. Time Deposits of Bank’ (TD) and ‘Certificate of Deposits’ (CD) are quite different. The following points are unique to the CD only:
- CD is a money market instruments in the form of a negotiable usance promissory note but TD of bank is not a negotiable instrument.
- It is issued at a discount to face value either in dematerialised form or as a Usance Promissory Note, against funds deposited by an investor with a bank or other eligible financial institution for a specified time period.
- CDs are issued by scheduled commercial banks and select AIFIs as per RBI directions but bank TDs are issued by all types of banks.
- Regional Rural Banks and Local Area Banks cannot issue CDs.
- CDs can be issued between 7 days and not exceeding one year, from the date of issue. AIFIs can issue CDs for a minimum period of 1 year and a maximum of 3 years, from the date of issue but TD can be issued for more than one year.
- Minimum amount of CD issue will be for a face value of ₹ 1 lac to an investor and it will be issued in multiples of ₹ 1 lac but no such restrictions in bank TD.
- CDs can be issued to individuals (excluding minors), corporations, companies (including banks and PDs), trusts, funds, associations, etc.
- Non-Resident Indians (NRIs), can subscribe to CDs on non-repatriable basis only. Such CDs cannot be transferred to another NRI in the secondary market.
- Premature cancellation not allowed but in case of bank TD it is allowed.
- Loan against collateral of CD not permitted exception; holder is Mutual funds, but loan against bank’s own deposits are allowed.
In view of the above facts, “Time Deposits of Bank” and “Certificate of Deposits” are not the same.
Question 3.
On the basis of the following information, calculate the Discounted Value of Certificate Deposit. (Aug 2021, 3 marks)
Face Value ₹ 50,00,000/-
Number of Days : 91
Days Rate of Interest : 7%
Answer:
The formula for calculation of discounted value of Certificate of Deposit (CD) is: Discounted Value of CD= [36,500*Face Value] / [36,500 + (No. of Days * Interest)]
By putting the value in the formula, we get:
Discounted Value of CD = (36,500 * 50,00,000) / [36,500 +(91*7)]
= (36,500 *50,00,000) / [36,500 + 637]
= (36,500 *50,00,000) / 37,137
= 49,14,236.48
Rounded off to nearest Rupees comes to ₹ 49,14,236/-
Question 4.
Write a short note on the following :
Banker as an investor
Answer:
As per bank’s investment policy and guidelines of the regulator, banks invest in securities under SLR and Non SLR investment categories.
These investments are made by banks for the following reasons:
- To comply with SLR requirements
- To optimally deploy surplus funds ‘
- To manage the gap between assets and liabilities (mismatch)
- To diversify risks
While investing funds in Non-SLR securities, the following need to be taken into account:
- They should adhere to exposure limits and counter-party limits.
- The financial statements of banks and corporate clients, where the funds would be invested, need to be properly analyzed.
- Like a lending banker, the investing banker also needs to verify all the important parameters to cover various risks.
- If the investments are in market related instruments, banks also need to do a proper analysis of the market risks and their impact.
- Banks should ensure that all such investments are properly valued by practicing the mark-to-market concept.
- Apart from trend ratio and other analysis, banks should also carry out PESTEL analysis (Political, Economic, Social, Technological, Environmental and Legal) and impact of the PESTEL factors on their investments.
- To protect the interests of the bank, while investing, careful assessment of the company’s performance and stock markets, also needs to be carried out.