Current Affairs - Banking & Finance

The Indian Finance Ministry has made amendments to the Prevention of Money Laundering Act (PMLA) rules on March 10, 2023.

• More Disclosures for NGOs: The amendments require reporting entities such as banks, financial institutions, and intermediaries to provide more disclosures related to transactions involving NGOs.
• This increased scrutiny is aimed at preventing money laundering and terrorist financing through NGOs.
• Greater Clarity on Politically Exposed Persons (PEPs): The amendments define PEPs under the PMLA in line with the recommendations of the Financial Action Task Force (FATF).
• This will help reporting entities to better identify and monitor PEPs, who are considered higher risk individuals due to their potential involvement in corrupt activities.
• Enhanced Due Diligence: Reporting entities will be required to undertake enhanced due diligence measures for customers who are PEPs, or for transactions involving high-risk countries or activities.
• This will help to identify and mitigate the risks of money laundering and terrorist financing.
• Increased Compliance Costs: The amendments may result in increased compliance costs for reporting entities, as they will need to invest in new systems and processes to comply with the enhanced requirements.
• This may also impact NGOs, who may face additional reporting requirements and scrutiny from reporting entities.

On February 22, the Securities and Exchange Board of India (SEBI) has given the National Stock Exchange of India (NSE) the green light to establish a Social Stock Exchange (SSE).

• It is a new segment within the existing stock exchange that helps social enterprises raise funds from the public through its mechanism.
• The SSE provides a medium for social enterprises to seek finance for their social initiatives and acquire visibility.
• The SSE offers increased transparency about fund mobilisation and utilisation, providing retail investors with an opportunity to invest in securities offered by for-profit social enterprises under the Main Board.
• Institutional investors and non-institutional investors can invest in securities issued by SEs in all other cases.

Eligibility to be listed on the SSE:

• Establish the primacy of social intent
• Fall under either non-profit organizations (NPO) or for-profit social enterprises (FPSEs)
• Establish the primacy of social intent
• Fall under either non-profit organizations (NPO) or for-profit social enterprises (FPSEs)
• Work towards eradicating hunger, poverty, malnutrition, and inequality; promoting education, employability, equality, empowerment of women and LGBTQIA+ communities; environmental sustainability; protection of national heritage and art; or bridging the digital divide
• Direct at least 67% of its activities towards achieving the stated objective, as evidenced by either revenue, expenditure, or the target population.

The Reserve Bank of India (RBI) has signed a Currency Swap Agreement with the Maldives Monetary Authority (MMA) under the SAARC Currency Swap Framework.

• This is to provide swap support as a backstop line of funding for short term foreign exchange liquidity requirements.
• This agreement will enable the MMA to make drawals in multiple tranches up to a maximum of USD 200 million from the RBI.

Highlights of the SAARC Currency Swap Agreement

• The SAARC currency swap facility came into operation on 15^th November, 2012.
• The RBI can offer a swap arrangement within the overall corpus of USD 2 billion.
  • The swap drawals can be made in US dollar, euro or Indian rupee.
  • The framework provides certain concessions for swap drawals in Indian rupee.
• The facility will be available to all SAARC member countries, subject to their signing the bilateral swap agreements.
• In 2020, the RBI signed a currency swap agreement for extending up to a USD 400 million to Sri Lanka.

What is Currency Swap?

• Swap is short for exchange. A contract or agreement to exchange currencies between two nations under predetermined terms and conditions is known as a currency swap.
• In the present context, the facility's role in the current situation is to offer swap support as a substitute source of funding for short-term foreign exchange liquidity needs.
• Central banks (or Governments) engage in currency swaps with foreign counterparts to meet short-term foreign exchange liquidity requirements or to ensure adequate foreign currency to avoid the Balance of Payments (BOP) crisis till longer arrangements can be made.
  • These swap operations carry no exchange rate or other market risks as transaction terms are set in advance.
• At the inception of the swap, the equivalent principal amounts are exchanged at the spot rate.
• At the end of the swap, the principal amounts are swapped back at either the prevailing spot rate, or at a pre-agreed rate such as the rate of the original exchange of principals. Using the original rate would remove transaction risk on the swap.

The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 2022 was awarded to Ben S. Bernanke, Douglas W. Diamond, Philip H. Dybvig (all from the USA) “for research on banks and financial crises”.

• Together, the work for which Bernanke, Dybvig and Diamond have been recognised has also laid the foundation for modern bank regulations. Their work has been “crucial to subsequent research that has enhanced our understanding of banks, bank regulation, banking crises and how financial crises should be managed”.
• They have demonstrated the importance of preventing widespread bank collapses that also gives an insight to avoid both serious crises and expensive bailouts.

(Image Source: WSJ)

Diamond and Dybvig’s Analysis

Since the Global Financial Crisis of 2008, banks have lost their sheen in the public eye. They are often seen as money-grabbing institutions that exist to profit off borrowers as well as depositors.

But in a world without banks, it would be impossible to make any long-term investment. That’s because, as Diamond and Dybvig’s 1983 paper showed, there are “fundamental conflicts between the needs of savers and investors”.

Savers-Investors Conflict

• Savers always want access to at least some part of their savings for unexpected use; this is also called the need for liquidity. They want the ability to pull out money when they need it.
• Borrowers, especially those taking out a loan for building a home or building a road, need the money for a much longer time. Borrowers cannot function if the money can be demanded back at a short notice.

Resolving this Mismatch

• Diamond and Dybvig showed that these mismatches can best be solved by institutions constructed exactly like banks.
• They developed a theoretical model that explains how banks create liquidity for savers, while borrowers can access long-term financing.

Banks as an Intermediaries in Crisis

• Their analysis also showed how the combination of these two activities (savings and lending) makes banks vulnerable to rumours about their imminent collapse.
• If a large number of savers simultaneously run to the bank to withdraw their money, the rumour may become a self-fulfilling prophecy – a bank run occurs and the bank collapses.

Scrutinizing Investments

• Diamond demonstrated how banks perform another societally important function. As intermediaries between many savers and borrowers, banks are better suited to assessing borrowers’ creditworthiness and ensuring that loans are used for good investments.

Ben Bernanke’ Analysis: Bank Run

Ben Bernanke analysed the Great Depression of the 1930s, the worst economic crisis in modern history. Among other things, he showed how bank runs were a decisive factor in the crisis becoming so deep and prolonged.

What is Bank Run?

• Bank runs happen when depositors become worried about the bank’s survival, and rush to withdraw their savings.

Effects of Bank Run

• Bankruptcy: If enough people withdraw their money simultaneously, the bank’s reserves cannot cover all the withdrawals, and it is driven to bankruptcy.
• Productive Investments are hampered: When the banks collapsed, valuable information about borrowers was lost and could not be recreated quickly. Society’s ability to channel savings to productive investments was thus severely diminished.

Finally Financial Crisis Decoded

• Until Bernanke’s paper, bank failures were seen as a “consequence” of the financial crisis. But Bernanke’s 1983 paper proved it was exactly the opposite— bank failures were the “cause” of the financial crisis.
• Using a combination of historical sources and statistical methods, his analysis showed which factors were important in the drop in GDP. He found that factors that were directly linked to failing banks accounted for the lion’s share of the downturn.

Remedy Options

• Bernanke demonstrated that the economy did not start to recover until the state finally implemented powerful measures to prevent additional bank panics.
• The deposit insurance provisions — where a certain amount of one’s deposits in a bank are insured — is a critical tool towards building trust and preventing bank runs.

On 29^th July 2022, India International Bullion Exchange (IIBX) was launched at Gujarat International Finance Tec-City (GIFT City) - India’s maiden International Financial Services Centre (IFSC).

Operator of the IIBX

• A holding company India International Bullion Holding IFSC will operate the International Bullion Exchange.
• It has been established by the National Stock Exchange, Multi Commodity Exchange, India INX International Exchange, National Securities Depository and Central Depository Services Ltd.

Some Criteria for Trading in IIBX

• To become a qualified jeweller, one must have a minimum net worth of Rs 25 crore and 90 per cent of the average annual turnover in the last three financial years through deals in goods categorised as precious metals.
• Apart from qualified jewellers, non-resident Indians and institutions will also be able to participate on the exchange after registering with the IFSCA.

Some other Facts

• The exchange will have three vaults – one operated by Sequel Global (ready and approved), the second one to be operated by Brinks India is ready and awaiting final approval and the third under construction.

Working Procedure

• Once gold is imported, it will be stored at the IFSC Authority-approved vault.
• Following this, a bullion depository receipt will be made and the gold will be ready for trading.
• Being a spot exchange, all the open positions will be marked for delivery at the end of the day.

Advantages

• The IIBX will be a gateway for bullion imports into India, where all bullion imports for domestic consumption shall be channelised through the exchange.
• In addition to providing a trading avenue to various participants, a bullion exchange will also offer the advantages of price discovery, transparency in disclosures, guaranteed centralised clearing and assurance of quality.
• A bullion exchange, apart from providing standardisation and transparent mechanism, will also be an important step towards financialisation of bullion-based products.

The government garnered Rs. 96,000 crore under the National Monetisation Pipeline in FY22, surpassing the target of Rs. 88,000 crore.

• The figure could touch Rs.1 lakh crore as data was still trickling in and was yet to be finalised.
• The roads and highways sector monetised assets worth Rs. 23,000 crore, power sector garnered Rs.9,500 crore, coal mining generated Rs. 40,000 crore and mining of minerals fetched Rs. 18,700 crore, and railways added Rs. 900 crore.

Targets for Monetization

• FY23: Rs 1.62 trillion
• FY24: Rs 1.79 trillion
• FY25: Rs 1.67 trillion

What is Asset Monetisation?

• Asset Monetisation involves creation of new sources of revenue by unlocking of value of hitherto unutilized or underutilized public assets. Internationally, it is recognized that public assets are a significant resource for all economies.

About National Monetisation Pipeline

• The National Monetisation Pipeline was launched in August 2021.
• It aims to unlock value in brownfield projects by engaging the private sector, transferring to them revenue rights and not ownership in the projects, and using the funds generated for infrastructure creation across the country.
• The National Monetisation Pipeline (NMP) estimates an aggregate monetisation potential of Rs 6 lakh crores through core assets of the Central Government, over a period of four years from FY 2022 to FY 2025.

Recently, Finance Secretary accused ratings agencies of “double standards” when assessing emerging markets and developing economies.

• Fitch, a rating agency, had stated that higher deficits and continued lack of clarity on medium-term consolidation plans in the recent Union Budget was its rationale for projecting of a downward trajectory in the country’s debt/GDP.
• Another agency, Moody’s, said the Union Budget was growth-oriented, credit positive for many issuers but the budgetary provisions posed fiscal challenges.

About Rating Agency

• Ratings agencies assess the credit worthiness or potential of an equity, debt or country. Their reports are read by investors to make an informed decision on whether or not to invest in a particular country or companies in that geography.
• They assess if a country, equity or debt is financially stable and whether it at a low/high default risk.
• In simpler terms, these reports help investors gauge if they would get a return on their investment.
• The agencies periodically re-evaluate a previously assigned ratings after new developments (example, Coronavirus pandemic or a geography-specific climate change), geo-political events or a significant economic announcement by the concerned entity.
• Their reports are sold and published in financial and daily newspapers.

Grading Pattern

The three prominent ratings agencies, viz., Standard & Poor’s, Moody’s and Fitch subscribe to largely similar grading patterns.

• Standard & Poor’s accord their highest grade, that is, AAA, to countries, equity or debt with the exceedingly high capacity to meet their financial commitments. Its lowest grade is ‘D’, accorded to entities with high probability of payment default or breach of an imputed promise.
• This is particularly accorded in case the concerned entity has filed for bankruptcy.
• Its grading slab includes letters A, B and C with an addition a single or double letter denoting a higher grade.
• Moody’s separates ratings into short and long-term definitions.
• The former involves obligations maturing in thirteen months or less whereas the latter involves obligations maturing in eleven months or more. Its longer-term grading ranges from Aaa to C, with Aaa being the highest.
• The succession pattern is similar to S&P. The short-term ratings scale ranges from P-1 to NP, with P-1 being the highest.
• Fitch, too, rates from AAA to D, with D being the lowest. It follows the same succession scheme as Moody’s and Fitch.

Impact of Ratings

Positive

• At the country level, investors rely on the ratings given by the credit rating agencies to make investment decisions.
• Many countries sell their securities in the international market, and a good credit rating can help them access high-value investors.
• A favorable rating may also attract other forms of investments like foreign direct investments to a country.

Negative

• Lowered rating of a country can potentially cause panic selling or offloading of investment by a foreign investor.

Criticism

• Popular ratings agencies publicly reveal their methodology, which is based on macroeconomic data publicly made available by a country, to lend credibility to their inferences.
• However, credit rating agencies were subjected to severe criticism for allegedly spurring the financial crisis in the United States, which began in 2017.
• Rating agencies were also criticized for possible conflict of interest between them and issuers of securities.

Former Reserve Bank of India (RBI) governor Urjit Patel has been appointed as a vice-president of the Asian Infrastructure Investment Bank (AIIB), a Beijing based multilateral development bank.

• He will succeed outgoing Vice President D J Pandian.
• He will be one of the five Vice Presidents of the AIIB with a three-year tenure.
• Urjit Patel was the 24th Governor of the Reserve Bank of India (RBI) succeeding Raghuram Rajan in September 2016 and was with RBI till December 2018.
• Jin Liqun is a Chinese politician, banker, and professor is the current President of AIIB.

AIIB & India

• India is a founding member of the Asian Infrastructure Investment Bank (AIIB) with the 2nd highest voting share after China.
• India has emerged as AIIB’s biggest beneficiary by obtaining $6.8 billion funding for 29 projects.
• AIIB has funded projects across sectors in India especially in transport and energy sectors. In December, AIIB approved the $150 million “Chennai City Partnership: Sustainable Urban Service Program” aiming to strengthen institutions and improve the quality and financial sustainability of selected urban services in Chennai.
• Also, the AIIB and the Asian Development Bank (ADB) in Manila are processing a $2 billion loan request from India to purchase 667 million Covid-19 jabs.

Members of AIIB

• Except the US and Japan, most of the developed and developing countries have joined the bank. In late December, the AIIB approved the application of Iraq to join, becoming the bank’s 51st regional member to bring its membership to 105.

Airtel Payments Bank has been categorised as a scheduled bank by the Reserve Bank of India (RBI).

Meaning of Scheduled Bank

• The banks in the Indian banking system are sub categorized as Scheduled Banks, Non-Schedule Banks, Private Banks and Public Banks.
• Scheduled banks are those banks that are listed under Schedule II of the Reserve Bank of India Act, 1934.
• The bank's paid-up capital and raised funds must be at least Rs. 5 lakh to qualify as a scheduled bank. These banks are liable for low interest loans from the RBI.
• They also have membership in clearing houses.
• They also have numerous obligations to fulfil such as maintaining an average daily Cash Reserve Ratio with the central bank.

Types of Scheduled Banks in India

• The banks listed in Schedule II are further classified as –
• Scheduled Commercial Public Sector Banks
• SBI and its associates
• Scheduled Commercial Private Sector Banks
• Old Private Banks
• New Private Sector Banks
• Scheduled Foreign Banks in India

Main Functions of Scheduled Banks

• Acceptance of deposits from the public
• Provide demand withdrawal facility
• Lending facility
• Transfer of funds
• Issue of drafts
• Provide customers with locker facilities
• Dealing with foreign exchange

Differences between a Scheduled Bank and Non-Scheduled Bank

On 9^th December, 2021, Capital markets regulator Securities and Exchange Board of India (SEBI) proposed a regulatory framework for algorithmic trading (algo trading) by retail investors to make such trading safe and prevent market manipulations.

Need

• At present, though the broker can identify the orders emanating from an Application Programming Interface (API), they are unable to differentiate between an algo and non-algo order emanating from an API.
• This kind of unregulated algos pose a risk to the market and can be mis-used for systematic market manipulation as well as to lure the retail investors by guaranteeing them higher returns.

Image Source: Business Standard

About Algorithmic Trading (Algo Trading)

• In market parlance, algo trading refers to any order that is generated using automated execution logic.
• The algo trading system automatically monitors the live stock prices and initiates an order when the given criteria are met.
• It is also known as automated or programmed trading since pre-programmed computer strategies execute buy and sell trades depending on set parameters, instructions or market pattern and conditions.

Benefits of Algorithmic Trading

• Trades are executed at the best possible prices.
• Trade order placement is instant and accurate (there is a high chance of execution at the desired levels).
• Trades are timed correctly and instantly to avoid significant price changes.
• Reduced transaction costs.
• Simultaneous automated checks on multiple market conditions.
• Reduced risk of manual errors when placing trades.
• Reduced the possibility of mistakes by human traders based on emotional and psychological factors.