Sample Copy: Promissory Note

India Vs. The Developed 'Others'...Bank Prime Lending Rates

In recent years, here are the trends in Commercial Bank Prime Lending Rates:

What do you notice in the graph? What might be the factors that keep India's interest rates at a level where it becomes noncompetitive? Whys is it that all developed countries have low interest rates whereas the underdeveloped countries have high interest rates?

Participate in the discussion and know more...

Note on Capital

Capital has a variety of meanings, but it generally refers to financial resources.

Capital includes financial assets, as well as the machinery and equipment businesses use in production. Investors use capital to buy stocks or mutual funds. Companies raise capital by selling bonds or stocks to finance their operations.

While capital can be currency or cash, it’s not the same thing as money. People use money to buy goods and services for consumption. Capital is more durable, and it creates wealth through investment. Land, cars, patents, software and brand names are all capital. They can be rented out or used to make products, all in an effort to create wealth. Investing capital instead of spending it as money often builds more capital.

Property rights give capital its value, allowing its owners to use it as they want. Since capital generates income, those investors, companies and societies who have the most capital are better off. How a person, firm or country chooses to allocate their capital goes a long way toward determining their level of prosperity.

Why Do We Need Reforms in Money Market?

The following are the major defects of the Indian Money market:

1. Major portion of money market held by unorganized players and incoherence between organized and unorganized money market

2. RBI's monetary policy becomes ineffective because of lack of integration between various sub-markets as well as various institutions and agencies.

3.    Diversity In Interest Rates. In the rural and urben segments, there are different rates of interest which create differences in costs of operation.

4.    Seasonality Of Money Market. Agriculture turnover happens twice in a year and hence there are seasonal fluctuations in rate of interest, liquidity and investment cycles. 

5.    Shortage Of Funds. Inadequate banking facilities, low savings, lack of banking habits, existence of parallel economy are a few reasons for shortage of funds and mobilization of funds.

6.    Absence Of Organised Bill Market. The bill market in India is not popular due to overdependence of cash transactions, high discounting rates, problem of dishonour of bills etc.

7.    Inadequate Banking Facilities. The reach of banking system is low and uneven across the country.

8.    Inefficient And Corrupt Management. Lack of professionalization and deficient service are the most important factors in inefficiency.


Comment further by researching more on this topic...

Festivities and Federal Reserve

"For only the second time in a decade, the U.S. Federal Reserve (Fed) raised U.S. interest rates by 0.25%. The move had been widely expected following firm evidence the U.S. economy is on the road to recovery.

This was the Fed’s final meeting before President-elect Donald Trump’s inauguration. Following his numerous campaign-trail promises of tax cuts and infrastructure spending, members of the Fed’s interest-rate setting committee may have been wary of the potential for such policies to further fan the flames of inflation.

Bond investors clearly expect interest rates to continue on an upward trajectory next year. The yield on two-year Treasuries, which are particularly sensitive to changes in interest rates, jumped to its highest level since 2009 as investors sold bonds." - Blog - Thinking Aloud Aberdeen Asset Management

Questions:

Q:1 Why would the Federal Reserve's action of raising interest rate coincide with recovery in US?

Q:2 How is a rising interest rate related to inflation?

Q:3 What is the benefit to Bond investors in this new scenario?

Q:4 If you had purchased bonds this Christmas, what would be your expectation in future?

Semester II students, show me what you know about these issues by posting answers a your reactions and view...

How Do Banks Operate?

Excerpt Taken from: 
Blog: Pragmatic Capitalism, Authored by Cullen Roche
 

The following is a general overview of the purpose of modern banks and how they operate in a simplistic sense.  This passage is an excerpt from Cullen Roche’s book “Pragmatic Capitalism: What Every Investor Needs to Know About Money and Finance”

The monetary system is designed to cater to the creation of the public’s money supply, primarily by private banks by establishing a money supply that is elastic. That is, it can expand and contract as the demand for money expands and contracts. Most modern money takes the form of bank deposits, and most market exchanges involving private agents are transacted in private bank money. As I have discussed, inside money governs the day-to-day functioning of modern fiat monetary systems. The role of outside money, which is created by the public sector, is comparatively minor and plays a mostly facilitating role.

Like the government, banks are also money issuers but not issuers of private sector net financial assets. That is, banking transactions always involve the creation of a private sector asset and a liability. Banks create loans independent of government constraint (aside from the regulatory framework). As I will explain, banks make loans independent of their reserve position with the government, rendering the traditional money multiplier deeply flawed.

The monetary system in the developed world is designed specifically around a competitive private banking system. The banking system is not a public-private partnership serving public purpose, as the central bank essentially is. The banking system is a privately owned component of the system run for private profit. The thinking behind this design was to disperse the power of money creation away from a centralized government and put it into the hands of non-government entities. The government’s relationship with the private banking system is more a support mechanism than anything else. In this regard I like to think of the government as being a facilitator in helping to sustain a viable credit-based money system.

It’s important to understand that banks are not constrained by the government (outside the regulatory framework) in terms of how they create money. Business schools teach that banks obtain deposits and then leverage those deposits ten times or so. This is why we call the modern banking system a fractional reserve banking system. Banks supposedly lend a portion of their reserves. There’s just one problem here: banks are never reserve constrained. Banks are always capital constrained. This can best be seen in countries such as Canada, which has no reserve requirements. Reserves are used for two purposes—to settle payments in the inter-bank market and to meet the Fed’s reserve requirements. Aside from this, reserves have little impact on the day-to-day lending operations of banks in the United States. This was recently confirmed in a paper from the Federal Reserve:

Changes in reserves are unrelated to changes in lending, and open market operations do not have a direct impact on lending. We conclude that the textbook treatment of money in the transmission mechanism can be rejected.

Growth, Development and Financial Markets (Anna O Krueger's Views)

Read this interesting write up by Anna O Krueger's speech (as Special Advisor to Managing Director, IMF) which talks about the ways and means to development and growth where financial markets matter throughout different stages of economic development and growth. The speech was given in Tokyo, in 2006.

Thinking about economic development has evolved over the past half century, partly in response to perceptions of poverty and theorizing about its causes (and inferring from those the presumed needed policy actions) and partly through the experience of development in countries both successful and unsuccessful. During these years, there have been a number of "fads", or virtually single causation theories, as to "the" causative factor (or, perhaps, two factors), largely in response to perceptions that development was less rapid than it should have been.

During the past decade, much of the "fad" and the emphasis has been placed on understanding the role of the financial sector, in part because earlier lessons were learned, and in part as a consequence of the financial crises of the 1990s. Understanding of the role of the financial sector has increased markedly, but research and insights continue to mount. As that has happened, some have turned to "governance issues" as "the key" to development, but lessons about the importance, and key role, of the financial sector in development have certainly been learned.

 

For countries experiencing rapid growth, development of a healthy financial sector is critical. Hence, in many emerging markets and developing countries today, emphasis must be placed (among other things) on reforms that enable improved functioning of the financial system. At early stages of development, this entails strengthening the rights of borrowers and lenders, development of a credit rating system, lowering the costs of obtaining credit (not the interest rate), and streamlining means for settlement of disputes.

The World Bank has recently provided data on a number of these phenomena across countries. It has created a scale ranging from 1 to 10 (highest) to indicate the degree to which borrowers' and creditors' rights are protected. Industrial countries generally (but not always) receive high ratings, with the US and Australia for example receiving ratings of 10 and 9 respectively. By contrast, Argentina scores 3, Mexico 2, and some countries 1 and even 0.

Provision of credit ratings, normally through private credit bureaus, is also highly variable across countries. Again, industrial countries normally score well, with coverage of most of the economy, whereas Brazil has coverage of about half the population, and Costa Rica less than 5 percent. More than half of the 55 countries surveyed had no private credit bureau coverage at all.

The cost of creating collateral for loans also varies widely. World Bank numbers estimate that it is less than 0.1 percent of per capita income in the United States and the Untied Kingdom. By way of comparison, it is 8.1 percent of per capita income in Korea, 2.7 percent in Japan, 11.7 percent in India, 20.7 percent in Nigeria, and 62.2 percent of per capita income in Morocco.

The ability to enforce contracts also matters. In most industrial countries, the time to achieve legal enforcement is around 6 months (250 days in the Untied States, 75 days in France), while in developing countries it can be much more: 591 days in Bolivia, 425 in India, and 1,000 in Poland. Clearly, inability to enforce loan obligations can itself stymie financial development.

Policy reforms entailing increasing the efficiency of bankruptcy proceedings, reducing the cost of collateral, enforcing contracts, and improving other aspects of the financial nexus are clearly important. But so, too, is the development of an efficient (and implemented) regulatory framework, and competition within the banking system. How this is achieved can vary greatly from country to country, but there is a strong presumption that the development of arms-length lending, competition within the banking system, and arrangements that permit timely enforceability of contracts clearly matter.

In Korea, reforms in many of these dimensions were undertaken in response to the crisis, and, as already indicated, growth resumed quickly and has been sustained. In some other emerging markets, reforms are proceeding, although with varying degrees of rapidity. And, as some of the numbers just mentioned indicate, there are many countries where significant improvements will need to be made in order to enable the financial system even to begin to carry out its role.

Clearly, the financial sector is not THE key to development, any more than human capital or physical capital accumulation were. Equally, however, failure to develop the financial sector can put an enormous brake on growth prospects and, indeed, if the issue is not addressed, can thwart development efforts. For countries where there is a strong commitment to growth, the lesson is clear: attention needs to be paid to financial sector issues as growth proceeds, unless it is preferred to wait for a crisis to force the necessary reforms.