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GS Paper: Indian Economy

  • RBI Clampdown on Lenders could moderate Credit Growth in 2024-25

    What is the news?

    The Reserve Bank of India (RBI) has undertaken rigorous regulatory actions to address lenders’ over-exuberance, enhance compliance culture, and protect customers.

    RBI’s Regulatory Actions: An Overview

     

    • Recent Examples: Recent regulatory moves by the RBI, such as restraining lending by IIFL Finance and JM Financial Products, and implementing restrictions on customer onboarding at Paytm Payments Bank, mark a departure from historically nominal financial penalties.
    • Implications: S&P Global Ratings predicts that these actions will escalate the cost of capital and moderate loan growth in the fiscal year 2024-25, projecting a decrease from 16% to 14%.

     

    How RBI regulates Lenders in India?

    1. Licensing and Regulation:
      • The Banking Regulation Act, 1949 empowers RBI to grant licenses to banks and regulate their operations.
      • Non-Banking Financial Companies (NBFCs) are regulated under the Reserve Bank of India Act, 1934 and governed by guidelines issued by RBI under Section 45-IA of the RBI Act.
    2. Prudential Regulations:
      • RBI issues prudential regulations under various Acts, including the Banking Regulation Act, 1949 and the RBI Act, 1934.
      • These regulations include guidelines on capital adequacy (Basel III norms), asset classification, provisioning norms, liquidity management, exposure limits, and risk management practices.
      • Non-compliance with these regulations may attract penalties or other enforcement actions under the relevant Acts.
    3. Supervision and Monitoring:
      • RBI conducts supervision and monitoring of banks and NBFCs under Section 35A of the Banking Regulation Act, 1949 and Section 45L of the RBI Act, 1934.
      • It has the authority to conduct on-site inspections, off-site surveillance, and review financial reports to assess compliance with regulatory requirements.
      • RBI may issue directives, guidelines, or corrective actions under Section 35A and Section 45L to address deficiencies identified during supervision.
    4. Policy Framework:
      • Monetary policy frameworks are governed by the RBI Act, 1934 and the Reserve Bank of India (RBI) Act, 1934, which empower RBI to formulate and implement monetary policies.
      • RBI’s Monetary Policy Committee (MPC) sets key policy rates such as the repo rate, reverse repo rate, and statutory liquidity ratio (SLR) to regulate credit flow, inflation, and overall economic conditions.
    5. Consumer Protection:
      • RBI issues guidelines under the Banking Regulation Act, 1949 and the RBI Act, 1934 to ensure fair practices and consumer protection in banking and NBFC operations.
      • The Banking Ombudsman Scheme, 2006 provides a mechanism for redressal of customer grievances against banks.
      • Violations of consumer protection norms may result in penalties or enforcement actions under the relevant Acts.
    6. Financial Stability:
      • RBI’s mandate to maintain financial stability is enshrined in the RBI Act, 1934.
      • It monitors systemic risks, including interconnectedness among lenders, under Section 45J of the RBI Act, 1934, and takes measures to mitigate risks to financial stability.
      • RBI may intervene in the interest of financial stability under Section 45W of the RBI Act, 1934, to prevent disruptions to the functioning of the financial system.

     

    PYQ:

    2012: The Reserve Bank of India (RBI) acts as a bankers’ bank. This would imply which of the following?

    1. Banks retain their deposits with the RBI.
    2. The RBI lends funds to the commercial banks in times of need.
    3. The RBI advises the commercial banks on monetary matters.

    Select the correct answer using the codes given below:

    1. 2 and 3 only
    2. 1 and 2 only
    3. 1 and 3 only
    4. 1, 2 and 3

     

    Practice MCQ:

    Consider the following statements regarding ‘Payment Banks’ in India:

    1. Payment Banks have the authority to accept demand deposits but are prohibited from issuing credit cards, disbursing loans, offering mutual funds units, and providing insurance products.
    2. Unlike scheduled commercial banks, Payment Banks are exempted from the obligation to maintain a cash reserve ratio with the Reserve Bank.
    3. Payment Banks are mandated to invest a minimum of 75% of their demand deposit balances in Statutory Liquidity Ratio (SLR) eligible Government securities/treasury bills.

    How many of the above statements is/are correct?

    1. One
    2. Two
    3. Three
    4. None

  • RBI and SEBI: India’s Financial Landscape under Scrutiny

    Why in the news-

    • Recent actions by both India’s banking regulator RBI and the securities watchdog SEBI have startled the market, exposing various malpractices in the financial sector.

    Context

    • Banking Sector: The Reserve Bank of India (RBI) faces political scrutiny following the Supreme Court’s ban on anonymous political funding instruments introduced by the government in 2018. Its oversight was questioned amidst concerns about opaque corporate donations in the Electoral Bonds Scheme which was recently held unconstitutional.
    • Securities Market: The Securities and Exchange Board of India (SEBI) is under pressure to address concerns about asset price inflation, concentrated positions in illiquid shares, and excessive speculation among retail investors. Its credibility was questioned after Hindenburg Research’s allegations.

    Financial Landscape and its Regulation

    [1] Reserve Bank of India (RBI)

    • The RBI is the central bank and monetary authority of India.
    • It is established on April 1, 1935, under the Reserve Bank of India Act, 1934.
    • Its idea was incepted from the recommendations of the Hilton Young Commission.
    • It is a centralized institution for India to effectively regulate its monetary and credit policies.
    • RBI had its initial headquarters in Kolkata, later moving permanently to Mumbai in 1937.
    • Initially, the RBI operated as a privately owned entity until its full nationalization in 1949.

    Key Regulatory Functions of the RBI:

    (i) Monetary Policy:

    • The RBI formulates and implements monetary policies to achieve price stability, economic growth, and financial stability.
    • The Monetary Policy Committee (MPC) determines the policy interest rates, such as the repo rate, reverse repo rate, and marginal standing facility rate, based on inflation targeting and growth objectives.
    • By adjusting these rates, the RBI influences money supply, credit flow, and interest rates in the economy.

    (ii) Banking Regulation and Supervision:

    • The RBI regulates and supervises banks and financial institutions to ensure their stability, soundness, and compliance with regulatory norms.
    • It issues guidelines, directives, and prudential regulations covering aspects like capital adequacy, asset quality, management effectiveness, and liquidity risk management.
    • The RBI conducts regular inspections, audits, and assessments of banks to assess their financial health and adherence to regulations.
    • It also intervenes in troubled banks to protect depositors’ interests and maintain financial stability.

    (iii) Payment and Settlement Systems:

    • The RBI manages and oversees payment and settlement systems to ensure efficiency, safety, and reliability in financial transactions.
    • It operates the Real-Time Gross Settlement (RTGS) system for large-value transactions and the National Electronic Funds Transfer (NEFT) system for retail transactions.
    • The RBI formulates regulations and standards for payment systems, promotes innovation in payment technologies, and monitors systemically important payment infrastructures to mitigate risks and enhance resilience.

    (iv) Financial Markets Regulation:

    • The RBI regulates and supervises financial markets, including money, bonds, foreign exchange, and derivative markets, to maintain market integrity and investor confidence.
    • It issues guidelines, directives, and regulations governing market participants, intermediaries, and trading activities.
    • The RBI monitors market developments, enforces compliance with regulations, and intervenes in markets to address disorderly conditions, liquidity shortages, or excessive volatility.
    • It also conducts open market operations (OMOs) to manage liquidity and stabilize interest rates.

    [2] Securities and Exchange Board of India (SEBI)

    • SEBI is the regulatory authority overseeing India’s securities and commodity markets.
    • Established in 1988 as a non-statutory body, SEBI was granted statutory powers with the enactment of the SEBI Act 1992 by the Indian Parliament.
    • It operates under the purview of the Ministry of Finance.
    • SEBI’s structure includes a chairman nominated by the GoI, members from the Union Finance Ministry, the Reserve Bank of India, and others.
    • Its headquarters is in Mumbai, with regional offices in Ahmedabad, Kolkata, Chennai, and Delhi.

    Key Regulatory Functions of the SEBI:

    (i) Formulating Regulations:

    • SEBI formulates regulations, guidelines, and directives to govern various aspects of the securities market.
    • This includes regulations related to public issuances, disclosures, insider trading, takeover bids, corporate governance, and investor protection.

    (ii) Monitoring Market Participants:

    • SEBI regulates and supervises market intermediaries such as stock exchanges, brokers, merchant bankers, portfolio managers, and mutual funds.
    • It sets eligibility criteria, registration requirements, and conduct norms for these entities and monitors their compliance with regulations.

    (iii) Overseeing Market Infrastructure:

    • SEBI oversees the functioning of stock exchanges, clearing corporations, depositories, and other market infrastructure institutions.
    • It ensures that these entities maintain adequate systems, procedures, and safeguards to facilitate fair, transparent, and efficient trading and settlement operations.

    (iv) Enforcing Securities Laws:

    • SEBI enforces securities laws and regulations by conducting inspections, investigations, and enforcement actions against violations.
    • It has the authority to impose penalties, suspend licenses, and initiate legal proceedings against individuals or entities found to be engaged in fraudulent or unfair practices.

    (v) Regulating Securities Offerings:

    • SEBI regulates public offerings of securities, including initial public offerings (IPOs), rights issues, and follow-on public offerings.
    • It reviews offer documents, ensures disclosure of material information to investors, and supervises the conduct of issuers, underwriters, and other intermediaries involved in the offering process.

    (vi) Monitoring Insider Trading and Market Manipulation:

    • SEBI monitors and regulates insider trading, market manipulation, and other fraudulent activities that can undermine market integrity.
    • It prohibits insider trading, imposes restrictions on share buybacks and open market operations, and investigates suspicious trading activities to maintain market fairness and transparency.

    PYQ:

     

    2015: In the light of Satyam Scandal (2009), discuss the changes brought in the corporate governance to ensure transparency and accountability.

     

    2021: With reference to India, consider the following statements:​

    1. Retail investors through demat account can invest in ‘Treasury Bills’ and ‘Government of India Debt Bonds’ in primary market.​
    2. The ‘Negotiated Dealing System-Order Matching’ is a government securities trading platform of the Reserve Bank of India. ​
    3. The ‘Central Depository Services Ltd.’ is jointly promoted by the Reserve Bank of India and the Bombay Stock Exchange. ​

    Which of the statements given above is/are correct?​

    1. 1 only ​
    2. 1 and 2 only ​
    3. 3 only ​
    4. 2 and 3 only ​

     

    Practice MCQ:

    With reference to the Securities and Exchange Board of India (SEBI), consider the following statements:

    1. It was established in 1988 as a non-statutory body.
    2. It operates under the Ministry of Corporate Affairs.
    3. It consists of a chairman, members from the Union Finance Ministry and the Reserve Bank of India.

    How many of the given statements is/are correct?

    1. One
    2. Two
    3. Three
    4. None

  • RBI may move some NBFCs to Top Layer this year

    In the news

    • Nearly two years after introducing a revised regulatory framework for non-banking finance companies (NBFCs), the Reserve Bank of India is set to review the categorisation of NBFCs in 2024.
    • Currently, 16 NBFCs are placed in the upper layer.

    What are Non-Banking Financial Companies (NBFCs)?

    • A NBFC is a company registered under the Companies Act, 1956.
    • It engaged in the business of loans and advances, acquisition of shares/stocks/bonds/debentures/securities issued by Government or local authority or other marketable securities of a like nature, leasing, hire-purchase, insurance business, and chit business.
    • It does NOT include any institution whose principal business is that of agriculture activity, industrial activity, purchase or sale of any goods (other than securities) or providing any services and sale/purchase/construction of immovable property.

    How are NBFCs different from Bank?

    • NBFCs lends and make investments and hence their activities are akin to that of banks.
    • However, there are a few differences as given below:
    1. Commercial Banks are regulated under Banking Regulation Act, 1949.
    2. NBFC CANNOT accept demand deposits.
    3. NBFCs DO NOT form part of the payment and settlement system and cannot issue cheques drawn on itself.
    4. Deposit insurance facility of Deposit Insurance and Credit Guarantee Corporation is NOT available to depositors of NBFCs, unlike in case of banks.

    Different types/categories of NBFCs registered with RBI

    NBFCs are categorized:

    1. in terms of the type of liabilities into Deposit and Non-Deposit accepting NBFCs,
    2. non deposit taking NBFCs by their size into systemically important and other non-deposit holding companies (NBFC-NDSI and NBFC-ND) and
    3. by the kind of activity they conduct.

    Within this broad categorization the different types of NBFCs are as follows:

    Definition
    Asset Finance Company (AFC) A financial institution primarily engaged in financing physical assets used in productive/economic activities, such as automobiles, tractors, machinery, and industrial equipment.
    Investment Company (IC) A company whose principal business involves acquiring securities.
    Loan Company (LC) A financial institution primarily engaged in providing finance through loans, advances, or other means for activities other than its own.

    Does not include Asset Finance Companies.
    Infrastructure Finance Company (IFC) A non-banking finance company that deploys at least 75% of its total assets in infrastructure loans, with a minimum Net Owned Funds of ₹300 crore, a minimum credit rating of ‘A’ or equivalent, and a CRAR of 15%.
    Systemically Important NBFCs NBFCs with an asset size of ₹500 crore or more, as per the last audited balance sheet.

    Considered significant due to their potential impact on the overall financial stability of the economy.

     

    Scale-Based Regulation of NBFCs

    • Scale-based regulations came into effect in October 2021 and were implemented a year later by RBI.
    • There are four layers namely the base layer, middle layer, upper layer and top layer.
    • As on September 30, 2023, NBFCs in the base, middle and upper layers constituted 6 per cent, 71 per cent and 23 per cent of the total assets of NBFCs respectively.
    • Presently, no NBFC is listed in the top layer.

    Here’s a breakdown of the key aspects of the SBR:

    1. Base Layer (NBFC-BL)
    • The Base Layer primarily comprises non-deposit-taking NBFCs with assets below Rs 1,000 crore.
    • It encompasses NBFC Peer to Peer (P2P), NBFC-Account Aggregator (AA), Non-Operative Financial Holding Company (NOFHC), and NBFCs without public funds and customer interface.
    1. Middle Layer (NBFC-ML)
    • The Middle Layer includes deposit-taking NBFCs and non-deposit-taking NBFCs with assets exceeding Rs 1,000 crore.
    • It encompasses NBFCs involved in specific activities such as Standalone Primary Dealers (SPDs), Infrastructure Debt Fund – NBFCs (IDF-NBFCs), Core Investment Companies (CICs), Housing Finance Companies (HFCs), and Infrastructure Finance Companies (NBFC-IFCs).

    III. Upper Layer (NBFC-UL)

    • The Upper Layer comprises NBFCs identified by RBI as requiring enhanced regulatory requirements based on specific parameters and scoring methodology.
    • The top 10 eligible NBFCs in terms of asset size will always be placed in the Upper Layer, irrespective of other factors.
    1. Top Layer (NBFC-TL)
    • NBFCs in the Upper Layer may be transferred to the Top Layer if RBI perceives a significant increase in potential systemic risk.
    • Currently, the Top Layer remains vacant but serves as a precautionary measure for heightened risk situations.

     

    With inputs from: https://rbi.org.in/scripts/PublicationsView.aspx?Id=21580

    Practice MCQ:

    Q. With reference to the Scale-Based Regulation of Non-Banking Financial Companies (NBFCs), consider the following statements:

    1. Higher the layer, least is the regulatory intervention required by the RBI.
    2. Currently, no NBFC is listed in the top layer.

    Which of the given statements is/are correct?

    a) Only 1

    b) Only 2

    c) Both 1 and 2

    d) Neither 1 nor 2

    Try this PYQ from CSE 2020:

    1. If you withdraw ` 1,00,000 in cash from your Demand Deposit Account at your bank, the immediate effect on aggregate money supply in the economy will be:

    (a) to reduce it by ` 1,00,000

    (b) to increase it by ` 1,00,000

    (c) to increase it by more than ` 1,00,000

    (d) to leave it unchanged

     

    [wpdiscuz-feedback id=”4p45hvwy63″ question=”Please leave a feedback on this” opened=”1″]Post your answers here.[/wpdiscuz-feedback]

  • [9 March 2024] The Hindu Op-ed: India’s suboptimal use of its labor power

    [9 March 2024] The Hindu Op-ed: India’s suboptimal use of its labor power

    PYQ Relevance:

    Prelims:
    Disguised unemployment generally means (UPSC CSE 2013)
    a) A large number of people remain unemployed
    b) Alternative employment is not available
    c) Marginal productivity of labor is zero
    d) Productivity of workers is low

    Mains:
    1. Account for the failure of the manufacturing sector in achieving the goal of labor-intensive exports. Suggest measures for more labor-intensive rather than capital-intensive exports. [UPSC CSE 2017]

    2. How globalization has led to the reduction of employment in the formal sector of the Indian economy? Is increased informalization detrimental to the development of the country? [UPSC CSE 2016]

    3. The nature of economic growth in India in recent times is often described as jobless growth. Do you agree with this view? Give arguments in favor of your answer. [UPSC CSE 2015]

    Note4Students: 

    Mains: Sectors of Indian Economy; Employment;

    Prelims: Types of Employment;

    Mentor comments: India’s labor market is grappling with issues such as underemployment, low-quality jobs, and high unemployment rates. In such a scenario, we need to focus on creating high-wage jobs and improving the quality of employment opportunities to tackle rising unemployment rates and disparities across regions, gender, and generations. Addressing these challenges requires a comprehensive approach that focuses on creating better job opportunities across various sectors while preparing the workforce for the future.

    Let’s learn. 

    —

    Why in the News?

    According to the recent Labour Force Participation Rate, India’s labor market faces challenges with a vast majority of the population earning income through informal employment, lacking job security and benefits. 

    What is the current state of the Indian Labor market?

    • According to the Periodic Labour Force Survey (PLFS), the labor force participation rate is 50%, with a lower female participation rate of 23% compared to 67% for males.
    • In 2017–18, 90.7% of employment was in the informal sector, marked by low productivity and underemployment. Self-employment accounts for 52% of workers, while only 23% are regular salaried workers.

    Context:

    • Although the recent data shows an increase in labor force participation and a decrease in unemployment rates in the Indian Market, the growth is primarily driven by self-employment and unpaid family workers.
    • There has been stagnation in real earnings for wage/salaried workers and the self-employed. The dominance of low-quality work in India’s labor market poses macroeconomic growth concerns and highlights the need for creating better job opportunities.

    What are the current major shifts in the Indian Labor Market?

    • Dynamics of job creation and loss: India’s job market is characterized by a scarcity of good jobs, with a large portion of the workforce employed in informal, low-wage, and insecure sectors like agriculture.
      • Services sector: It contributes significantly to both job creation and loss, with wholesale and retail trade playing a substantial role.
      • Construction sector: It is known for insecure working conditions and low pay, generates a significant number of new jobs, raising concerns about job quality. Unemployment rates have been high even before the pandemic, with challenges exacerbated by the COVID-19 crisis.
    • Improvements in Labour Market:
      • Labour Force Participation and Unemployment Rates: LFPR increased steadily from 52.35% in 2017-18 to 58.35% in 2021-22, driven notably by rural women. Overall unemployment rate decreased from 6.2% in 2017-18 to 4.2% in 2021-22, with a similar downward trend for youth unemployment.
      • Self-Employment Dynamics: LFPR and unemployment rate improvements largely attributed to self-employment. Rise in unpaid family workers and own-account workers reflect a decline in job quality within the workforce.
    • Earnings:
      • Earning Trends:
        • Aggregate Earnings: All-India average real daily earnings increased by around ₹10 between 2017-18 and 2021-22, a 4% increase.
        • Rural and Urban Earnings: Both rural and urban daily earnings increased by an average of ₹10 to ₹14.
        • Earnings Disparities: Wage and salaried workers had the highest earnings, followed by self-employed and casual workers. Salaried and self-employed earnings stagnated, while casual workers saw a 20% increase.
      • Employment Trends:
        • Self-Employment Growth: Self-employed workers saw the highest growth in employment between 2017-18 and 2021-22. The subcategory of unpaid family workers experienced significant growth in numbers.
        • Earnings Disparities: Top 20% of salaried workers experienced a drop in real daily average earnings.
      • Structural Transformation:
        • Labour Force Participation Rate (LFPR) rose, but closer examination reveals disparities in employment types.
        • Notable rise Female Workforce Participation driven by self-employment in agriculture.
        • Sectoral Shifts: Movement from agriculture to construction observed among male workers

    How can the challenges faced by the Indian Labor Market can be addressed?

    • Building Quality over Quantity: Government needs to explore innovative solutions to generate demand and create employment opportunities. Secondly, it also needs to support skill development initiatives, by bridging the skill gap by enhancing the industry-academia linkages, fostering internships, and encouraging entrepreneurship for better absorption of skilled labor.
    • Need for Labor Reforms: Advocate for rational and progressive labor reforms that consider the interests of both workers and employers.
    • Building good Work Culture: Promoting transparency, responsible business practices, and fair labor market operations through effective leadership and employee engagement initiatives is the need of the hour.
    • Need for constructive work: Strive for constructive dialogue, collaborative decision-making, and a cooperative environment to address disguised unemployment, seasonal unemployment, and educated unemployment through policies promoting job creation.

    Conclusion: According to NITI Aayog, India has potential to grow at 8% as the country is labor-rich with enough institutional maturity of a functioning democracy. In simpler terms, the Investment to GDP ratio is the area where we need to focus as it plays a crucial role in the demand-side of the economy.

    References

    https://www.thehindu.com/opinion/lead/indias-suboptimal-use-of-its-labour-power/article67929725.ece

    8 Major Problems Faced by Labour Market in India

    https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4609381

    https://www.adb.org/publications/demographic-dividends-india-evidence-and-implications-based-national-transfer-accounts

    https://www.ncbi.nlm.nih.gov/pmc/articles/PMC9848021/

    https://www.theindiaforum.in/economy/quantity-vs-quality-long-term-trends-job-creation-indian-labour-market

    https://www.thehindu.com/business/Economy/india-is-a-labour-rich-country-with-enough-institutional-maturity-can-get-to-8-growth-niti-aayog-vice-chairman/article67613743.ece

  • NUCFDC: Umbrella Body for Urban Co-op Banks established

    In the news

    • The Union Home Minister and Minister of Cooperation officially inaugurated the National Urban Cooperative Finance and Development Corporation Limited (NUCFDC), marking a significant milestone in the development of urban cooperative banking.

    About NUCFDC

    • Regulatory Approval: NUCFDC has obtained approval from the RBI, authorizing it to function as a Non-Banking Finance Company (NBFC) and serve as the apex body for the urban cooperative banking sector.
    • Self-Regulatory Status: Additionally, NUCFDC has been granted the status of a Self-Regulatory Organisation (SRO) for the sector, empowering it to oversee and regulate various aspects of urban cooperative banking operations.
    • Capital Enhancement: NUCFDC aims to augment its capital base, with ambitions to achieve a capitalization level of Rs. 300 crores, facilitating its mission to support and strengthen Urban Cooperative Banks (UCBs).

    Functions of NUCFDC

    • Utilization of Funds: The organization intends to deploy its capital resources towards bolstering the financial capabilities of UCBs, including the development of a shared technology infrastructure to enhance service delivery and reduce operational costs.
    • Comprehensive Support: Apart from providing financial liquidity and capital assistance, NUCFDC will establish a collaborative technology platform accessible to all UCBs, enabling them to expand their service offerings efficiently and affordably.
    • Advisory Services: NUCFDC will also extend advisory and consultancy services to UCBs, assisting them in areas such as fund management, regulatory compliance, and strategic planning.

    About Urban Cooperative Banks (UCBs)

    • Origins: UCBs trace their roots to cooperative credit societies, offering financial services to members within specific community groups.
    • Regulations: Regulated by the RBI under the Banking Regulation Act of 1949, UCBs adhere to stringent prudential norms and guidelines to ensure financial stability.
    • Operational Classification: UCBs are categorized into urban and rural cooperative banks based on their geographic scope. They operate under the governance of State Registrars of Cooperative Societies (RCS) or the Central Registrar of Cooperative Societies (CRCS) and the RBI.
    • Historical Evolution: The journey of UCBs dates back to the establishment of the first Cooperative Credit Society of Haryana in 1904, evolving over time with regulatory amendments and institutional reforms.

    Reforming the UCBs

    • Narasimham Committee Report (1998): It suggest subsequent regulatory interventions aimed at enhancing the governance, capitalization, and operational efficiency of UCBs.
    • Structural Recommendations Committee (2021): The formation of a 4-tier structure for UCBs, proposed by a committee appointed by the RBI in 2021, seeks to streamline their operations and ensure effective regulatory oversight based on deposit size tiers:
    1. Tier 1 with all unit UCBs and salary earner’s UCBs (irrespective of deposit size) and all other UCBs having deposits up to Rs 100 crore.
    2. Tier 2 with UCBs of deposits between Rs 100 crore and Rs 1,000 crore,
    3. Tier 3 with UCBs of deposits between Rs 1,000 crore and Rs 10,000 crore, and
    4. Tier 4 with UCBs of deposits more than Rs 10,000 crore.

    Challenges Faced by UCBs

    • Capital Constraints: UCBs encounter limitations in capital mobilization due to regulatory restrictions on dividend payouts and limited avenues for raising external funds.
    • Diversification Hurdles: The lack of operational diversification and dependence on member contributions for capital infusion pose challenges to UCBs’ financial resilience and expansion prospects.
    • Funding Alternatives: Access to alternative funding sources remains constrained for UCBs, necessitating innovative approaches to address liquidity requirements.
    • Profit Distribution Dynamics: Incentives for profit distribution are subdued in UCBs, impacting their attractiveness to investors and hindering their growth trajectory.
    • Solvency Pressures: Expansion initiatives and acquisitions can strain UCBs’ solvency and liquidity positions, necessitating prudent risk management practices and strategic planning.

    Try this PYQ from CSP 2021:

    With reference to ‘Urban Cooperative Banks’ in India, consider the following statements:

    1. They are supervised and regulated by local boards set up by the State Governments.
    2. They can issue equity shares and preference shares.
    3. They were brought under the purview of the Banking Regulation Act, 1949 through an Amendment in 1966.

    Which of the statements given above is/are correct?

    (a) 1 only
    (b) 2 and 3 only
    (c) 1 and 3 only
    (d) 1, 2 and 3

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  • Analysis of Centre’s Capital Expenditure and Fiscal Deficit

    deficit

    In the news

    • Capital Expenditure Decline: In January, the Centre’s capital expenditure saw a significant decline of 40.5%, totaling ₹47,600 crore compared to ₹80,000 crore in the previous year.
    • Fiscal Deficit Widening: By the end of January, the fiscal deficit reached 64% of the revised estimates for 2023-24. Despite challenges in expenditure, the government seems poised to meet the revised deficit target of 5.8% of GDP for the year.

    What is Fiscal Deficit?

    • Definition: Fiscal deficit is the excess of total disbursements from the Consolidated Fund of India over total receipts, excluding debt repayment, within a financial year.
    • Formula: Fiscal Deficit = Total expenditure of the government (capital and revenue expenditure) – Total income of the government (Revenue receipts + recovery of loans + other receipts).

    Government Income

    • Revenue receipts: This includes tax revenues collected by the government from various sources such as income tax, corporate tax, and indirect taxes like GST.
    • Capital receipts: This encompasses borrowings, disinvestments, and other sources of income.
    • Tax revenues: Income from GST and other taxes.
    • Non-tax revenues: Including interest receipts, dividends and profits, external grants, and receipts from union territories.
    • Other non-tax revenues: Revenue from fiscal, social, and economic services.

    Government Expenditure

    • Revenue Expenditure: Spending on day-to-day operations including salaries, subsidies, and interest payments.
    • Capital Expenditure: Investment in infrastructure, acquisition of assets, and long-term projects.
    • Interest Payments: Amount paid by the government as interest on its borrowings.
    • Grants-in-aid for the creation of capital assets: Funds provided for the creation of capital assets such as roads, bridges, and public buildings.

    Reasons behind Fiscal Deficit

    [1] Fall in Income

    • Lower tax collection: Economic slowdown, tax evasion, and GST implementation issues.
    • Impact of economic sectors shut during the pandemic: Closure of economic activities leading to decreased tax revenues.
    • Government’s missed disinvestment targets: Failure to achieve disinvestment targets resulting in lower capital receipts.

    [2] Rise in Expenditure

    • Factors contributing to high inflation: High inflation rates increasing import and borrowing costs.
    • Importance of social infrastructure investment: Emphasis on social infrastructure for inclusive growth and employment.
    • External market volatilities affecting Indian expenditure: Dependency on imports exposing India to external market fluctuations.
    • Unproductive expenditures like subsidies: Essential but unproductive expenditures adding to fiscal pressure.

    [3] Rise in Borrowings

    • Need for market borrowing for policy implementations: Borrowing for policy measures such as bank recapitalization, farm loan waivers, and UDAY.

    Implications of Fiscal Deficit

    • Vicious circle of borrowing and repayment: Continuous borrowing to repay loans leading to a debt trap.
    • Inflation: Increased borrowing leading to higher interest rates and inflation.
    • Reduced private sector borrowing: Government borrowing reducing borrowing opportunities for the private sector.
    • Discouragement of private investment: Inflation and limited financing discouraging private investment.
    • Risk of credit rating downgrade: High borrowing increasing the risk of credit rating downgrade.
    • Limits Revenue Spending: Rising fiscal deficit affecting government allowances like dearness allowance and dearness relief.
    • Foreign Dependence: Borrowing from foreign sources increasing dependence and exposure to external fiscal policies.

    Measures for Control: FRBM Act, 2003

    • The FRBM Act aims to instil fiscal discipline and ensure inter-generational equity in fiscal management, promoting long-term macro-economic stability.
    • Targets:
      1. Limit fiscal deficit to 3% of GDP by March 31, 2009.
      2. Completely eliminate revenue deficit.
      3. Reduce liabilities to 50% of estimated GDP by 2011.
      4. Prohibit direct borrowing from RBI to monetize the deficit.
    • Escape Clause: Section 4(2) of the Act allows the Centre to exceed annual fiscal deficit targets under specific circumstances, such as national security, calamity, agricultural collapse, or structural reforms.
    • Review Committee: In May 2016, a committee under NK Singh was formed to review the FRBM Act. Recommendations included targeting a fiscal deficit of 3% of GDP until March 31, 2020, reducing it to 2.8% in 2020-21, and further to 2.5% by 2023.
    • Current Targets:
      1. The latest provisions of the FRBM Act mandate limiting fiscal deficit to 3% of GDP by March 31, 2021.
      2. Central government debt should not exceed 40% of GDP by 2024-25, among other stipulations.

  • GST collections up 12.54% in February 2024

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    In the news

    • India’s GST revenues saw a robust growth of 12.54% in February, exceeding ₹1.68 lakh crore.
    • This marked the fourth-highest monthly collection since GST’s inception.

    Why discuss this?

    • The Goods and Services Tax (GST) system in India has been a pivotal component of the country’s tax structure since its implementation in July 2017.
    • Analyzing the trends and performance of GST revenues offers insights into the economic health and growth trajectory of the nation.

    Gross Revenues Overview

    • Yearly Comparison: The fiscal year 2023-24 witnessed a noteworthy increase, reaching ₹18.4 lakh crore, indicating an 11.7% rise from the previous year.
    • Yearly Uptick: This year’s growth stands as the third highest since the implementation of GST.
    • Domestic Transactions: Revenues from domestic transactions surged by 13.9%.
    • Imported Goods: Revenue from goods imports also saw a notable increase, rising by 8.5%.

    State-wise Breakdown

    • Overall Collection Analysis: After accounting for refunds, February’s GST collection amounted to ₹1.51 lakh crore, indicating a substantial 13.6% growth from the previous year.
    • State Variability: States exhibited diverse performances, with some experiencing declines while others exceeded national growth averages.
    • Declining Revenues: Five states witnessed contractions, with Mizoram and Manipur showing significant decreases.
    • Outperforming States: Twelve states, including Jammu and Kashmir, Assam, and Maharashtra, surpassed the national average growth rate.

    Compensation Cess Details

    • Components of GST Intake: February’s gross GST intake included CGST, SGST, and IGST, amounting to ₹84,098 crore.
    • Cess Collections: Compensation cess collections amounted to ₹12,839 crore, with additional revenue from imported goods.
    • Revenue Distribution: The Central government allocated substantial sums to CGST and SGST from IGST collections.
    • Revenue Allocation: After regular distributions, CGST received ₹73,641 crore, while SGST received ₹75,569 crore.

    About Goods and Services Tax (GST)

    • Definition: GST is an indirect tax that has replaced many indirect taxes in India such as excise duty, VAT, services tax, etc.
    • Legislation: The GST Act was passed in Parliament on 29th March 2017 and came into effect on 1st July 2017. It is a single domestic indirect tax law for the entire country.
    • Tax Structure: It is a comprehensive, multi-stage, destination-based tax that is levied on every value addition.
    • Taxation Points: Under the GST regime, the tax is levied at every point of sale. In the case of intra-state sales, Central GST and State GST are charged. All the inter-state sales are chargeable to the Integrated GST.

    Components of GST

    • CGST: It is the tax collected by the Central Government on an intra-state sale (e.g., a transaction happening within Maharashtra).
    • SGST: It is the tax collected by the state government on an intra-state sale (e.g., a transaction happening within Maharashtra).
    • IGST: It is a tax collected by the Central Government for an inter-state sale (e.g., Maharashtra to Tamil Nadu).

    Advantages of GST

    • GST has mainly removed the cascading effect on the sale of goods and services.
    • Removal of the cascading effect has impacted the cost of goods.
    • Since the GST regime eliminates the tax on tax, the cost of goods decreases.
    • Also, GST is mainly technologically driven.
    • All the activities like registration, return filing, application for refund and response to notice needs to be done online on the GST portal, which accelerates the processes.

    Issues with GST

    • High operational cost.
    • GST has given rise to complexity for many business owners across the nation.
    • GST has received criticism for being called a ‘Disability Tax’ as it now taxes articles such as braille paper, wheelchairs, hearing aid etc.
    • Fuels are not under GST, which goes against the ideals of the unification of commodities.

    Try this PYQ from CSP 2015:

    Q. All revenues received by the Union. Government by way of taxes and other receipts for the conduct of Government business are credited to the:

    (a) Contingency Fund of India

    (b) Public Account

    (c) Consolidated Fund of India

    (d) Deposits and Advances Fund

    [wpdiscuz-feedback id=”suvm1rufdq” question=”Please leave a feedback on this” opened=”1″]Post your responses here.[/wpdiscuz-feedback]

  • RBI updates the Framework related to Regulatory Sandbox scheme

    Why in the News?

    Recently, there have been significant updates made to the guidelines for the Regulatory Sandbox (RS) scheme by the RBI.

    What is the Regulatory Sandbox (RS) scheme?

    • Regulatory Sandbox (RS) scheme involves live testing of new financial products or services in a controlled regulatory environment with potential relaxations for testing purposes.
    • It allows regulators, innovators, financial service providers, and customers to test new financial innovations, collecting evidence on benefits and risks.
    • It facilitates the development of innovation-friendly regulations, enabling the delivery of low-cost financial products.
    • It enables Dynamic Regulatory Environments that adapt to emerging technologies

    What is the objective behind this decision of RBI?

    • Through this decision, RBI aims to encourage responsible innovation in financial services and ensure compliance with digital personal data protection norms.
      • This new adopted framework will enable on-tap proposals, replacing the previous structure where RBI presented the challenges to a cohort of technology firms and required them to devise solutions within a specified time frame.
    • Secondly, through this decision, the central bank (RBI) remains committed to supporting innovation and technology in the financial sector.
      • For example, recenty, the Paytm Payments Bank, due to its failure to comply with RBI norms, stifled innovation.

    Key Highlights of the RBI’s Updated guidelines on Regulatory Sandbox scheme:

    • Framework Alignment with Digital Personal Data Protection Act: The updated framework requires sandbox entities to ensure compliance with provisions of the Digital Personal Data Protection Act, 2023.
    • Diverse Range of Target Applicants: The target applicants for entry to the RS are fintech companies, including startups, banks, financial institutions, any other company, Limited Liability Partnership (LLP) and partnership firms, partnering with or providing support to financial services businesses.
    • Digital Personal Data Protection Norms Compliance: Under the updated guidelines, participating entities will have to comply with digital personal data protection norms.
    • Origins of Regulatory Sandbox Framework: The RBI had issued the ‘Enabling Framework for Regulatory Sandbox’ in August 2019, after wide ranging consultations with stakeholders.

     What is the Significance of Regulatory Sandbox?

    • Learning by doing: RS provides empirical evidence on benefits and risks of emerging technologies, enabling regulators to make informed decisions.
    • Testing viability: RS allows testing of product’s viability without large-scale roll-out, enabling modifications before broader market launch.
    • Financial inclusion: RS can improve pace of innovation and technology absorption, leading to financial inclusion and improved financial reach.
    • Evidence-based decision-making: RS reduces dependence on industry consultations for regulatory decision-making.
    • Better outcomes for consumers: RS leads to increased range of products, reduced costs, and improved access to financial services.

    What are the challenges along with Regulatory Sandbox scheme?

    • Flexibility and time: Innovators may face constraints in the sandbox process, but time-bound stages can mitigate this.
    • Bespoke authorizations: Transparent handling of applications and clear decision-making principles can address risks associated with discretionary judgments.
    • Legal waivers: The RBI or its RS does not provide legal waivers.
    • Regulatory approvals: Successful experiments in the sandbox may still require regulatory approvals for wider application.
    • Legal issues: Transparency and clear criteria in the RS framework can mitigate legal issues like consumer losses, ensuring clarity on liability for risks.

    Conclusion: The RBI’s updated Regulatory Sandbox guidelines promote responsible financial innovation. Addressing time constraints and ensuring transparent post-sandbox approvals are vital for fostering a conducive environment for ongoing advancements in the financial sector.

  • RBI Directs NPCI to Assess Paytm’s TPAP Request

    Introduction

    Understanding TPAP

    • Role: TPAPs facilitate UPI-based transactions by providing compliant applications to end-users, ensuring adherence to security protocols and regulatory standards.
    • Infrastructure: They leverage NPCI’s UPI framework and collaborate with payment service providers (PSPs) and banks to enable seamless transactions.

    Implications of TPAP Approval

    • Operational Continuity: TPAP approval is vital for Paytm to sustain UPI-based transactions, ensuring uninterrupted service for customers.
    • Migration Process: If approved, Paytm’s ‘@paytm’ handles will transition seamlessly to designated banks to prevent service disruptions, with OCL prohibited from adding new users until successful migration.
    • Risk Mitigation: RBI mandates certification of multiple banks as PSPs to manage high-volume UPI transactions, minimizing risk and enhancing system resilience.

    Recent Developments

    • PPBL Closure: Following RBI’s directive to shut Paytm Payments Bank (PPBL) operations by March 15, 2024, Paytm’s existing TPAP registration for UPI transactions faces uncertainty.
    • RBI Intervention: In response to PPBL’s impending closure, RBI has tasked NPCI with evaluating OCL’s request to maintain TPAP status, crucial for Paytm’s UPI operations continuity.

    Current Landscape

    • Presently, 22 NPCI-approved third-party UPI apps, including Google Pay, PhonePe, and Whatsapp, facilitate peer-to-peer transactions via UPI IDs.
    • RBI’s directive underscores the regulatory focus on maintaining stability and security in India’s digital payments ecosystem.

  • Explained: Financial Devolution among States

    Introduction

    • Several Opposition-ruled states, particularly from southern India, have voiced concerns over the present scheme of financial devolution, citing disparities in the allocation of tax revenue compared to their contributions.
    • Understanding the concept of the divisible pool of taxes and the role of the Finance Commission (FC) is crucial in addressing these issues.

    Divisible Pool of Taxes: Overview

    • Constitutional Provision: Article 270 of the Constitution outlines the distribution of net tax proceeds between the Centre and the States.
    • Share of taxes: Taxes shared include corporation tax, personal income tax, Central GST, and the Centre’s share of Integrated Goods and Services Tax (IGST), among others.
    • Finance Commission’s Role: Article 280(3) (a) mandates FC, constituted every five years, recommends the division of taxes and grants-in-aid to States based on specific criteria.
    • XVI FC: It consists of a chairman and members appointed by the President, with the 16th Finance Commission recently constituted under the chairmanship of Arvind Panagariya for the period 2026-31.

    Basis for Allocation: Horizontal and Vertical Devolution

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    • Vertical Devolution: States receive a share of 41% from the divisible pool, as per the 15th FC’s recommendation.
    • Key criteria for horizontal devolution: For horizontal devolution, FC suggested 12.5% weightage to demographic performance, 45% to income, 15% each to population and area, 10% to forest and ecology and 2.5% to tax and fiscal efforts.
    1. Income Distance: Reflects a state’s income relative to the state with the highest per capita income (Haryana), aiming to maintain equity among states.
    2. Population: Based on the 2011 Census, replacing the earlier 1971 Census for determining weightage.
    3. Forest and Ecology: Considers each state’s share of dense forest in the total forest cover.
    4. Demographic Performance: Rewards states for efforts in controlling population growth.
    5. Tax Effort: Rewards states with higher tax collection efficiency.

    Challenges and Issues

    • Exclusion of Cess and Surcharge: Around 23% of the Centre’s gross tax receipts come from cess and surcharge, which are not part of the divisible pool, leading to disparities in revenue sharing.
    • Variation in State Contributions: Some states receive less than a rupee for every rupee they contribute to Central taxes, indicating disparities in revenue distribution.
    • Reduced Share for Southern States: Southern states have witnessed a decline in their share of the divisible pool over successive FCs, affecting their fiscal autonomy.

    Proposed Reforms  

    • Expansion of Divisible Pool: Including a portion of cess and surcharge in the divisible pool could enhance revenue sharing among states.
    • Enhanced Weightage for Efficiency: Increasing the weightage for efficiency criteria in horizontal devolution, such as GST contribution, can promote equitable distribution.
    • Greater State Participation in FC: Establishing a formal mechanism for state participation in the FC’s constitution and functioning, akin to the GST council, can ensure a more inclusive decision-making process.

    Conclusion

    • Addressing issues of financial devolution requires a collaborative approach between the Centre and the States, focusing on equitable distribution and fiscal federalism.
    • Reforms in revenue-sharing mechanisms, along with enhanced state participation in decision-making bodies like the FC, are essential for promoting balanced development and resource allocation across the country.