Reverse Mortgage, Cash Credit, NPA, EMI, DRI

Reverse Mortgage Scheme

 Under this scheme, the senior citizens can unlock and tap the value of their residential house while enjoying the benefits of living in the house during their lifetime. Government of India introduced reverse mortgage a scheme in 2008.

This scheme is exact ‘reverse’ of plain home loan scheme. In case of a home loan one takes a lump sum loan and repays it in instalments in future. Under the reverse mortgage scheme, you get instalments and the loan is repayable in lump sum in future.

Here, the payment stream comes to the borrower for a fixed period of time in the form of monthly, quarterly or yearly payments. The maximum permissible monthly payments under this scheme cannot exceed Rs.

50,000 per month.

  •  A bank overdraft facility means an additional source of liquidity available to businesses and a useful tool to manage short-term cash flow problems.
  • An overdraft allows the individual to continue withdrawing money even if the account has no funds in it or not enough to cover the withdrawal. Basically, overdraft means that the bank allows customers to borrow a set amount of money.

Cash Credit

  • A cash credit is a short-term cash loan to a company.
  • A bank provides this type of funding, but only after the required security is given to secure the loan. 
  • Once a security for repayment has been given, the business that receives the loan can continuously draw from the bank up to a certain specified amount.

                                                                                                                                                                                       

Important Features of Cash Credit

 

1. Borrowing limit

  • A cash credit comes with a borrowing limit determined by the drawing power of the borrower. 
  • A company can withdraw funds up to the borrowing limit.

 

2. Interest on running balance

In contrast with other traditional debt financing methods such as loans, the interest charged is only on the running balance of the cash credit account and not on the borrowing limit.

 

3. Minimum commitment charge

  • The short-term loan comes with a minimum charge from the loan amount regardless of whether the borrower is able to utilize it. 
  • For example, banks typically include a clause that requires the borrower to pay a minimum interest on a predetermined amount or the amount withdrawn, whichever is higher.

 

4. Collateral security

It is secured against a security such as stock, debtors, etc. and/or fixed assets and properties as collateral security.

 

5. Credit period

  • It is typically given for a maximum period of 12 months, after which the drawing power is re-evaluated.

Example of Cash Credit

  • Company A is a phone manufacturer and operates a factory where the company invests money to purchase raw materials to convert them into finished goods. 
  • However, the products in finished goods inventory are not immediately sold – the company’s capital is stuck in the form of inventories. 
  • In order for Company A to meet its expenses and wait for their finished goods inventory to convert into cash, the company takes a cash credit loan to successfully run their business without a shortfall.

Disadvantages of Cash Credit High rate of interest

  1. Minimum commitment charges
  2. Difficulty in securing
  3. Temporary source of finance

 

Overdraft

  • An overdraft is an extension of credit from a lending institution when an account reaches zero or A deficit in a bank account caused by drawing more money than the account holds.

NPA (Non- Performing Assets)

A Non-Performing Asset (NPA) refers to a classification for loans or advances that are in default or are in arrears on scheduled payments of principal or interest. In most cases, debt is classified as non-performing when loan payments have not been made for a period of 90 days.

Types of assets:-

  1. Standard assets:

Assets which are generating regular income to the bank

  1. Sub-standard assets:

An asset which is overdue for a period of more than 90 days but less than

12 months

  1. Doubtful assets:

An asset which is overdue for a period of more than 12 months.

  1. Loss assets:

Assets which are doubtful and considered as non-recoverable by bank, internal or external auditor or central bank inspectors

  1. Sub-standard assets: 

Doubtful assets and Loss assets are NPA.

Causes of NPA

  1. Default 

One of the main reason behind NPA is default by borrowers.

  1. Economic conditions 

The Economic condition of a region affected by natural calamities or any other reason may cause NPA.

  1. No more proper risk management 

Speculation is one of the major reason behind default. Sometimes banks provide loans to borrowers with bad credit history. There is a high probability of default in these cases.

  1. Mis-management 

Often ill-minded borrowers bribe bank officials to get loans with an intention of default. 

  1. Diversion of funds 

Many times, borrowers divert the borrowed funds to purposes other than mentioned in loan documents. It is very hard to recover from this kind of borrowers.

Prompt Corrective Action

 PCA framework is one of such supervisory tools, which involves monitoring of certain performance indicators of the banks as an early warning exercise and is initiated once such thresholds as relating to capital, asset quality etc. are breached. 

 Its objective is to facilitate the banks to take corrective measures including those prescribed by the Reserve Bank, in a timely manner, in order to restore their financial health. 

 The framework also provides an opportunity to the Reserve Bank to pay focussed attention on such banks by engaging with the management more closely in those areas. The PCA framework is, thus, intended to encourage banks to eschew certain riskier activities and focus on conserving capital so that their balance sheets can become stronger. The Reserve Bank has emphasized that the PCA framework has been in operation since December 2002.

 

Debt Recovery Tribunals (DRTs)

  • Debt Recovery Tribunals were established to facilitate the debt recovery involving banks and other financial institutions with their customers like NPA.  DRTs were set up after the passing of Recovery of Debts due to Banks and Financial Institutions Act (RDBBFI), 1993. 
  • Appeals against orders passed by DRTs lie before Debts Recovery Appellate Tribunal (DRAT). The civil courts were directed to hand over all such cases to Debt Recovery Tribunals (DRTs) and Debt Recovery Appellate Tribunals (DRATs), constituted under the Act

DRTs can take cases from banks for disputed loans above Rs 10 Lakhs At present, there are 33 DRTs and 5 DRATs functioning at various parts of the country.

  • Compared to the ordinary court procedures, DRTs were able to handle large number of cases with low delay during the initial phases. 

 

Asset Reconstruction Companies (ARCs)

  • The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, 2002; enacted in December 2002 provides the legal basis for the setting up ARCs in India. Section 2 (1) of the Act explains the meaning of Asset Securitization. 
  • Asset Reconstruction Companies or ARCs purchases bad assets or NPAs from banks at a negotiable price and helps banks to clean up their balance sheets (by removing the NPAs). ARCs are also elaborated under Section 3 of the Act.
  • At the same time, the new Insolvency and Bankruptcy Act will give a critical role to the ARCs in settling the bad assets through the insolvency process.

Capital needs for ARCs

  • As per amendment made on the SARFAESI Act in 2016, an ARC should have a minimum net owned fund of Rs 2 crore.
  • The RBI plans to raise this amount to Rs 100 crore by end March 2019.  Similarly, the ARCs have to maintain a capital adequacy ratio of 15% of its risk weighted assets.

 

Equated Monthly Installment (EMI)

Definition: 

Equated monthly installments are used to pay off both interest and principal each month so that over a specified number of years, the loan is paid off in full.

Description: 

The EMI is dependent on multiple factors, such as: 

  1. Principal borrowed 
  2. Rate of interest 
  3. Tenure of the loan 
  4. Monthly/annual resting period 
  • For a fixed interest rate loan, the EMI remains fixed for the entire tenure of the loan, provided there is no default or part-payment in between. 
  • The EMI is used to pay off both the principal and interest components of an outstanding loan. 
  • The first EMI has the highest interest component and the lowest principal component. In case the rate of interest reduces through the tenure of the loan (as in the case of floating rate loans) the subsequent EMIs get reduced or the tenure of the loan falls or a mix of both. 
  • It further explains that, with most common types of loans, such as real estate mortgages, the borrower makes fixed periodic payments to the lender over the course of several years with the goal of retiring the loan.

 

Differential Rate of Interest Scheme (DRI)

  • DRI, a scheme for extending financial assistance at concessional rate of interest to a selected low-income group for productive endeavours is known as Differential Rate of Interest Scheme (DRI) is now being implemented by all Scheduled Commercial Banks.
  • Under the DRI Scheme, banks provide finance up to Rs.15,000/- at a concessional rate of interest of 4 percent per annum to the weaker sections of the community for engaging in productive and gainful activities.
  • In the case of physically handicapped persons, a sum of Rs.5,000/- for purchase of aids, appliances and equipments may be granted, apart from the loan amount of Rs.15,000/-. In case of housing loan under DRI scheme, a maximum loan amount of Rs.20,000 is allowed with lenders and the demand for the same which remains volatile.

Types of Money and Measures of Money Supply

A.) Types of Money: There are majorly four types of Money accepted widely as follows:-

 

1.) Fiat Money: It is a legal tender that is declared by Government and it is accepted by all people and companies or any other institutions within the country for payment transactions. Fiat money is not backed by physical commodities. It is just a value that is derived between the relationships of supply and demand. Its intrinsic value is significantly lower than its face value. Examples of Fiat Money are Coins and Bills.

 

2.) Commodity Money: Commodity money is the oldest type of money. It has been considered as a medium of exchange, a unit of account, and a store of value. It is related and originated from the ‘barter system’ where people fulfill their requirements by giving goods or services as payment. The commodity itself is valued as money. Examples of commodity money are Gold, coins, spices, wheat or food grains, etc.

 

3.) Fiduciary Money: Fiduciary Money value depends on the confidence that it is generally accepted as a medium of exchange. It is not declared by legal tender by the government thus people do not abide to accept it as means of payment. If people are confident that the promise will not be broken, they could use it as a regular fiat or commodity money. Examples are Cheques, Banknotes, and Drafts, etc.

 

4.) Commercial Bank Money: It is debt-generated money of commercial banks that can be exchanged for money or to buy goods or services. Commercial bank money is generated through fractional-reserve banking, in banking practice, banks keep only a fraction of their deposits in reserve and lending out the remainder, while maintaining the concurrent accountability to redeem all these deposits upon demand. 

 

Measures of Money: There four measures for money supply are as follows: M1, M2, M3, and M4. It is classified by the Reserve Bank of India (RBI) in April 1977 before this classification the RBI published only one measure of the money supply which is M.

 M1: It is the first measure of the money supply known as narrow money.

 

Coins and notes of all denominations which are in circulation within the public are called M1 money. 

 

Demand Deposits in the commercial banks and co-operative banks are also considered in this measurement; excluding inter-bank deposits.

 

Current deposits of foreign central banks, financial institutions are also considered in this measurement of money. 

 

M2: This second measure of money supply consists of M1+ post office savings bank deposits.

 

In the money supply savings deposits of commercial and cooperative banks are already included it is necessary to include post offices savings bank deposits. The post office deposits have been given more preference than bank deposits in the majority of people from rural and urban areas from a safety point of view. 

 

M3: This third measure consists of M1+ Commercial and cooperative banks’ time deposits. It excludes interbank time deposits. It is known as ‘broad money by the Reserve Bank of India. 

 

M4: The fourth measure of money supply consists of M3+ all post office deposits including time deposits and demand deposits. 

 

M3 includes total deposits of banks and currency with the public in circulation thus RBI prefers it most in credit budgeting for its credit policy. Even it is also taken into account in formulating macroeconomic objectives of the economy every year.