money supply, banking & financial institutions section 9 MCQ Questions & Answers Detailed Explanation

Answer: (d)

Answer: (a)

Answer: (d)

In money market, short term (less than one-year maturity), highly liquid and debt instruments are traded. State Development Loans (SDL) have a maturity of more than a year.

Cash management bills, Treasury bills and Certificate of deposits are debt instruments with less than one year maturity.

Certificate of Deposit (CD) is a negotiable/tradable money market instrument (a kind of Promissory Note) and issued in dematerialised form against funds deposited at a bank or other eligible financial institution for a specified time period.

(It is different from the Deposit certificates that individuals get when they deposit money in a bank that is non-tradable).

Answer: (c)

Answer: (b)

Every Bank calculates its own MCLR Rate based on marginal cost of deposits, operational costs, reserve requirements and tenor premium. So MCLR (or Base Rate) is an “internal benchmark” that varies from bank to bank. Banks link their lending rate with MCLR.

But, the transmission of policy (repo) rate changes to the lending rate of banks under the MCLR framework has not been satisfactory due to various reasons like:

1. Banks feared that they will lose the depositors/customers if they will reduce the deposit rate first, and since the deposit rate was not reduced, MCLR (or base rate) was also not coming down.
2. Government offering higher interest rates on its own small savings schemes like Kisan Vikas Patra, Sukanya Samriddhi Scheme, PPF etc.

Hence, RBI has made it mandatory for banks to link all new floating rate personal or retail loans and floating rate loans to MSMEs to an external benchmark effective October 1, 2019.

Banks can choose one of the four external benchmarks –

1. repo rate,
2. three-month Treasury bill yield,
3. six-month treasury bill yield or
4. any other benchmark interest rate published by Financial Benchmarks India Pvt. Ltd.

Banks are not mandated to link their deposit rates with an external benchmark rate.

Now, suppose Axis Bank links its loan rates as per following: Home Loan = repo rate + 3% (3% is called the Spread) Education Loan = repo rate + 4% Personal Loan = repo rate + 5%

Here, all the loans are linked to the repo rate, which is an external benchmark, on which Axis Bank does not have any control. So, the moment RBI changes the repo rate, it will automatically be transmitted to all the lending rates at the same moment for the new loans (Even if the bank links the lending rate with Treasury bill yield; when RBI changes repo rate, the T-bill yield also changes in the market immediately).

The purpose of linking the lending rate with an external benchmark is the faster transmission of repo rate into the lending rate and this mechanism is more transparent also. Adopting multiple benchmarks by the same bank is not allowed within a loan category

Banks are free to decide the components of spread and the amount of spread. But in general, the spread consists of credit risk premium, business strategy, operational costs of banks etc. While the banks will be free to decide on the spread over the external benchmark, credit risk premium can change only when the borrower’s credit assessment undergoes a substantial change. The other components of the spread like operating cost can be altered once in three years.

The interest rate under the external benchmark shall be reset at least once in three months. This means that if a borrower has taken a loan on 1st Jan 2020 and RBI changes the repo rate on 1st Feb 2020, then the borrower may not get the immediate benefit of the rate cut as the interest rate on his loan will only get revised at the latest by 1st April 2020 (within three months of the loan taken).

RBI has mandated banks to link the lending rate with an “anchor rate” like MCLR or repo rate (while MCLR was the internal rate of banks, but the repo is an external rate). But there is no mandate for NBFCs to link their lending rates.

Answer: (a)