Monetary and Banking Reforms

of India

SUBMITTED BY :
DARSHIKA VANI (54115)
DIVYA PATIDAR

(54120)

DIVYANI BHARGAVA
(54121)
PRATIK CHHABRA (54135)
PRIYANKA SALUJA (54136)

Agenda
Introduction
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

INTRODUCTION

Monetary Policy

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
and liquidity.
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.

Objectives
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 Banks 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.

Direct Instruments
Cash reserve ratio (CRR)
The money supply in the economy is influenced by CRR.
It is the ratio of a banks 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. approved securities.
The reduction in SLR enhances the liquidity of commercial banks.

Indirect Instruments
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.

i. Repo Rate:
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 more expensive.
ii.Reverse Repo Rate:
The rate at which RBI borrows from commercial banks.

PMs 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 growth.
"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 economic problems

Thoughts from the ex-Governor

The debate on growth-inflation balance has been clouded by some
"oversimplifications".
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"

SELECTIVE/ QUALITATIVE MEASURES

The RBI directs commercial banks to meet their social obligations through
selective/ qualitative measures.

These measures control the distribution and direction of credit to various sectors of
the economy.

CEILING ON CREDIT
MARGIN REQUIREMENTS
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 since 91

The Indicators now

Indicator

Current rate

Inflation

6.46%

Bank rate

9.00%

CRR

4.00%

SLR

23%

Repo rate

7.75%

Reverse repo rate

6.75%

Marginal Standing facility rate 8.75%

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).

Banking reforms in India

History and Development in Indian Banking

Sector
Banking Sector can be divided into four phases
1.

Evolutionary phase (Prior to 1950)

2.

Foundation Phase (Between 1950 -1968)

3.

Expansion Phase( 1968-1984)

4.

Consolidation Phase( 1984-1990)

5.

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 advancement
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 banks
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 more banks.
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 semiurban and rural areas.

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 :

RBIs approach
Cautious and proper sequencing of various measures giving adequate time
to the various agents to undertake the necessary norms e.g. gradual
introduction of prudential norms
Mutually reinforcing measures, that as a package would be enabling reform
but non-disruptive of the confidence in the system e.g. reduction in refinance
with reduction in CRR
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 Supervision
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.

Reform Measures
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.

Statutory Pre-emptions

Major problem faced by the banking system was on account of statutory preemption of banks resources to finance Government's budgetary needs
Removal of these constraints meant a planned reduction in statutory preemption
Effective CRR reduced from 15% in 1991 to 4.75% at present
SLR reduced from 38.5% in 1992 to 24% at present

Reform Measures
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

Stabilization

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.
Credit Controls
Selective credit controls have been dispensed with and there is a greater freedom to both
banks and borrowers in matters relating to credit

Reform Measures
Privatization
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

Prudential Norms
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

Reform Measures
Competition and Transparency

Competition is sought to be fostered by permitting new private sector

banks, and more liberal entry of branches of foreign banks

Supervision
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.

Reform Measures
Structural changes
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 from competition.
The guidelines for licensing of new banks in the private sector were issued by
RBI in January 1993
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 financial system
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 sector
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 bank-like 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.

Be Good Do Good

Thank You