RBI’s Monetary Policy and Its Impact on Corporates

RBI’s Monetary Policy and Its Impact on Corporates | CMS Tools

RBI’s Monetary Policy and Its Impact on Corporates

Monetary policy is one of the most important tools that RBI uses to guide the economy. Its objective is to link economic activities in the desired areas for proper, balanced development.

Monetary policy is administered through a number of instruments that affect the financial sector and are very relevant to the corporate sector.

Therefore, it is essential for a company’s Treasury Head to understand these and be aware of their specific relevance to the company’s financial operations. RBI announces changes in monetary policy every year and sometimes in the interim.

Following are some of the important monetary policy instruments:

• Reserve Requirement i.e. CRR and SLR: An increase in the reserve ratio will reduce the money supply and make it difficult to get bank credit.
• Open market operations are the buying and selling of securities such as treasury bills and government securities by the RBI: In open market operations, the buying or selling affects the money supply in the economy.
• Lending by RBI: It affects the reserve level and lending power of banks.
• Direct Bank Credit Control: RBI may limit or liberalize lending by banks to various economic sectors, which may trigger or retard corporate activity. For example, export credit may be cheaper, prompting companies to take action.
• Guidelines on Corporate Deposits: These Direct Declarations directly affect corporate credit policy, and may include changes to the terms that companies must apply carefully to avoid penalties.
• Exchange Rates: In a controlled economy like ours, foreign exchange is still not completely market-driven and the Reserve Bank of India plays an important role in shaping the movement of the Indian rupee against the US dollar and other hard currencies.

What is Cash Management System

Cash is king, and maximizing the cash available for use is a major challenge for most companies. This is done with the help of the Cash Management System (CMS).

The main obstacle facing a CMS is ‘collect or float float’, which means that the amount is collected but not used as it is in the pipeline. For example, a check has been given by a customer in Bathinda, but it may take 12 days for it to be credited to the overdraft account of the company in Mumbai. An efficient CMS that minimizes this float is critical to a company’s control over its cash.

Effective Cash Management

A company’s CMS must enhance the collection of receivables, control payments to business creditors, and efficiently manage liquid cash. This can be done by enabling greater connectivity to their branch network and providing better IT solutions and services in cash management.

An effective cash management system looks at three things:

• Deciding and controlling the optimum cash balance to hold
• Planning the inflow and outflow of cash
• Investing surplus cash with the best returns and minimum risk

Objectives of the cash management system

• Build and operate a robust networking facility that connects the various agencies involved in the movement of cash, thereby minimizing the time taken between any two agencies.
• Running a powerful information system that tracks cash online and ensures that relevant managers act quickly on information to resolve issues and prevent cash from getting stuck in the pipeline.
• To involve banks and other financial intermediaries in the process of finding cost-effective solutions to the problem of excessive time lag in depositing and making cash available for use.

Banks in India over the past two and a half decades have done remarkable work in this area by introducing several innovative CMS products, and are now able to give credit to their customers even for local checks deposited the next day.

CMS features also include check collection, tracking of actual payments, and Management Information System (MIS) on the collection behavior of parties. Not only this, it is no longer just an operational tool, but also a strategic tool.

The benefits of the cash management system

1. Online information on global cash balances at all times
2. Banking anywhere and anytime without losing control
3. Optimum use of cash and minimum idle cash balance
4. Quick and accurate compliance with external reporting requirements like bank statements, Credit Authorization Scheme (CAS) data, etc.
5. Ability to manage MBA (Multi-banking setup) from one place
6. Ability to generate better revenue from cash balances

Cash Management System Products and Tools

1. Decentralized Collection: Traveling from one outstation check to the head office and back again for clearing is a huge waste of time. This can be avoided by using net connectivity to update the system at branches and the head office of the banks receiving the cheque and enabling credit to the HO account on the very next day itself.

2. Concentration Banking: This idea has evolved into an intensive banking system known as ‘concentration banking’. A company will have overdrafts in the HO and will have multiple current accounts across all its sales and stock points. Thanks to concentration banking, information on balances is always available across the country, and transfers are enabled.

3. Lockbox System: Here checks are received directly in the lockbox provided for this purpose by the bank, and customers are advised to send their checks to this lockbox. Through this process, the time taken for the customer to collect and deposit the check is eliminated. Thus one more link in the chain is removed, thereby speeding up the process.

4. Electronic Receipts and Payments: In the new era of banking anywhere and anytime it is now possible to make a direct credit to the recipient’s account using online banking services. This is especially beneficial for making regular payments such as payments of salaries and payments to vendors.

Only a simple list of payees and amounts, duly authorized, is sent to the bank; And the credit is instant if the employees have accounts in the same branch.
Banks also provide facilities to their customers to prepare and mail checks on their behalf to reduce the clerical workload.

5. Electronic data transfer between constituents: When two companies are in the advanced stages of automating all their processes, the paperwork related to transactions between them may disappear entirely. This is facilitated by the electronic transfer of orders, invoices, debit notes, and final payments and receipts.

Reconciliation is also done online. Accounting packages provide an excellent interface with spreadsheets from which to download data or to which data can be uploaded and sent.

6. Better Clearing System of Banks: Thanks to advanced information technology, banks have influenced innovations in clearing house activities and this has significantly reduced the turnaround time (TAT).

7. Payment Management: Large companies work on payment cycles eg. Specific days of the week or month when payments to vendors will be held. If the seller is loose or if the invoice is not generated properly he will miss the cycle and will have to wait till the next cycle, even if the bill is due midway.

It’s also a good way for a company’s vendors to become more efficient and accurate in their administration, documentation, and accounting, and can result in a lasting benefit in year-end closing and audit time and effort.

Multinational Cash Management

A multinational company, viz. A company that has offices in multiple countries needs a CMS that can handle additional issues arising from the global exposure of the Treasury function. The main purpose of such CMS is to see how quickly and cheaply the funds available at one end of the world can be used by an office at the other end.

The answer lies in combining global strategy with local practices. Treasury policies of a multinational company will attempt to match cash management best practices available in the countries in which they operate, but without harming their global strategic intent.

Thus a company famous for its “best payer” name may find cash movement logistics very slow in a third-world country. Rather than damage its reputation for prompt payments, the company will work with sellers to set up automatic transfers to sellers’ bank accounts at an international bank.

Another challenge in multinational cash management is exchange rate fluctuations. The aim here is to minimize the adverse impact of exchange rate changes on the company’s bottom line.

MNCs adopt a variety of strategies to achieve this objective.

• Contracting with customers and vendors who fix the exchange rate ‘band’ and determining the price change if the exchange rate goes out of the band.
• Setting up of Foreign Exchange Earner’s Foreign Currency (EEFC) accounts i.e. bank accounts in foreign currencies, with the freedom to convert the balance into local currency at a favorable time or make foreign currency payments from that account.
• Linking accounts with a single bank across all geographies makes payments much easier and reduces idle cash in the process.

What is Working Capital Management

Working capital is that portion of a firm’s capital that is needed to finance short-term or current assets, including inventory and receivables. It is the ‘operating’ capital required for day-to-day activity.

Both short-term and long-term funds can be used for financing working assets. Short-term sources of funds provide flexibility and low costs, and long-term sources offer less risk and increased liquidity. The ‘fixed’ or long-term segment of working capital should be financed from long-term funds and the ‘convertible’ segment from short-term funds.

Fixed or core working capital is the minimum amount of networking assets required by the business, below which the volume of the business is not likely to go down. It is a permanent investment to be financed continuously.

This includes the working capital needed to keep the capital in circulation, as well as a reserve to provide for unforeseen contingencies such as a strike or unexpected shortfall. This amount has to be budgeted every year and its funding is channeled through long-term sources, at least cost and on best terms.

Variable or floating working capital is the fluctuating portion of networking assets. Variation is due to seasonality, one-time practices such as inactivity at the end of campaigns and periods, or the seasonality of customer/vendor cash flows. This capital is financed from short-term funds.

Smart management of working capital is an important factor in the success (or failure) of a business.

The factors that determine working capital management are:

• The planned level of activity
• Nature of business and distinctive features of its working assets
• Seasonal
• Regarding Management Initiatives

• • Inventory Control
  • Trade credit is given to customers
  • Trade credit available from vendors
  • Cash Management

• Requirement of other current assets like deposits and advances

How much working capital does a business require?

Is there any number or value or ratio that can be determined as the ‘standard’ for the working capital of a company? The answer is no, definitely not. What is ideal for one company may be unacceptable for another, and it all depends on a proper assessment of the factors listed above.

A business firm will need a healthy amount of fast-moving goods; On the other hand, a company selling to end-users will probably need far less inventory, but they will invest more in credits and receivables.

Data Communication and Networking MCQ with Answers

Liquidity and Working Capital Management

Working capital management has a direct impact on liquidity. The cash crunch felt by many businesses is often the result of poor management of working capital, such as overproduction and stockpiling, or excessive credit to customers to acquire the business, etc.

A firm’s liquidity or ability to meet short-term fund requirements is affected not only by the amount invested in working capital but also by its composition. For example, a company that has a large current liability amount on account of advances received from customers is in a much better position than a company whose current liabilities are much larger due to unpaid vendors.

Creative working capital management is needed to ensure that a firm has mature short-term debt and sufficient resources to meet the upcoming operating expenses.

Foreign Exchange Dealers Association of India (FEDAI)

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