Banking Sector in India: UPSC Previous Year Questions (Indian Economy)

Explanation

Interest Coverage Ratio is a financial metric used to assess a company’s ability to meet its interest obligations on its debt. It’s calculated as:

Interest Coverage Ratio = Earnings Before Interest and Taxes (EBIT) / Interest Expense Statements 1 and 2 are correct: The interest coverage ratio is a debt and profitability ratio used to determine how easily a company can pay interest on its outstanding debt. Banks use the ICR to assess the current financial health of a firm. A low ICR suggests the firm may face difficulties repaying interest on its loans, posing a higher risk to lenders. ICR trends can help banks foresee emerging risks. A declining ICR signals worsening financial health, hinting at future repayment challenges.

Statement 3 is incorrect: A higher ICR implies that the firm generates sufficient earnings to cover its interest expenses comfortably, which is favorable. Conversely, a low ICR indicates a firm’s weakened ability to service its debt.

Explanation

Expansionary Monetary Policy is also known as Ac-commodative Monetary Policy has its main objective to increase the money supply in the economy through several measures such as:

Lowering interest rates.

Reducing reserve requirements for banks.

Purchasing government securities by RBI The goal of expansionary policy is to stimulate economic growth by encouraging business activities and consumer spending, while also helping reduce unemployment.

Statement 1 is incorrect: Statutory Liquidity Ratio (SLR) is the percentage of a bank’s net demand and time liabilities that must be maintained in the form of liquid assets, such as cash, gold, or government securities. Reducing the SLR allows banks to have more funds available for lending, thereby increasing the money supply in the economy. Hence RBI would cut and optimise the Statutory Liquidity Ratio.

Statement 2 is correct: Marginal Standing Facility (MSF) Rate is the rate at which banks can borrow overnight funds from the RBI against approved government securities. Increasing the MSF rate makes borrowing from the RBI more expensive for banks, which could discourage lending and contract the money supply. Thus raising the MSF rate is contrary to expansionary policy goals.

Statement 3 is incorrect: Bank Rate is the rate at which the RBI lends to commercial banks without any collateral. Repo Rate is rate at which the RBI lends to commercial banks against government securities. Lowering these rates reduces the cost of borrowing for banks, encouraging them to lend more to businesses and consumers, thereby increasing the money supply. Hence, cutting the Bank Rate and Repo Rate is consistent with an expansionary monetary policy.

Explanation

Rural co-operatives include District Central Cooperative Banks (DCCBs), State Co-operative Banks (StCBs), and Primary Agricultural Credit Societies (PACS).

Statement 1 is incorrect: Although the focus of rural cooperative lending is agriculture, the share in credit flow to the agriculture of rural cooperatives is only 12.1%, as compared to 76% of Scheduled Commercial Banks (SCBs), and 11.9% of Regional Rural Banks.

Statement 2 is correct: A District Co-operative Central Bank (DCCB) is a cooperative bank operating at the district level in various parts of India. It was established to provide banking to the rural hinterland for the agricultural sector with the branches primarily established in rural and semi-urban areas. DCCBs mobilise deposits from the public and provide credit to the public and PACS.

Explanation

The Service Area Approach (SAA) was implemented under the purview of the Lead Bank Scheme. It was introduced by the Reserve Bank of India (RBI) in April 1989. The SAA aimed to facilitate the planned and orderly development of rural and semi-urban areas. Under this approach, each commercial bank branch in these areas was designated to serve a specific cluster of 15 to 25 villages. The designated branch was responsible for meeting the banking needs of its assigned service area, thereby strengthening the link between bank credit and rural development.

Explanation

Statement 1 is correct: The Reserve Bank of India (RBI) directed payment system providers to ensure that all payment system data is stored only in India. This is part of the data localization policy.

Statement 2 is incorrect: The RBI’s directive does not require payment systems to be owned or operated by public sector enterprises only. The policy applies to all payment system providers regardless of whether they are public or private entities. It focuses on the localization of data storage rather than ownership structures.

Statement 3 is incorrect: The directive does not require payment system providers to submit audit reports to the Comptroller and Auditor General of India. Instead, they are required to submit a System Audit Report (SAR) conducted by CERT-IN empaneled auditors to the RBI not later than December 31.

Explanation

The Inter-Creditor Agreement (ICA) was signed by Indian banks and financial institutions to expedite the resolution of stressed assets involving amounts of 50 crore or more under consortium lending arrangements. The ICA was part of the "Sashakt" committee recommendations which proposed a five-pronged strategy to tackle NPAs. The ICA provides a structured framework for multiple lenders to collaborate and resolve stressed assets efficiently. Key features include:

Majority Decision Binding: If 66% of the lenders by value agree on a resolution plan, it becomes binding on all participating lenders. This was done to prevent individual holdouts from delaying resolutions. Timely ReAns: The agreement emphasizes prompt action, setting specific timelines to finalize and implement resolution plans. Asset Management Approach: It encourages the formation of independent asset management companies to manage and turn around distressed assets.

Explanation

Banks Board Bureau recommends for selection of heads - Public Sector Banks and Financial Institutions and helps banks in developing strategies and capital raising plans. Bank Board Bureau was established as an independent organisation in February 2016 based on the suggestions of the RBI appointed Nayak Committee. It was part of the Indradhanush Plan. It suggested the selection of full-time directors and non-ex-ecutive chairs for Public Sector Banks (PSBs) and state-owned financial institutions. Note: Now, Financial Services Institutions Bureau (FSIB) was put in place by the Government in place of BBB for recommending candidates for PSBs heads

Explanation

A bank’s assets are what it owns and what generates income for the bank. They represent how the bank uses the funds it has mobilized. A bank’s liabilities are what it owes to others. They represent the sources of funds that the bank uses to acquire assets and conduct its business. A commercial bank’s balance sheet, assets and liabilities are categorized as follows:

Assets:

Advances: These are loans and credits extended to customers, generating interest income for the bank. Investments: Holdings in government securities, bonds, and other approved securities that earn returns. Money at Call and Short Notice: Short-term funds lent to other banks or financial institutions, typically repayable on demand or within a short period. Liabilities:

Deposits: Funds accepted from the public, including savings, current, and fixed deposits, which the bank is obligated to repay. Hence, option (b) is correct.

Explanation

Option (d) is correct: P-Notes, short for Participatory Notes, are financial instruments that let foreign investors indirectly invest in the Indian stock market without registering with the market regulator Securities and Exchange Board of India (SEBI). P-Notes act like a substitute for underlying Indian company shares. Essentially, P-Notes act as a proxy for direct investment. The overseas investor buys a P-Note from the FPI, and the FPI invests the underlying funds in Indian securities on behalf of the P-Note holder. Benefits for foreign investors include avoiding the hassle of registering with SEBI and offering anonymity. Options (a), (b) and (c) are incorrect:

Certificate of Deposits (CDs) are short-term debt instruments issued by banks to raise funds. They are not related to foreign investment in the stock market. Commercial Paper is also a short-term debt instrument issued by companies to raise working capital. It is also not directly used for foreign investment in the stock market. Promissory Note is a written promise to pay a specific sum of money at a certain date. While it can be used in various financial transactions, it’s not the instrument used for indirect foreign investment in the stock market through FPIs

Explanation

An expansionary monetary policy may lead to lower interest rates and thus flight of foreign capital from India (which would get better returns abroad). Also, such a policy may fuel inflation and higher imports through higher government spending and further cause a slide of the rupee. Options (a), (b) and (c) are incorrect: As these include the likely measures the Government/ RBI would take to stop the slide of the Indian rupee:

Curbing imports of nonessential goods-and promoting exports would help control imports and thus the depreciation of the rupee. Masala bonds were brought in to curb the slide of rupee since the borrowing is rupee-dominated and does not put pressure on our currency through borrowing dollars. Easing external commercial borrowing (ECBs) will lead to higher borrowing abroad and would temporarily bridge the deficit of forex in India preventing the slide of rupee.