UNIT I

Overview of Formal Financial System [copy]

Banking and Non-Banking Institutions:
Scheduled Commercial Banks in India: Scheduled commercial banks are those included in the
second schedule of the Reserve Bank of India Act, 1934. In terms of ownership and function,
commercial banks can be classified into four categories: public sector banks, private sector banks,
foreign banks in India, and regional rural banks. There are 84 scheduled commercial banks—21
public sector banks, 21 in the private sector, and 43 foreign banks.

Public Sector Banks: Public sector banks are banks in which the government has a major holding.
These can be classified into two groups: (i) the State Bank of India and its associates; and (ii)
nationalized banks.
State Bank of India- The State Bank of India was initially known as the Imperial Bank. Imperial Bank
was formed in 1921 by the amalgamation of three presidency banks—the Bank of Bengal, the Bank
of Bombay, and the Bank of Madras. The Imperial Bank acted as a banker to the government until
the establishment of the RBI in 1935. The Imperial Bank was nationalized under the State Bank of
India Act, 1955, which was passed on May 8, 1955. The State Bank of India came into existence on
July 1, 1955. This marked the beginning of the first phase of nationalization of banks. The objectives
of nationalization were- To extend banking facilities on a large scale, particularly in the rural and
semi-urban areas. • To promote agricultural finance and to remedy the defects in the system of
agricultural finance. • To help the Reserve Bank in its credit policies. • To help the government
to pursue the broad economic policies.
The SBI is now amongst the world’s largest banks, with a treasury pool of `9,01,642 crore, with
24,017 branches and 59,263 ATMs. The merged Bank caters to 42.04 crore customers, with a
market share of 23.07 per cent and 21.16 per cent in Deposits and Advances. The number of foreign
offices of SBI is 195, spread across 36 countries in all the continents. It is a banker to India’s top 250
companies. The SBI has 21 non-banking subsidiaries. It has eight foreign banking subsidiaries. The
government ownership is now 59.41 per cent. SBI has positioned itself as ‘universal bank’ catering
to the diverse needs of the society, by converting its branches into ‘super shoppe’ selling all its
products—banking, insurance, mutual fund, and credit cards.
Nationalized Banks-

 In 1969, fourteen big Indian joint stock banks in the private sector were nationalized. The
nationalization was effected by an ordinance which was later replaced by an act of
parliament, known as the Banking Companies Act, 1970. This was the second phase of
nationalization. Six commercial banks in the private sector with deposits over `200 crore
were nationalized on August 15, 1980—the third phase of nationalization. In all, 28 banks
were nationalized from 1955–1980. At present, there are 27 nationalized banks: the State
Bank of India and its six associates and 19 nationalized banks (New India Bank was merged
with Punjab National Bank) and IDBI which is classified as other public sector bank.
 The major objectives of nationalization were to widen the branch network of banks
particularly in the rural and semi-urban areas which, in turn, would help in greater
mobilization of savings and flow of credit to neglected sectors such as agriculture, and
small-scale industries.
 The nationalized banks are a dominant segment in commercial banking.

Private Sector Banks:

 The banks which have been setup in the 1990s under the guidelines of the Narasimham
Committee are referred to as new private sector banks.
 Private Sector Banks means banks licensed to operate in India under Banking Regulation
Act, 1949, other than Urban Co-operative Banks, Foreign Banks and banks established under
specific Statutes.
 Today, there are 21 private sector banks in the banking sector: 12 old private sector banks
and 9 new private sector banks. These new banks have brought in state-of-the-art
technology and aggressively marketed their products. These banks reported profits in the
very first year of their existence.
 The level of foreign participation in private sector banks has been enhanced to strengthen
the corporate governance, risk management, and technological competence of these
banks.
 New private sector banks to withstand the competition from public sector banks came up
with innovative products and superior service. They tapped new markets such as retailing,
capital markets, bancassurance and tie-ups with automobile dealers for vehicle finance.
They accessed low-cost NRI funds and managed the associated forex risk for them.

Local Area banks: These banks are set up in private sector to cater to the credit needs of the
local people and to provide efficient and competitive financial intermediation services in their
area of operation. The RBI issued guidelines for the setting up of local area banks in August
1996. The banks are registered as a public limited company under the Companies Act, 1956
and are issued licenses under the Banking Regulation Act, 1949. The minimum paid up capital
for such a bank is `5 crore and the promoters’ contribution for such a bank is at least `2 crore.
The promoters of the bank may comprise individuals, corporate entities, trusts and societies.
These banks are set up in district towns, and hence their focus of lending is on sectors like
agriculture and its allied activities such as SSI, agro-industrial activities, trading activities and the
non-farm sector with a view to ensure the provision of timely and adequate credit to the local
clientele in the area of operation. The area of operation of the bank should be limiting to a
maximum of three geographically neighbouring districts and they are allowed to open branches
only in their area of operation. The local area banks are subject to prudential norms,
 accounting policies and other policies as laid down by RBI. The profitability of these LABs is
higher, but they remain a miniscule portion of the entire banking system (0.02 per cent of the
asset size of SCBs). There are four local area banks operating in certain places such as Coastal
Local Area Bank Ltd. in Andhra Pradesh, Krishna Bhima Samruddhi Local Area Bank Ltd. which
operates in Mahbubnagar district of Andhra Pradesh, Gulbarga, and Raichur districts in
Karnataka and Subhadra Local Area Bank Ltd. in Kolhapur.

Small Finance Banks: On 27 November 2014, the Reserve Bank of India issued the required
guidelines that have to be followed for licensing of small finance banks in the private sector.

 The objectives of setting up the small finance banks were to further the financial
inclusion by (a) provision of savings vehicles and (ii) supply of credit to small business
units, small and marginal farmers, micro and small industries and other unorganized
sector entities, through high technology but low-cost operations.
 Resident individuals/professionals with 10 years of experience in banking and finance
and companies and societies owned and controlled by residents will be eligible to set
up small finance banks. The existing Non-Banking Finance Companies (NBFCs), Micro
Finance Institutions (MFIs) and Local Area Banks (LABs) that are owned and controlled
by residents can also opt for conversion into small finance banks.
 The small finance bank shall primarily undertake basic banking activities of acceptance
of deposits and lending to the unserved and underserved sections including small
business units, small and marginal farmers, micro and small industries and unorganized
sector entities.
 The minimum paid-up equity capital for small finance banks shall be `100 crore.
 The promoter’s minimum initial contribution to the paid-up equity capital of such small
finance bank shall at least be 40 per cent and gradually brought down to 26 per cent
within 12 years from the date of commencement of business of the bank.
 The small finance bank will be subject to all prudential norms and regulations of RBI as
applicable to the existing commercial banks including requirement of maintenance of
Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR).

Payments Banks: The Reserve Bank of India issued the guidelines for licensing of payments
banks on 27 November 2014.

 The objectives of setting up of payment banks will be to process further the financial
inclusion by providing (i) small savings accounts and (ii) payments/remittance services to
migrant labour workforce, low-income households, small businesses, other unorganized
sector entities and other users.
 Existing non-bank Prepaid Payment Instrument (PPI) issuers and other entities such as
individuals/professionals; Non-Banking Finance Companies (NBFCs), corporate Business
Correspondents (BCs), mobile telephone companies, super-market chains, companies, real
sector cooperatives that are owned and controlled by residents and public sector entities
may apply to set up payments banks. A promoter/promoter group can have a joint venture
with an existing scheduled commercial bank to set up payments bank.
 Scope of activities: a. Acceptance of demand deposits- The payment bank was initially be
restricted to hold a maximum balance of `100,000 per individual customer. b. Issuance of
ATM/debit cards- The payments banks, however, cannot issue credit cards. c. Payments
and remittance services through various channels. d. BC of another bank, subject to the
 Reserve Bank guidelines on BCs. e. Distribution of non-risk sharing simple financial
products like mutual fund units and insurance products, etc.
 The minimum paid-up equity capital for payments banks shall be `100 crore. The payments
bank should have a leverage ratio of not less than 3 per cent, i.e., its outside liabilities
should not exceed 33.33 times its net worth.
 The payments bank cannot undertake lending activities. Apart from amounts maintained as
Cash Reserve Ratio (CRR) with the Reserve Bank on its outside demand and time liabilities, it
will be required to invest minimum 75 per cent of its ‘demand deposit balances’ in
Statutory Liquidity Ratio (SLR).
 The promoter›s minimum initial contribution to the paid-up equity capital of such
payments bank shall at least be 40 per cent for the first five years from the commencement
of its business.

Foreign Banks in India: As at end March 2016, there were 43 foreign banks operating in India with
331 branches. In addition, 45 foreign banks were operating in India through representative offices.
The Standard Chartered Bank leads the pack with 92 branches in India. There are four main drivers
of foreign banks presence in India, viz., (i) the desire of banks to follow their home customers
abroad; (ii) the attractiveness of local profit; (iii) opportunities in the host countries, and (iv) the
presence of mechanisms to mitigate information costs of doing business in foreign markets. Some
of the foreign banks have set up different entities which are operating in India as subsidiaries in the
form of either non-banking financing companies or limited companies in the non-financial sector in
India that undertake diverse businesses such as dealing in securities, leasing and finance, and
information and technology. Also, foreign banks have wholly-owned subsidiaries to run their
global business process outsourcing jobs. The presence of foreign banks in India has benefitted the
financial system by enhancing competition, transfer of technology and specialized skills resulting
in higher efficiency and greater customer satisfaction. They have also enabled large Indian
companies to access foreign currency resources from their overseas branches in times of foreign
currency constraint. They are active players in the money market and foreign exchange market
which has contributed to enhancing the liquidity and deepening of these markets in terms of both
volumes and products. Foreign banks may operate in India through any one of the three channels
namely, (i) branch/es; (ii) a wholly owned subsidiary; or (iii) a subsidiary with aggregate foreign
investment up to a maximum of 74 per cent in a private bank. New foreign banks are allowed to
conduct business in India after taking into consideration the financial soundness of the bank,
international and home country ranking, rating, international presence, and economic and
political relations between the two countries. Foreign banks in India have to mandatorily lend 32
per cent of their adjusted net bank credit. Foreign banks need to park 20 per cent of their profits
from India operations with the RBI. These profits are kept as cash, as unencumbered approved
securities or a combination of the two.

Regional Rural banks: Regional Rural Banks (RRBs) in India are the scheduled commercial banks
that conduct banking activities for the rural areas at the state level. These banks are under
the ownership of Ministry of Finance, Government of India. The RRBs were established as per the
recommendations of the Narasimham Committee to cater to the rural credit needs of the farming
and other rural communities. RRBs were set up under the Regional Rural Bank Act of 1976. The
Prathama Grameen Bank was the first bank to be established on 02nd October 1975. The Syndicate
Bank became the first commercial bank to sponsor the Prathama Grameen Bank RRB. As the name
suggests, the Regional Rural Banks cater to the needs of the rural and underprivileged people at the
regional level across different states in the country. The RRBs are entrusted to cater to the needs of
the rural people in the backward regions and bring financial inclusion at the primary level. The
main objective of the RRBs is to provide credit and other banking facilities to the small, marginal
farmers, agricultural laborers, small artisans, etc. in the rural areas for boosting the rural economy.
At present, there are 43 RRBs in the country and each of them is sponsored by the government of
India in collaboration with the state government and sponsor bank.

Risk Management Process in Banks: Risk may be defined as an exposure of a transaction

with loss, which occurs with some probability and which can be expected, measured and
minimized. An element of risk is inherent in the banking operations. Banks have to manage and
balance risk. Risk management system is important for Indian banks in the reforms era. Volatility
has increased and margins have squeezed and hence, if banks do not have a cushion against losses,
they may face a problem of survival. Thus, risk management is necessary to ensure sound, stable
and efficient banking system. It is a continuous process which helps identify the amount and type
of risks that the bank is willing to take, mobilize enough capital to cover such risks and allocate
capital to profitable business units. Risk management involves identification, measurement,
monitoring and controlling risks to optimize risk-reward trade-off.
The steps of risk management process is as follows: -
Risk Analysis- It implies a backroom exercise of looking at the entire gamut of risks. Risk analysis is
defining the risk, which, in turn requires understanding the nature of risks to which the bank is
exposed to and then try to quantify their impact on the bank.
Risk Identification- This involves identifying risks attached to the assets, liabilities and the process
of the bank requires a clear understanding of the operations, organization structure, form of the
organization, process flow, geographical concentration of risk, etc. The banking system faces
different types of risks such as-

 Credit risk: This arises due to default in payment or delayed payment. In other words, it is
the risk of not getting back the money that is lent. Credit risks include counterparty default
risk-the possibility that the other party in an agreement will default and concentration risk
—probability that any single exposure or group of exposures may have the potential to
produce losses large enough to threaten a bank’s health or ability to maintain its core
operations.
 Interest rate risk (IRR): This arises from adverse movements in interest rates which bring
about changes in a bank’s portfolio value both in trading book and in banking book.
Changes in market interest rates might adversely affect a bank’s financial condition.
 Market risk: This risk arises due to fluctuations in market prices of equity due to general
market-related factors. A bank generally invests funds in securities including equity market.
The changes in the value of a bank’s investment portfolio as a result of securities market
behaviour is called market risk.
 Foreign exchange risk: This risk arises from adverse movements in currency exchange rates.
Banks undertake operations in foreign exchange. The increased capital flows across the
globe coupled with volatility has made the banks’ balance sheets vulnerable to exchange
rate movements. Mismatched currency position also exposes it to country risk and
settlement risk. Change in exchange rate has an impact on the bank’s foreign exchange
open positions and consequently its capital requirements.
 Operational risk: This risk emanates from inadequate or failed internal processes, people,
system and procedures and controls or from external events. Disruptions in operational
flow due to failure of internal system results in financial losses. Operational risk events
include internal and external frauds, workplace safety system failures, etc.
 Liquidity risk: This risk arises from a bank’s inability to meet its obligations when they
become due, and refers to situations in which a tradeable financial instrument or an asset
may not be realized in cash. Liquidity risk may be classified into: (i) Term Liquidity Risk
which arises due to unexpected delays in repayments of the capital in lending transactions;
(ii) Withdrawal/Call Risk, which arises on account of excess withdrawal of deposits than
expected thus creating constraints for bank to meet its payment obligations-deposit run-
offs in a bank-specific event; (iii) Structural Liquidity Risk which arises when the necessary
funding transactions cannot be carried out;(iv) Contingent liquidity risk which is the risk
associated with finding additional funds or replacing maturing liabilities under potential,
future stressed market conditions; and (v) Market liquidity risk which arises when positions
cannot be sold within a desired time period or can be sold only at a discount
 Strategic Risk: This risk arises on account of poor implementation of business decisions and
failure to adapt to changes in the economic environment which has adverse effects on
capital and earnings.
 Contingent Risk: This is also referred to as off-balance sheet risk as it is associated with off
balance sheet activities of banks such as lines of credit, and forward contracts.

Risk Measurement- Statistical models are used to measure and manage the financial risks to
which banks are exposed. These models provide a framework for identifying, analysing,
measuring, communicating and managing these risks. Some popular statistical models used by
banks are: Gap analysis model: which calculates the repricing gap between the interest revenue
earned on the bank’s assets and the interest paid on its liabilities over a particular period of
time. Value at Risk: which measures market risk inherent in trading portfolios. Banks also carry
out Duration Gap analysis to estimate the impact of change in interest rates on economic
value of Bank’s assets and liabilities and thus arrive at changes in Market Value of Equity (MVE).
Credit Risk Assessment (CRA) Models to assess the counterparty Risk, by taking into account
the various risks categorized broadly into financial, business, industrial and management
Risks, each of which is scored separately. Banks have also set up exposure limits to achieve a
well-diversified portfolio across dimensions such as companies, group companies, industries,
collateral type, and geography. For avoidance of concentration of credit risks, internal guidelines
on prudential exposure norms in respect of individual companies, group companies, banks,
individual borrowers, non-corporate entities, sensitive sectors such as capital market, real
estate, sensitive commodities, etc. have been put in place by banks.

Risk Control- Banks have put processes and controls in place in regard to various aspects of
Credit Risk Management such as appraisal, pricing, credit approval authority, documentation,
reporting and monitoring, review and renewal of credit facilities, managing of problem loans,
credit monitoring, etc. Banks have laid down trading and investment policies with defined
market risk management parameters for each asset class and have got these policies approved
by their boards. To control and mitigate operational risks, banks have issued detailed
procedural guidelines for processing various banking transactions and necessary instructions to
all offices regarding delegation of financial powers, which detail sanctioning powers of various
levels of officials for different types of financial transactions. Banks have started training
programmes for their staff to create an awareness of the different types of risks. Banks have
put in place a system of prompt submission of reports on frauds and a comprehensive system
of preventive vigilance. Banks have also set up an Inspection & Management Audit
Department to periodically conduct risk-based audits and evaluate adequacy and effectiveness
of the control systems and the functioning of various control procedures. Some banks have
obtained insurance cover for potential operational risks. Banks have started building a
comprehensive database of losses due to Operational Risks.

Risk Monitoring- Risk monitoring is evaluating the performance of bank’s risk management
strategies in achieving overall objectives. For effective monitoring, risk measures should be
reported regularly and clearly comparing current exposures to policy limits. Further past risk
estimates should be compared with actual outcomes to identify any shortcomings in risk
measurement techniques. Regular monitoring activities can help in quickly detecting and
correcting deficiencies in the policies, processes and procedures for managing risk, which, in
turn, reduce the potential frequency and/or severity of a loss. The risk management strategy
also has to change in accordance with the changed risk climate. This will be possible only if a
concrete monitoring system is in place right from the beginning.

CREDIT RATING AGENCIES: MEANING, METHODOLOGY AND AGENCIES IN INDIA

 Credit rating agencies have come into existence to assist the investors in their investment
decisions, by assessing the creditworthiness of the borrowers. Credit rating is the
assessment of a borrower’s credit quality. Credit rating performs the function of credit risk
evaluation reflecting the borrower’s expected capability to repay the debt as per terms of
issue. It is a well-informed opinion made available to the public, and might influence their
investment decisions. Credit rating, however, is neither a general purpose evaluation nor an
overall assessment of credit risk of a firm. Ratings neither evaluate the reasonableness of the
issue price or possibilities for capital gains nor take into account the liquidity in the
secondary market. Ratings also do not take into account the risk of prepayment by issuer.
An agency that performs the rating of debt instruments is known as credit rating agency. At
present, the scope of a credit rating agency is not limited to rating of debts. Credit rating
agencies now undertake financial analysis and assessment of financial products,
individuals, institutions, and governments.
 Importance: Credit rating helps in the development of financial markets.
Credit rating enables investors to draw up the credit–risk profile and assess the adequacy
or otherwise of the risk–premium offered by the market. It saves the investors, time and
enables them to take a quick decision and provides them better choices among available
investment opportunities based on their risk-return preferences.
Credit rating is a tool in the hands of financial intermediaries, such as banks and financial
institutions that can be effectively employed for taking decisions relating to lending and
investments.
Credit rating helps the market regulators in promoting stability and efficiency in the
securities market. Ratings make markets more efficient and transparent.
Ratings help corporates and investors manage and mitigate risks, take pricing and
valuation decisions, reduce time to market, generate more revenue and enhance returns.
Rating agencies also help shape public policy on infrastructure in emerging markets, and
thereby help catalyse economic growth and development in these geographies.
 Agencies in India: The prominent rating agencies in India are: • CRISIL Limited • ICRA
Limited • CARE Ratings • India Ratings and Research Pvt. Ltd. (formerly Fitch Ratings India
Pvt. Ltd.) • Brickwork Ratings India Pvt. Ltd. • SMERA Ratings Limited • Infomerics
Valuation and Rating Pvt. Ltd. The Indian credit rating industry is next to the US in terms of
number of ratings issued and in the number of agencies. CRISIL is the market leader in the
credit rating industry with a 70 per cent market share.
 Methodology: The rating of a financial instrument requires a thorough analysis of relevant
factors that affect the creditworthiness of the issuer. The primary focus of the rating
exercise is to assess future cash generation capability and their adequacy to meet debt
obligations in adverse conditions. The analysis attempts to determine the long-term
fundamentals and the probabilities of change in these fundamentals, which could affect
the credit-worthiness of the borrower. Analysis typically involves at least five years of
operating history and financial data as well as company and rating agency forecasts of
future performance.
The analytical framework for rating consists of the following five broad areas:
1. Economy analysis: The Economic environment is assessed to determine the degree of
operating risk faced by the company in a given business. Here the economy wide factors
which have a bearing on the industry are taken into consideration. The strategic nature of
the industry in the prevailing policy environment, regulatory oversight governing
industries, etc. are also analysed.
2. Business Analysis: This covers an analysis of industry risk, market position in the country,
operating efficiency of the company, and legal position.
• An analysis of industry risk focuses on the prospects of the industry and the competitive
factors affecting the industry. Industry risk covers an analysis of actual and estimated
demand/supply, number of firms and potential entrants in the industry, government
policies relating to the industry, the performance of the industry, its future potentiality,
and other factors.
• Market position in the industry covers the study of market share of the firms (marketing
strengths and weaknesses of the firm vis-a-vis its competitors), marketing arrangements,
products, and customers.
• Operating efficiency is a study of production processes of the firm, its cost structure,
locational advantages, labour relationships, input availability, and prices.
• Legal position covers a study of prospectus, accuracy of information, and filing of forms,
returns, and so on with proper regulatory authorities.
3. Financial Analysis: Financial analysis includes an analysis of accounting quality, earnings
protection, cash flow adequacy, and financial flexibility. It involves evaluation of past and
expected future financial performance.
• Accounting quality is known as the study of method of income recognition, inventory
valuation, depreciation policies, auditor’s remarks, and off-balance liabilities accounts. A
review of accounting quality and adherence to prudential accounting norms are examined
for measuring the company’s performance. Change of accounting policy in a particular year
which results in improved reported performance is also analysed.
• Earnings protection is examined with reference to profitability ratios, earnings growth,
and projected earnings, among others. Financial ratios are used to make a holistic
assessment of financial performance of the company, as also to see the company’s
performance—intra-firm and inter-firm within the industry.
• Adequacy of cash flows includes a study of future cash flows, working capital needs, and
capital budgets. Cash flow analysis forms an important part of credit rating decisions.
Availability of internally generated cash for servicing debt is the most comforting factor for
rating decisions as compared to dependence on external sources of cash to cover
temporary shortfalls.
• Financial flexibility is examined in terms of whether alternative sources of liquidity are
available to the company as and when required. It also examines whether financing plans
have been developed and the feasibility of such plans. Company’s contingency plans under
various stress scenarios are considered and examined. Ability to access capital markets and
other sources of funds whenever a company faces financial crunch is reviewed. Existence of
liquid investments, access to lines of credits from strong group concerns to tide over stress
situations, ability to sell assets quickly, defer capital expenditure, etc. are also considered.
• Validation of projections and sensitivity analysis: The projected performance of the
company over the life of the instrument is critically examined and assumptions underlying
the projections are validated. A sensitivity analysis is performed through several ‘what if’
scenarios to assess a company’s capacity to cope with changes in its operating
environment. A scenario analysis is undertaken wherein each critical parameter is stress
tested to arrive at the performance of the company in a stress situation. Debt service
coverage for each of the scenarios would indicate the capability of the company to service
its debt, under each scenario.
4. Management Evaluation: This includes a study of the track record of the management,
the management’s capacity to overcome adverse situations, goals, philosophy, strategies,
control systems, personnel policies, and performance of group companies. An assessment
of the management’s plan in comparison to those of its competitors can provide important
insights into the company’s ability to sustain its business.
5. Fundamental Analysis: This covers an analysis of liquidity management, asset quality,
profitability and, interest and tax sensitivity.
• Liquidity management can be known through a study of capital structure, matching of
assets and liabilities, liquid assets, maturing deposits, among others.
• Asset quality includes the company’s credit management, policies for monitoring credit,
composition of assets, and sector risk.
• Profitability is examined through a study of profitability ratios, spreads, reserves, and
non-business income.
• Interest and tax sensitivity is in terms of exposure to interest rate charges, hedge against
interest rate, tax provisions, and impact of tax law changes.

The above information is collected and then analysed by a team of professionals in an

agency. Companies are asked to fill up the forms and provide the required data. If
necessary, meetings with top management suppliers, and dealers, and a visit to the plant
or proposed sites are arranged to collect and confirm additional data and issues relating to
credit evaluation of a firm. This team of professionals/analysts submits their
recommendations to the rating committee. The committee discusses this report and then
assigns rating. Once the quantitative data is analysed, it is the seasoned judgement of the
rating committee, which makes rating of an agency unique and sometimes controversial.
Rating involves a lot of subjectivity in the process. The rating assigned is then notified to
the issuer and only on his acceptance, the rating is published. A rating agency assures strict
confidentiality of information to its client. If the client wants to furnish additional
information, he can do so and gets the rating reviewed again. Once the issuer decides to
use and publish the rating, the agency has to continuously monitor it over the entire life of
the instrument. The rating agency continuously monitors the corporate, and rating is
monitored till the life of the instrument. This process is known as surveillance. Rating may
be upgraded, downgraded, or continue unchanged, depending upon new information or
developments and their resultant effect on the debt instrument being rated. The revised
ratings are also published and made public in financial dailies and newspapers.
 NON-PERFORMING ASSETS
An asset, including a leased asset, becomes non performing when it ceases to generate
income for the bank. A non performing asset (NPA) is a loan or an advance where:
(i) interest and/or instalment of principal remain overdue for a period of more than 90
days in respect of a term loan,
(ii) the account remains ‘out of order’, in respect of an Overdraft/Cash Credit (OD/CC),
(iii) the bill remains overdue for a period of more than 90 days in the case of bills
purchased and discounted,
(iv) the instalment of principal or interest remains overdue for two crop seasons for
short duration crops,
(v) the instalment of principal or interest thereon remains overdue for one crop season
for long duration crops,
(vi) the amount of liquidity facility remains outstanding for more than 90 days, in
respect of a securitization transaction undertaken in terms of guidelines on
securitization dated February 1, 2006.
(vii) in respect of derivative transactions, the overdue receivables representing positive
mark-to-market value of a derivative contract remain unpaid for a period of 90
days from the specified due date for payment.

*In case of interest payments, banks should, classify an account as NPA only if the interest
due and charged during any quarter is not serviced fully within 90 days from the end of the
quarter.

Tools to manage NPAs for BANKS

 One Time Settlement/Compromise Scheme: Banks have been advised to devise one-
time compromise settlement schemes for resolution of NPAs. The RBI issued guidelines for
this scheme in March 2000. This scheme covers NPAs classified as doubtful and NPAs
classified as sub-standard, which have subsequently become doubtful or less. This scheme
covers actions under the SARFAESI Act and also cases pending before courts/DRTs/BIFR,
subject to consent decree being obtained from them but does not cover cases of wilful
default, fraud and malfeasance. As per this scheme, for NPAs upto Rs 10 crore, the
minimum amount that should be recovered should be 100 per cent of the outstanding
balance in the account. For NPAs above `10 crore, the CMDs of the respective banks should
personally supervise the settlement of NPAs on a case-to-case basis. The RBI has allowed
the board of directors to evolve policy guidelines regarding one-time settlement of NPAs as
a part of their loan recovery policy. The amount arrived for settlement is to be paid in
lumpsum. If not, borrowers should pay at least 25 per cent upfront and the balance within
one year with interest at the existing PLR.
 Lok Adalat: They were constituted under the Legal Services Authority Act, 1987. They have
been setup to help banks to settle disputes involving accounts in ‘doubtful’ and ‘loss’
category with an outstanding balance of `20 lakh. Lok Adalat help in resolving disputes
between the parties by conciliation, mediation, compromise or amicable settlement and
thereby reduce burden on courts. They were conferred ad-judicial status and every award
of the Lok Adalat shall be deemed to be a decree of a civil court and no appeal can be made
to any court against the award made by the Lok Adalat. They are generally presided over by
two or three senior persons including retired senior civil servants, defence personnel and
 judicial officers. Debt recovery tribunals (DRTs) have now been empowered to organize Lok
Adalats to decide on cases of NPAs of Rs 10 lakh and above. Banks were advised to
participate in the Lok Adalats convened by various DRTs/DRATs for resolving cases involving
`10 lakh and above to reduce the stock of NPAs.
 Corporate Debt Restructuring (CDR)
 SARFAESI Act: The government enacted the Securitization and Reconstruction of Financial
Assets and Enforcement of Security Interest SARFAESI Act, 2002 for enforcement of
security interest for realization of dues without the intervention of courts or tribunals. This
act is a step towards bringing down the level of risk in the system and encouraging banks
to lend. The act deals with the following aspects: (i) securitization, (ii) asset reconstruction,
and (iii) security enforcement. Securitization is conversion of a financial or non-financial
asset into securities. Asset reconstruction is a financial tool for corporate debt restructuring
and financial rehabilitation through re-bundling, takeovers or sale. Enforcement of security
interest confers the right on lenders to possess(foreclose) a non-performing loan.
Objectives of SARFAESI Act • To strengthen the creditors’ rights of recovery. • To pave the
way for speedy NPA recovery. • To empower ARCs for asset reconstruction and recoveries
 CIBIL: In developed financial markets there are specialized financial institutions, known as
credit-bureaus, that maintain records of credit histories of individuals and business
entities. They are usually set up by lenders—mostly banks and credit card companies.
Whenever an individual seeks a loan from a bank or finance company the lender before
extending the loan checks his credit profile with the bureau to find out whether the
borrower has defaulted with any other lender and whether he is capable of settling the
loan. This credit bureau also enables lenders to take quick decisions and charge a
differential price based on the credit profile of the borrower. Functions of Credit Bureau •
Maintain records and credit histories of borrowers. • Provide information of borrowers to
lenders. • Help mitigate adverse selection and moral hazard problems in the market for
credit. The State Bank of India (SBI), Housing Development Finance Corporation Limited
(HDFC), Dun and Bradstreet Information Services India Private Limited (D&B), and
TransUnion International Inc (TransUnion) signed the Shareholders’ Agreement on January
30, 2001 to establish the Credit Information Bureau (India) Limited (CIBIL). CIBIL provides
credit information of borrowers to banks, financial institutions, non-banking financial
companies, housing finance companies and credit card companies. The data is shared on
the principle of reciprocity—data can be obtained from CIBIL only by members who
contribute all data on all borrowers. CIBIL is India’s first credit information bureau to help
the financial institutions make informed, objective and speeder credit decisions and
thereby curb the growth of NPAs and improve the functioning of the financial system.

Tools to manage NPAs for CORPORATE

 Appointment of Resolution Professional (IP): Immediately upon receipt of the approval
by the regulator and the committee of creditors, IP takes over the running business of the
defaulting company. Thus, from the date of appointment of IP, all powers of the board of
directors shall be suspended and vested in the hands of IP. He shall propose a ‘resolution
plan’ which means a plan proposed for insolvency resolution of the corporate debtor as a
going concern. He shall have the immunity from criminal prosecution or any other liability
done in good faith. IP may also act as liquidator and form an estate of assets and
consolidate, verify and determine the value of creditors’ claims.
 Liquidation: Under the code, a corporate debtor may be put into liquidation in the
following scenarios: i. 75 per cent majority of the creditor’s committee resolves to
liquidate the corporate debtor at any time during the insolvency resolution process.
ii. The creditor’s committee does not approve a resolution plan within 180 days (or within
the extended 90 days).
iii. The NCLT rejects the resolution plan submitted to it on technical grounds.
iv. The debtor contravenes the agreed resolution plan and an affected person makes an
application to the NCLT to liquidate the corporate debtor.
Once the NCLT passes an order of liquidation, a moratorium is imposed on the pending
legal proceedings against the corporate debtor and the assets of the debtor vest in the
liquidation estate.
 Distribution of assets (Priority Waterfall): 1.The proceeds from the sale of the liquidation
assets shall be distributed in the following order of priority and within such period and in
such manner as may be specified, namely: a. The insolvency resolution process costs and
the liquidation costs paid in full. b. The following debts which shall rank equally between
and among the following: i. Workmen’s dues for the period of 24 months preceding the
liquidation commencement date; and ii. Debts owed to a secured creditor in the event such
secured creditor has relinquished security. c. Wages and any unpaid dues owed to
employees other than workmen for the period of twelve months preceding the liquidation
commencement date. d.Financial debts owed to unsecured creditors. e. The following dues
shall rank equally between and among the following: i. Any amount due to the Central
government and the State government including the amount to be received on account of
the consolidated fund of India and the consolidated fund of a state, if any, in respect of the
whole or any part of the period of two years preceding the liquidation commencement date.
ii. Debts owed to a secured creditor for any amount unpaid following the enforcement of
security interest. f. Any remaining debts and dues. g. Preference shareholders, if any and h.
Equity shareholders or partners, as the case may be. 2. Any contractual arrangements
between recipients under sub-section (1) with equal ranking, if disrupting the order of
priority under that sub-section shall be disregarded by the liquidator. 3. The fees payable to
the liquidator shall be deducted proportionately from the proceeds payable to each class of
recipients under sub-section (1) and the proceeds to the relevant recipient shall be
distributed after such deduction. Explanation: For the purpose of this section— i. It is hereby
clarified that at each stage of the distribution of proceeds in respect of a class of recipients
that rank equally, each of the debts will either be paid in full, or will be paid in equal
proportion within the same class of recipients, if the proceeds are insufficient to meet the
debts in full. ii. The term “workmen’s dues” shall have the same meaning as assigned to it in
section 326 of the Companies Act, 2013(18 of 2013).
 Moratorium: The adjudication authority will declare moratorium period during which no
action can be taken against the company or the assets of the company. The threat from
secured creditors under the SARFAESI Act shall also be mitigated during the moratorium
period. Each creditor shall vote in accordance with the voting share assigned to it and if 75
per cent of the creditors approve the resolution plan, the said resolution plan shall be
implemented. If the resolution plan is not approved by the committee of creditors, then
within a specific time period it would cause initiation of liquidation. Similarly, debtors have
also a right to opt for voluntary liquidation by passing a special resolution in general
meeting. IP may act as liquidator and exercise all powers of the board of directors.
 NBFC
A Non-Banking Financial Corporation (NBFC) is a company that is registered under the Companies
Act, 1956 and is involved in the lending business, hire-purchase, leasing, insurance business,
receiving deposits in some cases, chit funds, stocks, and shares acquisition, etc. The functions of
the NBFCs are managed by both the Ministry of Corporate Affairs and the Reserve Bank of India.
These companies get NBFC License with the Reserve Bank of India (RBI). NBFCs are intermediaries
engaged in the business of finances. NBFC accepts deposits, delivers credit and plays an important
role in channelizing the scarce financial resources towards the creation of wealth. They
supplement the organized banking sector in meeting the increasing financial requirements of the
corporate sector, delivering credit to the unorganized sector and small local borrowers. However,
they cannot finance any agricultural activity, industrial activity, sale, purchase or construction of
immovable property.NBFC focuses on activities related to loans and advances, acquisition of
shares, stock, bonds, debentures, securities issued by the government/local authority or other
similar marketable securities, leasing, hire-purchase, insurance business, etc. The financial services
offered by NBFCs include disbursement of finances and loans, acquisition of stocks, shares or
bonds, etc.

Different Types of NBFCs

The NBFCs can be categorised under two broad heads:

 On the nature of their activity

 On the basis of deposits

The different types of Non-Banking Financial Corporations or NBFCs are as follows:

 On the nature of their activity:

o Asset Finance Company
o Loan Company
o Mortgage Guarantee Company
o Investment Company
o Core Investment Company
o Infrastructure Finance Company
o Micro Finance Company
o Housing Finance Company
 On the basis of deposits:
o Deposit accepting Non-Banking Financial Corporations
o Non-deposit accepting Non-Banking Financial Corporations

Objectives of NBFC Sector

 Making financial services accessible to one and all.
 By offering quicker funds and credit to the Indian trade and commerce industry, these
entities are enabling the nation-wide growth of large infrastructure projects.
 Small businesses, start-ups, and MSMEs/SSIs are dependent on funds offered by NBFCs.
 As these small businesses expand their operations, their need for skilled and unskilled
labour, goes up to fulfil the increase in operations. Thus, indirectly, each new NBFC
registration creates more job opportunities at the macro-economic level.
  NBFCs cater to the urban, as well as unorganised rural areas, offering loans to satisfy
different requirements. Whereas banks provide finance to the organized sector only. Over
the last few years, consumer lending has seen a continuous rise, with NBFCs catering to a
large portion. With the growth in the economy, the requirement for loans is bound to surge.
And NBFCs, along with banks, can give a strong push to the growth and development of the
Indian economy.

NBFC Role in Revolutionising the Economy

 Growth: In terms of year-on-year (YoY) growth rate, the NBFC sector beat the banking
sector in contributing to the economy every year. On an average, this segment grew by
22% every year, in its initial stages. Despite the slowdown in the economy and various
setbacks faced in the last few years, the sector is still growing and enhancing operations.
 Profitability: NBFCs have been more profitable than the banking sector because of lower
costs. This enabled them to offer cheaper credit to customers. As a result, the amount of
money lent to customers by NBFCs is higher than that of the banking sector with more
customers opting for NBFCs.
 Enhancing the Financial Market: An NBFC caters to the urban and rural poor companies and
plays a complementary role in financial inclusion. These financial companies bring much-
needed diversity to the market by diversifying the risks, increasing liquidity in the markets
thereby bringing efficiency and promoting financial stability to the financial sector. They
highlight the public issues of corporations as well as providing funds needed by the start-up
companies as capital.
 Infrastructure Lending: NBFCs by lending to infrastructure projects, contribute largely to
the economy. This is very important for the growth of a developing country like India.
 Promoting Inclusive Growth: NBFCs cater to a wide variety of customers both in urban and
rural areas. They finance projects of small-scale companies, which is important for the
growth in rural areas. They also provide small-ticket loans for affordable housing projects.
Microfinance plays an important role to attain stable financial inclusions.
 Upliftment in the Employment Sector: With the growth in operations of the small industries
and businesses, the policies of NBFCs are uplifting the job situation. More opportunities for
employment are arising with the influence of the NBFCs in the private as well as
government sectors. The business activities in the private sector provide more
employment opportunities and occupation practices.
 Mobilization of Assets: With more public preferring to deposit in NBFCs because of their
higher rate of interest, NBFCs allow mobilization of resources; funds and capitals. Due to
their easier norms for investing, these companies create a balance between intra-regional
income and asset distribution. Turning the savings into investments, these companies
 contribute to economic development as compared to traditional bank practices. Proper
organization of capital helps in the development of the trade and industry, leading to
economic progress. They operate not intending to maximise their profit and are, therefore,
engaged in activities that generate zero or very low revenue.
 Financing for Long-Term: NBFC play a key role in providing firms with funds through equity
participation. As against traditional banks, NBFCs supply long-run credit to trade and
commerce industry. They facilitate to fund large infrastructure projects and boost
economic development.
 Raising the Standard of Living: NBFCs collaborate with the government for the upliftment of
the society. The NBFCs attract deposits from the general public and convert it into capital
for industrial and other sectors for smooth economic development. The rise in businesses
consequently raises the demand for workforce and creates employment opportunities
raises the purchasing power of individuals and, subsequently, raising demands. This works
to upgrade the living standards of a society. Also, foreign deposits are attracted to these
financial institutions and support economic process and development.
 Innovative Products: NBFCs, by being flexible in terms of lending and investment
opportunities than banks, are more proactive in innovating financial products. This
facilitates their growth in an exceedingly prudent manner. They fine-tune their selling
campaigns in regard to their target customers. The factorization & bill payment service has
been revolutionized. NBFC P2P is a relatively new segment in India that is already creating
waves by providing considerably higher margins and facilitating loans at a lower cost.

RBI
The Reserve Bank of India was established by legislation in 1934 through the Reserve Bank
of India Act, 1934. It started functioning from April 1, 1935. Its central office is at Mumbai
since 1937. Since nationalization in 1949, it is fully owned by the Government of India. The
Reserve Bank of India is the central bank of our country. The preamble prescribes the
objectives as: (i) to secure monetary stability within the country; (ii) to operate the currency
and credit system to the advantage of the country.
 The bank is managed by a central board of directors and four local boards of directors.
Central board: The central board is appointed/nominated by the central government for a
period of four years. It consists of official directors and non-official directors.
Local boards: There are four local boards, one each for the four regions of the country in
Mumbai, Kolkata, Chennai, and New Delhi. The membership of each local board consists of
five members appointed by the central government for a term of four years.
 Offices: The RBI has 22 regional offices, most of them in state capitals.
 Main Functions of the RBI: • To formulate, implement, and monitor the monetary policy.
• To prescribe parameters of banking operations within which the country’s banking and
financial system functions. • To facilitate external trade and payment and promote orderly
development and maintenance of foreign exchange market in India. • To issue and
 exchange or destroy currency and coins • To perform merchant banking function for the
central and the state governments. • To maintain banking accounts of all scheduled banks.
 Role of the Reserve Bank of India:
(i) Monetary Authority of the Country- Monetary policy-making is the central function
of the Reserve Bank. Monetary policy represents policies, objectives, and
instruments directed towards regulating money supply and the cost and availability
of credit in the economy. The RBI conducts the monetary policy with the help of an
intermediate target, the operating instruments, and procedures. The RBI usually
sets the broad money (M3) as the intermediate target.
(ii) Regulator and Supervisor of the Financial System- The objectives of the Reserve
Bank as a regulator and supervisor of the financial system are to maintain public
confidence in the system, protect depositors’ interest and provide cost-effective
banking services to the public. The RBI regulates and supervises the banking
system in India under the provisions of the Banking Regulation Act, 1949, and the
Reserve Bank of India Act, 1934.
(iii) Banker to the Government-The Reserve Bank manages the public debt of the
central and the state governments and also acts as a banker to them under the
provisions of the Reserve Bank of India Act, 1934. The RBI provides a range of
banking services such as acceptance of money on government account,
payment/withdrawal of funds, and collection and transfer of funds by various
means throughout India. The Reserve Bank also provides safe custody facility;
manages special funds like the Consolidated Sinking Fund, issues and manages
bonds like relief bonds; and administers schemes for disbursal of pensions of
central and state governments’ employees through PSBs.
(iv) Manager of Exchange Control- The function of the Reserve Bank is to develop and
regulate the foreign exchange market. The bank’s role is to facilitate external trade
and payment and promote orderly development and maintenance of foreign
exchange market in India. The foreign exchange transactions are regulated under
the Foreign Exchange Management Act, 1999. The RBI undertakes two-way
operations in the forex markets to even out lumps or lows in demand/ supply and
reduce volatility. The Reserve Bank also enters periodically into foreign exchange
transactions to prevent undue fluctuations in the exchange rate and to ensure
orderly market conditions.
(v) Issuer of Currency- The RBI acts as the sole currency authority under Section 22 for
the issue of bank notes on which there would be no stamp duty. It issues notes in
the following denominations: `2, `5, `10, `20, `50, `100, `500. Bank notes are printed
at four notes presses, of which the Currency Note Press, Nasik, and Bank Note
Press, Dewas, are owned by the central government and the presses at Mysore and
Salboni are owned by the Bharatiya Reserve Bank Note Mudran Limited, a wholly-
owned subsidiary of the Reserve Bank.
(vi) Developmental Role- The Reserve Bank performs a wide range of promotional
functions to support national objectives. The RBI helped to set up a number of
development financial institutions. It has also helped to set up, promote and foster
financial markets. Since 1991–92, the RBI has played an activist role of promoting
financial sector reforms for attaining sustainable economic growth and stability.
The Reserve Bank has made priority sector lending mandatory for both public and
private sector banks. As agriculture continues to provide productive employment
 opportunities for two-thirds of the population, a higher amount of credit is directed
to agriculture.
(vii) Banker to the Banks- The scheduled banks maintain balances in their current
account with the RBI mainly for maintaining the Cash Reserve Ratio (CRR) and as
working funds for clearing adjustments. RBI has powers to collect credit
information from banking companies and appoint any bank as its agent. The
central bank provides a variety of financial facilities and accommodations to
scheduled banks. It takes care of temporary liquidity gaps in the banking system
through refinancing schemes. It acts as lender of last resort to foster financial
stability.

SEBI
SEBI is an autonomous organization that works under the administration of the Union Finance
Ministry. The Security and Exchange Board of India (SEBI) is managed by the following members:

1. The chairman was nominated by the Union Government of India.

2. Two members, i.e., Officers from the Union Finance Ministry.
3. One member from the Reserve Bank of India.
4. The remaining five members are nominated by the Union Government of India. Three of the five
members should be full-time members.

Objectives of SEBI: • Protect the interest of the investor in securities. • Promote the
development of securities market. • Regulating the securities market.
Powers and Functions of the SEBI

SEBI has specific responsibilities under the SEBI Act, 1992 as listed below: • Regulating the
business in stock exchanges and any other securities markets; • Registering and regulating the
working of stock brokers, sub—brokers, share transfer agents, bankers to an issue, trustees of
trust deeds, registrars to an issue, merchant bankers, underwriters, portfolio managers, investment
advisers and such other intermediaries who may be associated with securities markets in any
manner; • Registering and regulating the working of the depositories, participants, custodians of
securities, foreign institutional investors, credit rating agencies and such other intermediaries as
the Board may, by notification, specify in this behalf; • Registering and regulating the working of
venture capital funds and collective investment schemes, including mutual funds; • Promoting
and regulating self-regulatory organisations; • Prohibiting fraudulent and unfair trade practices
relating to securities markets; • Promoting investors’ education and training of intermediaries of
securities markets; • Prohibiting insider trading in securities; • Regulating substantial acquisition
of shares and takeover of companies; • Calling for information from, undertaking inspection,
conducting inquiries and audits of the stock exchanges, mutual funds, other persons associated
with the securities market, intermediaries and self-regulatory organisations in the securities
market

The SEBI exercises powers under Sections 11 and 11B of the SEBI Act, 1992, and 17 other
regulations. The SEBI, with its powers, can carry out the following functions: • Ask any
intermediary or market participant for information. • Inspect books of depository participants,
issuers or beneficiary owners. • Suspend or of cancel a certificate registration granted to a
depository participant or issuer. • Request the RBI to inspect books of a banker to an issue and
suspend or cancel the registration of the banker to an issue. • Suspend or cancel certification
issued to the custodian of securities. • Suspend or cancel registration issued to foreign
institutional investors. • Investigate and inspect books of accounts and records of insiders. •
Investigate an acquirer, a seller, or merchant banker for violating takeover rules. • Suspend or
cancel the registration of a merchant banker. • Investigate the affairs of mutual funds, their
trustees, and asset management companies. • Investigate any person dealing in securities on
complaint of contravention of trading regulation. • Suspend or cancel the registration of errant
portfolio managers. • Cancel the certification of registrars and share transfer agents. • Cancel
the certification of brokers who fail to furnish information of transactions in securities or who
furnish false information.

The SEBI supervises the securities market through on-site and off-site inspections, enforcement,
enquiry against violation of rules and regulations, and prosecutions. It undertakes inspection of
the books and records of depository participants and registrar to an issue. It also undertakes
inspection of stock exchanges to ensure that • the exchange provides a fair, equitable, and
growing market to investors; • the exchange has complied with the conditions if any, imposed on
it at the time of renewal of grant of its recognition under Section 4 of the SC (R) Act, 1956; • the
exchange’s organization systems and practices are in accordance with the Securities Contracts
(Regulation) Act, 1956 and rules framed thereunder; • the exchange has implemented the
directions, guidelines, and instructions issued by the SEBI from time to time; and • there are
adequate control mechanisms and risk management system.

Housing Finance: Housing finance is a business of financial intermediation wherein the money
raised through various sources such as public deposits, institutional borrowings (from banks),
refinance from NHB and their own capital, is lent to borrowers for purchasing a house. These
intermediaries lend money by accepting mortgage by deposit of title deeds of the residential
property. The concept of housing finance was pioneered by Housing Development Finance
Corporation (HDFC) in October 1977. The prominent players in this industry continue to be housing-
finance companies (HFCs) and commercial (local as well as foreign) banks. Cooperative banks and
other cooperative-sector institutions have developed their own niche and have been catering to
their markets, extensively.
Housing Finance Companies: A housing-finance company (HFC) is a company which mainly carries
on the business of housing finance or has one of its main object clauses in the Memorandum of
Association, of carrying on the business of providing finance for the housing. A HFC is required to
have certificate of registration from NHB, a minimum net-owned funds of `200 lakhs. About 43
HFCs have been granted certificate of registration under Section 29A of the NHB Act, 1987.
List of Top 15 Housing Finance Companies in India

 LIC Housing Finance Limited

 Indiabulls Housing Finance Limited
 ICICI Home Finance
 L&T Housing Finance Limited
 PNB Housing Finance Limited
 Tata Capital Housing Finance Limited (TCHFL)
 Edelweiss Housing Finance Limited
 Fullerton India Home Finance Company Limited
 Bajaj Housing Finance Limited
 Aditya Birla Housing Finance Limited
  Shriram Housing Finance Ltd
 Aadhar Housing Finance Limited
 Piramal Housing Finance Limited
 Shubham Housing Development Finance Company Limited

Repricing of Loan: Repricing refers to switching to a new home loan package within the
same bank. It is when you or a mortgage broker negotiate with your current lender to
get a lower interest rate on your home loan.

Floating vs Fixed Rate: Fixed exchange rates mean that two currencies will always be
exchanged at the same price while floating exchange rates mean that the prices between each
currency can change depending on market factors; primarily supply and demand. A floating
exchange rate is determined by the private market through supply and demand. A fixed, or
pegged, rate is a rate the government (central bank) sets and maintains as the official exchange
rate. A set price will be determined against a major world currency. A floating rate is often termed
"self-correcting," as any differences in supply and demand will automatically be corrected in the
market.
 fixed home loan interest rate on home loans maintains a constant interest rate that does
not change with market conditions.
 Floating interest rates on home loans are determined by market fluctuation. The interest
rate may rise and fall with the market volatility.

The Rest Method: A rest is the interval at which the balance of the loan amount is recalculated. It
is applicable in the cases of reducing balance loan amounts. The rest can be yearly, monthly or
daily. A brief description is as follows:
 Annual rest: During an annual rest, although one pays the EMIs, the loan amount based on
which the interest is paid is recalculated at the end of the 12 months only. Therefore, one
ends up paying interest on the same loan amount, even when the outstanding loan amount
reduces each month.
 Monthly rest: Unlike annual rest, during monthly rest, the remaining amount of home loan
is calculated each month. The balance amount decreases every month. The customer has
the advantage because the rest matches the frequency of the user’s loan repayment
 Daily rest: Generally, salaried employees do not choice this option. It is more convenient
self-employed people who receive income at irregular intervals.