Look Ma, I am a scheduled bank

So you probably heard some bank running an advertisement campaign saying they are now a scheduled bank. What does this mean? Does it even matter?

What is a scheduled bank?

As per the Reserve Bank of India Act of 1934 and its amendments, from which the RBI draws its powers and rules from, a bank included in the Second schedule of the act is called a scheduled bank.

That sounded like a 2 mark answer in a pop quiz

So how does a bank become a scheduled bank?

Artist’s impression of RBI telling a bank how to get onto the schedule

A bank can be included in the second schedule if it satisfies (or removed if it does not satisfy) all of the following criteria:

• Has a paid-up capital and reserves of an aggregate value of not less
  than five lakhs of rupees

Someone probably forgot to update this in a while.

• Satisfies the Bank (RBI) that its affairs are not being conducted in a
  manner detrimental to the interests of its depositors

My problem with language like this is that a lot of it is left for interpretation. What does satisfy even mean? Sometimes my hunger is satisfied after eating one biscuit, sometimes I need to spend an hour at a buffet.

• Is a State co-operative bank or a company as defined in
  section 3 of the Companies Act, 1956, or an institution notified by
  the Central Government in this behalf or a corporation or a company
  incorporated by or under any law in force in any place outside
  India

Cool beans

The flip side is the requirement for the scheduled bank to keep some percentage of its total demand and time liabilities with RBI (There is a penalty if the scheduled bank is below the minimum prescribed by RBI). There is an increased reporting requirement as well for scheduled banks.

Yay! More reporting — who doesn’t like more reporting? Its odd though that once RBI is convinced that a bank is serving the depositors interests, the reporting requirements increase and not decrease.

What are the perks?

The major perk is that a scheduled bank can borrow money from RBI, the interest rate at which RBI loans money to the scheduled bank is “Repo rate”.

Tiny detour — You would have heard this from time to time — “RBI has reduced the repo rate”. A crude explanation would be, RBI decreases the repo rate to reduce what it costs a scheduled bank to borrow money, the hope is that in turn the scheduled bank reduces the rate at which it lends to its customers. This trickle down causes the end customers to borrow, consume and create more leading to an overall growth of the economy.

So banks, both scheduled and non-scheduled borrow money to lend, if they don’t have enough depositor money to lend from. The difference is that a scheduled bank has the possibility to get money from RBI or the Bond Market ( a market where people sell and purchase money at different rates based on how worthy the borrower is, as “rated” by some rating agencies — Phew! ), whereas a non scheduled bank can only (usually) get money from the Bond Market.

In some sense being a scheduled bank is like getting a good grade, which a bank can show off to others to get a better interest rates from the Bond market.

Artists impression of a bank after it becomes scheduled

But then do grades matter though? Especially when the criteria is umm.. a bit arbitrary?

Here are two ways I have been thinking about this:

1. A bank could already be doing well, leading to a favorable rate from the Bond market and then RBI recognizes the bank as a scheduled bank.
2. RBI could make a bank scheduled, signalling the Bond market to give the bank favorable rates.

I have been trying to see if there is a way to gather data to see which of the above happens, unfortunately I do not have significant data to show 1 or 2.

One approach I took is to compare the MCLR (Marginal Cost of Funds based Lending Rate — This is what it costs the banks to lend for a specific term, they will need to add some % above this to make some money for themselves) from before and after being scheduled.

Here is a snap shot of the MCLR for 3 small finance banks from before and after they have been included in the second schedule.

Since MCLR has an operational efficiency component in it, it is hard to figure out if there is a direct correlation from being scheduled and reduction in the cost of over all fund acquisition. Maybe we can watch these three banks over time to see if there is a trend in their MCLRs that is significant or if the ratings from rating agencies follow a trend.

If the reader knows a better way of doing this — please feel reach out to me, I would be grateful.

Some banks also try to advertise the fact that they have become scheduled to signal to their customers that they are somehow better now and should be given more deposits.

From Jana SFB’s website as of 21-October-2019

Not many people even understand what a scheduled bank means for this to matter, but then their MCLR did go do down 🤷

That’s about as much as I know about scheduled banks. Thanks for reading.

Fin.