The accounting and auditing of intermediaries and Information on small borrowers has improved and information sharing through operationalisation of credit information bureaus has helped to reduce information asymmetry. The technological infrastructure has developed with modern-day requirements in information technology and communications networking The primary beneficiaries of the announced reforms are the state-owned banks, which control over three-quarters of total assets in the financial system. In the year 2005, the Central Government gave State-run banks significantly greater operational and managerial freedom, including the rights to: establish overseas branches or subsidiaries; exit non-profitable ventures; set human resource policies; and acquire domestic and foreign banks
Monetary and Banking Reforms of
KALI PRASAD PANDEY 212013
• Monetary Policy
– Role of RBI
– Current Monetary policy
– Monetary Policy Review
– Factors affecting Monetary Policy
• Banking Reforms
– History & Development in Banking
Role & Objectives
Reforms & Measures taken
– Narsimhan Committee Recommendations
• Impact of Banking Reforms
Monetary Policy –Meaning….
Monetary policy is the macroeconomic policy laid down by the central
bank. It involves management of money supply and interest rate and is
the demand side economic policy used by the government of a country to
achieve macroeconomic objectives like inflation, consumption, growth
Reserve Bank of India states that,
• Monetary policy refers to the use of instruments under the
control of the central bank to regulate the availability, cost and
use of money and credit.
• Maintaining price stability
• Ensuring adequate flow of credit to the productive Sectors
of the economy to support economic growth
• Rapid economic growth
• Balance of payment equilibrium
• Full employment
• Equal income distribution
Role of RBI
• One of the most important functions of central banks is formulation and
execution of monetary policy. In the Indian context, the basic functions of
the Reserve Bank of India as enunciated in the Preamble to the RBI Act, 1934
are:“to regulate the issue of Bank notes and the keeping of reserves with a
view to securing monetary stability in India and generally to operate the
currency and credit system of the country to its advantage.”
• Thus, the Reserve Bank’s mandate for monetary policy flows from its
monetary stability objective. Essentially, monetary policy deals with the use
of various policy instruments for influencing the cost and availability of
money in the economy. As macroeconomic conditions change, a central bank
may change the choice of instruments in its monetary policy. The overall
goal is to promote economic growth and ensure price stability.
Methods and Role of RBI
• The RBI aims to achieve its objectives of economic growth
and control of inflation through various methods.
These methods can be grouped as:
– General/ quantitative methods
– Selective/ qualitative methods
General/ Quantitative methods
• These methods maintain and control the total quantity or
volume of credit or money supply in the economy.
– Open Market Operations
• Open market operations indicate the buying/ selling of govt. securities in the open
market to balance the money supply in the economy
– Deployment of Credit
• The RBI has taken various measures to deploy credit in different sector of the
economy. The certain %age of the bank credit has been fixed for various sectors like
agriculture, export etc.
Cash reserve ratio (CRR)
The money supply in the economy is influenced by CRR.
It is the ratio of a bank’s time and demand liabilities to be kept in reserve with the RBI.
The RBI is authorized to vary the CRR between 3% and 15%.
Statutory liquidity ratio (SLR):
Under SLR, banks have to invest a certain percentage of its time and demand liabilities in govt.
The reduction in SLR enhances the liquidity of commercial banks.
Liquidity Adjustment Facility (LAF):
– Consists of daily infusion or absorption of liquidity on a repurchase basis,
through repo (liquidity injection) and reverse repo (liquidity absorption)
auction operations, using government securities as collateral.
– Repo rate is the rate at which the RBI lends shot-term money to the banks
against securities. When the repo rate increases borrowing from RBI becomes
ii. Reverse Repo Rate:
– The rate at which RBI borrows from commercial banks.
• Marginal Standing Facility (MSF):
• Market Stabilization Scheme (MSS):
Instituted under which scheduled commercial
banks can borrow over night at their discretion up
to one per cent of their respective NDTL at 100
basis points above the repo rate to provide a safety
valve against unanticipated liquidity shocks
• Bank rate:
Bank Rate is the rate at which central bank of the
country (in India it is RBI) allows finance to
Bank Rate is a tool, which central bank uses for
Any upward revision in Bank Rate by central bank
is an indication that banks should also increase
deposit rates as well as Base Rate / Benchmark
Prime Lending Rate.
Liquidity of a more enduring nature arising from
large capital flows is absorbed through sale of
short-dated government securities and treasury
The mobilized cash is held in a separate
government account with the Reserve Bank.
PM’s view at the Monetary Policy…
• “I think we expect the Governor to evolve a policy with the help of professional
persons for a national consensus if we have to carry on with implementing social
and economic changes in a complex economy,“
The remarks assume significance in the context of the raging debate over RBI's
hawkish policy stance on checking inflation vis a vis government priority on
• "The time has come to look at the possibilities and limitations of the monetary
policy in a globalised economy and dealing with the constraints of the macro
Thoughts from the ex-Governor
The debate on growth-inflation balance has been clouded by some
• “One such oversimplification is to say that governments are for growth and central
banks are for price stability.”
• “Another oversimplification is to assert that there is a tension between growth and
inflation, and that one necessarily has to play the trade-off between growth and
inflation in policy making"
Current Monetary Policy
• Repo Rate
It has been decided to:
Reduce the policy repo rate under the liquidity adjustment facility (LAF) by 25 basis points from 7.5
per cent to 7.25 per cent with immediate effect.
• Reverse Repo Rate
The reverse repo rate under the LAF, determined with a spread of 100 basis points below the repo
rate, stands adjusted to 6.25 per cent with immediate effect.
• Marginal Standing Facility Rate
The Marginal Standing Facility (MSF) rate, determined with a spread of 100 basis points above the
repo rate, stands adjusted to 8.25 per cent with immediate effect.
• Bank Rate
The Bank Rate stands adjusted to 8.25 per cent with immediate effect.
Current Monetary Policy
• Cash Reserve Ratio
The cash reserve ratio (CRR) of scheduled banks has been retained at 4.0 per cent of
their net demand and time liabilities (NDTL).
The Current State
• The pace of infrastructure project completion is subdued and new project starts remain
muted. Consumption, while relatively firm so far, is starting to weaken even in rural
areas, with durable goods consumption hit hard. Consequently, growth is trailing below
potential and the output gap is widening. Some pick-up is expected on account of the
brightening prospects for agriculture due to kharif output and the upturn in exports.
Also, as infrastructure investments are expedited, and as projects cleared by the
Cabinet Committee on Investment come on stream, growth could pick up in the second
half of the year.
• The growth of industrial production slid to 0.6 per cent in February 2013 from 2.4 per
cent a month ago, mainly due to contraction in mining and electricity generation and
slowing growth in manufacturing. Consequently, on a cumulative basis, growth in
industrial production decelerated to 0.9 per cent during 2012-13 (April-February) from
3.5 per cent in the corresponding period of the previous year.
• On the demand side, the persisting decline in capital goods production during April
2012 – February 2013 reflects depressed investment conditions. The moderation in
corporate sales and weakening consumer confidence suggest that the slowdown could
be spreading to consumption spending.
The Policy Review- last quarter
• Reduce the marginal standing facility (MSF) rate by 25 basis points from 9.0 per cent
to 8.75 per cent with immediate effect;
• Increase the policy repo rate under the liquidity adjustment facility (LAF) by 25 basis
points from 7.5 per cent to 7.75 per cent with immediate effect
• Keep cash reserve ratio (CRR) unchanged at 4.0 per cent of net demand and time
liability (NDTL); and
Increase the liquidity provided through term repos of 7-day and 14-day tenor from
0.25 per cent of NDTL of the banking system to 0.5 per cent with immediate effect.
• The reverse repo rate under the LAF stands adjusted to 6.75 per cent and the Bank
Rate stands reduced to 8.75 per cent with immediate effect. With these changes, the
MSF rate and the Bank Rate are recalibrated to 100 basis points above the repo rate.
Policy Review-the assessments
• In India, industrial activity has weakened, with a contraction in consumer durables
and tepid growth in capital goods reflecting the ongoing downturn in both
consumption and investment demand. Strengthening export growth and signs of
revival in some services.
• In the meantime, with many large entities holding back on payments, liquidity
pressures are building up on small and medium enterprises. A number are facing
conditions of financial distress. Remedies partly lie in the speed-up of government
and public sector payments, and on measures to channel credit to small and
• Inflation measured by the wholesale price index (WPI) rose in September for the
fourth month in succession. The pass-through of rupee depreciation into prices of
manufactured products is acting, along with elevated food and fuel inflation, to
offset possible disinflationary effects of low growth
SELECTIVE/ QUALITATIVE MEASURES
• The RBI directs commercial banks to meet their social obligations through selective/ qualitative
These measures control the distribution and direction of credit to various sectors of the economy.
CEILING ON CREDIT
DISCRIMINATORY RATES OF INTEREST
FACTORS AFFECTING MONETARY POLICY
There exist a non-monetized sector
Excess of non-banking financial institutions (NBFI)
Existence of unorganized financial market
Money not appearing in an economy
Monetary policy and fiscal policy lacks coordination
The Indicators now…
Reverse repo rate
Marginal Standing facility rate
History and Development in Indian Banking Sector
Banking Sector can be divided into four phases
Evolutionary phase (Prior to 1950)
Foundation Phase (Between 1950 -1968)
Expansion Phase( 1968-1984)
Consolidation Phase( 1984-1990)
Reformatory Phase ( After 1990)
Phase-1-> Evolutionary Phase(Prior to 1930)
• Enactment of RBI Act 1935 gave birth to Scheduled Banks in India.
• First Bank which was established with Indian Ownership and management
was Oudh Commercial Bank, formed in 1881
• Next was Ayodhya Bank in 1884, followed by Punjab National Bank in 1894
and Nedungadi Bank in 1899.
• Allahabad Bank was established in 1865 with the help of European
Management was also very prominent in those days.
• In 20th Century ,We had twelve more scheduled banks coming up with the
major ones being Bank of Baroda(1906), Canara Bank (1906), The Indian
Bank (1907),The Bank of India(1908), Central Bank of India(1911)
Evolutionary Phase-New Developments
In the 20th century , the banking sector was recognized as a powerful
instrument to drive the economic development of the country.
By 1921, the need of a State bank which had all support and resources from
the government was felt.
Three Presidency banks were amalgamated to form Imperial Bank of India.
Role: To extend banking facilities
To render money resources more accessible to trade and industry
Promote financial system which extends support to social and economic
Play the role of quasi-central bank and there by making it a sole repository
of all funds
Phase 2-> Foundation Phase(1948-1968)
By 1935 , Reserve Bank of India came into existence.
Period of reorganizing and consolidation for existing banking system
Banking Companies Act was passed in 1949 to conduct and control commercial
Banking sector which in the pre-independence era was supporting the needs of the
government , rich individuals and traders opened its doors .
Credit was extended to small borrowers, agricultural sector
Transformation of Imperial Bank of India to State Bank of India.
Redefining the role of SBI in Indian economy
Strengthening the cooperative credit structure
Setting up framework for providing long term finance to agriculture and Industry.
Phase 3->Expansion Phase (1968-1984)
The Year 1969 brought the “First Banking Revolution”
Socialization of Banking.
Nationalization of 14 Banks to make banking services reach the masses.
Rapid branch expansion, credit creation ,deposits mobilization
Penetration of banks into rural areas.
Banks funded all major Government projects and Schemes.
Second Phase of Banking revolution came in April,1980 with nationalization of 6
Birth of Regional Rural Bank in 1975 and NABARD in 1982
Commercial Banks declined from 281 in 1968 to 268 in 1984.
Phase 3->Expansion Phase (1968-1984)
No. of Scheduled Bank rose from 71 to 264
No. of registration for Unscheduled banks declined from 210 to 4
As many as 50000 new branches were opened with 3/4th of them in semi-urban and rural
Phase 4-> Consolidation Phase: (1984-1990)
Why there was a need of Consolidation
• Gross inefficiency and loss of control was widespread in many offices
• Retail lending to more risk-prone areas at concessional interest rates had raised costs, affected
the quality of assets of banks and put their profitability under strain.
• Competition amongst the banks was at a low ebb.
• Customer service was least priority to banks
• Performance of banks was measured in terms of growth of deposits , advances and quality
took a backseat.
Phase 4-> Consolidation Phase: (1984-1990)
Steps taken for Consolidation
• Relaxation of tight regulations under which banks were operating
• Serious attention was given to improving housekeeping, customer services, credit
management, staff productivity and profitability of the banks.
• Concrete steps were taken to rationalize the rates of bank deposits and lending.
• Composition of assets was fixed at 63.5% of bank funds as CRR and SLR
• Salary structure was negotiated by IBA and validated by government.
Factors responsible for decline in earnings and profits
• Directed investment in terms of minimum Statutory Liquidity Ratios which together
with variable Cash Reserve Ratio, pre-empting well over half of the total resources
mobilized by banks.
• Directed credit programme of deploying 40 per cent of bank credit to the priority
sectors at low interest rates.
• Low capital base.
• Low technology.
• Phenomenal branch expansion.
• Political interference in loan disbursal and poverty eradication programmes.
Why Reforms were needed?
• The reforms were initiated in the middle of a “current account” crisis that
occurred in early 1991.
• The crisis was caused by poor macroeconomic performance, characterized by
:• a public deficit of 10 per cent of GDP,
• a current account deficit of 3 per cent of GDP,
• an inflation rate of 10 per cent
• Growing domestic and foreign debt, and
• A temporary oil price boom following the Iraqi invasion of Kuwait in 1990.
Reformatory Phase (Post 1991)
The main objective of the financial sector reforms in India initiated in the early 1990s was to
create an efficient, competitive and stable financial sector that could then contribute in
greater measure to stimulate growth.
The monetary policy framework made a phased shift from direct instruments of monetary
management to an increasing reliance on indirect instruments.
However, as appropriate monetary transmission cannot take place without efficient price
discovery of interest rates and exchange rates in the overall functioning of financial markets,
the corresponding development of the money market, Government securities market and
the foreign exchange market became necessary.
Reforms in the various segments, therefore, had to be coordinated.
FINANCIAL AND BANKING SECTOR REFORMS :
Cautious and proper sequencing of various measures giving adequate time to the
various agents to undertake the necessary norms e.g. gradual introduction of
Mutually reinforcing measures, that as a package would be enabling reform but nondisruptive of the confidence in the system e.g. reduction in refinance with reduction in
Complementarily between reforms in banking sector and changes in fiscal, external
and monetary policies, especially in terms of co-ordination with Government
e.g.recapitalisation of Government owned banks coupled with prudential regulation
Developing financial infrastructure in terms of supervisory body, audit standards,
technology and legal framework; e.g., establishment of Board for Financial
Taking initiatives to nurture, develop and integrate money, debt and forex markets, in
a way that all major banks have an opportunity to develop skills, participate and
benefit; e.g., gradual reduction in the minimum period for maturity of term deposits.
Interest rate liberalization
Prior to the reforms, interest rates were a tool of cross-subsidization between different sectors
of the economy.
• Interest rate structure had grown increasingly complex with both lending and deposit rates
set by RBI
• At present, RBI is only setting the interest rates for NRI deposits.
Major problem faced by the banking system was on account of statutory pre-emption of banks
resources to finance Government's budgetary needs
• Removal of these constraints meant a planned reduction in statutory pre-emption
• Effective CRR reduced from 15% in 1991 to 4.75% at present
• SLR reduced from 38.5% in 1992 to 24% at present
Priority sector lending
• Identified as one of the major reasons for the below average profitability of Indian banks.
• The Narasimham Committee recommended a reduction from 40% to 10%
• While nominal targets have remained unchanged, the effective burden of priority sector advances has
been reduced by expanding the definition of priority sector lending
• Due to directed lending practices and poor risk management skills, India's banks had accrued a significant
level of NPLs.
• Prior to any privatization, the balance sheets of PSBs had to be cleaned up through capital injections.
• Selective credit controls have been dispensed with and there is a greater freedom to both banks and
borrowers in matters relating to credit
In 1993 partial private shareholding of the SBI was allowed, which made it the first SOB to raise
equity in the capital markets.
• After the 1994 amendment of the Banking Regulation Act, PSBs were allowed to offer up to
49% of their equity to the public
• This led to the partial privatization of 11 PSBs
Starting with the guidelines on income recognition, asset classification, provisioning and capital
adequacy the RBI issued in 1992/93, there have been continuous efforts to enhance the transparency
and accountability of the banking sector introduced gradually to meet the international standards
• Income Recognition & Asset Classification norms of 90 days as per international standards
• Prudential liquidity management guidelines and Operational risk management guidelines for
Systems and Control
• Competition and Transparency
Competition is sought to be fostered by permitting new private sector banks, and more
liberal entry of branches of foreign banks
• An independent Board for Financial Supervision under aegis of the RBI has been
established, and consistent with international practice, focus is also on offsite inspections
and on control systems internal to the banks.
• Before the start of the 1991 reforms, there was little effective competition in the Indian banking
system due to strict entry restrictions for new banks, which effectively shielded the incumbents
• The guidelines for licensing of new banks in the private sector were issued by RBI in January
• RBI granted licenses to 10 banks in the private sector during 1993 to 2000
• By March 2005, the new private sector banks and the foreign banks had a combined share of
almost 20% of total assets.
Narsimhan Committee Recommendations
• Review – aspects relating to the structure, organization, procedures and functioning of the
• Constituted in 1991, the committee submitted two reports in 1992 and 1998, which laid
significant thrust on enhancing the efficiency and viability of the banking sector
• The Narsimhan committee laid the foundation for the reformation of the Indian banking
Reduction of SLR to 25% over a period of 5 years
Progressive reduction of CRR to 3-5%
Phasing out of directed credit programme and redefinition of the priority sector
Stipulation of minimum CAR of 8% by March 1996
Adoption of uniform accounting practices in regard to income recognition, asset
classification and provisioning against bad and doubtful debts
IMPACT OF REFORMS IN THE BANKING SECTOR IN INDIA
• India has lead to improve access to credit through newly established domestic banks, foreign banks and banklike intermediaries. Government debt markets have developed, enabling greater operational independence in
monetary policy making.
• Significant improvement in Information infrastructure.
• Operational and Managerial freedom to State owned Banks
• Government of India removed limits on banks Statutory Liquidity Ratio (SLR) and Cash Reserve Ratio (CRR)
requirements, and gave the central bank greater flexibility to set the limits.
• In the first phase, between March 2005 and 2009, foreign banks will be allowed to establish a wholly owned
subsidiary or to convert existing operations into a subsidiary.
• The RBI has raised the limit of Foreign Direct Investment in private banks to 74 percent from 49 percent.
• 5 per cent foreign investment limit in private banks by individual foreign banks
• 10 per cent foreign investment limit in private banks by foreign institutional investors or individual investors or
individual corporate entities.